Hugh’s Views- NAIC’s conflicting positions
Many of Captive Review’s readers, even American ones, ought to be reminded that the NAIC sets standards for insurance regulation in US states. They don’t pass any laws themselves. At the same time those who discuss, dream up, and promulgate the standards and model laws are the very insurance regulators that the standards apply to. This self-dealing puts them into conflicting positions, possibly even actionable infringement of federal law, which is what Jon Harkavy was inveighing against. So standards are set, and model laws are dreamed up by the NAIC.
Every state that wants to attain or keep its NAIC accreditation has to adhere to the NAIC’s standards and pass all their model acts. What happens if they don’t, and the NAIC withholds or cancels a state’s accreditation because it hasn’t passed some of the model laws, or sidesteps some of the rules and guidelines? Lack of NAIC accreditation means that other states can no longer accept examinations performed by the domiciliary state on its domiciled insurers doing business in other states. Yet another NAIC rule. The expense and labour, particularly on smaller insurers, of being subjected to multiple examinations, is enormous, and may well spur an insurer domiciled in a non accredited state to re-domesticate to an accredited one.
A few large states, like New York , which in the past was de-accredited because it refused on principle to enact certain Model Laws which the NAIC deemed required for accreditation, are so important that they can say to other states something like: “If you’re not going to recognise the exams the New York Insurance Department performs on its domiciled insurers, then New York won’t recognise the examinations which your insurance department performs on your state’s domiciled insurers doing business in New York either”. Using this muscle such larger states as New York can and have persuaded the NAIC to find them in “substantial compliance” with NAIC accreditation standards and allow them to keep their accreditation.
Who determines “substantial compliance”? John Harkavy, executive vice-president and general counsel of Risk Services, points out that it is actually the regulators themselves; with the NAIC serving as judge, jury, and lawmaker—power held by few if any accreditation bodies in the United States. Smaller states – and most of the main captive domicile states are smaller – can’t wield that kind of influence, and so are bullied and (Harkavy’s term) boycotted into compliance. All this has a direct influence on captives – on those that write direct, and are therefore doing business in other states, and on those fronting companies that will demand higher collateral from captives domiciled in non-accredited states.
I am reminded of the anti-fronting example. In the 1990s the NAIC, whose members and staff have always revealed an anti-captive bias, dreamed up a model act that the captive community dubbed the “anti-fronting act” that all states were supposed to pass. It would have restricted fronting insurers from reinsuring to a lot of normal captives, and especially those based offshore. In those days the insurance commissioner in Vermont, the largest captive domicile state, decided to risk losing its accreditation, and led the struggle to have the anti-fronting model act withdrawn, which it eventually was. This anti fronting bias has re-emerged. The NAIC, in its accreditation standards for Risk Retention Group regulation, now requires that a Risk Retention Group must retain at least 5% of the risk.
Europeans do not have the luxury of a powerful insurance commissioner successfully leading the defence of captive insurance interests. The only one who tried, Victor Rod of Luxembourg, whose sole negative vote against the Solvency 2 directive was influenced by the number of captives domiciled there, was simply outvoted by the rest of the EU insurance supervisors.
Implications to watch for
Captive owners and managers have insisted on being treated as bona fide insurance companies for defending their tax positions. Many are now regretting it because of all the increased insurance regulation, both under the NAIC’s requirements and under Solvency 2. The one glimmer of exemption I found for captives in the NAIC’s crab-like movement towards applying Solvency 2 in American states was in their premium volume threshold for requiring insurers (and therefore captives) to apply the rigors of ORSA – it’s $500 million (compare that with the EU’s threshold of about $6 million).
Watch for the machinations of the NAIC’s Committee E, the one on Financial Condition, to realise that they should lower that threshold down to where all captives have to go through an ORSA exercise, sometimes several times a year – which is what European-domiciled captives have to do as one of their Pillar 2 risk management requirements.
I will be watching for the implications of the NAIC coming up with a “Captive Insurance Model Act” that all states will be required to pass. It’s being talked about if not actually being worked on in Committee E to try to head off any Federal supervision of insurers. And I’ll be watching to see which states’ member insurance commissioners defend the captive community’s interests.