Connecticut's insurance commissioner is contending that the Federal Insurance Office (FIO) might be unnecessarily overlapping state turf through its examination of use of captives and special purpose vehicles (SPVs) to finance perceived excess reserves.
Concern that FIO might be duplicating state regulatory efforts in an area of mutual concern was underscored by Connecticut Commissioner Tom Leonardi in a meeting and in remarks to a reporter last week.
Examination of issues involving the use of captives and SPVs to finance perceived redundant reserves set certain life insurance contracts should continue to be led by state regulators, Leonardi said in a phone interview March 15.
The issue has caught the attention of FIO staff, and ultimately the director, Michael McRaith.
Leonardi's public suggestion during a Federal Advisory Committee on Insurance (FACI) March 13 discussion that the NAIC already was handling the issue and no group would be necessary at the federal level was quickly countered by McRaith.
McRaith said he was not interested in duplicating the efforts of the states, but needs the U.S. Treasury Department to be "fully informed" about what is going on with this type of risk transfer.
To that end, McRaith called for the creation of a task force operating out of the FACI.
"My feeling then and now is that it is a duplication of effort," Leonardi said in the follow-up interview, adding that duplications of efforts are costly, inefficient and an ineffective way to find solutions to issues.
The NAIC has been examining the use of captives (to transfer perceived excess XXX (Triple X) and AXXX reserves) for some time, and it is one the NAIC's top priorities, Leonardi said of an NAIC subgroup's study of insurers' use of captives and SPVs.
Some regulators have been very concerned that reserves are being stored in captives, or transferred using letters of credit, away from the eyes of regulatory examiners, falsely inflating the insurers' risk-based capital numbers and gaming the system to free up more capital for use in the market at the possible expense of future financial solvency.
These XXX reserve standards for the industry are The Valuation of Life Insurance Policies Model Regulation (Regulation XXX) and the much-fraught Actuarial Guideline 38 (AG 38), The Application of the Valuation of Life Insurance Policies Model Regulation (AXXX).
"What some see as appropriate levels of statutory reserves, other see as excessive, unnecessarily raising the cost to buyers of term insurance and SGUL (universal life products with secondary guarantees)," wrote Christian DesRochers in an actuarial article for Taxing Times back in 2008. "Arguably, the issues surrounding XXX and AXXX have been a driving force in the development of principles-based reserves (PBR). The story of XXX and AXXX also has federal income tax aspects."
Genwoth splashed on the redundant reserve securitization scene was in late 2006. It announced the establishment of a $475 million financing facility to securitize the noneconomic portion of AXXX reserves associated with a block of ULSG business, marking a milestone as the first securitization to finance the redundancy in statutory reserves underlying ULSG products calculated under AG 38, according to the actuarial firm Milliman.
"Securitizing redundant reserves typically involves a reinsurance transaction with a captive," a January 2007 article by Steven I. Schreiber and Eric S. Schwartz, consulting actuaries in the New York office of Milliman, stated. "In an AXXX transaction, either the entire ULSG product risk or just the secondary guarantee risk may be ceded to the captive. The insurer ceding the business needs to make sure that if it cedes just the secondary guarantee risk, it gets the appropriate reserve credit it is expecting."
However, development of robust models for AXXX business is challenging because of the complexity of the products as well as because of the complexity of the AXXX calculations, the actuaries, who were involved in the first wave of securitizations, warned.
The NAIC began its work in earnest in early 2012 on studying insurers use of captives and securitization vehicles as it hammered out AG 38 issues and final PBR development work simultaneously, and published a survey last March on each state or jurisdiction's laws captive industry and regulations governing it.
