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US Solvency Modernization and Regulatory Process Joe Fritsch, Deputy Superintendent New York Insurance Department, U.S.

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US Solvency Modernization and Regulatory Process Joe Fritsch, Deputy Superintendent New York Insurance Department, U.S.

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    2. Agenda

    3. What Does the NAIC Do? What’s the U.S. Regulatory Process?

    4. NAIC Created in 1871 by state insurance regulators to address the need to coordinate regulation of multi-state insurers. NAIC members are the state insurance commissioners. NAIC members have regulatory authority, but the NAIC organization does not. NAIC staff provide immense support to the U.S. insurance regulators who execute state-based insurance regulation. The NAIC provides a forum for the development of uniform policy, including model laws and regulations, financial reporting and RBC requirements. commissioner directors or superintendents make up the “ members” naic through various working groups of state regulators draft model laws and regulations but must be passed by individual state legislatures. The important solvency model laws we make an accreditation standard to ensure states adopting consistent standards/ For example the RBC model law was an accreditation standard commissioner directors or superintendents make up the “ members” naic through various working groups of state regulators draft model laws and regulations but must be passed by individual state legislatures. The important solvency model laws we make an accreditation standard to ensure states adopting consistent standards/ For example the RBC model law was an accreditation standard

    5. Membership: Strength in Numbers 56 Members Strong 50 States, the District of Columbia 5 U.S. territories American Samoa, Guam, Northern Mariana Islands, Puerto Rico, the Virgin Islands Picture is opening session at the naic meetingPicture is opening session at the naic meeting

    6. NAIC Offices KANSAS CITY – Executive Headquarters NAIC’s service and support offices assist state insurance regulators providing: financial, actuarial, legal, computer, research, market conduct and economic expertise. NEW YORK CITY – Securities Valuation Office The Securities Valuation Office (SVO) examines the credit quality and value of insurer’s investment portfolios for the benefit of the regulatory community. WASHINGTON, D.C. – Government Affairs Office This office advises state regulators on policy implications of federal legislation and other federal and international actions affecting their authority over the business of insurance. SVO: Quality assessment and pricing of insurer’s securities Insurer’s investment portfolio analysis Requires highly trained financial analysis professionals, high levels of data access and comprehensive tools New york is one few departments that have separate capital markets bureau made up of staff with wall street experience analyze company risk profile of assets and alms also approve derivative use plans SVO: Quality assessment and pricing of insurer’s securities Insurer’s investment portfolio analysis Requires highly trained financial analysis professionals, high levels of data access and comprehensive tools New york is one few departments that have separate capital markets bureau made up of staff with wall street experience analyze company risk profile of assets and alms also approve derivative use plans

    7. The NAIC at Work Committee Structure Financial Solvency Initiatives Model Laws and Regulation Development Regulator and Consumer Education State Accreditation Program Regulatory Insurance Databases & Computer Systems IT Systems (data filing, licensing, rate/form filings, & more) Market division , rates forms, financial, consumers, life products and property products. All licensed companies file their statutory financial statements with the naic. Financial solvency initiatives I will discuss later under the SMIMarket division , rates forms, financial, consumers, life products and property products. All licensed companies file their statutory financial statements with the naic. Financial solvency initiatives I will discuss later under the SMI

    8. The NAIC at Work Provide state insurance departments services and support in the areas of: - financial, actuarial, legal, technology, research, market conduct and economic expertise. NAIC maintains a Technology Center that houses ten years of history for over 5,200 insurance companies, and 4,000,000 insurance agents accessible by over 13,000 state insurance regulators via the internet or a high speed, dedicated frame relay network. Also provide information via the internet to consumers, insurance industry and federal regulators.

    9. Outside of the NAIC State legislatures and state insurance departments create and implement state laws and regulations. State insurance departments are charged with the insurance regulatory functions. Deviations from NAIC Any deviation for example to naďf Accounting practice procedure models would be disclosed in the statutory financial statents we call them prescribed differences by law and permitted by the commissioner or superintendent.Any deviation for example to naďf Accounting practice procedure models would be disclosed in the statutory financial statents we call them prescribed differences by law and permitted by the commissioner or superintendent.

    10. Accreditation Program Financial Regulation Standards & Accreditation Program Ensures baseline financial regulatory processes and practices in each accredited state Generates savings to the states and industry, through regulatory reliance placed on accredited states Reduces duplication of financial regulatory processes by setting baseline expectations Without the program, financial solvency regulatory processes and costs would increase exponentially States might not rely on each other to regulate licensed companies domiciled in other states Would result in millions of dollars in examination costs to the industry

    11. U.S. Solvency Modernization

    12. Evolution of the U.S. Solvency System We have developed a detailed and uniform financial regulatory system in the U.S. In the 1990s we created risk-based capital requirements and have continued to improve the formula over time, including adding stochastic modeling and trend tests. SAP was codified in 2001 into a comprehensive guide and has continued to be updated & improved since. We are placing greater emphasis on Governance through a Model Audit Rule. We are proposing to modernize Reinsurance & Principles-Based Reserving

    13. Evolution of the U.S. Solvency System What is clear is that we have been continuously improving U.S. insurance regulation for many years. What we have on our plates now is an investigation of new ideas and an opportunity to create the Gold Standard of Solvency Systems through the Solvency Modernization Initiative (SMI)! Long-term work plan – continuous evolution The work we will do will not only be a Gold Standard for our system, but will determine how we respond to U.S. International Activities. We will be looking inward, but also dialoguing outward.The work we will do will not only be a Gold Standard for our system, but will determine how we respond to U.S. International Activities. We will be looking inward, but also dialoguing outward.

    14. SMI Work Plan Analyze other financial supervisory modernization initiatives, to the extent appropriate. Analysis should include the Basel II international capital framework for banks and implementation in the U.S.; solvency work by the International Association of Insurance Supervisors (IAIS); solvency proposals under consideration in other jurisdictions, including Australia, Canada, Japan and the EU; accounting standards being developed by the International Accounting Standards Board (IASB). As an on-going process, and as details emerge from the EU, complete the analysis of EU/S2. Identify areas for U.S. regulators to consider including in the current NAIC programs. We thinking reaching out to federal banking regulators about lessoned learned Naic As members of the IAIS we have been commenting about the IASB insurance contract paper major area concern Allowing own credit standing (as you rating goes down so does liability) Day one gains using exit value vs settlement value and PC using UE prem Detail of discounting and utilizing risk margin ( comparability and consistency) Transparency and corporate governance key (no off balance sheet) Group supervision and group capital The naic is currently working on comparison of the regulatory regime in US vs Solvency II we must consider the entire regulatory process not just confidence level for regulatory capital. Must include all the other tool discuss previouslyWe thinking reaching out to federal banking regulators about lessoned learned Naic As members of the IAIS we have been commenting about the IASB insurance contract paper major area concern Allowing own credit standing (as you rating goes down so does liability) Day one gains using exit value vs settlement value and PC using UE prem Detail of discounting and utilizing risk margin ( comparability and consistency) Transparency and corporate governance key (no off balance sheet) Group supervision and group capital The naic is currently working on comparison of the regulatory regime in US vs Solvency II we must consider the entire regulatory process not just confidence level for regulatory capital. Must include all the other tool discuss previously

    15. SMI Work Plan – 5 Focus Areas Capital Requirements International Accounting Insurance Valuation Reinsurance Group Regulation

    16. SMI Work Plan – Articulation of US solvency framework and principles Study other sectors and solvency and accounting initiatives Improve our risk focused exams Creation of new reinsurance framework Principle based reserving life products Changes to group supervision Implementation of new ideas to incorporate in US solvency system

    17. US Group Wide Supervision Role of the NAIC in US group wide supervision Overview of US Supervision of Insurers Coordinated Oversight Among State Insurance Regulators Communication Among Insurance Regulators Communication with Other Regulators Transition: With a Clearer understanding of the overall role of the NAIC in state regulation, let’s look a little closer at the NAIC role in US group wide supervision. Extremely helpful financial crisis with the monoclines and AIG weekly calls both among 50 state commissioners and also had iais call for international regulatorsTransition: With a Clearer understanding of the overall role of the NAIC in state regulation, let’s look a little closer at the NAIC role in US group wide supervision. Extremely helpful financial crisis with the monoclines and AIG weekly calls both among 50 state commissioners and also had iais call for international regulators

    18. US Supervision of Insurers Supervision: Entity Level State regulators’ legal authority and responsibility exist at the individual entity level Direct responsibility for the state’s consumers/citizens Perform domiciliary entity (& holding company system as needed) analysis quarterly; conduct exams a minimum of once every 5 years Supervision: Holding Company System Requires coordinated oversight with: Other US state insurance regulators Other US state and federal regulators Banking, Thrift, SEC, USDA, FEMA, FBIIC Non-US insurance regulators Transition from 1st Point (Entity Level Supervision) to 2nd Point (Holding Co. System): However, since entities frequently become members of a holding company system, state insurance regulators must look beyond the entity level in performing their due diligence review of the domiciliary legal entity. (FBIIC = Financial and Banking Information Infrastructure Committee, a group under the President’s Working Group on Financial Markets)Transition from 1st Point (Entity Level Supervision) to 2nd Point (Holding Co. System): However, since entities frequently become members of a holding company system, state insurance regulators must look beyond the entity level in performing their due diligence review of the domiciliary legal entity. (FBIIC = Financial and Banking Information Infrastructure Committee, a group under the President’s Working Group on Financial Markets)

    19. Coordinated Oversight Coordination among State Insurance Regulators Financial statement disclosure of affiliated activities (NAIC uniform format and electronic data capture) Holding Company Organization Chart; material affiliated transactions Investments in holding company entities Coordinated Analysis and Monitoring Domiciliary states perform holding company analysis and coordinate with other states as needed Coordinated Examination Option Lead state(s) run the exam; other states rely upon this work and/or participate NAIC Exam Tracking Tool posts coordinated exam schedule and staff and NAIC server hosts the online examination Independent Function of Financial Analysis Working Group (FAWG): Entity level analysis for “Nationally Significant Insurers”; advice to states Group level analysis for large holding company systems Analysis of events/situations that will materially impact the industry Financial Statement Disclosure Notes: Contains the Holding Company Org Chart (Schedule Y, Part 1); captures the material intercompany transactions (Schedule Y, Part 2) All investment schedules have affiliated investment sections, as do the notes to financial statements; The NAIC blank includes significant disclosure of affiliated transactions since those have historically been a common cause of solvency stress for regulated insurers. Coordinated Examination Option: Say “Option” because it is not a requirement or a given that a coordinated exam will be called. Independent Function of FAWG: Stress that this group is a peer review for the states’ analysis work; staffed only by experienced financial analysts FAWG provides advice and recommendations to the states in performing their solvency oversight If questioned about the Group Analysis, it is limited by what information we can get from the public disclosures or from other regulators Example of Events that Materially Impact the Industry: subprime mortgage exposure review by FAWG.Financial Statement Disclosure Notes: Contains the Holding Company Org Chart (Schedule Y, Part 1); captures the material intercompany transactions (Schedule Y, Part 2) All investment schedules have affiliated investment sections, as do the notes to financial statements; The NAIC blank includes significant disclosure of affiliated transactions since those have historically been a common cause of solvency stress for regulated insurers. Coordinated Examination Option: Say “Option” because it is not a requirement or a given that a coordinated exam will be called. Independent Function of FAWG: Stress that this group is a peer review for the states’ analysis work; staffed only by experienced financial analysts FAWG provides advice and recommendations to the states in performing their solvency oversight If questioned about the Group Analysis, it is limited by what information we can get from the public disclosures or from other regulators Example of Events that Materially Impact the Industry: subprime mortgage exposure review by FAWG.

    20. Ins. Regulator Communication State-to-State Communication: Sharing of exam/analysis reports & findings Ad hoc discussions NAIC Supported Avenues of Communication: FAWG presentation by domiciliary regulator NAIC database displays state decisions on change of control requests (e.g., purchases of insurers) NAIC hosts interim meetings and conference calls between states to discuss solvency or other concerns with individual entities or groups (FAWG recommends) FAWG presentation – domiciliary regulator addresses concerns, questions, recommendations of FAWG. Form A database = decisions on change of control NAIC Hosted Meetings: Other concerns, e.g., market conduct concerns (like AIG)FAWG presentation – domiciliary regulator addresses concerns, questions, recommendations of FAWG. Form A database = decisions on change of control NAIC Hosted Meetings: Other concerns, e.g., market conduct concerns (like AIG)

    21. Other Communication Communication with Other US Regulators: Miscellaneous calls and meetings NAIC-hosted quarterly conference calls with federal banking & thrift regulators Communication with Non-US Ins. Regulators: Individual state Memoranda of Understanding NAIC Multilateral Memoranda of Understanding Ad hoc discussions, e.g., FAWG chair discussion with EU regulator regarding mortgage guaranty ins. Much of the concern with sharing information is confidentiality. Having these types of Memoranda agreements helps to relieve some of those concerns and allow more sharing of confidential information. The NAIC developed a model MOU on information sharing with the EU. To date, agreements based on this Model MOU have been signed between Nebraska-Germany (BaFIN), California-Germany (BaFIN), Iowa-Netherlands; agreements have also been signed between Delaware-UK (FSA) and Delaware-Ireland. Several other states have draft agreements with EU jurisdictions. Much of the concern with sharing information is confidentiality. Having these types of Memoranda agreements helps to relieve some of those concerns and allow more sharing of confidential information. The NAIC developed a model MOU on information sharing with the EU. To date, agreements based on this Model MOU have been signed between Nebraska-Germany (BaFIN), California-Germany (BaFIN), Iowa-Netherlands; agreements have also been signed between Delaware-UK (FSA) and Delaware-Ireland. Several other states have draft agreements with EU jurisdictions.

    22. Other Communication Communication with Other US Regulators: Miscellaneous calls and meetings NAIC-hosted quarterly conference calls with federal banking & thrift regulators Communication with Non-US Ins. Regulators: Individual state Memoranda of Understanding NAIC Multilateral Memoranda of Understanding Ad hoc discussions, e.g., FAWG chair discussion with EU regulator regarding mortgage guaranty ins. Much of the concern with sharing information is confidentiality. Having these types of Memoranda agreements helps to relieve some of those concerns and allow more sharing of confidential information. The NAIC developed a model MOU on information sharing with the EU. To date, agreements based on this Model MOU have been signed between Nebraska-Germany (BaFIN), California-Germany (BaFIN), Iowa-Netherlands; agreements have also been signed between Delaware-UK (FSA) and Delaware-Ireland. Several other states have draft agreements with EU jurisdictions. Much of the concern with sharing information is confidentiality. Having these types of Memoranda agreements helps to relieve some of those concerns and allow more sharing of confidential information. The NAIC developed a model MOU on information sharing with the EU. To date, agreements based on this Model MOU have been signed between Nebraska-Germany (BaFIN), California-Germany (BaFIN), Iowa-Netherlands; agreements have also been signed between Delaware-UK (FSA) and Delaware-Ireland. Several other states have draft agreements with EU jurisdictions.

    23. Other Communication Communication with Other US Regulators: Miscellaneous calls and meetings NAIC-hosted quarterly conference calls with federal banking & thrift regulators Communication with Non-US Ins. Regulators: Individual state Memoranda of Understanding NAIC Multilateral Memoranda of Understanding Ad hoc discussions, e.g., FAWG chair discussion with EU regulator regarding mortgage guaranty ins. Much of the concern with sharing information is confidentiality. Having these types of Memoranda agreements helps to relieve some of those concerns and allow more sharing of confidential information. The NAIC developed a model MOU on information sharing with the EU. To date, agreements based on this Model MOU have been signed between Nebraska-Germany (BaFIN), California-Germany (BaFIN), Iowa-Netherlands; agreements have also been signed between Delaware-UK (FSA) and Delaware-Ireland. Several other states have draft agreements with EU jurisdictions. Much of the concern with sharing information is confidentiality. Having these types of Memoranda agreements helps to relieve some of those concerns and allow more sharing of confidential information. The NAIC developed a model MOU on information sharing with the EU. To date, agreements based on this Model MOU have been signed between Nebraska-Germany (BaFIN), California-Germany (BaFIN), Iowa-Netherlands; agreements have also been signed between Delaware-UK (FSA) and Delaware-Ireland. Several other states have draft agreements with EU jurisdictions.

    24. NAIC Reinsurance Regulatory Modernization Proposal Flexible to accommodate the rapidly changing reinsurance environment while providing for appropriate levels of financial stability, and solvency Facilitate cross-border transactions and enhance competition within the U.S. market while ensuring that U.S. insurers and policyholders are adequately protected

    25. NAIC Reinsurance Regulatory Modernization Proposal Mutual Recognition Assessing regulatory effectiveness through an “outcomes-oriented” approach, it would determine which non-U.S. jurisdictions are entitled to enter into mutual recognition agreements Facilitate cross-border transactions and enhance competition within the U.S. market while ensuring that U.S. insurers and policyholders are adequately protected

    26. NAIC Reinsurance Regulatory Modernization Proposal National Reinsurer Single State U.S. Regulator – U.S. Reinsurers Reinsurers would be licensed in one jurisdiction in order to access the U.S. market (minimum criteria established to qualify for single state regulatory approach done by RSRD) The national reinsurer similar to pass porting if license one us state can do business all states The national reinsurer similar to pass porting if license one us state can do business all states

    27. NAIC Reinsurance Regulatory Modernization Proposal Port of Entry – Non-U.S. Reinsurers Non-U.S. reinsurers would be certified to access the U.S. market through one jurisdiction. Become certified through a Port of Entry State Post reduced collateral for appropriately rated reinsurers Creates Alternative Credit for Cessions to Unauthorized Reinsurers (US and Non-US) Based On: creditworthiness (ratings from 2 rating agencies) Regulatory equivalent a minimum net worth of $250 million an MOU and required contract terms unauthorized reinsurer required to post collateral if ceding company declared insolvent or rehab It would be prospective for contracts after certain effective date Creates Alternative Credit for Cessions to Unauthorized Reinsurers (US and Non-US) Based On: creditworthiness (ratings from 2 rating agencies) Regulatory equivalent a minimum net worth of $250 million an MOU and required contract terms unauthorized reinsurer required to post collateral if ceding company declared insolvent or rehab It would be prospective for contracts after certain effective date

    28. NAIC Reinsurance Regulatory Modernization Proposal Develops overarching principles to govern the regulatory equivalence of non-U.S. jurisdictions Moves the U.S. towards international standards

    29. NAIC Reinsurance Regulatory Modernization Proposal Must have minimum surplus or equivalent equity of $ 250 million Establish appropriate collateral levels from zero to 100% based on rating and other criteria on a prospective basis. Business practice of reinsurer Slow pay reinsurers (file sched F or S) Review audited financial statements Any regulatory action against reinsurer

    30. NAIC Reinsurance Regulatory Modernization Proposal Ratings Collateral Required Secure – 1 0% Secure – 2 10% Secure – 3 20% Secure – 4 75% Vulnerable – 5 100% Example rating S&P Secure 1 AAA 2 AA- and above 3 A- 4 BBB+ 5 below BBB-Example rating S&P Secure 1 AAA 2 AA- and above 3 A- 4 BBB+ 5 below BBB-

    31. NAIC Reinsurance Regulatory Modernization Proposal Reinsurance is a Financial Services Business that is Global Current Model Cannot be Justified from a Risk Perspective Adds Costs to the System that Exceed the Benefit Provided Information Systems and Regulatory Oversight Has Been Enhanced Since the Current Rules Were Put in Place in NY Reinsurance is a Business to Business Transaction Collateral Rules Intended to Address Solvency – We Can Do This w/o 100% Collateral Why are we doing this?? Can justify CCCC Licensed 0 collateral AA rated 100% Why are we doing this?? Can justify CCCC Licensed 0 collateral AA rated 100%

    32. NAIC Reinsurance Regulatory Modernization Proposal Regulators concerns Solvency of Ceding Insurer Recognition of Regulatory Equivalence Enforceability of Judgments Against Reinsurers in Non-U.S. Jurisdictions

    33. NAIC Reinsurance Regulatory Modernization Proposal Objections Not Geographically Agnostic – Cessions to Licensed/Accredited Reinsurers Get Automatic Pass Response Department Has Regulatory Oversight over Licensed/Accredited Reinsurers Proposal is Giving a Substantial Benefit for Cessions to Qualified Unauthorized Reinsurers (i.e. Reduction in Required Collateral up to 90%) Proposal Adds Principle Based Standards for Cessions to ALL Reinsurers

    34. Solvency Modernization Working Group The SMI Working Group will meet march 11 and 12 phoenix Arizona The agenda is to discuss to papers that are out for consultation Capital requirements Governance and risk management We received many comments and recommendationsWe received many comments and recommendations

    35. Solvency Modernization Working Group The SMI issues The US solvency regime is comprehensive and well tested however we are always looking to improve based on international standards and lessons learned from the financials crisis Capital requirements what should safety level for solvency Should we introduce internal models ss

    36. Solvency Modernization Working Group Other issues Orsa own risk solvency assessment should U.S. require it Group capital and group supervision ss

    37. QUESTIONS?

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