materials - group capital calculation (e) working...

© 2016 National Association of Insurance Commissioners 1

Date: 8/19/16

2016 Summer National Meeting San Diego, California

GROUP CAPITAL CALCULATION (E) WORKING GROUP

Friday, August 26, 2016 8:00 – 9:00 a.m.

Manchester Grand Hyatt—Grand Hall B—Lobby Level

ROLL CALL

David Altmaier, Chair Florida Justin Schrader Nebraska Susan Bernard/Ron Dahlquist California Peter L. Hartt New Jersey Kathy Belfi Connecticut Tony Riddick North Carolina Philip Barlow District of Columbia Dale Bruggeman Ohio Kevin Fry Illinois Mike Boerner/Doug Slape Texas Leslie Nehring Missouri

AGENDA 1. Consider Adoption of its Minutes—Commissioner David Altmaier (FL)

• Aug. 11 Attachment A

• July 20 Attachment B • June 14 Attachment C • May 26 Attachment D • April 3 Attachment E

2. Hear Presentation from the Blue Cross Blue Shield Association (BCBSA) on the Group

Capital Calculation—Carl Labus (BCBSA) and Shari Westerfield (BCBSA) Attachment F

3. Continue Discussions on Treatment of Certain Insurers in the Inventory Method —Commissioner David Altmaier (FL)

Attachment G

4. Discuss Treatment of U.S. Insurers Not Subject to Risk-Based Capital Requirements and

Permitted and Prescribed Practices—Commissioner David Altmaier (FL) Attachment H

5. Discuss Adjustments for Top-Tier Companies That Utilize Generally Accepted Accounting Principles (GAAP)—Commissioner David Altmaier (FL)

Attachment H

6. Discuss Any Other Matters Brought Before the Working Group —Commissioner David Altmaier (FL)

7. Adjournment W:\National Meetings\2016\Summer\Cmte\E\GCCWG\GCCWG Agenda 08-26-16.doc

1

Attachment -- Financial Condition (E) Committee

8/--/16


Draft: 8/18/16

Group Capital Calculation (E) Working Group Conference Call Aug. 11, 2016

The Group Capital Calculation (E) Working Group of the Financial Condition (E) Committee met via conference call Aug. 11, 2016. The following Working Group members participated: David Altmaier, Chair (FL); Kim Hudson (CA); Kathy Belfi (CT); Philip Barlow (DC); Kevin Fry (IL); Leslie Nehring (MO); Tony Riddick (NC); Justin Schrader (NE); Peter L. Hartt (NJ); Dale Bruggeman (OH); and Mike Boerner and Doug Slape (TX). 1. Continued Discussion on the Use of the Inventory Method for the Group Capital Calculation Commissioner Altmaier said that there have been no objections to the use of the inventory method for the group capital calculation. In the inventory approach, financial amounts such as total available capital and minimum capital would be provided for all entities, and this information would provide the regulators with greater analytical abilities, particularly in reviewing trends for individual entities after several years of data has been submitted. There are still, however, certain aspects of the inventory approach that need to be discussed further by the Working Group. Lou Felice (NAIC) discussed a memorandum from NAIC staff (Attachment 1) that discusses several issues related to use of the inventory approach. With respect to non-insurance entities that are not subject to capital requirements, he said that in the current risk-based capital (RBC) formula, most of these entities get a flat 22.5% charge on the book/adjusted carrying value (BACV). Considering the use of this charge in the current RBC formula, Mr. Felice said this charge may also be reasonable for these entities in the group capital calculation, particularly because these entities utilize generally accepted accounting principles (GAAP), which is less conservative than statutory accounting principles (SAP). Utilization of a flat charge in the group capital calculation would be the simplest approach and would require limited additional data. Of course, use of a flat charge is not necessarily risk-sensitive, although that may be acceptable as the group capital calculation is an analytical tool, as opposed to a requirement. He said that the Working Group could develop a more risk-sensitive approach to these entities, but that would require the submission of additional data and further analysis. Commissioner Altmaier agreed, saying that the Working Group has not concluded that the 22.5% charge is appropriate, and it has discussed a hybrid approach in which a flat charge is used initially, but that a more risk-sensitive charge could be considered after additional data is collected and analyzed. He said that the Capital Adequacy (E) Task Force and its working groups have spent a substantial amount of time and effort developing the appropriate risk charges for non-insurance affiliates in the RBC formula, making it an appropriate starting point for the group capital calculation. Mr. Felice noted that the calculation should include a minimum charge of zero in cases in which there is negative equity in the entity. Michelle Rogers (National Association of Mutual Insurance Companies—NAMIC) asked how internationally-held non-insurance affiliates would be treated. Mr. Felice said they would most likely be treated in a similar manner to U.S. non-insurance entities. With respect to non-insurance entities that are subject to capital requirement, Mr. Felice said that banks would comprise the majority of this category. In the group capital calculation, he said that a flat charge could be applied to the BACV or that the existing sectorial capital requirement could be utilized. He provided a high-level summary of the capital requirements of the Federal Reserve Board (FRB), noting that a factor is applied to the entity’s risk-weighted assets. There is also a back-up requirement that utilizes a leverage ratio. He said using existing sectorial capital requirements is more risk-sensitive to a flat charge and is already calibrated to some sort of intervention level. Mr. Felice discussed the group capital calculation when the top-tier company utilizes GAAP, which would most likely have a higher group capital ratio, as opposed to the same group with the top-tier company being an insurer utilizing SAP. He said that the Working Group will need to discuss how to treat senior debt within the holding company, particularly as top-tier GAAP companies can be used primarily as a financing mechanism. He said obtaining an inventory of all of the companies and understanding their actual stand-alone value is an important step in the group capital calculation. 2. Discussed the Treatment of Non-U.S. Insurers and the Possible Use of Scalars Commissioner Altmaier discussed the treatment of non-U.S. insurers in the group capital calculation, noting that the current property/casualty (P/C) and health RBC formulas include a factor multiplied by BACV for all foreign insurers directly or indirectly owned by an RBC-filing U.S insurer. The life formula only includes treatment of Canadian insurance subsidiaries and affiliates. Non-U.S. insurers are also subject to capital requirements in their home jurisdiction, but it may be difficult to

Attachment A

3


8/--/16


compare foreign capital requirements to those in the U.S., primarily due to differences in accounting systems and regulatory environments. The use of scalars was initially discussed by the American Council of Life Insurers (ACLI) and the American Insurance Association (AIA) in their joint presentation to the Working Group at the Spring National Meeting. Dan Daveline (NAIC) summarized a memorandum from NAIC staff (Attachment 2) that discusses the possible use of scalars. He said NAIC staff agree in principle with the concept of a scalar, but they do not believe that the NAIC has sufficient data to develop scalars for particular countries. He said that if financial data is collected over time, this data could be analyzed and possibly used to develop country-specific scalars. Alternatively, a data call could be performed to obtain this financial information now. He discussed that this approach differs from the approach suggested by the ACLI and the AIA, which suggested that the scalar could be developed using a country’s qualified jurisdiction review or based on its Financial Sector Assessment Program (FSAP) results. Mr. Daveline said these reviews are more related to regulatory outcomes, rather than the assessing the comparability of capital requirements across jurisdictions. He suggested that the members of industry be given the opportunity to propose what indicators they believe would be most helpful in developing country-specific scalars. Bill Sergeant (State Farm) said that in considering the results of a country’s FSAP results, Insurance Core Principle (ICP) #17 could be the focus as it discusses the principles for an appropriate required capital regime, noting that such should be risk-based and include appropriate regulatory triggers. 3. Discussed the Treatment of U.S. Insurers That Do Not File RBC Commissioner Altmaier said there is one more type of entity that the Working Group has not had much discussion on yet, and that is the category of U.S. insurers that do not currently file RBC reports. This includes entities such as captive insurers and mortgage guaranty insurers. He said when considering these types of insurers and their possible treatment in a group capital calculation, initially three different options come to mind: 1) apply the most applicable RBC formula to these insurers; 2) apply some sort of prescribed minimum; or 3) apply the current RBC flat charge for affiliated entities. He said this topic will be discussed further during the Working Group’s next meeting. Having no further business, the Group Capital Calculation (E) Working Group adjourned. W:\National Meetings\2016\Summer\Cmte\E\GCCWG\Aug 11 CC\08-11 GCCWGmin.docx

Attachment A

4


8/--/16


Draft: 8/2/16

Group Capital Calculation (E) Working Group Conference Call

July 20, 2016 The Group Capital Calculation (E) Working Group of the Financial Condition (E) Committee met via conference call July 20, 2016. The following Working Group members participated: David Altmaier, Chair (FL); Susan Bernard (CA); Kathy Belfi (CT); Philip Barlow (DC); Kevin Fry (IL); Leslie Nehring (MO); Tony Riddick (NC); Justin Schrader (NE); Peter L. Hartt (NJ); Dale Bruggeman (OH); and Mike Boerner and Doug Slape (TX). 1. Discussed Group Capital Calculation When an Insurance Company is the Top-Tier Company in the Group Commissioner Altmaier said during the Working Group’s June 14 conference call, NAIC staff discussed a sample group capital calculation to provide a context of what such a calculation could look like and what aspects of a calculation the Working Group would need to discuss further. As a result of this discussion, a few questions were raised, and NAIC staff developed a memorandum (Attachment 1) to address these questions. One of the issues related to the group capital calculation when a U.S insurance company is at the top of the holding company versus another type of company such as a company following generally accepted accounting principles (GAAP). This question is driven, at least in part, by the thought that the RBC ratio of the top-tiered insurance company in the group would capture an estimation of a group capital ratio that would not be inconsistent with the estimation as contemplated with the actual calculation. Dan Daveline (NAIC) provided an overview of the memorandum (Attachment 1), noting that in performing a group capital calculation, it is important to have an inventory of all companies in the group. The idea of creating an inventory of all companies was included in the joint presentation from the American Council of Life Insurers (ACLI) and the American Insurance Association (AIA) at the Spring National Meeting. Mr. Daveline said having this inventory is important for three reasons. First, from a mechanical standpoint, using an inventory method results in treating all groups the same, regardless of their complexity, ownership structure, etc. This provides for a level of consistency in the group capital calculation. Second, developing an inventory of all companies provides regulators with additional analytical abilities when financial data (such as regulatory capital and available capital) is provided for the various entities within the group. The regulators would be able to consider entity-level financial information and review it for trends that may develop. Third, the financial data collected over time could be analyzed and perhaps eventually used to support a more risk-focused charge for non-insurance entities, as opposed to a flat equity charge. In considering the inventory method, Mr. Daveline said the Working Group may want to consider requiring less information or data on certain types of entities such as limited partnerships that are under a certain materiality threshold. Bruce Byrnes (Berkshire Hathaway Group) said that the International Association of Insurance Supervisors (IAIS) recently released for comment an updated version of its proposed International Capital Standard (ICS), and the ICS suggests that non-financial entities could be excluded from the group capital calculation. Lou Felice (NAIC) said that there has been discussion internationally regarding at what level the group calculation should be, particularly in regards to non-financial holding companies or entities. He said the current U.S. RBC calculation does not exclude any particular type of entity that is owned by an insurer. Mr. Bruggeman said for some complex holding companies with significant non-insurance business, the Working Group should consider at what point the group calculation should end as it may not make sense to include entities well above or outside the scope of the insurance group. Mr. Daveline discussed an example calculation to further demonstrate the mechanics of the calculation and how the end result could differ based on the type of company that is at the top level of the organizational chart (Attachment 2). In using an aggregation approach to the calculation, the first step would be to provide an inventory of all companies in the group. For all entities, an authorized control level (ACL) regulatory capital amount and a total available capital amount would be the two primary inputs. For each entity that directly owns another entity, the subsidiary’s regulatory capital amount and the total available capital amount would need to be deducted from the parent’s respective amounts in order to avoid the double-counting of that capital. In the example calculation, Mr. Daveline said that NAIC staff previously discussed that the regulatory capital level could be multiplied by a factor of 3.0 to arrive at a minimum regulatory capital level that would be equivalent to the current trend-test level or 300% of the ACL amount. Using this process for a fictitious company in the example calculation, the group capital ratio does roughly estimate the RBC ratio for the top-tier insurance company. The small variation in the group capital ratio and the RBC ratio in this particular example is the treatment of a bank subsidiary that is directly owned by the top-tier insurance company. In calculating the ACL-level regulatory capital for this entity, a flat

Attachment B

5


8/--/16


charge of 8% was used as a general estimate of the actual bank capital requirement. However, the amount of ACL regulatory capital subtracted from the parent’s ACL regulatory capital used the 22.5% affiliate charge currently used in the RBC formula, as this amount is already embedded in the parent’s RBC calculation. Mr. Daveline discussed a second example calculation in which the group structure and financial information is identical to the first example, except that the top-tier company is a holding company that uses GAAP accounting and directly owns the previously top-tier insurance company. Again, in this example, a subsidiary’s regulatory capital and available capital would need to be deducted from that of its direct parent in order to avoid double-counting. In situations in which all entities are under one holding company, the holding company’s available capital would represent the capital (or GAAP equity) of the group after eliminations. In this hypothetical example, a 22.5% charge was taken against the top-tier holding company to calculate its ACL-level regulatory capital. For this fictitious group with a GAAP holding company at the top, the group capital ratio is slightly higher than the ratio for the group with the insurance holding company as the top-tier company. This is logical as GAAP accounting allows for additional assets such as goodwill to be included, while statutory accounting does not permit this. Because of this, the Working Group may want to consider requiring certain top-side adjustments to GAAP equity for items such as intangible assets. This is also why the Working Group may want to consider retaining a fairly high equity charge, such as 22.5%, on non-insurance entities that do not follow statutory accounting. Mr. Daveline said this aggregation approach does allow for a mixed accounting model, although certain adjustments may be appropriate. Mr. Daveline suggested that in preparing the inventory of companies, the inventory could include the different categories for entities such as U.S. insurers subject to RBC, U.S. insurers not subject to RBC, foreign insurers, other regulated entities and non-regulated entities. Steve Broadie (National Association of Mutual Insurance Companies—NAMIC) asked why the trend-test level RBC is being used in the example as the minimum regulatory capital, as opposed to the 200% used in the company action level. Mr. Daveline said the trend-test level was used as this is the first level at which regulatory intervention is contemplated, so it is a reasonable basis for the minimum level for purposes of the group capital ratio. Commissioner Altmaier said there will be opportunity to comment on this and other issues later during an exposure period. 2. Continued Discussions on Treatment of Non-Insurance Entities in the Group Capital Calculation Another question raised during the Working Group’s June 14 call was the affect that the covariance calculation would have on a group capital calculation, and this topic is also discussed in the memorandum prepared by NAIC staff. Mr. Daveline said NAIC staff considered this and reviewed numbers in relation to the fictitious company discussed previously. He said using the covariance calculation does have an impact on the ratio, but it is fairly immaterial. He discussed the desire to keep the calculation as simple as possible, so NAIC staff recommends that the covariance calculation not be used in the group capital calculation, at least initially. The Working Group could always reconsider this in the future. Mr. Felice said that most insurance subsidiaries are included outside of the covariance calculation in the RBC formula, whereas there are some non-insurance subsidiaries that are affected by the covariance calculation. Maintaining an inventory of all companies would help inform any future decisions. Commissioner Altmaier said one more question related to whether the treatment of an entity would differ based on where it is located within the group. Mr. Daveline said that utilizing the inventory method addresses that issue in that all entities would be included regardless of location in the group. He said that regulators have expressed a desire for the same factor to be applied to all non-insurers, although no decision has been made regarding what the factor should be. Commissioner Altmaier said this topic will be discussed further on the Working Group’s next conference call. Commissioner Altmaier asked if there were any objections to utilizing the inventory method as a framework for building the group capital calculation. There were no objections. On the Working Group’s next call, he said he would like to address the questions related to the factor for non-insurers, as well as the use of the trend-test level in the group capital calculation. In addition, he said the Working Group should also start discussing the treatment of foreign insurers and the possible use of scalars. Having no further business, the Group Capital Calculation (E) Working Group adjourned. W:\National Meetings\2016\Summer\Cmte\E\GCCWG\July 20 CC\07-20 GCCWGmin.docx

Attachment B

6


8/--/16


Draft: 6/30/16

Group Capital Calculation (E) Working Group Conference Call June 14, 2016

The Group Capital Calculation (E) Working Group of the Financial Condition (E) Committee met via conference call June 14, 2016. The following Working Group members participated: David Altmaier, Chair (FL); Susan Bernard (CA); Kathy Belfi (CT); Philip Barlow (DC); Kevin Fry (IL); Leslie Nehring (MO); Tony Riddick (NC); Justin Schrader (NE); Kristine Maurer (NJ); Dale Bruggeman (OH); and Doug Slape (TX). 1. Received an Update on the Work of the FRB Related to Group Capital Commissioner Altmaier said on June 3, the Federal Reserve Board (FRB) approved an advance notice of proposed rulemaking (NPM) inviting comment on conceptual frameworks for capital standards that could apply to systemically important insurance companies and to insurance companies that own a bank or thrift. A consolidated approach would apply to systemically important insurance companies, while a building block approach would apply to less complex insurance companies that also own a bank or thrift. The consolidated approach would categorize an entire insurance firm’s assets and insurance liabilities into risk segments, apply appropriate risk factors to each segment at the consolidated level, and then set a minimum ratio of required capital. The building block approach would aggregate existing capital requirements across a firm’s different legal entities to arrive at a combined, group-level capital requirement, subject to certain adjustments. In concept, the building block approach is similar to the RBC aggregation approach selected by the NAIC for its group capital calculation. 2. Discussed Referral Received from the Financial Condition (E) Committee Related to FSAP Recommendations Commissioner Altmaier discussed a referral from the Financial Condition (E) Committee (Attachment 1) regarding recommendations included in the 2015 U.S. Financial Sector Assessment Program (FSAP) report. The Committee requests that the Working Group consider three recommendations during the normal course of completing its charge of constructing a group capital calculation. Commissioner Altmaier noted that two of the recommendations relate to group-level stress testing, while the other recommendation relates to monitoring of investments at the group level to address potential regulatory arbitrage and search for yield at the group level. Commissioner Altmaier said discussions on these topics will naturally occur as the Working Group completes work related to its charge. 3. Discussed Sample Group Capital Calculation Commissioner Altmaier said during the Working Group’s May 26 conference call, it directed NAIC staff to consider concepts related to how non-insurers and non-RBC filers could be treated in a group capital calculation. In order to provide regulators and stakeholders with a frame of reference as to how a group capital calculation could possibly work, NAIC staff developed a sample group capital calculation. He said the purpose of presenting the group capital calculation is not to engage on a detailed discussion of the calculation, but rather to simply provide context related to what a calculation might look like under an RBC aggregation approach. Julie Garber (NAIC) discussed that the sample group capital calculation has been simplified (Attachment 2), and its primary purpose is to demonstrate how the mechanics of such a group capital calculation could work. She also noted that there are a number of key decisions that will need to be made by the Working Group in the future as it constructs the actual calculation. Ms. Garber discussed that the end result of the calculation could be a ratio of available regulatory capital aggregated for all entities divided by the minimum regulatory capital aggregated for all entities. A group capital ratio under a certain threshold could be a signal to the regulator that further regulatory review is warranted or appropriate. She said determining the minimum regulatory capital amounts for each entity will be the more challenging part of the ratio, particularly for those entities that are not currently subject to regulatory capital requirements. Ms. Garber discussed that the population of entities within an insurance holding company includes five different types of entities: 1) U.S. insurers that are subject to RBC requirements; 2) U.S. insurers that are not subject to RBC requirements; 3) non-U.S. insurers; 4) banks and other regulated entities that are subject to capital requirements; and 5) non-regulated entities that are not subject to capital requirements. For each of these entities, the Working Group will need to determine how to calculate the amount of available regulatory capital and the minimum regulatory capital. There would need to be certain

Attachment C

7


8/--/16


adjustments for the capital amount of subsidiaries included in the parent’s capital, as well as adjustments for minority interests. Ms. Garber said that in order for the ratio to be meaningful and comparable across groups, the Working Group needs to develop a consistent methodology for determining the available regulatory capital and minimum regulatory capital for all types of entities. Determining what constitutes the available regulatory capital will be much easier than determining the minimum regulatory capital. She suggested that in determining that minimum regulatory capital amount, the trend test amount RBC, or 300% of the authorized control level (ACL), could be used as the baseline. This amount represents the largest amount of regulatory capital that is required before regulatory action or intervention is contemplated. The regulatory capital amounts for the other types of insurers and regulated entities could then be calibrated to similarly reflect the highest level of regulatory capital the entity must have before regulatory action is contemplated based on the requirements of the home jurisdiction. For non-regulated entities, the minimum regulatory capital amount could be a flat charge against stockholder’s equity. For example, a 30% charge could be used for these entities, as 30% is the current RBC charge for other affiliates. When using the trend test (or 300% ACL) as the benchmark, a resulting group capital ratio of less than 1.0 could indicate that further regulatory review is appropriate. Ms. Garber then discussed an example group capital calculation on a simple, hypothetical insurance holding company group. 4. Discussed the Treatment of Non-Insurance Entities in the Group Capital Calculation Commissioner Altmaier said that during the Working Group’s call on May 26, questions were asked related to current RBC charges for the various affiliate categories and the total population and size of entities within insurance holding company systems. Lou Felice (NAIC) provided an overview of the current subsidiary charges in the three RBC formulas (Attachment 3), noting that certain affiliates are included in the “0” component of the RBC formula and are not subject to covariance, while other affiliates are included in the “1” component of the RBC formula and are included in the covariance calculation. For insurance affiliates included in the “0” component, the RBC basis is usually the subsidiary’s RBC after covariance multiplied by the percentage of ownership. For the other affiliates included in the “1” component, the RBC basis is usually the book/adjusted carrying value (BACV) multiplied by a certain factor. Mr. Felice said that although there are some differences in the treatment between the three formulas, they are generally the same. He said that the Working Group will want to discuss how to treat an affiliate’s capital if it is already included in the upstream insurance company’s capital to avoid double-counting. Ms. Garber said that the NAIC does not currently collect financial information on non-U.S. insurers and non-insurers, so the information on the relative size of entities and groups could not be provided. However, the NAIC does collect organizational charts in data format on Schedule Y, Part 1A. Aggregating this data includes a manual process and given the large number of lines of data, a complete population of the number of entities within insurance holding company systems was not calculated. Rather, NAIC staff analyzed information provided in Schedule Y, Part 1A and was able to provide summarized information to demonstrate that the number of entities within a group can vary significantly between groups in the U.S. For example, there are a large number of groups that have five or less entities within the group, while there are a small number of groups that have more than 1,000 entities within the group. In addition, there are several groups that have between 60 and 200 entities. Commissioner Altmaier discussed that based on the recommendation from the ComFrame Development and Analysis (G) Working Group, the joint presentation by the American Council of Life Insurers (ACLI) and the American Insurance Association (AIA) at the Spring National Meeting, and the sample group capital calculation presented by NAIC staff, two potential options are emerging for the treatment of non-insurance entities: 1) apply existing banking rules (such as Basel III) to the applicable entities that do not fall under insurance rules; and 2) apply the existing RBC affiliate equity charge. Both of these would require a minimal amount of additional data to be provided. Although applying a flat equity charge would be a simple approach, it is not necessarily risk-sensitive. Commissioner Altmaier discussed a possible hybrid approach in which a flat charge is used initially, and companies could begin providing financial data such as an industry code, total liabilities and net income. At some point, that data could be used to develop more risk-focused charges for certain industries or entities. There are many different holding company structures, and some include an insurance company at top, while others include some sort of holding company at the top. Additionally, some entities may be directly owned by an insurance company, while others are affiliates of an insurance company, with the insurer holding no direct ownership. The Working Group discussed whether treatment of a non-insurer should differ based on where it resides within the holding company structure. The Working Group also discussed at what level in the holding company the group calculation should begin, and whether that

Attachment C

8


8/--/16


would be at the top company (regardless of whether it is an insurer) or at the top insurance company-level. Commissioner Altmaier suggested that the calculation begin with the entity at the top of the holding company, regardless of whether that entity is an insurer, because the purpose is to look at the capital level within the entire group. Mr. Felice said that for most non-insurers in a group, the primary risk is the asset risk associated with owning the company. Because of this, a case could be made that for those entities not currently subject to capital requirements, the same charge should be used no matter where within the holding company structure it resides. Mr. Bruggeman and Mr. Slape agreed. Mr. Bruggeman said that if there is an insurance company at the top of the holding company and all other entities fall below the insurance company, the RBC of the insurance company would probably represent a fair approximation of the group’s capital. The calculation would be more complex if a holding company is at top level of the organization and non-insurer organizations are affiliates of the insurer, rather than subsidiaries. William Sergeant (State Farm Insurance Companies) suggested that different factors could be used based on whether an entity existed to support the insurance company’s operations. He noted that consideration of charges for entities that are owned by an insurance company versus those that are affiliates of an insurance company is complicated by the covariance calculation. Commissioner Altmaier said the Working Group will continue its discussion on this topic during its next conference call. Having no further business, the Group Capital Calculation (E) Working Group adjourned. W:\National Meetings\2016\Summer\Cmte\E\GCCWG\June 14 CC\06-14 GCCWGmin.docx

Attachment C

9


8/--/16


Draft: 6/9/16

Group Capital Calculation (E) Working Group Conference Call May 26, 2016

The Group Capital Calculation (E) Working Group of the Financial Condition (E) Committee met via conference call May 26, 2016. The following Working Group members participated: David Altmaier, Chair (FL); Ron Dahlquist (CA); Kathy Belfi (CT); Philip Barlow (DC); Eric Moser (IL); Leslie Nehring (MO); Tony Riddick (NC); Justin Schrader (NE); Peter L. Hartt (NJ); Dale Bruggeman (OH); and David Mattax and Doug Slape (TX). 1. Discussed Remarks from the FRB

Commissioner Altmaier said that Daniel K. Tarullo (Federal Reserve Board—FRB) recently discussed the FRB’s timing and direction related to its group capital project. Commissioner Altmaier said he is encouraged by some of the comments that were made, specifically with respect to the rejection of the market adjusted valuation concept, as well as the similarities between the FRB’s building-block approach and the methodology chosen by the NAIC in its consideration of a group capital calculation. He said that the Working Group’s charge includes staying apprised of the work being performed related to group capital both by the FRB and the International Association of Insurance Supervisors (IAIS), by liaising with the ComFrame Development and Analysis (G) Working Group, and would continue to monitor the activities of the FRB related to this topic accordingly.

2. Discussed a Recommendation from the ComFrame Development and Analysis (G) Working Group Commissioner Altmaier discussed the recommendation from the ComFrame Development and Analysis (G) Working Group (see NAIC Proceedings – Fall 2015, International Insurance Relations (G) Committee, Attachment Three), noting that this recommendation will guide the work of the Group Capital Calculation (E) Working Group over the next several months. He noted that the Working Group’s charge is to develop a group capital calculation and not a regulatory standard or requirement. This calculation will be an additional tool for use by U.S. regulators in monitoring the financial solvency of the group. Commissioner Altmaier discussed the scope and scalability of the calculation, stating that the Working Group will need to have discussions on this topic, but he said it is more prudent to first discuss and develop the actual calculation. Once the calculation is developed, then the Working Group can consider whether there are certain groups to which the calculation should not apply. Commissioner Altmaier said that there continues to be an open invitation for industry representatives to make a formal presentation to the Working Group regarding possible construction of a group capital calculation during a future conference call. Commissioner Altmaier said there are a number of important issues noted in the ComFrame Development and Analysis (G) Working Group’s recommendation that the Group Capital Calculation (E) Working Group will need to discuss in the future, including the following: 1) a going concern versus gone concern approach; 2) treatment of subordinated debt; 3) eliminations to avoid double-counting and other adjustments; and 4) stress testing. 3. Discussed Treatment of Insurers That Do Not File RBC and Treatment of Non-Insurance Entities in the Group Capital

Calculation Commissioner Altmaier said there are several options the Working Group can consider regarding the methodology for including entities within a group that do not file RBC reports in the U.S. or non-insurance entities that are not subject to any capital requirements in any jurisdiction. He said several options are included in the recommendation from the ComFrame Development and Analysis (G) Working Group, as well as in the joint presentation provided to the Working Group by the American Council of Life Insurers (ACLI) and American Insurance Association (AIA) at the Spring National Meeting. He noted that the existing RBC formulas already have capital charges in place for insurance companies that own affiliates that are not subject to RBC in the U.S. Further, for non-U.S. insurers that file something similar to an RBC report in their home jurisdiction, he said the NAIC’s group capital calculation could utilize the information from the foreign jurisdiction in the aggregation process, or the non-U.S. insurer could use the U.S. RBC formula in calculating amounts to be aggregated into the group capital calculation. Mr. Barlow asked about the approximate total number and types of entities in the U.S. that would need to be included in a group capital calculation. Michelle Rogers (National Association of Mutual Insurance Companies—NAMIC) asked for

Attachment D

11


8/--/16


information on the capital charges for the various types of affiliates that are currently included in the RBC formula. Commissioner Altmaier directed NAIC staff to perform research on these two items. He said that the Working Group will need to consider not only entities that are directly owned by a U.S. insurance company, and thereby included in the company’s RBC, but also entities within the group that are not owned by a U.S. insurance company. Mr. Slape said the Working Group will need to consider other activities within the holding company and determine what gaps exist in the current formula and RBC reporting. He said this will probably entail some form of group-level reporting. He also said that the Working Group will need to determine some sort of scalar for other jurisdictional capital requirements that may be included in the group capital calculation for non-U.S. entities. He said this scalar would need to consider the varying standards in the other jurisdictions. Commissioner Altmaier asked NAIC staff to begin developing the mechanics of how the calculation could be structured by considering today’s discussions and the recommendations provided by the ACLI, AIA and the ComFrame Development and Analysis (G) Working Group. Having no further business, the Group Capital Calculation (E) Working Group adjourned. W:\National Meetings\2016\Summer\Cmte\E\GCCWG\May 26 CC\05-26 GCCWGmin.docx

Attachment D

12

Draft Pending Adoption

Attachment Four Financial Condition (E) Committee

4/5/16


Draft: 4/11/16

Group Capital Calculation (E) Working Group New Orleans, Louisiana

April 3, 2016 The Group Capital Calculation (E) Working Group of the Financial Condition (E) Committee met in New Orleans, LA, April 3, 2016. The following Working Group members participated: David Altmaier, Chair (FL); Susan Bernard and Ron Dahlquist (CA); Kathy Belfi (CT); Philip Barlow (DC); Kevin Fry (IL); Leslie Nehring (MO); Tony Riddick (NC); Justin Schrader (NE); Peter L. Hartt (NJ); Dale Bruggeman (OH); and David Mattax and Doug Slape (TX). 1. Heard Opening Remarks and Discussed its Charge Mr. Altmaier said the ComFrame Development and Analysis (G) Working Group has been monitoring the International Association of Insurance Supervisors’ (IAIS) work related to the IAIS Common Framework for the Supervision of Internationally Active Insurance Group (ComFrame), which includes an international capital standard (ICS). Through this work, it became evident that the U.S. financial solvency regulation framework could also benefit from the development of a group capital assessment, and the ComFrame Development and Analysis (G) Working Group began discussion on the matter, considering a number of different group capital calculation methodologies. In late 2015, the Working Group, and ultimately the International Insurance Relations (G) Committee, adopted a recommended charge to the Financial Condition (E) Committee that it construct a group capital calculation using an RBC aggregation methodology (see NAIC Proceedings – Fall 2015, International Insurance Relations (G) Committee, Attachment Three). In February 2016, the Financial Condition (E) Committee created the Group Capital Calculation (E) Working Group and assigned it the following charge: Construct a U.S. group capital calculation using an RBC aggregation methodology; liaise as necessary with the ComFrame Development and Analysis (G) Working Group on international capital developments and consider group capital developments by the Federal Reserve Board, both of which may help inform the construction of a U.S. group capital calculation. Mr. Altmaier said the recommendation from the International Insurance Relations (G) Committee includes a number of issues that still need to be determined, noting that this Working Group will be deliberating those matters over the coming months, with input from interested stakeholders. 2. Heard a Joint Presentation from the ACLI and the AIA Regarding the Construction of a Group Capital Calculation During the Financial Condition (E) Committee’s Feb. 10, 2016, conference call, Superintendent Eric A. Cioppa (ME) invited those parties that have previously presented on the topic of the group capital calculation to the Federal Reserve Board (FRB) to provide their presentations to the Working Group. Bruce Ferguson (American Council of Life Insurers—ACLI) said the ACLI has collaborated with the American Insurance Association (AIA) in developing an aggregation and calibration approach to the group capital calculation, which includes the aggregation of local available and required capital levels to create a group solvency ratio and appropriate calibration across regimes to create comparable measures that can be aggregated into a group-wide measurement. Mr. Ferguson provided an overview of the approach, noting that it is a principle-based approach that includes the following principles: 1) reflects appropriate regime, including non-insurance regimes; 2) minimal adjustments to existing solvency regimes; 3) indifferent to corporate structure; 4) comparable across all regimes; and 5) fully transparent. Mr. Ferguson discussed the steps in the aggregation and calibration approach that are imbedded in the five principles: identification and assignment; inventory; qualification and adjustment; and scaling and aggregation. He noted that several policy issues still need to be addressed, including the necessity and appropriateness of a group capital calculation for all insurance groups, how state insurance regulators would implement and coordinate assessment of such a calculation, and the basis and scope of a commissioner’s authority to adopt and act on the calculation. Mr. Altmaier said the Working Group’s charge to is to construct a group capital calculation, and not a group capital standard. He said the calculation will assist state insurance regulators by supplementing their reviews of existing group solvency tools such as the Own Risk and Solvency Assessment (ORSA) filings and Enterprise Risk Report (Form F) filings. One of the benefits of the RBC aggregation approach is that it allows regulators to leverage some of the existing regulatory tools in

Attachment E

13

Draft Pending Adoption

Attachment Four Financial Condition (E) Committee

4/5/16


preparing the calculation. He discussed that the issue of the scope of the calculation, and whether certain smaller groups would be excluded from the calculation, is one of the topics the Working Group will need to address. Director Hartt said that one of the principles discussed by Mr. Ferguson indicates that Basel III can be applied to all non-insurance entities and asked whether he was certain that Basel III could be applied to every type of non-insurance entity. Mr. Ferguson said that Basel III appears to be the most appropriate standard to use in these situations, but that it is unclear if it can be applied to all non-insurance entities. Director Hartt indicated that the group capital calculation needs to capture every significant entity, and Mr. Ferguson agreed. Mr. Altmaier said that the treatment of those entities not subject to RBC is a significant policy issue to be discussed by the Working Group. 3. Discussed Next Steps Mr. Altmaier said there are many open issues related to the group capital calculation that the Working Group will need to address. He said that, in February 2016, Superintendent Cioppa invited presentations from those groups that had previously presented to the FRB. Mr. Altmaier said the Working Group would like to hear from industry representatives that would like to share their reviews on the RBC aggregation approach to the group capital calculation, regardless of whether they have already presented their reviews to the FRB. Mr. Slape stated that he has been approached by members of the industry indicating that they are not in favor of the RBC aggregation approach. Mr. Altmaier said the ComFrame Development and Analysis (G) Working Group considered the various group capital methodologies in an open and transparent manner. There was a general consensus from industry representatives that the preferred calculation method is RBC aggregation. Therefore, the Group Capital Calculation (E) Working Group’s charge is to construct the calculation using an RBC aggregation methodology, and it does not have any flexibility on that issue at this time. Michelle Rogers (National Association of Mutual Insurance Companies—NAMIC) said NAMIC supports the RBC aggregation approach, as it provides the simplest means to calculate group capital, while not being overly burdensome and maintaining the integrity of the legal entity RBC. She also discussed the importance of performing field testing before the calculation is finalized, as well as further discussions on the scope of the calculation. Steve Broadie (Property Casualty Insurers Association of America—PCI) said the PCI has discussed group capital with the FRB and continues to support the RBC aggregation methodology, as it is the most cost-effective approach. He suggested that the group capital calculation follow the current RBC formula as closely as practical. Jeff Alton (CNA Financial) asked that as the IAIS moves forward with its ICS, whether it is the intent that the group capital calculation would meet the Financial Sector Assessment Program (FSAP) standard. Mr. Altmaier said the goal is to develop a calculation based on a U.S. regulatory perspective based on the needs of the U.S. state insurance regulators. He noted that the Working Group is charged with liaising with both the FRB and the ComFrame Development and Analysis (E) Working Group. Tracey Laws (Reinsurance Association of America—RAA) asked about the timing of the project. Mr. Altmaier said that although there are currently no formal deadlines, the Working Group needs to address its charge in an expeditious manner. Mr. Altmaier reiterated the invitation for industry representatives to make a formal presentation to the Working Group during a future conference call. Having no further business, the Group Capital Calculation (E) Working Group adjourned. W:\National Meetings\2016\Spring\Cmte\E\GCCWG\04-GCCWGmin.docx

Attachment E

14

Blue Cross Blue Shield Association is an association of independent Blue Cross and Blue Shield companies.

Group RBC Calculation Proposal Group Capital Calculation (E) Working Group NAIC Summer National Meeting August 26, 2016

Shari Westerfield, Chief Actuary, Blue Cross Blue Shield Association Carl Labus, Managing Director, Blue Cross Blue Shield Association

Attachment F

15

2

16-446-S54

Rationale:

• Familiarity by industry with RBC models

• RBC model development was well tested

• Proven regulator model is effective in identifying weakly capitalized companies

• Substantial effort to develop new model avoided for information only filing

• As information becomes available factors can be updated and applied

Group RBC Calculation Utilizes Existing Life, P&C, and Health Formulas

Attachment F

16

3

16-446-S54

Group RBC Calculation Proposal – Risk Charges

Non-Insurance or Insurance Holding Company RBC formula based on majority of insurance business

*Lower level holding companies charged based on carrying value in excess of net worth of insurance subsidiaries per current RBC instructions

Affiliate Risk

U.S. Insurance Affiliates Company Action Level

Non-Insurance Affiliates Applicable foreign or U.S. net worth charge based on current formula*

Asset Risk Interest Rate Risk Underwriting Risk

Credit Risk Business Risk

Holding Company Complete RBC formula as if an insurer

U.S. Insurance Holding Company Risk charges per RBC model

Attachment F

17

4

16-446-S54

Applies to Insurance or Non-Insurance Holding Company Risk Charge Scenarios for Parent Entity

Risk Charges Application

Affiliate

• U.S. insurance affiliates • Company Action Level

• Non-Insurance affiliates • Current 30% of net worth

• Non-U.S. Insurance or other regulated affiliates

• 100% of net worth; or • Applicable country or business

regulatory requirements

Asset Interest Rate (Life Only) Underwriting Credit Business

• Parent U.S. insurance entities complete as currently done

• Non-Insurance Parent Holding Company complete as if an insurer - Primarily will be driven by affiliate risk charges - No underwriting risk charge - Other risk charges could be minimal for holding companies

RBC and ACL • Risk charges calculated above applied to existing covariance formulas

• Authorized Control Level (ACL) is 50% of calculated RBC ratio (CAL)

Attachment F

18

5

16-446-S54

Group RBC Calculation

Numerator

• Insurance Holding Company = Total Adjusted Capital per RBC model; or

• Non-Insurance Holding Company = U.S GAAP Equity or Foreign Equivalent • Financial audits attest to the Holding

Company net worth • Could include goodwill and differences in

valuations for investments and other assets

Denominator

• Authorized Control Level (50% RBC after Covariance)

Attachment F

19

6

16-446-S54

BCBSA’s proposal is conceptually similar to the ACLI/AIA proposal and NAIC’s inventory method. This proposal: • Requires identification / inventory of all legal entities

– Insurance and non-insurance – U.S. and alien

• No double counting - reflects excess capital for lower and parent level holding companies – Affiliate risk/capital has already been reflected in the formula

There are differences, however: • Unique risks of the parent holding company are recognized by utilizing existing RBC

formulas, rather than a one size fits all approach of applying a single factor to GAAP capital

• Currently, the RBC formula assesses risk on total capital for non-insurance and alien entities – Where capital standards exist, risks assessed on capital values could be replaced by minimum

capital standard amounts for different businesses (e.g., banking industry) – Factors currently applied in the RBC formulas to alien and non-insurance affiliates could be altered

to ensure compatibility with other solvency regime standards

BCBSA Group RBC Proposal and Inventory Method

Attachment F

20

7

16-446-S54

Group RBC Example

Attachment F

21

8

16-446-S54

Group RBC Calculation Proposal Example

Big Holding Company, Inc. C O R P O R AT E S T R U C T U R E

Big Holding Company

Medium Holding

Company

Health Affiliate 1

Health Affiliate 2 Life Affiliate Alien Insurer Other Affiliate

Attachment F

22

9

16-446-S54


Big Holding Company - Affiliated Company Risk as calculated on XR002 Tab of HRBC Formula

Entity Affiliate TypeFactor from

XR003 (if applicable)

Afilliate's RBC After

Covariance

Affilliate's Book/Adj Carrying Value of Common Stock OR GAAP Carrying Value

Component added to H0

Component added to H1 Formula

Medium Holding Company Holding Company Excess of Subsidiaries 0.3 n/a 200,000,000 0 60,000,000 H1 = (GAAP Carrying Value) * 0.3Health Affiliate 1 Indirectly Owned Insurer Subject to RBC Affiliate RBC 100,000,000 200,000,000 100,000,000 0 H0 = Affiliate HRBCHealth Affiliate 2 Directly Owned Insurer Subject to RBC Affiliate RBC 200,000,000 500,000,000 200,000,000 0 H0 = Affiliate HRBCLife Affiliate Directly Owned Insurer Subject to RBC Affiliate RBC 50,000,000 120,000,000 50,000,000 0 H0 = Affiliate LRBCAlien Insurer Directly Owned Alien Insurer 1.0 n/a 60,000,000 60,000,000 0 H0 = (GAAP Carrying Value Equivalent) * 1.0Other Affiliate Other Affiliated Investments 0.3 n/a 15,000,000 0 4,500,000 H1 = (GAAP Carrying Value) * 0.3

Total 410,000,000 64,500,000

• Capture risks associated with affiliates in the affiliate risk section of the existing formula. − For insurance affiliates, report RBC after covariance from affiliate filings − For non-insurance affiliates, report GAAP capital, foreign equivalent, or existing minimum

capital requirement and apply appropriate charge − For lower tier holding companies, report statutory capital, GAAP capital, foreign equivalent, or

existing minimum capital requirement in excess of subsidiary capital to avoid double counting

Attachment F

23

10

16-446-S54


RBC Factor Calculation Description Result

H0 Asset Risk - AffiliatesH0 Component from Affiliate Companies Pages (XR002/XR003) 410,000,000 H1 Component from Affiliate Companies Pages (XR002/XR003) 64,500,000 + H1 Component from Big Holding Company's GAAP equivalent calculation on RBC Investment tabs (XR006 - XR011). Report asset values pertaining only to Big Holding Company and exclude affiliated investment values, which are already included on lines above. 20,000,000

H2 Underwriting Risk should be zero 0

H3 Credit RiskH3 Component from Big Holding Company's GAAP equivalent calculation on RBC Credit Risk tabs (XR019-XR020) 30,000,000

H4 Business Risk should be relatively small 10,000,000

Covariance Calculation H0 + sqrt(H12 + H22 + H32 + H42) 500,223,334 Authorized Control Level (ACL) 50% * (RBC After Covariance) 250,111,667

Total Adjusted Capital (TAC)Use GAAP Net Worth of Big Holding Company which includes net worth of affiliates 1,250,558,335

RBC Ratio 500%

H1 Asset Risk - Other

• Calculate the remaining risk attributable to the parent holding company, using existing RBC formulas and GAAP statement equivalent values for formula entries

• Calculate RBC after covariance and ACL

• Use GAAP Capital as the measure of TAC

Attachment F

24

11

16-446-S54

Group RBC Calculation Additional Considerations

Build Upon Existing Requirements

1 • Easier for

industry and regulators to implement and understand

• Could alter for compatibility with other solvency regime standards

Going vs. Gone Concern 2

• GAAP valuations supported by financial audits

• GAAP equity could include goodwill, which would be assessed a risk charge under this approach

Treatment of Subordinated Debt

3 • Retain

consistency with current RBC formulas: surplus notes included in statutory capital, but not GAAP equity

Stress Testing 4

• ORSA is a valuable tool to the regulator and is the appropriate mechanism for testing under normal and severe stress scenarios.

Attachment F

25

--

MEMORANDUM

TO: Group Capital Calculation (E) Working Group FROM: NAIC Staff DATE: Aug. 22, 2016 RE: Questions on Various Aspects of the Inventory Method Background Information The Working Group has identified the inventory method as the most appropriate approach to the NAIC’s group capital calculation, and there have been no objections to this approach. The benefits of the inventory approach include providing a roadmap of all entities within the defined group and providing valuable entity-level financial data to allow for additional analytical abilities. In regard to the inventory method, there are various topics that the Working Group has discussed during recent conference calls, although further consideration of these items is appropriate. The purpose of this memo is to identify those items and to pose questions that will hopefully provide feedback for the Working Group’s consideration as part of its deliberations. Factor to be Used for Non-Insurance Entities Not Subject to Other Capital Requirements The Working Group has discussed the treatment of non-insurance entities that are not subject to capital requirements on several occasions and much of this discussion has focused on a flat charge that could be applied the entity’s book/adjusted carrying value (BACV.) This approach is similar to what is currently utilized in the risk-based capital (RBC) formula. Utilization of a flat equity charge for non-insurance entities that are not subject to other capital requirements is a simple approach and would require a minimal amount of additional data. It also fits well with the position that all non-insurance entities should be treated the same no matter where they are owned in the holding company structure. However, it is understood that this approach is not necessarily risk-sensitive. Question 1: Is applying a flat charge to an entity’s BACV an appropriate approach for non-insurance entities that are not subject to other capital requirements? If the answer is no, please suggest an alternative approach, including why that approach is preferable to a flat charge. If a flat-charge approach is utilized, the Working Group will need to determine what the charge should be. On an after-tax basis, the current RBC charge for most non-insurance affiliates is 22.5% of BACV. Using an RBC aggregation approach requires that RBC be used in the calculation for all RBC filers. The Capital Adequacy (E) Task Force and its working groups have spent a considerable amount of time developing the appropriate risk charge in the current RBC formula. Since the 22.5% factor was developed with the understanding that most of these affiliates utilize generally accepted accounting principles (GAAP), it has been discussed that the 22.5% charge may be appropriate for a group capital calculation when considering that GAAP is not as conservative as statutory accounting principles (SAP). This factor could be applied to calculate the minimum regulatory capital amount in the group capital calculation. The charge would have a minimum of zero to address cases in which there is negative equity in any entity in the group, including an intermediate or top holding company. Question 2: If the Working Group decides that a flat charge should be applied to an entity’s BACV, is the current RBC charge of 22.5% appropriate? If the answer is no, what should the charge be and why do you believe that charge is appropriate?

Attachment G

27

© 2016 National Association of Insurance Commissioners

2

The Working Group has also discussed the possibility of a hybrid approach in which a flat charge is used initially and additional data is collected (i.e., industry code, total liabilities, net income, etc.) At some point, that data could be used to develop more risk-focused charges for certain types of non-insurers that are common to the industry (i.e., insurance agencies, investment management companies, etc.) Consideration should be given to how and from whom such data would be collected (e.g. via a broad-based data call, via data provided by volunteering groups or data collected by all groups over time.) Question 3: Do you believe that use of a hybrid approach is appropriate? If the answer is yes, what data should be collected and how can that be used in determining a more risk-focused approach? Treatment of Non-Insurance Entities that are Subject to Capital Requirements During its Aug. 11 conference call, the Working Group discussed non-insurance entities that are subject to capital requirements, and this category primarily includes U.S. banks. When determining how the minimum regulatory capital amount should be calculated for purposes of the U.S. group capital calculation, two main options are apparent: 1) the entity’s existing sectorial minimum capital requirement; or 2) a flat equity charge such as 22.5%. Using existing sectorial requirements is more risk-sensitive and is already calibrated to some sort of regulatory intervention level using an underlying GAAP accounting basis, while using a flat equity charge would be the simplest approach and is the most aligned with entity-level RBC charges. Question 4: Which approach is more appropriate for non-insurance entities that are subject to capital requirements: the entity’s existing sectorial capital requirement or a flat equity charge? Why do you feel that approach is more appropriate? Question 5: If the Working Group decides that a flat charge should be used for these regulated entities, is the current RBC charge of 22.5% appropriate? If the answer is no, what should the charge be and why do you believe that charge is appropriate? Use of Scalars for Non-U.S. Insurers On the Aug. 11 conference call, the Working Group discussed the use of scalars by non-U.S. insurers. NAIC staff suggested that because of the lack of sufficient data currently available, the scalars initially be set at 1.0. Over time, the group capital calculation could obtain financial information for these non-U.S. insurers that could be analyzed to ascertain whether a different scalar for a particular jurisdiction is appropriate. Alternatively, a data call could be performed to collect several years of data right now. In their presentation to the Working Group at the Spring National Meeting, the American Council of Life Insurers (ACLI) and the American Insurance Association (AIA) suggested that metrics such as a country’s qualified jurisdiction review or its Financial Sector Assessment Program (FSAP) results be used in determining the scalar. NAIC staff indicated that these reviews are more related to regulatory outcomes, as opposed to assessing the comparability of capital requirements across jurisdictions. Question 6: Is analyzing financial information from non-U.S. insurers an appropriate approach to developing country-specific scalars? If the answer is yes, what specific financial information should be obtained and analyzed in developing the scalar? If the answer is no, what approach do you prefer and why is that approach more appropriate? Question 7: If the Working Group elects to base development of country-specific scalars on financial information, should this information be collected over a number of years or should a data call be performed to collect this information now? Question 8: If the data is collected over a number of years, what approach to these entities should be taken in the interim? Two possible options include the current RBC flat charge for the entity or the entity’s non-scaled capital requirements. W:\National Meetings\2016\Summer\Cmte\E\GCCWG\Aug 11 CC\NAIC Staff Memo to GCCWG - Inventory method items.docx

Attachment G

28

--

MEMORANDUM

TO: Group Capital Calculation (E) Working Group FROM: NAIC Staff DATE: August 22, 2016 RE: U.S. Insurers that Do Not File RBC, Prescribed/Permitted Practices and On-Top Adjustments to GAAP Background Information When considering the approach that should be taken towards both U.S. insurers that are not subject to risk-based capital (RBC) requirements and permitted practices, it may be helpful to restate one of the basic principles of an aggregated RBC group capital approach. Specifically, such an approach is based upon the fundamental view that what is most relevant are the individual insurers’ and/or other regulated entities’ minimum capital requirements. In other words, it is most important for the regulator to understand each of those minimum requirements and any approach that ignores such requirements is flawed, disregarding practical reality that no regulator can have its authority overridden at the entity level. Another basic principle of an aggregation approach is recognition that no consistent valuation basis is embraced and utilized by all jurisdictions in the world, and therefore the belief is that a mixed accounting model is acceptable since it reflects an appropriate measurement of the adequacy of capital for a given regulated entity, and it does not force one single valuation system upon insurers that is not cost beneficial for all of the insurers operating throughout the world. Finally, although not a principle, as the U.S. state regulators have thought about a group capital calculation, they have recognized that its value as an analytical tool is related to understanding the capital requirements of each entity within the group and the level of capital resources allocated to meet each requirement as a means to insulate and protect the interests of policyholders of the U.S. insurance entities. NAIC staff has placed a high degree of emphasis on the analytical value as it has developed the idea of an inventory method that, for all practical purposes, represents a consolidation of two figures: minimum capital and available capital. It is worth noting and pointing out something important relative to the examples of this inventory approach. This represents a bottom-up approach to both minimum capital and available capital, with an emphasis on the former. The bottom-up approach for minimum capital is very important since, again, that represents something that cannot be overridden by another regulator, and therefore, directly impacts the calculation’s minimum required capital. However, the bottom-up approach for available capital is less about developing a total available capital amount and is more about the use of that figure for analytical analysis. So while the bottom-up approach remains favored by NAIC staff to recognize that each entity brings its accounting basis to the available capital calculation on a basis that should be consistent with which the capital requirements for that entity have been or will be developed, an alternate view is that the available capital is the actual capital measured on the basis of accounting by the top-tier company. In this view, eliminations are necessary to approximate available capital at the entity-level. From this standpoint, a stock insurer at the top of the holding company structure will utilize the capital on that statutory basis. By comparison, a non-insurance company that uses generally accepted accounting principles (GAAP) at the top of the holding company structure will utilize the capital on the basis of GAAP. Use of some limited top level adjustments (such as those under SSAP No. 97) reflects the idea of trying to make these figures more comparable. Specific precision is not sought in this method, but rather estimation. Some of this view is incorporated in NAIC staff’s recommendations related to U.S. insurers that do not file RBC.

Attachment H

29

2

1. U.S. Non-RBC Filers For Which There Is No RBC Formula (U.S. Insurers) Given the background, NAIC staff is of the opinion that for those U.S. insurers that do not have an RBC formula, the minimum capital per state law should be used as the basis for what is used for that insurer in the group capital calculation. However, where requirements differ between states for a particular type of non-RBC insurer, one basis for the calculation could be chosen and applied to all insurers of that particular type. NAIC staff would suggest that the requirements be further specified as follows:

Mortgage Guaranty Insurers: The minimum capital requirement shall be based upon the NAIC’s requirements set forth in the Mortgage Guaranty Insurance Model Act (#630), specifically considering Section 3 (minimum capital and surplus requirements) and Section 12 (capital, surplus and contingency reserves equal to the minimum of 1/25th of the a total liability net of reinsurance.) Financial Guaranty Insurers: The minimum capital requirement shall be based upon the NAIC’s requirements set forth in the Financial Guaranty Insurance Guideline (Guideline 1626), specifically considering Section 2B (minimum capital requirements) and Section 3 (Contingency, Loss and Unearned Premium Reserves) and the other requirements of that guideline that impact capital (e.g. specific limits). Title and Other Companies: A selected basis for minimum capital requirements derived from a review of state laws. Where there is a one-off treatment of a certain type of insurer that otherwise would file RBC (e.g., HMOs domiciled in California), the minimum capital required by their respective regulator could be considered in lieu of requiring the entity to complete an RBC blank

2. U.S. Captive Insurance Companies Before considering this topic any further, it should be understood that what is being proposed for U.S. captive insurance companies would not apply to any holding company that does not have a traditional U.S. insurance company. However, for any U.S. insurer that has a U.S. captive insurance company in its holding company structure, it must comply with the requirements of what is proposed on the presumption that any captive used by an insurance company could be used to circumvent the policyholder protections put in place by states. The only exception that would be allowed is if the captive was being used exclusively for self-insurance or insurance provided exclusively to its own employees and/or its affiliates.

RBC: All entities that do not meet the limited exceptions noted above would be required to complete an NAIC RBC formula using their basis of accounting, but with limited adjustments as set forth below. Limited Accounting Adjustments: Recognizing the previous point that available capital that will be used in the group capital calculation will be based upon either U.S. GAAP with limited adjustments, or statutory accounting principles (SAP), NAIC staff is of the opinion that an approach similar to the SSAP No. 97 approach should be used for determining the valuation used for U.S. captives.

SSAP No. 97 Requirements Paragraph 9 of SSAP No. 97 provides a listing of adjustments that would be required by U.S. captive insurance companies. This specifically includes adjustments to non-admit assets pursuant to SSAP No. 6 (Uncollected balances), SSAP No. 16R (EDP Equipment), SSAP. No 19 (Furniture and Fixtures), SSAP No. 21 (Other Admitted Assets), SSAP No. 29 (Prepaid Expenses), SSAP No. 68 (Goodwill), SSAP No. 105 (Working Capital Finance Investments), deferred acquisition costs and other capitalized expenses, deferred tax assets in excess of 10% of equity, surplus notes issued by the reporting entity, and specifically identified life valuation differences. Additional Required Adjustments The SSAP No. 97 adjustments are primarily designed to address valuation of asset differences and do not address liability valuation differences. NAIC staff is of the opinion that in addition to the SSAP No. 97 adjustments, this calculation should also require the captive insurer’s financials to utilize the valuation basis used by the direct writer of the business, thus eliminating any benefit that may have otherwise been derived by the U.S. insurer on a direct basis, and in doing so, providing a more accurate reflection. The only exception to this requirement that the direct writers’ valuation be used for the business would be a captive established for XXX/AXXX issues, on the basis that the vast majority of states have recognized a different valuation may be reasonable on XXX/AXXX. For these captives, regulators should consider

Attachment H

30

3

whether they would accept a different valuation that allows the captive to report reserves under principle-based reserving (PBR) (since it becomes operational on Jan. 1, 2017) for both new business and inforce business. Although both may be reasonable from a group capital standpoint, allowing this option for inforce business may encourage formation of additional captives than may currently exist, and therefore the Working Group may want to consider limiting only to those insurers that already had such in place prior to Jan. 1, 2016. By doing so, it would at least bring consistency in the valuation of the business prior to Actuarial Guideline XLVIII (AG 48). Regulators should consider whether allowing full retroactive recognition of XXX/AXXX reserves on a PBR-basis is consistent with the level of RBC requirements that were developed in conjunction with the level of reserves for business written prior to Jan. 1, 2017.

3. Prescribed and Permitted Practices NAIC staff chose to address this issue in this particular memo because we believe it is closely related to the adjustments being made for U.S. captive insurers. The reason being because as one considers those adjustments, the concern that can arise is whether groups will choose to cede their U.S. business to non-U.S. based captives, knowing that statutory rules can be circumvented in this way. Although NAIC staff believes that most prescribed and permitted practices are generally not driven by an attempt to avoid statutory rules, the impact can be similar. NAIC staff was always of the opinion that the easiest way to address the issue of prescribed and permitted practices was to require an on-top adjustment (e.g. the last tab of the excel file that was distributed prior to the June 20 conference call) that totals all such adjustments of their impact on capital (as included in Note 1 of the financial statements), then detail in a separate sheet. That is the recommendation related to prescribed and permitted practices. NAIC staff is of the opinion that this should be fairly simple for companies, and should be fairly simple to develop an instruction for. NAIC staff recommends that another tab/page of the calculation be structured to allow the company to include other on-top adjustments for transactions that may circumvent the regulatory processes of individual jurisdictions through the movement of the liabilities and/or assets to another jurisdiction or entity. One of the few disadvantages of the aggregation method compared to the consolidation method is that the latter requires capital levels based upon one factor regardless where the business/assets is originated. NAIC staff is of the opinion that this risk can be mitigated by requiring the group to include a capital impact of any transaction that may circumvent the regulatory process. This is specifically meant to address the potential concern that arises relative to the above expected adjustments for U.S. captives but not the same for non-U.S. captives. NAIC staff believes the most effective way to address this may be to place some type of threshold that only requires a listing of such if it is material to the group as a whole (e.g. equal to or greater than 3% of minimum capital before such determination). Such a threshold may also be applied at the entity-level rather than the group-level, if desired. The threshold would recognize that insurers use different capital allocation techniques among non-captive insurers and many would not consider such practices as problematic unless they are material. Oftentimes, regulators utilize 3-5% as a consideration for materiality at the insurance entity level. 4. On-Top Adjustments As noted in the background information on page 1, NAIC staff supports a bottom-up approach to aggregation for available capital that replaces the consolidated GAAP at the holding company level with the sum of the entity-based underlying available capital. This seems most consistent with an entity build-up of capital requirements developed with the accounting regime in mind. However, the idea of utilizing on-top adjustments was previously mentioned by NAIC staff in the context of a comparison of the calculation of available capital for a top-tier U.S. GAAP company, compared to a top-tier stock or mutual insurance company. If that path is chosen, NAIC staff would suggest the Working Group consider whether the previously suggested SSAP No. 97 list, along with the other adjustments considered for U.S. captives, would be a reasonable listing of possible adjustments. Again, the idea is that this would only be required of top-tier companies if the Working Group members consider available capital at the top-tier to be a starting point or one worthy of further analysis compared to a full aggregation approach. It is also worth reminding the Working Group that the Insurance Holding Company System Regulatory Act (#440) and Insurance Holding Company System Model Regulation (#450) collectively require the Form B filing to include a copy of the annual financial statements that are either certified by an independent public accountant or reviewed by a certified public accountant (under limited exceptions), unless the filer is an insurer, for which U.S. insurers are generally required to submit an annual audit. Point being, the financial statements being utilized as the starting point for available capital should already be subject to an audit. As previously noted, this approach utilizes a top-down approach to available capital, but in requiring a bottom-up inventory approach, the calculation serves as a powerful analytical tool which has far more value than a consolidated approach to capital. W:\National Meetings\2016\Summer\Cmte\E\GCCWG\National Meeting\Att H - NAIC Staff Memo - Non-RBC US Insurers and GAAP adjustments.docx

Attachment H

31

materials - group capital calculation (e) working...

Documents