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February 2015 | CIPR Newsle er

FEBRUARY 2015

Eric Nordman CIPR Director 816-783-8232

[email protected]

Kris DeFrain Director, Research & Actuarial

816-783-8229 [email protected]

Shanique (Nikki) Hall Manager, CIPR 212-386-1930 [email protected]

Dimitris Karapiperis Research Analyst III


Anne Obersteadt Senior Researcher


NAIC Central Office Center for Insurance Policy and Research 1100 Walnut Street, Suite 1500 Kansas City, MO 64106-2197 Phone: 816-842-3600 Fax: 816-783-8175 h p://cipr.naic.org

Inside this Issue

Director’s Corner 2 Emerging Regulatory Issues in 2015 3 This ar cle, wri en by NAIC President and Montana Commissioner of Securi es and Insurance Monica Lindeen, shares her views on some of the key challenges and ini a ves NAIC and its members will be working on in 2015 and beyond including cybersecurity concerns; the imple-menta on of Principle-Based Reserving standards; the use of cap ves for life insurance re-serves; con nued progress on implementa on of the Affordable Care Act; issues facing regula-tors related to the recent passage of NARAB II; and our rela ons with interna onal regulators. An Overview of the Federal Affordable Care Act 3Rs 10 One of the primary goals of the health care reforms is to expand access to health care insurance coverage. However, the influx of previously uninsured individuals into the new health insurance exchanges could make it difficult for insurers to price plans accurately. To address these risks, the Affordable Care Act (ACA) contains three programs intended to stabilize policyholder premi-ums and mi gate risk that may occur due to ACA insurance market reforms for certain seg-ments of the U.S. major medical insurance market. This ar cle will discuss the Transi onal Rein-surance Program, the Temporary Risk Corridors Program and the Permanent Risk Adjustment Program. Collec vely, these three programs are o en referred to as the 3Rs. TRIA Renewed … at Long Last 13 The Terrorism Risk Insurance Act (TRIA) was overwhelmingly passed by both the Senate and House of Representa ves and was signed into law by President Obama on Jan. 12, 2015. H.R. 26—the Terrorism Risk Insurance Program Reauthoriza on Act of 2015—extends the federal backstop program for six years. The legisla on that passed was long overdue. This ar cle iden-fies several of the important changes to the program.

Sharing a Ride, Not the Risk 15 At the crossroads of untapped consumer demand and market inefficiency is innova on. Com-mercial ride-sharing and car-sharing are two such recent market innova ons. The emergence of the car-sharing and commercial ride-sharing business models are a product of the expand-ing sharing economy. To study regulatory issues related to insurance coverage for transporta-

on sharing and other emerging sharing products, the NAIC Property and Casualty Insurance (C) Commi ee appointed the Sharing Economy (C) Working Group in 2014. This ar cle will discuss some of the insurance issues surrounding commercial ride-sharing and car-sharing. NAIC Pivotal in IAIS Forma on 22 Recognizing the evolu on of globaliza on taking hold in the insurance sector, the NAIC first sponsored an “Interna onal Conference of Insurance Regulatory Officials” in 1986 in con-junc on with the NAIC Na onal Mee ngs. These conferences, which brought together insur-ance regulatory officials from across the globe, were the genesis behind the forma on of the Interna onal Associa on of Insurance Supervisors (IAIS). This ar cle will provide a historical background on how the NAIC was integral in the IAIS forma on. The Exposure of Life Insurance Companies to Interest Rate Risk 25 State insurance regulators are keenly aware life insurers’ financial health depends, to a great extent, on their ability to overcome the challenges posed by the current extended period of low interest rates. Cognizant of the cri cal importance of interest rate risk for life insurance companies, the CIPR hosted an event tled “Naviga ng Interest Rate Risk in the Life Insur-ance Industry” during the NAIC 2014 Fall Na onal Mee ng. This ar cle will recap the event and share preliminary insights from a future CIPR Study examining interest rate risk. Data at a Glance: Property/Casualty Market Concentra on and Profitability 30

2 February 2015 | CIPR Newsle er

D ’ C

The staff at the NAIC Center for Insurance Policy and Re-search (CIPR) are pleased to provide you the latest issue of the CIPR Newsle er. Inside this issue, I am proud to intro-duce our annual featured ar cle from our NAIC President and Montana Insurance Commissioner Monica Lindeen. It discusses her thoughts on several important regulatory priori es for 2015. Among the key topics for regulatory focus include cybersecurity; progress on the implementa-

on of Principle-Based Reserving; con nued focus on cap-ve reinsurance transac ons; con nued implementa on of

the Affordable Care Act; the recent enactment of NARAB II and its implementa on; as well as interna onal insurance rela ons. There is a terrific ar cle on the Affordable Care Act 3Rs—the Transi onal Reinsurance Program, the Temporary Risk Corridors Program and the Permanent Risk Adjustment Pro-gram. These three risk management programs, collec vely referred to as the 3Rs, are intended to protect consumers by stabilizing premiums during the ini al years of the laws’ implementa on. Eric King, NAIC Health Actuary, provides an overview of these interconnected programs. Our next ar cle looks at the Terrorism Risk Insurance Act’s recent reauthoriza on. President Obama signed H.R. 26, the Terrorism Risk Insurance Program Reauthoriza on Act of 2015 on Jan. 12, 2015. However, the program expired Dec. 31, 2014 a er the Senate failed to reauthorize it be-fore adjourning for the year. H.R. 26 extends the federal backstop program for six years, keeping it alive through 2020. The legisla on that passed was long overdue. In this ar cle I iden fy several of the important changes to the program and provide informa on on interim guidance pub-lished on Feb. 4, 2015. Senior Researcher Anne Obersteadt provides an in-depth overview of the CIPR event on Commercial Ride-Sharing and Car-Sharing Issues that took place on Aug. 16, 2014. Com-mercial ride-sharing companies such as Uber and Ly have increasingly gained in popularity over the past few years as a new op on in the public transporta on market. They now operate in dozens of U.S. ci es and interna onal countries. However, while these emerging business models bring new opportuni es, they also raise some new insurance-related ques ons. The NAIC recently formed the Sharing Economy (C) Working Group to iden fy transporta on-sharing issues. CIPR Manager Nikki Hall takes us down memory lane with an ar cle that provides a historical background on how the NAIC was integral in the forma on of the Interna onal As-

A D Eric Nordman, CPCU, CIE, is the director of the NAIC Regulatory Services Division and the CIPR. He directs the Regulatory Services Division staff in a wide range of insurance research, financial and market regulatory ac vi es, suppor ng NAIC commi ees, task forces and working groups. He has been with the NAIC since 1991. Prior to his ap-

pointment as director of the Regulatory Services Division, Nordman was director of the Research Division and, before that, the NAIC senior regulatory specialist. Before joining the NAIC, he was with the Michigan Insurance Bureau for 13 years. Nordman earned a bachelor’s degree in mathema cs from Michigan State University. He is a member of the CPCU Society and the Insurance Regulatory Examiners Society.

socia on of Insurance Supervisors (IAIS). As early as 1985, the NAIC took steps to sponsor an Interna onal Confer-ence of Insurance Regulatory Officials, which was essen-

ally the origin of the IAIS. The NAIC also served as Secre-tariat of the IAIS for the first two years a er it was incor-porated, which included providing the seed money, ini al staffing and office resources for the IAIS. The growth and achievement of the IAIS over the past 20 years have been significant and the NAIC is extremely proud to be a found-ing member of the IAIS. The low interest rate environment, and the uncertainty surrounding the magnitude and pace of the an cipated rate increases, con nues to be an issue that keeps insur-ance execu ves up at night. In November 2014, the CIPR hosted an event tled Naviga ng Interest Rate Risk in the Life Insurance Industry. Research Analyst Dimitris Karapiperis provides a recap of the event and shares pre-liminary insights from a future CIPR study examining inter-est rate risk. We close with our data-at-a glance ar cle wri en by Re-search and Actuarial Manager Jennifer Gardner. This issue we feature an analysis of market concentra on and profit-ability for several property/casualty lines of business. I hope you enjoy this issue of the CIPR Newsle er. Your comments and sugges ons for improvement are always welcome. Eric Nordman CIPR Director

February 2015 | CIPR Newsle er 3

E R I 2015

By Monica Lindeen, NAIC President and Montana Commis-sioner of Securi es and Insurance I As I assume the Office of President of the NAIC, I am both humbled and challenged when I consider the wide range of issues state insurance regulators are facing. I first want to thank my regulatory colleagues for having faith in me to lead the organiza on this year. I will not let you down. I believe it was Benjamin Franklin who said, “If you fail to plan, you are planning to fail.” This quote is just as true to-day as it was in Colonial mes. Heeding Mr. Franklin’s ad-vice, the na on’s insurance commissioners gather early each year to plan how to address the daun ng challenges before us. I want to take this opportunity to share with you some of my thoughts on the key issues we will be facing together in 2015 and perhaps shed some light on recent accomplishments and what lies ahead. There are several issues I want to men on in this ar cle. I will add a word of cau on for issues not included. Lack of men on does not mean an issue is unimportant. Rather, the issues in this ar cle seem to be ones where extra em-phasis is warranted because of their mely nature and po-li cal forces around us. I plan to cover cybersecurity con-cerns; progress on implementa on of Principle-Based Re-serving (PBR) standards; progress on use of cap ves for life insurance reserves; con nued progress on implementa on of the Affordable Care Act (ACA); issues facing regulators related to the recent passage of the Na onal Associa on of Registered Agents and Brokers Reform Act (or NARAB II); and our rela ons with interna onal regulators. C Hardly a day goes by without hearing about another cyber-security breech. Some hacker will obtain confiden al per-sonal or financial informa on from a business who le a crack in their cyber-armor. If a company owns a computer, they are at risk. These data breeches can be very expensive for the businesses. Every business is at risk and digital a ack incidents have become more common, sophis cated and costly. Cyber risk is now widely acknowledged to be a significant emerging threat to businesses—it is no longer an informa on technology problem, but a CEO problem. For insurers the risk is compounded as, in addi on to man-aging their own cyber risks, some insurers accept cyber risk transfers and offer other cyber risk management services to American businesses. There are a number of possible expo-sures for businesses to address and insurers to cover. A short list includes: • Iden ty the ;

• Business interrup on; • Reputa onal risk; • Costs associated with data restora on or repair costs; • The of customer lists or trade secrets; • Hardware and so ware repair costs; • Costs of credit monitoring services for impacted con-

sumers; and • Li ga on costs. Most general liability policies do not cover cyber-risks, and cyber insurance policies are highly customized for each cli-ent in a new and rapidly evolving market that is es mated to reach $2 billion this year. The federal government has stepped up its scru ny of cy-bersecurity. This has led to increasing calls for legisla on and regula on for enhanced cybersecurity measures to address the numerous risks posed by a cyber-a ack. Effec-

ve laws and regula ons are important tools to protect the security and economic vitality of our na on. In 2013, President Obama issued Execu ve Order 13636, “Improving Cri cal Infrastructure Cybersecurity,” tasking the Na onal Ins tute of Standards and Technology (NIST) with developing best prac ces for managing cyber risks. In Febru-ary 2014, the NIST released a new framework for improving cri cal infrastructure cybersecurity. The framework provides a structure of standards, guidelines and prac ces to aid or-ganiza ons, regulators and customers with cri cal infra-structures in effec vely managing their cyber risks. The pre-viously released Execu ve Order pushes federal agencies to assess whether and how exis ng cybersecurity regula on could be streamlined and be er aligned with the NIST Cy-bersecurity Framework. With the con nued emergence of this area, I thought it expedi ous to appoint a single task force to serve as the coordina ng body for the NAIC cybersecurity effort. I have asked Commissioner Adam Hamm (ND) to lead the Cyberse-curity (EX) Task Force with the able assistance of Director Ray Farmer (SC) as his vice chair. The NAIC Execu ve Com-mi ee has adopted some rather broad charges for the group. The Commi ee asked the Task Force to: • Monitor cybersecurity developments; • Keep the Execu ve Commi ee informed on cybersecu-

rity issues and make recommenda ons as may be ap-propriate;

• Coordinate ac vi es with NAIC standing commi ees regarding cybersecurity issues;

• Represent the NAIC and communicate with other en -(Continued on page 4)


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es/groups, including the sharing of informa on as may be appropriate, on cybersecurity issues; and

• Perform such other tasks as may be assigned by the Ex-ecu ve Commi ee rela ng to the area of cybersecurity.

Among the several tasks the Task Force expects to complete in 2015 are: • Dra ing of guiding principles for regula on of cyberse-

curity; • Gathering informa on about state and NAIC best prac-

ces in cyber risk management; • Recommending updates to the Financial Condi on Ex-

aminers Handbook and the Market Regula on Hand-book to implement best prac ces in cybersecurity over-sight;

• Developing a supplement to the Annual Statement to collect informa on about cyber insurance markets. I expect we will collect informa on about the number and types of policies wri en, the associated premium and loss informa on and market trends. The goal is to get a handle on which insurers are wri ng cybersecuri-ty business and evaluate whether this business pre-sents any solvency risks to the insurers;

• Dra ing a Consumer Bill of Rights to allow consumer to take steps to monitor their financial informa on and do what they can to prevent or iden fy on a mely basis when their financial or health informa on has been compromised. The insurer has an obliga on to let peo-ple know as soon as possible that their informa on is at risk. The proposed Consumer Bill of Rights would con-tain the informa on about what the insurer intends to do to assist cyber vic ms and explain the consumer’s rights; and

• Working collabora vely with other state and federal regulatory counterparts to share informa on and best prac ces with respect to cybersecurity.

An important role Commissioner Hamm will serve is being the face of insurance regula on with our federal counter-parts. There are two groups where there is much interface. The first is the Financial and Banking Informa on Infrastruc-ture Commi ee (FBIIC). The FBIIC is chartered under the President’s Working Group on Financial Markets, and is charged with improving coordina on and communica on among financial regulators, enhancing the resiliency of the financial sector, and promo ng the public/private partner-ship. Treasury’s Assistant Secretary for Financial Ins tu ons chairs the commi ee. The NAIC has long been a member of this group. It works with cyber risks and natural disasters. The Cybersecurity Forum for Independent and Execu ve Branch Regulators (known as the Forum) is another organi-za on of state and federal regulators. The Forum member-

ship is much broader than the FBIIC. It is led by the Nuclear Regulatory Commission and includes a number of state and federal agencies including the Coast Guard, the U.S. Depart-ment of Health and Human Services (HHS), Homeland Secu-rity, Transporta on, the Treasury, the Federal Avia on Ad-ministra on, the U.S. Securi es and Exchange Commission and many others. The purpose of the voluntary Forum is to increase the overall effec veness and consistency of regula-tory authori es’ cybersecurity efforts pertaining to U.S. cri -cal infrastructure. The Forum is essen ally a communica on and informa on sharing body. Another group conduc ng important cybersecurity work is the Financial Services Informa on Sharing and Analysis Cen-ter or FS-ISAC. The FS-ISAC is a global financial industry re-source for cyber and physical threat intelligence analysis and sharing. The FS-ISAC was created by and for its members and operates as a member-owned non-profit en ty. It was launched in 1999 by the financial services sector in response to a Presiden al Direc ve manda ng the public and private sectors share informa on about physical and cyber security threats and vulnerabili es to help protect the U.S. cri cal infrastructure. The FS-ISAC has developed a Cri cal Infra-structure No fica on System allowing the FS-ISAC to send security alerts to mul ple recipients around the globe near-simultaneously while providing for user authen ca on and delivery confirma on. Joining the FS-ISAC is one of the best ways financial services firms can do their part to protect the industry and its vital role in cri cal infrastructure. I believe it is important for all insurers to par cipate in FS-ISAC. P -B R Insurance regulators have long been discussing the possibil-ity of modernizing the approach to how best to account for life insurance reserves. The current method relies on a pro-scrip ve formulaic approach many consider to be less than op mal for a number of reasons. The primary reason is the approach does not recognize specific company coverage and underwri ng nuances and, therefore, is either over-sta ng or understa ng necessary reserves to support the policies being wri en. The Principle-Based Reserves Implementa on (EX) Task Force (PBR Task Force) serves as the coordina ng body for all projects related to the Principle-Based Reserves ini a ve for life and health policies. In 2013, the PBR Task Force adopted the Principle-Based Reserving (PBR) Implementa-

on Plan. The Plan is currently being updated and will be discussed at the upcoming NAIC 2015 Spring Na onal Mee ng. The implementa on plan provides a framework for implementa on and is a working document to be modi-fied as necessary to meet the challenges ahead.

(Continued on page 5)


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State Legislatures are considering whether to adopt two NAIC model laws implemen ng the legal framework needed to make PBR a reality. The two models are the Standard Valua on Law (#820) and the Standard Nonforfeiture Law for Life Insurance (#808). For PBR to become effec ve the two models need to be adopted by 42 states represen ng at least 75% of applicable premium. To date, 20 states have adopted the revised model laws. There are two main issues the PBR Task Force will be ad-dressing in the near future. One pressing issue is to define what the term “substan ally similar” means when it comes to the model laws adopted by the legislatures. Some legis-latures have deviated from the model language by adop ng small insurer exemp ons and imposing PBR standards retroac vely. A second issue is whether a “small company exemp on” should be implemented and, if so, the scope of the exemp-

on. Should they be exempt from applica on of the Valua-on Manual or exempt from having to perform other ex-

emp on tests? At present, numerous exemp ons are al-ready adopted in the Valua on Manual to exclude products with lower risk. However, small insurers are encouraging legislatures to implement premium-based exemp ons into the Standard Valua on Law. The PBR Task Force is currently considering a proposal to exempt some insurers from having to perform exemp on tests when the insurer’s premium size is below a yet-to-be specified limit. The current proposal would exempt compa-nies with the lower premium, but with caveats about risk. For example, the risk-based capital (RBC) score must be greater than 450%. Regulators recognize a different skill set is needed for evalu-a on of the reserves set by insurers under a PBR frame-work. They also recognize the informa on needed by regu-lators to evaluate insurer reserves must be enhanced. Working toward the issue of skills, the PBR Review (EX) Working Group is coordina ng the development of financial analysis, examina on and actuarial review procedures and evalua ng insurance department and NAIC actuarial staff resource requirements. It is likely the states and the NAIC will need to add highly-skilled staff to be prepared to evalu-ate insurer reserves in the future. It is an cipated changes will be needed to the Life Annual Statement. The PBR Blanks (EX) Subgroup has created a set of proposed Annual Statement PBR blanks changes and a VM-20 PBR Reserve Supplement. There is a data collec on template for repor ng of insurer modeling and modeling assump ons. NAIC staff has begun the process of research-ing the costs of purchasing modeling so ware to be used by

NAIC staff in assis ng states with examina ons of insurer PBR reserve calcula ons. Implementa on of PBR will require insurance regulators to work collabora vely to oversee insurers. Peer and quality reviews of PBR will be conducted by a new Valua on Analy-sis (E) Working Group (VAWG). The VAWG will operate in a manner similar to the Financial Analysis (E) Working Group, working collabora vely with other state insurance regula-tors, responding to issues and ques ons, and recommend-ing PBR requirements and interpreta ons. Charges and op-era ng procedures for the VAWG have been developed and exposed for regulatory comment. Comments have been received and are being compiled for discussion on a confer-ence call. Policy-level data repor ng to a sta s cal agent is required in Model #820. The PBR Task Force is currently discussing the crea on of a Company Experience Repor ng Framework. The first dra of the Company Experience Repor ng Frame-work includes the selec on of a sta s cal agent by an NAIC commi ee; three to five states contrac ng with that sta s -cal agent; housing of experience data and industry tables at the NAIC to facilitate sharing with the states; crea on of confiden ality agreements with the NAIC as needed; and considera on of all life insurers sharing in the data-repor ng expense. Educa on and training for state insurance regulators is cur-rently being developed. Last year, an introductory PBR webi-nar was conducted and is available on demand through the NAIC Educa on and Training Department.1 Another webinar will be conducted this year regarding the new Actuarial Guideline XLVIII (AG48) and use of PBR calcula ons to deter-mine the level of primary securi es for a company. A PBR-related company survey is also being conducted to bring awareness to PBR and gather informa on about companies’ preparedness and expected impact of PBR. I am hopeful regulators and insurers will reach common ground on many of these implementa on ma ers in 2015. The interests of consumers are well served when a financial-ly sound insurance industry deploys its capital in an efficient, yet conserva ve manner. I believe we will have the neces-sary building blocks in place to accomplish the task. C Another issue related to the life insurance industry is what many believe is a work-around to avoid the applica on of very conserva ve statutory accoun ng provisions to re-serves for certain products. The use by life insurers to fi-

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for-life-products/event-summary-6f16036062244a4293d66940dbb5814c.aspx


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nance XXX2 and AXXX3 reserves has been a significant and conten ous issue in recent years. Life insurers have increas-ingly turned to cap ves to “finance” purported reserve re-dundancies associated with requirements under Regula on XXX and AXXX. The generally agreed-upon solu on to this issue is to move from a rule-based approach to a principle-based approach. The implementa on of principle-based reserving (PBR) should curtail the need for life insurers to create new cap ves and special purpose vehicles (SPVs) to address these perceived reserving redundancies. More recently, insurers are reques ng, and regulators are gran ng, transac ons allowing insurers to receive per-mi ed accoun ng prac ces without having to disclose the impact. This is achieved by ceding to a cap ve because cap-

ves are subject to different state laws and are currently exempted from the NAIC Accredita on program.4 Thus, each cap ve reinsurance agreement can receive different accoun ng treatment, and the results are not always dis-closed in public statutory financial statements since cap ve financial statements are usually confiden al. The result of this accoun ng and regulatory arbitrage is to complicate state insurance regulators’ ability to efficiently and effec-

vely regulate insurers and the broader insurance market. It is for these very reasons the NAIC did an extensive study on the impacts of cap ve reinsurance transac ons and is-sued the Cap ves and Special Purpose Vehicles White Paper in 2012. The results of the White Paper iden fied XXX/AXXX cap ve reinsurance transac ons as the first item to address. A XXX/AXXX Reinsurance Framework was adopted in con-cept by the NAIC in August 2014, and several of the concep-tual components have been constructed and implemented. Moreover, as you may be aware there has been some me-dia coverage highligh ng concerns with cap ve reinsur-ance. In addi on, the 2014 Financial Stability Oversight Council (FSOC) Annual Report iden fied variable annuity and long-term care cap ve transac ons as areas of par cu-lar concern in addi on to XXX/AXXX transac ons. In re-sponse, the Financial Regula on Standards and Accredita-

on (F) Commi ee is considering a change to the exis ng cap ve exclusion from the Accredita on program. This con-sidera on is currently focused on cap ve reinsurance trans-ac ons for XXX/AXXX, variable annuity and long-term care business. The NAIC has used Rector & Associates, Inc. (Rector) to help iden fy and mediate solu ons regarding XXX and AXXX cap-

ves and SPVs and to make recommenda ons regarding the poten al regulatory treatment of these transac ons. Rec-tor’s proposed XXX/AXXX Reinsurance Framework, which was adopted in concept by PBR Task Force and then the

Execu ve (EX) Commi ee at the 2014 Summer Na onal Mee ng, focuses on the ceding insurer’s ability to take cred-it for reinsurance. The ceding insurer will be allowed to take credit for reinsurance for the XXX/AXXX reinsurance transac-

on with a cap ve if: • The ceding insurer establishes the formulaic reserve in

full; • The ceding insurer sa sfies the Primary Security Re-

quirement—receives high quality assets as collateral in the amount calculated using the PBR-like Actuarial Method;

• Por ons of the full formulaic reserve exceeding the Primary Security Requirement may be collateralized by Other Security as defined;

• At least one party to the financing transac on holds an appropriate RBC “cushion” (as yet to be determined); and

• The reinsurance arrangement is approved by the ceding insurer’s domes c regulator.

The credit for reinsurance can only be modified through changes to the Credit for Reinsurance Model Law, and is thus, a longer-term solu on. In the mean me, the proposal includes a short-term solu on to use Actuarial Guideline XLVIII (AG48). AG48 was adopted with an effec ve date of January 15, 2015 and is included in the NAIC Accoun ng Prac ces and Procedures Manual. In adop ng AG48, the NAIC established na onal standards regarding XXX/AXXX cap ve reinsurance transac ons. This guidance includes regula on of the types of assets backing an insurer’s statu-tory reserve. AG48 takes effect in 2015. I am confident regulators can work through their differ-ences to implement a solu on fair to all. It is important to reach an equitable solu on for consumers, compe ng in-surers and regulators to have confidence the system is fair to all. As PBR is implemented, these differences should go away. In the mean me, the interim solu ons are necessary for a level playing field to be restored. As Rhode Island Su-perintendent Joe Tor said at a recent conference, our rep-uta ons are on the line. Regulators need to stop approving


2 Used to describe the actuarial reserves required to be held under the Valua on of Life Insurance Policies Model Regula on (#830), which is commonly referred to as Regula on XXX (or, more simply, XXX).

3 Used to describe the actuarial reserves required to be held under the Actuarial Guideline XXXVIII—The Applica on of the Valua on of Life Insurance Policies Mod-el Regula on (AG 38), which is commonly referred to as AXXX.

4 Statutory Accoun ng presented in the NAIC Accoun ng Prac ces and Procedures Manual (AP&P Manual) is the baseline accoun ng requirement for insurers and provides for consistent financial statements and allows comparability of company results, an important issue for the analysis and examina on work performed by state insurance regulators. Requiring insurers to u lize the AP&P Manual is an Accredita on requirement.


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transac ons that circumvent NAIC standards which we all agreed upon. To do otherwise jeopardizes our credibility and reputa on. A C A I It seems long ago when the federal Pa ent Protec on and Affordable Care Act (PPACA) along with the Health Care and Educa on Reconcilia on Act of 2010 (jointly referred to as the Affordable Care Act―ACA) was enacted thus making significant changes to the U.S. health insurance system. Yet the calendar says it was only five years. While much pro-gress has been accomplished on the implementa on of the ACA since the law was enacted, there is s ll a lot of work le . There are numerous NAIC commi ees, working groups and subgroups— 15 in all— currently addressing the cri cal responsibili es the law specifically assigned to the NAIC, such as development of the medical loss ra o (MLR) formu-la, consumer informa on and a consulta ve role on market reforms, health insurance exchanges, risk- sharing mecha-nisms and rate review standards. Last year, the NAIC membership met with President Obama, along with then-Health and Human Services Secretary Kath-leen Sebelius, the Centers for Medicare and Medicaid Ser-vices (CMS) Administrator Marilyn Tavenner and other high-level federal officials at the White House. The mee ng was an opportunity to advance our dialogue with the Administra-

on on a number of cri cal issues including network adequa-cy, essen al health benefits for 2016 and effec ve oversight of the ac vi es of navigators and assisters. State regulators are commi ed to coordina ng with the CMS and the Center for Consumer Informa on and Insurance Oversight (CCIIO) to ensure health reform implementa on grants the states necessary flexibility to protect consumers and safeguard stable and compe ve insurance markets. This year, under the able leadership of New Hampshire In-surance Commissioner Roger Sevigny, the Health Insurance and Managed Care (B) Commi ee will be working of a num-ber of topics, including: updates to Frequently Asked Ques-

ons (FAQs) and changes to the Summary of Benefits and Coverage and the Glossary; a white paper addressing the poten al issues related to self-insurance using stop-loss cov-erage; another white paper on the oversight of navigators, producers and assisters; work on rate and affordability and disclosure issues in the long-term care insurance market; and modifica ons to SERFF to improve usability for issuers uploading templates and a report to assist in making the status of plan transfers more transparent for regulators. Although the ACA has been on the books for a while, there remain a number of issues to resolve. I look forward to working with the NAIC membership to take on the chal-

lenge. People’s views on the ACA remain divided, but insur-ance regulators are united in their resolve to get the job done in an apoli cal manner. NARAB II In 1999, the enactment of the Gramm-Leach-Bliley Act (GLBA) sought to streamline non-resident licensing for insur-ance agents and brokers (producers) by requiring the states to enact certain reforms in the insurance producer-licensing process. A requisite number of states had to achieve either reciprocity or uniformity in non-resident producer licensing otherwise the Na onal Associa on of Registered Agents and Brokers (NARAB) would have been created. State enact-ments of producer licensing reciprocity laws based on the NAIC Producer Licensing Model Act forestalled the crea on of NARAB at the me. However, while much progress has been made over the years to improve uniformity and streamline non-resident producer licensing, not all states became reciprocal, inhib-i ng the implementa on of na onal licensing reciprocity. As a result, several insurance producer trade associa ons pro-moted a modified version of the original NARAB proposal: the Na onal Associa on of Registered Agents and Brokers Reform Act (or, “NARAB II,” as it was commonly called). Congress enacted NARAB II and President Obama signed the legisla on on January 12, 2015. It was a ached to the re-newal of the Terrorism Risk Insurance Program. We have long supported NARAB II, which is intended to streamline the non-resident producer licensing process while ensuring policyholders are well protected. NARAB II preserves the states’ ability to protect consumers and regu-late producer conduct—it does not create a federal regula-tor but establishes a non-profit corpora on, known as NARAB, controlled by its Board of Directors. NARAB is to be governed by a 13-member board comprised of eight state insurance commissioners and five insurance industry repre-senta ves subject to Presiden al appointment and Senate confirma on. Ac ng through its board, NARAB will establish membership criteria for producers to obtain non-resident authority to sell, solicit or nego ate insurance (and perform incidental ac vi-

es) in any state for which producer pays that state’s licens-ing fee for any line(s) of insurance for which the producer is licensed in the home state. NARAB membership is not man-datory for producers. The law preserves the rights of a state pertaining to resident licensing and con nuing educa on, supervision and enforcement of conduct, and disciplinary ac ons for nonresident producers, and leaves intact a state’s full range of authori es for resident producers. The act also



E R I 2015 (C )

includes important disclosures to the states, addresses busi-ness en ty licensing, and protects state revenues. As with any change, implementa on of NARAB II will be chal-lenging. As one of my key ini a ves, I am commi ed to work-ing with NAIC members and the Na onal Insurance Producer Registry Board of Directors to implement a cost-effec ve and efficient improvement to our regulatory processes. This oper-a onal efficiency allows us to preserve state oversight of im-portant consumer protec ons related to the sale of insur-ance products in our jurisdic ons. It also provides regulators with a supermajority of members on the NARAB II board. I There are two interna onal developments that are key con-cerns this year—a covered agreement and group capital standards. Both of these issues have garnered considerable discussion lately and con nue to play a prominent role in interna onal discussions. Covered Agreement The no on of a covered agreement was included in Title V of the Dodd-Frank Wall Street Reform and Consumer Pro-tec on Act (Dodd-Frank Act) as a unique stand-by authority for Treasury and the United States Trade Representa ve (USTR) to address, if necessary, those areas where U.S. state insurance laws or regula ons treat non-U.S. insurers differently than U.S. insurers. A covered agreement can serve as a basis for preemp on of state law under certain circumstances.5 Historically, in the area of reinsurance collateral, U.S. insur-ance regulators have required non-U.S. reinsurers to hold 100% collateral within the U.S. for the risks they assume from U.S. insurers. As reinsurers are ul mately providing security to insurance companies that are directly protec ng U.S. policyholders, requiring reinsurers to hold collateral in the U.S. is intended to ensure claims-paying capital is availa-ble and reachable by U.S. firms and regulators should it be needed, par cularly in the wake of a natural disaster. For-eign reinsurers’ regulators and poli cians have objected to their insurers having to post collateral in the U.S. because this makes such capital unavailable for other purposes, in-cluding investment opportuni es. Recognizing the poten al for varia on in collateral require-ments across states makes planning for collateral liability more uncertain and thus poten ally more expensive. State regulators have been working together through the NAIC to reduce collateral requirements in a consistent manner com-mensurate with the financial strength of the reinsurer and the quality of the regulatory regime that oversees it. In 2011 the NAIC passed amendments to its “Credit for Rein-

surance Models” that once implemented by a state, will allow foreign reinsurers to post significantly less than 100% collateral for U.S. claims, provided the reinsurer is evaluated and cer fied. Individual reinsurers are cer fied based on criteria that include, but are not limited to, financial strength, mely claims payment history, and the require-ment a reinsurer be domiciled and licensed in a qualified jurisdic on. The NAIC has established a comprehensive process for eval-ua ng a jurisdic ons’ oversight of reinsurers in order to de-termine whether it is a jurisdic on for purposes of reduced collateral. As of January 1, 2015, Bermuda, France, Germa-ny, Ireland, Japan, Switzerland, and the U.K. have been placed on the NAIC List of Qualified Jurisdic ons. The NAIC has also established a peer review system surrounding the cer fica on of foreign reinsurers by states, which provides a foreign reinsurer an opportunity for a passport throughout the U.S. To date, 26 foreign reinsurers have been cer fied under this peer review system. In light of the progress made by the NAIC and the states to modernize credit for reinsurance rules, I am not convinced a covered agreement for reinsurance collateral is necessary. To date, 25 states have passed legisla on, represen ng 60% of direct U.S. premium, to implement the revised NAIC Credit for Reinsurance Models and an addi onal 12 states have indicated their plans to do so in the coming months, which would raise the total market coverage to 93%. If this provi-sion becomes an accredita on standard, the states will have accomplished what the covered agreement purports to do. Group Capital The severity of the 2008 global financial crisis underscored the interconnected nature of financial ins tu ons, as well as the risks they pose to the financial system when they are in distress. While the insurance industry was not the root cause of the financial crisis, insurance markets have become increasingly global and interconnected, and ac vi es they engage in have become increasingly ed to financial mar-kets. The Financial Stability Board (FSB) was established in 2009 to coordinate at the interna onal level the work of na onal financial supervisors and interna onal standard se ng bodies and to develop and promote the implementa-

on of effec ve regulatory, supervisory and other financial sector policies in the interest of financial stability.


5 A covered agreement is nego ated jointly by the U.S. Treasury’s Federal Insurance Office (FIO) and the USTR with foreign authori es and can only enter into force if the FIO and USTR follow the submission and layover provisions of Title V of the Dodd-Frank Act, which require the FIO and USTR to jointly submit the agreement to the House Financial Services, House Ways and Means, Senate Banking, and Senate Finance commi ees on a day the House and Senate are in session and wait for a period of 90 days to elapse.


E R I 2015 (C )

A A

However, recent interna onal developments, including the determina on that certain insurers are systemically risky and that capital standards similar to those applied to banks are needed for insurers, has increased concern over inter-na onal organiza ons seeking more prescrip ve regula on worldwide. At the direc on of the FSB, the Interna onal Associa on of Insurance Supervisors (IAIS) has moved rapid-ly to develop basic capital requirements (BCR) to serve as a basis for applying higher loss absorbency (HLA) capital measures (capital buffers). This effort is part of the policy measures recommended for applica on to global systemi-cally important insurers (G-SIIs). A BCR was approved at the end of last year and the IAIS is now focusing on developing a methodology to determine the HLA capital requirements this year, with implementa-

on expected by 2019. In addi on, the IAIS is currently de-veloping a risk-based global insurance capital standard (ICS) to apply to all interna onally ac ve insurance groups (IAIGs) and plans to have a proposal by the end of 2016. Implemen-ta on would begin in 2019, a er tes ng and refinement by the IAIS in consulta on with insurance supervisors and IAIGs in the interim period. I would like to point out we are extensively engaged in the IAIS capital standards development process. The ComFrame Development and Analysis (G) Working Group (CDAWG) has been mee ng on a regular basis since its forma on last year to discuss the IAIS capital ini a ves and is in the process of gathering feedback from regulators on the ques ons posed in the consulta on document. Addi onally, several mee ngs have taken place between the NAIC, Federal Reserve and Treasury, as well as with stakeholders to advance the discus-sion and develop a U.S. perspec ve. With respect to the HLA, it is expected the CDAWG, as well as the NAIC Financial Stability (EX) Task Force, will consider the proposed method-ology to determine an appropriate HLA once the IAIS releas-es its consulta on document in June of this year. U.S. insurance regulators recognize the IAIS is determined to pursue the development of global insurance capital standards on a fast-track basis, despite the significant chal-lenges to translate fundamentally different regulatory and accoun ng systems in order to achieve some form of com-mon measurement of group capital adequacy. We con nue to work construc vely within the IAIS process to advocate for capital standards that are reasonable in their applica-

on, compa ble with our system, and prac cal for all juris-dic ons. Standards used for banking regula on are not ap-propriate for the insurance sector; standards for insurers should be designed to reflect the insurance business model. If the IAIS recommends excessive or inflexible capital stand-ards, then they would not likely be implemented broadly

Monica Lindeen was elected Commissioner of Securi es and Insurance, Montana State Auditor in 2008 and re-elected to a second term in November 2012. Lindeen makes it her mission to protect Montana's securi es and insurance consumers through educa-

on, fairness, and transparency. During Lindeen’s tenure, her office has returned more than $374 million to investors and

insurance consumers and fielded tens of thousands of phone calls from Montanans struggling with their insurance companies. Lindeen also received the Excellence in Consumer Advocacy Award, presented by the NAIC’s Consumer Representa ves, in 2013. She received the honor in recogni on for her work as a strong voice for consumer protec on and her dedica on in main-taining states’ rights in insurance Lindeen began her career in public service represen ng a rural district in the Montana House of Representa ves. Due to her hard work in the legislature, she earned a reputa on as a common-sense moderate who could get things done. She quickly became a leader in the House and served four terms (1999-2006). Lindeen earned a bachelor's degree in educa on, specializing in English and history. She completed graduate coursework in educa onal founda ons at MSU-Billings.

worldwide, par cularly if they would increase costs on in-surers and consumers, reduce the availability of long-term products, and curtail long-term investment. I am commi ed to con nuing our work with the IAIS, but stand ready to oppose IAIS proposals that will not work un-der the U.S. regulatory framework. The IAIS must realize insurance regula on cannot be a one-size-fits-all proposal. What works in mature markets might not work in emerging markets. Instead of the IAIS a emp ng to dictate how the world must work, I will encourage a more though ul ap-proach of mutual recogni on. Not every country chooses to have a single na on regulator covering all financial services firms. Choosing to measure jurisdic ons on an outcome basis rather than structure provides the flexibility necessary to navigate our modern world. C As you can plainly see, 2015 will be a busy year. Cybersecu-rity threats combined with several other regulatory issues will keep us busy. I am hopeful we can all work together to promote compe ve insurance markets to serve insurance consumers. Insurance regula on is a noble calling. With your help, I hope insurance regulators can leave the world a be er place from our efforts.


A O F A C A 3R (R , R C , R A P )

By Eric King, NAIC Health Actuary I One of the primary goals of the health care reforms adopt-ed under the federal Pa ent Protec on and Affordable Care Act (PPACA), along with the Health Care and Educa on Rec-oncilia on Act of 2010 (jointly referred to as the Affordable Care Act―ACA) is to expand access to health care insurance coverage. The ACA includes various mechanisms to accom-plish this goal, including extending dependent care cover-age; requiring insurers to accept all applicants, regardless of any pre-exis ng condi ons; and the crea on of new state-based health insurance exchanges to help individuals and small businesses purchase insurance. However, the influx of previously uninsured individuals into the new health insur-ance exchanges could make it difficult for insurers to price plans accurately. To address these risks, the ACA contains three programs that are intended to stabilize policyholder premiums and mi gate risk that may occur due to ACA insurance market reforms for certain segments of the U.S. major medical in-surance market. These are the Transi onal Reinsurance Program, the Temporary Risk Corridors Program and the Permanent Risk Adjustment Program. Collec vely, these three programs are o en referred to as the 3Rs. The 3Rs play a fundamental role in crea ng a viable health market for consumers. They are designed to lessen the fi-nancial risk health insurers and exchanges will face when enrolling addi onal individuals and small groups. Together, these interconnected programs aim to protect health insur-ance companies against unpredictable losses or unmanage-able risk selec on, and to keep consumers’ premiums from spiraling out of control in the early years of the law’s cover-age provisions. This ar cle provides an overview of the ACA’s 3Rs. T R P The ACA establishes a temporary reinsurance fund that will compensate plans when they have enrollees with especially high claims. The goal of the Transi onal Reinsurance Pro-gram is to stabilize premiums during the ini al years of the individual market by offse ng the expenses of high-cost individuals. The Transi onal Reinsurance Program is described in Sec-

on 1341 of the ACA. This sec on s pulates that such a program must be established in order to provide reinsur-ance protec on to insurers that sell non-grandfathered (issued a er March 24, 2010) individual market major medi-

cal insurance plans. The program will only be in effect for plan years 2014, 2015 and 2016. It is funded with contribu-

ons from major medical insurers in all three (individual, small group and large group) markets, as well as contribu-

ons from self-insured group health plans. The ACA estab-lishes the total amount to be collected ($12 billion in 2014; $8 billion in 2015; and $5 billion in 2016) and distributed ($10 billion in 2014; $6 billion in 2015; and $4 billion in 2016) each year. The contribu on amount is then set annu-ally by the United States Department of Health and Human Services (HHS), and is currently $44 per member per year for policies covering the 2015 plan year. Payments are made from the program to qualified individual major medical market plans that have individual claimants with claim amounts for the given plan year that are be-tween a specified a achment point and reinsurance cap, and the payments for claims between the a achment point and cap are subject to a specified coinsurance rate. The pay-ment parameters for the 2015 plan year are as follows: $70,000 a achment point; $250,000 reinsurance cap; and 50% coinsurance. The payment parameters are subject to change by HHS for the 2016 plan year. The dra proposal for 2016 can be found at the U.S. Government Publishing Office website.1 T R C P The Temporary Risk Corridors Program is designed to mi -gate against pricing uncertainty. Health plans with unusually high claims and administra ve costs will receive payments from this program, while health plans with unusually low claims and administra ve costs will make payments into this program. The Temporary Risk Corridors Program is described in Sec-

on 1342 of the ACA. This sec on directs the Secretary of the HHS to establish and administer a risk corridors program for Qualified Health Plans2 (QHPs) in the individual and small


1 www.gpo.gov/fdsys/pkg/FR-2014-11-26/pdf/2014-27858.pdf. 2 A Qualified Health Plan is defined in Sec on 1301 of the ACA as follows: (a) QUALI-

FIED HEALTH PLAN—In this tle: (1) IN GENERAL.—The term ‘‘qualified health plan’’ means a health plan that—(A) has in effect a cer fica on (which may include a seal or other indica on of approval) that such plan meets the criteria for cer fica on described in sec on 1311(c) issued or recognized by each Exchange through which such plan is offered; (B) provides the essen al health benefits package described in sec on 1302(a); and (C) is offered by a health insurance issuer that—(i) is licensed and in good standing to offer health insurance coverage in each State in which such issuer offers health insurance coverage under this tle; (ii) agrees to offer at least one qualified health plan in the silver level and at least one plan in the gold level in each such Exchange; (iii) agrees to charge the same premium rate for each qualified health plan of the issuer without regard to whether the plan is offered through an Exchange or whether the plan is offered directly from the issuer or through an agent; and (iv) complies with the regula ons developed by the Secretary under sec on 1311(d) and such other requirements as an applicable Exchange may establish.


A O F A C A 3R (C )

Example 2 – Actual Allowable Costs Greater than 108% of Target Amount AAC = $120 Ra o of AAC to TA = $120/$100 = 120% Payment to QHP from program = 2.5% of TA, plus 80% of AAC in excess of 108% of TA = (2.5% x $100) + 80% x [$120 – (108% x $100)] = $2.50 + 80% x [$120 - $108] = $2.50 + $9.60 = $12.10 Example 3 – Actual Allowable Costs Less than 97% of Target Amount, but Greater than or Equal to 92% of Target Amount AAC = $96 Ra o of AAC to TA = $96/$100 = 96% Payment from QHP to program = 50% of difference be-tween 97% of TA and AAC = 50% x [(97% x $100) - $96] = 50% x [$97 - $96] = $0.50 Example 4 – Actual Allowable Costs Less than 92% of Target Amount AAC = $89 Ra o of AAC to TA = $89/$100 = 89% Payment from QHP to program = 2.5% of TA, plus 80% of difference between 92% of TA and AAC = (2.5% x $100) + 80% x [(92% x $100) - $89] = $2.50 + 80% x [$92 - $89] = $4.90


group markets. Its intent is to mi gate the risk of errors in QHP rate se ng by providing a mechanism for insurers to share gains and losses above or below a specified corridor. The program will only be in effect for plan years 2014, 2015 and 2016. The risk corridor calcula on is performed at the QHP level, and it compares each QHP’s actual allowable costs (essen ally, claims costs) to its target amount (premiums less administra ve costs). If this ra o is below specified corridor percentages, the QHP pays into the program, and if the ra o is above specified corridor percentages, the QHP receives funds from the program. The risk corridor percent-ages and payment calcula ons are shown below in Figure 1. Some examples follow that may help to understand the mechanics of the risk corridor calcula on. Assume the tar-get amount for each of these examples is $100. AAC = actu-al allowable costs, and TA = target amount. Example 1 – Actual Allowable Costs Greater than 103% of Target Amount, but Less than or Equal to 108% of Target Amount AAC = $105 Ra o of AAC to TA = $105/$100 = 105% Payment to QHP from program = 50% of AAC in excess of 103% of TA = 50% x [$105 - (103% x $100)] = 50% x [$105 - $103] = $1

F 1: R A A C T A

Greater than 103%, but Less than or Equal to 108%

Greater than 108% Less than 97%, but

Greater than or Equal to 92%

Less than 92%

Payment from QHP to Program

50% of Difference be-tween 97% of Target Amount and Actual

Allowable Costs

2.5% of Target Amount, Plus 80% of Difference Between 92% of Target

Amount and Actual Allow-able Costs

Payment to QHP from Program

50% of Actual Allow-able Costs in Excess of 103% of Target

Amount

2.5% of Target Amount, Plus 80% of

Actual Allowable Costs in Excess of 108% of

Target Amount


A O F A C A 3R (C )

The ACA regula ons assume the Temporary Risk Corridors Program will be budget-neutral; payments to the program from QHPs will equal payments to QHPs from the program. P R A P The ACA’s Permanent Risk Adjustment Program is designed to spread risk among health plans to balance the adverse selec on3 some carriers will experience. Its intent is to mi -gate the effects of adverse selec on against health plans by transferring funds from plans that enroll lower-than-average risk members to plans that enroll higher-than-average risk members. The Permanent Risk Adjustment Program is described in Sec on 1343 of the ACA. This sec on directs the Secretary of the HHS, in consulta on with the states, to establish cri-teria and methods to carry out risk adjustment calcula ons for individual and small group market plans sold inside and outside the exchanges established in accordance with the ACA. The risk adjustment program for a state can be admin-istered by HHS or the state, if the state operates a state-based exchange. The HHS risk adjustment methodology uses a hierarchical condi on category (HCC) model to determine an insurance plan member’s risk score. Each member’s risk score begins as a base score that is determined using demographic data (age and gender), as well as the level of the member plan (bronze, silver, gold, pla num or catastrophic). It also uses a separate set of base scores for infants, children and adults. Concurrent claims data (claims data for the current plan year is used to calculate the current risk score) is used to group each member’s reported Interna onal Classifica on of Diseases, version 9 (ICD-9) codes present in claims data into HCC groups. Each of these groups maps to a value that is added to the base risk score to produce a final risk score.

The risk adjustment calcula on is performed at the market (individual vs. small group), plan and state level. For each state, plan and market combina on, the average risk score for all members in the given cell is calculated. If the insurer’s risk score for the cell is greater than the average cell risk score, payments are transferred from the risk adjustment program to the insurer. If the insurer’s risk score for the given cell is less than the average cell risk score, payments are transferred from the insurer to the risk adjustment pro-gram. The amounts transferred from insurers to the risk adjustment program for a given cell are designed to equal amounts transferred from the risk adjustment program to insurers for that cell. A I More informa on about the Transi onal Reinsurance Pro-gram, the Temporary Risk Corridors Program and the Per-manent Risk Adjustment Program can be found at the Cen-ter for Consumer Informa on and Insurance Oversight (CCIIO) website at: www.cms.gov/cciio/index.html.

A A

Eric King is the health actuary for the NAIC, where he provides support to the Health Actuarial (B) Task Force. Mr. King joined the NAIC in May 2010. Prior to joining the NAIC, he worked for several insurers in the areas of Medicare Advantage, Medicare Part D, individual major medical, Medicare supplement, and short- and long-term disability. Mr. King is a Fellow of the Society of Actuaries (SOA) and a member of the American Academy of Actuaries (Academy), and he holds a Bachelor of Science in applied mathema cs from Washington University in St. Louis.

3 Adverse selec on occurs when individuals who are most in need of health care are more likely to need and seek coverage, while low-risk individuals are more likely to opt out of coverage.


TRIA R … L L

was renewed twice (2005 and 2007). While the program reauthoriza ons occurred late in the year, neither me did the program authoriza on expire as they did when 2014 drew to a close. On Dec. 30 2014, a Treasury spokesperson had this to say about the Terrorism Risk Insurance Program, “The Terror-ism Risk Insurance Act is important to our na onal security and essen al for con nued economic growth. When Con-gress returns next year, we hope it acts swi ly to pass a long-term reauthoriza on consistent with the bipar san, bicameral TRIA (Terrorism Risk Insurance Act) compromise to maintain a func oning and affordable insurance market for terrorism risk. While we hope for a speedy renewal, un l Congress acts, Treasury will wind down the program consistent with its expira on.” It seems incredible one depar ng Senator (Tom Coburn (R-OK)) was able to prevent the enactment of a bill with such broad bipar san consensus. However, his par ng shot was to block the passage of the bill, not because he was op-posed to the Terrorism Risk Insurance Program, but rather he was opposed to Title Two dealing with the Na onal As-socia on of Registered Agents and Brokers (NARAB). When the new Congress convened, passage of the TRIA was top of the list for bipar san considera on. H.R. 26—The Terrorism Risk Insurance Program Reauthoriza on Act of 2015—passed the House of Representa ves by a vote of 416-5 on Jan. 7, 2015. The next day, the Senate voted 94-4 to adopt the bill. It went to President Obama’s desk where he signed it into law on Jan. 12, 2015. With the signing one would think everything was once again right with the world. However, there were some loose ends needing a en on. The revised Terrorism Risk Insurance Program does contain some changes. The following list iden fies several of the more important changes to the program: • The program was extended through Dec. 31, 2020. • The Insurer Deduc ble was set at 20% of an insurer’s

direct earned premium of the preceding calendar year and the federal share of compensa on was set at 85% of insured losses that exceed insurer deduc bles un l Jan. 1, 2016. Then the federal share is decreased by one percentage point per calendar year un l it reaches 80%.

• The cer fica on process was changed to requiring the Secretary of the Treasury to cer fy acts of terrorism in consulta on with the Secretary of Homeland Security instead of the Secretary of State.

• The program trigger was amended to apply to cer fied acts with insured losses exceeding $100 million for cal-endar year 2015, $120 million for calendar year 2016, $140 million for calendar year 2017, $160 million for


By Eric Nordman, Director of Regulatory Services and CIPR As I began to write this ar cle in early January, I was not sure what to make of the unbelievable poli cs ge ng in the way of implemen ng a prac cal and cost-effec ve solu on to address a major risk. I am talking about the failure to reauthorize the Terrorism Risk Insurance Program. As the ball dropped in Times Square, many businesses in the East-ern Time Zone experienced a significant change in insurance coverage for the risks they face. At the stroke of midnight the Terrorism Risk Insurance Program went away leaving many unsuspec ng businesses with a gap in their risk-management toolkit. Luckily, the dawn came without a major terrorist a ack so everything on the surface seemed bright. However, people quickly came to realize Congress was playing with fire by failing to renew the program. When the World Trade Center buildings collapsed on Sept. 11, 2001, the insurance indus-try’s perspec ve about the risk of loss from acts of terror-ism changed drama cally. It became apparent a deter-mined terrorist could cause substan al damage under the right circumstances. The defini on of substan al damage shi ed from millions of dollars to billions of dollars. A er the Twin Towers fell, the reac on of the insurance industry was predictable. They moved to limit their expo-sure to losses caused by terrorists. The na on’s airlines re-ceived no ces of cancella on within a week. Other business owners were soon to follow as the insurance industry tried to figure out what to do. State insurance regulators reacted to the looming coverage crisis by mee ng to discuss a common solu on. As a result of the conversa ons, an uneasy truce was reached. In De-cember 2001, the NAIC published a model bulle n for states to use to provide at least some level of terrorism coverage in light of Congressional failure to act at the me. The solu on outlined in the model bulle n provided for insurers to cover acts of terrorism as long as they did not reach a catastrophic level. For property insurance, the ex-clusion for acts of terrorism would only apply if the acts of terrorism resulted in industry-wide insurance losses in ex-cess of $25 million for related incidents occurring within a 72 hour period. Also allowed were exclusions for nuclear, biological, chemical or radiological events (NBCR). The al-lowed exclusion for commercial liability insurance was a bit more complicated. It kept the $25 million and 72 hour thresholds, but added an alterna ve of 50 or more people sustaining death or serious physical injury. In 2002, Congress reacted to the lack of a robust market for insuring acts of terrorism by crea ng the Terrorism Risk Insurance Program. The successful common sense program


TRIA R … L L (C )

calendar year 2018, $180 million for calendar year 2019, and $200 million for calendar year 2020 and any calendar year therea er.

• The mandatory recoupment of the federal share through policyholder surcharges increased to 140 per-cent from 133 percent.

• The insurance marketplace aggregate reten on amount was established at the lesser of $27.5 billion, increasing annually by $2 billion un l it equals $37.5 billion, and the aggregate amount of insured losses for the calendar year for all insurers. In the calendar year following the calendar year in which the marketplace reten on amount equals $37.5 billion, and beginning in calendar year 2020 it is revised to be the lesser of the annual average of the sum of insurer deduc bles for all insurers par cipa ng in the program for the prior three calendar years as such sum is determined by the Secretary of the Treasury by regula on.

• The Secretary of the Treasury is required, not later than nine months a er the date of enactment of the Act, to conduct and complete a study on the cer fica on pro-cess, including the establishment of a reasonable me-table by which the Secretary must make an accurate determina on on whether to cer fy an act as an act of terrorism.

• Insurers par cipa ng in the program are required to submit to the Secretary of the Treasury for a Congres-sional report to be submi ed June 30, 2016 and every June 30 therea er, informa on regarding insurance cov-erage for terrorism losses in order to evaluate the effec-

veness of the program. The informa on to be provided includes: lines of insurance with exposure to terrorism losses, premiums earned on coverage, geographical loca-

on of exposures, pricing of coverage, the take-up rate for coverage, the amount of private reinsurance for acts of terrorism purchased and such other ma ers as the Secretary considers appropriate. This informa on may be collected by a sta s cal aggregator and in coordina-

on with State insurance regulatory authori es. • The Comptroller General of the United States is re-

quired to complete a study on the viability and effects of the federal government assessing and collec ng up-front premiums and crea ng a capital reserve fund.

• The Secretary of the Treasury is required to conduct a study not later than June 30, 2017 and every June 30 therea er to iden fy compe ve challenges small in-surers face in the terrorism risk insurance marketplace.

• The Secretary of the Treasury is required to appoint an Advisory Commi ee on Risk-Sharing Mechanisms to provide advice, recommenda ons and encouragement with respect to the crea on and development of non-governmental risk-sharing mechanisms. The Advisory Commi ee will be composed of nine members who are

directors, officers, or other employees of insurers, reinsurers or capital market par cipants.

• The terms “program year” and “transi on period” are changed to “calendar year” throughout the law.

Insurance regulators tracked the progress of H.R. 26 as it was being considered and issued a model bulle n for reg-ulators to communicate a consistent message to insurers about changes to the program and steps needed for insur-ers to comply with disclosure no ces and changes to poli-cy forms. On Feb. 4, 2015, the Treasury published interim guidance concerning the Act. The interim guidance helped calm frayed nerves. It provided an extension of the deadline for providing disclosures and offers of coverage to Apr. 13, 2015. This allowed insurers some breathing room to com-ply with the requirements in the Act. The Treasury also advised the model disclosures in the NAIC Model Bulle n are consistent with the disclosure requirements of the Terrorism Risk Insurance Program. The Treasury provided addi onal guidance to assist insurers with understanding the changes made to eliminate the required disclosure at

me of purchase and what to do under various coverage and offer scenarios. With the legisla on on the books, insurers are working through the backlog of pending disclosures, offers and explana ons to policyholders. Next on the horizon is working with various federal agencies on studies of sever-al topics. Included on the list are: the study of the cer fi-ca on process by the Treasury; the collec on of data to evaluate the effec veness of the program; conduc ng a study on the viability of collec ng upfront premiums and crea ng a capital reserve fund; and conduc ng a study on compe ve challenges small insurers face in the terrorism risk insurance marketplace. As you can see, there is much work before us.

A D Eric Nordman, CPCU, CIE, is the director of the NAIC Regulatory Services Division and the CIPR. He directs the Regulatory Services Division staff in a wide range of insurance research, financial and market regulatory ac vi es, suppor ng NAIC commi ees, task forces and working groups. He has been with the NAIC since 1991. Prior to his

appointment as director of the Regulatory Services Division, Nordman was director of the Research Division and, before that, the NAIC’s senior regulatory specialist. Before joining the NAIC, he was with the Michigan Insurance Bureau for 13 years. Nordman earned a bachelor’s degree in mathema cs from Michigan State University. He is a member of the CPCU Society and the Insurance Regulatory Examiners Society.


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Anne Obersteadt, CIPR Senior Researcher I At the crossroads of untapped consumer demand and mar-ket inefficiency is innova on. Commercial ride-sharing and car-sharing are two such recent market innova ons. Com-mercial ride-sharing companies, such as Uber and Ly , lev-erage mobile applica ons (apps) to connect for-hire drivers with paying riders. Car-sharing companies, such as Re-layRides and Zipcar, allow individuals to rent cars for a peri-od of me as short as an hour. Both of these new pla orms transform personal assets into revenue genera ng services by shrinking tradi onal barriers of entry and pricing well below compe ng tradi onal taxi and rental car alterna ves. The popularity of these services has propelled commercial ride-sharing and car-sharing companies into dozens of U.S. ci es over the past few years, posing both opportuni es and challenges. To study regulatory issues related to insurance coverage for transporta on sharing and other emerging sharing prod-ucts, the NAIC Property and Casualty Insurance (C) Com-mi ee appointed the Sharing Economy (C) Working Group in 2014. The Working Group has begun to iden fy transpor-ta on-sharing issues by developing a white paper, Trans-porta on Network Company Insurance Principles for Legis-lators and Regulators. At the comple on of this white pa-per, an cipated in the spring of 2015, the Working Group will then begin iden fying home-sharing issues in an addi-

onal white paper. O A * The crea on of this Working Group was the outgrowth of the recent CIPR event, Commercial Ride-Sharing and Car-Sharing Issues. The event, held during the NAIC Summer Na onal Mee ng brought together a panel of subject-ma er experts to discuss issues surrounding these new business models. More than 300 people a ended, including insurance regulators, industry representa ves, consumer advocates, insurance execu ves, and journalists/reporters from various media outlets. The event was moderated by California Insurance Commissioner Dave Jones. This ar cle will highlight the opportuni es and poten al insurance con-cerns discussed during the event. While speaking at the event, Alex Benn, chief opera ng officer of RelayRides, told the audience his company is the largest na onwide marketplace allowing individuals to rent their cars to others while not in use. “With 300 million cars and 200 million drivers in the U.S., there is a lot of excess

supply and economic inefficiency,” he said, adding car-sharing unlocks inefficiency. He used the example of an indi-vidual who may not need use of an extra car during the weekend connec ng with someone seeking to rent a car for a weekend trip to see friends. “It brings communi es to-gether and allows people to u lize underused resources where o en the car is the most valuable asset an individual may have,” he added. Benn pointed to the economic oppor-tunity as one of the greatest benefits of car-sharing, with car owners averaging $250 a month ren ng their car, and renters enjoying prices that are, on average, 35% less than tradi onal rental cars. Gus Fuldner, head of risk management at Uber Technolo-gies Inc., stated Uber created an app enabling consumers to get a ride when and where they want in an average of five minutes. “Our founders regularly found themselves in San Francisco with no cabs in sight,” he said. “They looked down at their phones and, like entrepreneurs, wondered how they could use them to help solve their problem of finding a cab.” Five years later, he said, Uber is opera ng in more than 160 ci es in 43 countries around the world. Fuldner also believes commercial ride-sharing provides new safe, reliable, and convenient transporta on op ons, which are available in previously underserved areas. He believes it also has a posi ve impact on communi es by crea ng extremely flexible economic opportuni es for thousands of drivers. Uber drivers can make themselves available to provide transporta on on a part- me basis, which, Fuldner points out, has not been historically availa-ble due to transporta on and insurance regula on. “Drivers and riders love commercial ride-sharing,” Fuldner said. Drivers benefit from revenue genera ng opportuni-

es and passengers benefit from taxi services priced 40% to 60% lower than a tradi onal cab. Commercial ride-sharing and car-sharing have also fre-quently been associated with several societal benefits. Ac-cording to the U.S. Department of Transporta on’s Federal Highway Administra on, fewer vehicles on the road mean less conges on, road maintenance and greenhouse gas emissions. The ability to rent or obtain livery service through cheaper and more flexible methods increases transporta on affordability, possibly providing an alterna-

ve to car ownership altogether. Addi onally, the ability to (Continued on page 16)

* It is important to note this is a fast moving industry and many things have changed since the event. Addi onally, the views expressed by panelists are their own and should not be seen as endorsed opinions of the NAIC.


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generate revenue to offset opera ng costs increases vehi-cle ownership affordability. Fuldner cited commercial ride-sharing’s proven track record of removing drunk drivers from the road as another important societal benefit. “Many people chose to drink and drive, not because they can’t afford a taxi, but because it’s too inconvenient and unreliable to meet their needs,” he explained. W I , C C While these emerging business models bring new oppor-tuni es, they also raise new insurance-related ques ons. Most of these ques ons center on insurance coverage gap concerns and underwri ng and pricing considera ons. For state insurance regulators, balancing innova on with con-sumer protec on is paramount. “Our challenge as regula-tors and policy-makers,” Commissioner Jones stated, “is to keep up with what our cons tuents want, while also making sure appropriate safeguards are in place, so when things go wrong, there is adequate insurance in place.” Car-sharing For car-sharing, Bob Passmore, senior director of personal lines policy at Property Casualty Insurers Associa on of America (PCI) said personal auto insurers’ main concern is they might be expected to provide coverage for uses not underwri en or priced for under the private passenger policy. “When you rent out your car, you cross a line into commercial ac vity, triggering exclusions which have been in place for years,” he explained. The most common exclusion is the livery exclusion contained in most stand-ard private passenger policies. This exclusion precludes the personal auto insurer from covering claims arising from the use of a personal vehicle while it is rented. This could create an insurance gap, leaving car-sharing par ci-pants and third par es unknowingly exposed to risk dur-ing the rental period. In the case of RelayRides, Benn said he does not see any insurance coverage gaps. Benn said RelayRides has always believed that car-sharing is a commercial use for the own-ers, but not the renters. “During the rental period, we have a commercial policy which steps in and provides in-surance coverage for the car owners, renters, and Re-layRides to address the exposure of the rental period,” he told the audience. RelayRides states on its website that as part of every rent-al, its insurer’s policy covers both car owners and renters with $1 million in liability coverage, and owners enjoy

physical damage, collision, and comprehensive coverage up to the actual cash value of the car, subject to specific exclusions. Renters may choose from three physical dam-age exposure op ons, ranging from premium protec on, which limits comprehensive/collision out-of-pocket expo-sure to $500 to a no-protec on op on, which does not limit their out-of-pocket exposure for damage to the own-er’s car. This allows renters to choose less protec on, at a lower price, if they conclude they already have adequate other insurance. However, Passmore pointed out many policyholders are unaware of how their insurance policy covers car-sharing or do not ask their insurer the necessary ques ons. Pri-vate passenger policies and terms can vary greatly from insurer to insurer. Most private passenger policies include coverage when a policyholder rents a vehicle, but Pass-more said it was important for policyholders to under-stand if their personal auto carrier viewed rentals from a car sharing organiza on similarly. Benn indicated, in his experience, insurers typically do view rentals from a car sharing organiza on similarly a er they understand the circumstances more fully. Many car-sharing companies include liability insurance, and a variety of different levels of more comprehensive coverage op ons either in the rental price or as a supple-mental purchase op on. However, Passmore pointed out there can s ll be coverage variances between policies offered under car-sharing agreements and those of the private passenger insurance, crea ng insurance gaps. For this reason, “[PCI] thinks it is important commercial cover-age mirror what the driver has on the personal side to avoid things being le out,” Passmore said. Complica ng the issue is insurers’ lack of knowledge re-garding their policyholders’ use of personal vehicles for car-sharing rental. O en mes, insurers do not find out their policyholders are ren ng out their cars through car-sharing agreements un l a claim is submi ed. “There is nothing manda ng insurers receive no fica on and this is something our members would like to see,” Passmore said. NAIC funded consumer representa ve Sonja Larkin-Thorne pointed out this makes it hard for insurers to ap-propriately price policies and it contributes to an in-creased volume of fraud. She used the example of an in-surer who rated a policy based on the policyholder’s re-ported 6,000 mileage usage, when, in reality, the car is being used to drive 20,000 miles a year by unknown car-



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structure of private passenger auto insurers. However, the PCI’s first preference would be for the states to not man-date a commercial lines policy at all, as this would give in-surers the room to poten ally provide innova ve under-wri ng solu ons as more data is gathered on car-sharing. Passmore explained, “We don’t want to shut the door to innova on in transporta on or insurance.” Commercial Ride-Sharing The insurance issues surrounding commercial ride-sharing programs differ in important ways from those of car-sharing programs. Personal insurers’ use of the livery exclusion to protect themselves against commercial auto exposures is also at the heart of this insurance coverage debate. Howev-er, defining the ac vi es which cons tute commercial use is less clear in commercial ride-sharing transac ons than car-sharing transac ons. In car-sharing transac ons, the rental period is absolute, making the me period of commercial ac vity clearly defined. In contrast, commercial ride-sharing involves varying levels of expense and travel sharing inter-ac on between a driver and a passenger. Thus, the lines between commercial and personal use of a vehicle in a commercial ride-sharing agreement are more blurred. I G To be er iden fy when business ac vity commences, the commercial ride-sharing process has been defined as in-cluding three periods (as illustrated in Figure 1 below): 1) App On: Wai ng for Match; 2) Match Found; and 3) Passen-ger in Vehicle. The first of the three periods is when the driver turns on the applica on to indicate he or she is avail-able for hire and waits for a passenger match. During this phase, the driver could be at home or ac vely driving in the area. The second period involves when the match is made and the driver is en route to pick up the passenger. Period 3 commences when the passenger is picked up and in the vehicle and ends when the passenger leaves the vehicle.


sharing renters taking it on vaca on. This increases costs on the exis ng policyholders, Larkin-Thorne argued, because the costs incurred in inves ga ng claims to determine if the exposure lies on the personal or commercial side are inap-propriately passed along to the private passenger policy-holders. The issue of equity in passing along associated claims costs is par cularly complex in the states (such as California, Oregon and Washington) where personal insurers are mandated to maintain coverage of vehicles used in car-sharing. Commis-sioner Jones explained, in the case of California, “The idea was to provide a mechanism whereby the personal lines auto insurance would con nue to cover your personal use of the car, but when the car was used in the car-sharing re-gime, there would be a requirement on the part of the car-sharing facilitator to provide commercial insurance covering the liability associated with the rental of the car.” On the up-side, this regula on protects consumers against ge ng dropped by their insurer for par cipa ng in car-sharing services. However, it could also lead to personal insurers incurring the expense of inves ga ng and rejec ng a claim inappropriately filed under the personal auto policy. Larkin-Thorne stated determining through claims inves ga-

on if the claims costs should be paid by the personal or commercial policies would unfairly pass along claim costs to private passenger auto policyholders. “The bo om line is, it costs to inves gate that claim and that cost would be passed along to the policyholder,” she said. Benn pointed out RelayRides has never required an owner’s private passenger auto insurer to deny a claim before their policy would cover it. Passmore said the PCI has been work-ing toward establishing a “bright line” between commercial and personal covered ac vi es. This would alleviate any poten al claims inves ga on burdens for personal insurers and prevent unwarranted costs from ending up in the cost

F 1. T R -S B M

Period 1: App On:

Wai ng For Match

Period 2: Match Found

Period 3: Passenger in

Vehicle


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There is general agreement the second and third periods cons tute commercial ac vity. However, the insurance in-dustry and several of the commercial ride-sharing compa-nies have not always agreed on the applicability of the liv-ery exclusion to the first period, leaving the poten al for an insurance coverage gap. At the me of the event, many commercial ride-sharing companies believed the private passenger policy applied during the first period. They de-fined commercial ac vity as beginning once the driver ac-cepts a commercial ride-sharing match using the app. “The majority of exis ng policy language focuses on whether or not the driver is carrying a passenger for-hire or reward,” Fuldner told the audience. He also argued the exposure during this period is most appropriately covered under the personal auto policy because the driver is available for hire, but not yet earning fares. “It is important to understand the driver is alone, with no passenger in the vehicle,” he said. “Both the vehicle and the drivers during this period were rated by the personal auto carrier.” Passmore acknowledged some insurers use the for-hire exclusion language, but stated the common opinion in the insurance industry is coverage for Period 1 would be exclud-ed under a private passenger auto policy. He stressed com-mercial ride-sharing drivers and taxi drivers have similar behavior pa erns during Period 1 because they both seek higher density areas where there is increased passenger demand. This can include higher risk areas near spor ng events, restaurants and bars, which are not contemplated by private passenger auto underwriters. Given these similari es, those in the taxi and limousine in-dustry argue there should be parity between a state’s or municipality’s requirement of their companies and commer-cial ride-sharing companies. “The only difference between a taxi and a [commercial ride-sharing company] is [commercial

ride-sharing companies] beat us to the technology. This is plain and simple livery. It’s commercial, not personal,” ex-plained Philip Jagiela, of the Na onal Limousine Associa on. He cited the disparity in premium between a taxi service and a commercial ride-sharing company as an example, with taxis averaging $6,500 in annual insurance premiums versus $4,500 in average annual insurance premiums for commer-cial ride-sharing companies. Fuldner disagreed, poin ng out the higher policy costs for taxis reflect their higher usage, where mul ple drivers operate the taxi 24 hours a day. This is fundamentally different than delivering these services with a personal auto driven on a part- me basis, he argued. Although Uber believes the vast majority of insurance poli-cies cover the first period of a ride-share transac on, they do acknowledge the poten al for some policies to exclude coverage. To address these gap concerns, Uber added lia-bility coverage con ngent to a driver’s personal auto policy for Period 1. Fuldner was quick to point out these coverage addi ons meet the minimum statutory requirement in all states. In the event a driver’s claim pertaining to Period 1 is denied by the personal auto insurer, Uber’s con ngent poli-cy will cover liabili es for bodily injury up to $50,000 per individual per accident, not to exceed $100,000 per acci-dent, and up to $25,000 for property damage ($50/$100/$25) (Figure 2). For the second and third periods, where Uber believes com-mercial ac vity takes place, Uber provides $1 million of commercial third-party liability insurance. Unlike the con n-gent liability policy covering Period 1, this coverage is prima-ry to a driver’s personal auto policy and excess to any other commercial policy obtained by the driver. It also provides $1 million of under/uninsured motorist coverage per incident and $50,000 of comprehensive and collision insurance con-

ngent if the driver has this protec on on his or her individ-(Continued on page 19)

F 2. U X I C

Source: h p://blog.uber.com/ridesharinginsurance. *$30,000 property damage mandated in Colorado effec ve Jan. 15, 2015.


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ual policy. Fuldner explains, “While someone is providing the actual commercial ac vity and there is a passenger in the car needing to be protected, we are providing coverage which meets or exceeds taxis and limousines in every U.S. jurisdic on we operate.” Larkin-Thorne said workers’ compensa on is another poten-

al insurance gap, because commercial ride-sharing compa-nies consider drivers independent contractors, not employ-ees. “If I’m involved in an accident while driving part- me and am unable to go to my full me job, where is the work-ers compensa on coverage?” she asked. “Uber wouldn’t provide it, as it doesn’t consider me an employee. This is a very serious gap for individuals who are trying to earn extra income, who may not understand their personal exposure to loss of income which could occur if this should happen.” Fuldner disagreed, saying the ques ons around independent contractors providing workers’ compensa on insurance is a far broader topic than commercial ride-sharing. He empha-sized this would be a good opportunity for the insurance industry to develop addi onal occupa onal hazard or disa-bility insurance products for independent contractors. R B F G There is much debate across the U.S. regarding whether regulators should mandate insurance coverage for commer-cial ride-sharing companies and, if so, what the appropriate coverage levels should be to protect consumers. California was one of the first states to enact legisla on se ng insur-ance requirements for commercial ride-sharing companies. In September 2013, the California Public U li es Commis-sion (CPUC) ruled to establish the transporta on network company (TNC) as a new transporta on category for com-panies offering commercial ride-sharing services. The ruling required commercial ride-sharing companies to be licensed as a TNC through the CPUC and to meet certain safety and regulatory requirements. This included providing a mini-mum of $1 million per incident in commercial liability cover-age “for incidents involving vehicles and drivers while they are providing TNC services.”1 Commercial ride-sharing com-panies complied with the requirement by securing coverage for the second and third periods, believing the first period did not cons tute a TNC service. This le an insurance gap in Period 1, which became evident on New Year’s Eve (12/31/13) when a commercial ride-sharing driver struck and killed a child and found he had no insurance coverage. Legislators and regulators in California responded by taking a closer look at how commercial ride-sharing companies were responding to the requirements previously set; par cularly,

the insurance requirements. Commissioner Jones told the audience he recommended to the CPUC $1 million in com-mercial coverage should be required for each of the three periods. His recommenda ons followed a March 20 inves -ga ve hearing he held on the issue. On June 10, 2014, the CPUC issued a proposed decision to clarify certain commer-cial ride-sharing rules it established in September 2013. As part of this proposed rule, TNC services would be defined as whenever the driver has the app open and/or is available to accept rides from the commercial ride-sharing company. During this me, the California Legislature was also deba ng the appropriate coverage level for the first period. In August 2014, a er much compromise, the California State Senate and California State Assembly passed AB 2293. The final bill defined TNC ac vi es to include all three periods, with the commercial ride-sharing company’s insurance providing primary coverage. While it kept the $1 million commercial liability coverage as the minimum requirement for Period 2 and Period 3, it allowed for lower minimum cov-erage amounts of $50/$100/$30, with an excess coverage of $200,000 in Period 1.2 It also required a commercial ride-sharing company’s liability insurance to defend and indemni-fy policyholders. The bill was careful to specify the insurance requirement could be fulfilled by the commercial ride-sharing company or the driver, or a combina on thereof, and to give a delayed effec ve date of July 2015. This was to al-low me for insurers to develop new hybrid products.3 Colorado was also one of the first states to pass legisla on regula ng commercial ride-sharing companies (also termed TNCs in this state). Colorado Insurance Commissioner Mar-guerite Salazar advised the audience Colorado started by taking a phased-in approach. A er spending a year deba ng on what regula ons were needed, Senate Bill 125 was signed into law June 5, 2014, and became effec ve Sept. 3, 2014. “This is an important industry and [the debates cen-tered on] how we as a state could protect consumers, but at the same me not discourage these new jobs and opportu-ni es,” Commissioner Salazar said. Under the bill, a com-mercial ride-sharing company must file documenta on with the Colorado Public U li es Commission, which regulates this business, showing the commercial ride-sharing compa-


1 Proposed Decision of Commissioner Peevey before the California Public U li es Commission. Retrieved Dec. 16, 2014, from h p://docs.cpuc.ca.gov/PublishedDocs/Published/G000/M077/K112/77112285.PDF. 2 The CPUC has the authority to set higher insurance requirements 3 Brooks, J. (Sept. 2, 2014). “California Bill Would Enable Uber, Ly Drivers to Finally Get Insurance.” News Fix. Retrieved Dec. 16, 2014, from ww2.kqed.org/news/09/02/2014/Uber_Ly _California_insurance.


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ny or the driver has secured primary liability coverage dur-ing a prearranged ride, defined as Period Two. The bill also requires a minimum of $1 million in primary commercial liability coverage for the second and third periods. During the coverage gap of Period 1, which Commissioner Salazar said was the most debated piece, the commercial ride-sharing company or the driver shall maintain con n-gent liability insurance at the state minimum limit of $25/$50/$15. A er Jan. 15, 2015, the commercial ride-sharing company or the driver will be required to maintain a prima-ry liability policy, with the limit increasing to $50/$100/$30. “This essen ally removes the gap period and requires com-mercial auto coverage from app on to app off,” Commis-sioner Salazar said. “It s ll, however, does not require cov-erage under a personal auto policy. So either the TNC or the driver would need to purchase a commercial auto policy.” State insurance regulators from more than 25 states, in their role to protect consumers, have issued consumer alerts warning consumers they may not have coverage un-der their private passenger auto policy for these types of services. In addi on, the Na onal Conference of Insurance Legislators (NCOIL) is currently considering a proposed model act to regulate insurance requirements for ride-sharing companies and their drivers. The proposed model would preempt any local ordinance, resolu on, or other law adopted to impose, require, or otherwise regulate insur-ance requirements for ride-sharing companies and the pro-vision of ride-sharing company services. It would establish, among other insurance requirements, that ride-sharing companies provide primary liability coverage for all three periods, but would not require private passenger auto in-surance policies to cover a driver’s ride-sharing ac vity. It also calls for various disclosures to ride-sharing drivers and passengers. N P S D As new insurance requirements are enacted across the states, commercial ride-sharing companies and their drivers will need new insurance product solu ons. New laws, like those in California and Colorado, leave open the opportunity for insurers to create hybrid products covering both com-mercial and personal use of a vehicle. Addi onally, commer-cial ride-sharing companies need commercial insurance solu-

ons which provide the flexibility to cover Period 1, should the driver not purchase a commercial or hybrid policy. Insuring commercial ride-sharing companies is challenging, because it is an emerging business with li le data to support

underwri ng and ra ng decisions. This, said John Clarke, senior vice president of marke ng for James River Insurance, is what makes the risk a good fit for the surplus lines indus-try. James River, a surplus lines writer domiciled in Ohio, writes insurance coverage for Uber and Ly . Because insur-ance for this product did not yet exist, Clarke said the com-pany had to become comfortable with the business model before accep ng the risk. They did this by examining factors such as expected mileage and trip lengths, road exposure, usage place and me, driver screening and data-collec on methods. “Commercial ride-sharing companies are collec ng an enormous amount of usage informa on on how their drivers are opera ng,” Clarke said. “This is the ul mate us-age-based product because not only are the customers and drivers ra ng each other, you’re collec ng all this data, and the ra ng is based on precise usage.” Insurance regulators and insurers are looking for this type of data to assist them in understanding the exposures and risks associated with each commercial ride-sharing period. Commissioner Salazar told the audience Colorado issued a data call to the top 10 taxi and limousine insurers in re-sponse to the lack of commercial ride-sharing data. She said this data is needed to assist insurance regulators in under-taking a study, required under Senate Bill 125, to determine if the insurance requirements for Period 1 are sufficient. To help fill the data need, Fuldner said Uber is inves ga ng which mechanisms would allow it to share its data with in-surers and regulators, while preserving consumer privacy and compe on concerns. “We had extensive conversa ons with some of the personal auto carriers in the U.S. to work with them to figure out their data needs to create a policy which complies with laws such as Colorado’s law,” he said. On Jan. 6, 2015, the Colorado Insurance Department issued its report to the General Assembly, recommending the mini-mum insurance requirements for Period 1 remain at $50/$100/$30. In its report, the Department stated it had collect-ed taxi and private passenger auto data from insurance com-panies currently wri ng livery conveyance coverage for taxi-cabs, ra ng and advisory organiza ons, Ly and Uber. A Stakeholder mee ng was held on Sept. 23, 2014 to gather addi onal informa on. Following the analysis of collected informa on and data, the Department determined there was not enough credible informa on to determine the ade-quacy of insurance coverage requirements for Period 1. It stated, however, based on the limited informa on it had acquired, it recommended the current insurance require-



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ments be maintained. It noted the entrance of at least three new insurers into this space and proposed, should the Gen-eral Assembly determine addi onal informa on is neces-sary, it wait un l no earlier than 2019 to conduct another study to allow for specific claims experience to develop. Passmore told the audience the PCI has been very careful when making sugges ons on legisla on and regula ons to leave the door open for insurers to develop products. An insurer’s first concern is to protect itself from taking on un-intended risk, Passmore explained. The next step is to gath-er data to allow for insurers to become more comfortable with the risk. “Once you have rules in place of who is providing coverage and when, then you have a chance for data to be developed and shared,” he said. “All we need is

me and some of the par es in the industry will take up the challenge and try to develop products.” As noted earlier, some companies have taken up the chal-lenge and moved into this niche space. Among those are Erie Indemnity, MetLife & Home, USAA, and Farmers Insur-ance. Erie Indemnity announced in a Nov. 2014 press re-lease it would offer a hybrid auto-insurance policy providing coverage in all three periods to for-hire drivers using com-mercial ride-sharing services. Erie Indemnity is offering the coverage to commercial ride-sharing drivers by removing the for-hire exclusion from the “business-use” designa on on its personal auto policy. Tradi onally, the “business-use” designa on has been used to cover delivery drivers. The product will only be available in Illinois and Indiana, but the company has said it could expand if demand warrants. MetLife & Home announced in late January it had partnered with Ly to offer endorsement coverage for all three peri-ods to Ly drivers in Colorado. The endorsement would offer coverage for Bodily Injury Liability, Property Damage Liability, Medical Payments, and Physical Damage up to limits selected on the policy, with applicable premiums based on mileage driven while engaged in commercial ride-sharing ac vi es. USAA and Farmers Insurance announced, separately, in January they would begin offering coverage in February for Period 1 to commercial ride-sharing drivers in Colorado. Metromile, a partner of Na onal General Assur-ance Co., announced in January it would also begin offering similar coverage in February for Period 1 to commercial ride-sharing drivers in California.

T F The emergence of the car-sharing and commercial ride-sharing business models are a product of the expanding sharing economy. As our society becomes more technologi-cally connected, innovators will con nue to introduce new “sharing” pla orms, disrup ng tradi onal business models. The market has already seen the sharing economy expand into the sharing of boats, apartments, and homes. These new business models will need new insurance solu ons, posing challenges and opportuni es for insurers. For com-mercial ride-sharing and car-sharing insurance products, there appears to be an emerging marketplace niche. How-ever, growth, in part, will depend on the development of regula ons and legisla on in states across the U.S. Commissioner Jones told the audience the crea on of the NAIC Sharing Economy (C) Working Group would assist in this process by taking a look at related consumer reports, how to obtain data, inves ga ng the ac vi es of other insurance departments and public u lity commissions, and ge ng a be er sense of where coverage gaps exist. As Commissioner Jones explained, “We are seeing the sharing economy expand and consumers depend on the insurance industry to make sure these new business models can come to market.”

A A

Anne Obersteadt is a researcher with the NAIC Center for Insurance Policy and Research (CIPR). She has 14 years of ex-perience with the NAIC performing finan-cial, sta s cal and research analysis on all insurance sectors. In her current role, she has authored several ar cles for the CIPR Newsle er, a CIPR Study on the

State of the Life Insurance Industry, organized forums on insur-ance related issues, and provided support for NAIC working groups. Before joining CIPR, she worked in other NAIC Depart-ments where she published sta s cal reports, provided insur-ance guidance and sta s cal data for external par es, ana-lyzed insurer financial filings for solvency issues, and authored commentaries on the financial performance of the life and property/casualty insurance sectors. Prior to the NAIC, she worked as a commercial loan officer at U.S. Bank. Ms. Ober-steadt has a bachelor’s degree in business administra on and an MBA in finance.


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ment of risk-based capital (RBC) requirements and the NAIC Financial Regula on Standards and Accredita on Program to help strengthen solvency regula on. Moreover, the world’s financial markets were experiencing a substan al increase in globaliza on during this me. The term “globaliza on” began to be more commonly used in the 1980s, reflec ng technological advances that made it easier and quicker to complete interna onal transac ons—both trade and financial flows.4 In response to increased globaliza on, as well as condi ons in the overall economy, the states and the NAIC took steps to sponsor an Interna-

onal Conference of Insurance Regulatory Officials. These conferences provided a unique opportunity for par cipants to discuss key regulatory issues and to exchange infor-ma on of mutual concerns and issues with foreign regula-tory officials. The remainder of the ar cle provides a look at how these conferences were essen ally the origin of the IAIS. The IAIS is a voluntary membership organiza on of insurance super-visors and regulators from around the world. It was incor-porated in 1994 to develop interna onal principles and standards for insurance supervision and to improve supervi-sory systems for the insurance industry through mutual assistance and coopera on. Over the last two decades, the IAIS membership has grown from 68 charter members to represen ng more than 200 members from nearly 150 ju-risdic ons. Members include insurance-specific authori es, central banks, financial ins tu ons, ministries of finance and interna onal organiza ons. H B 5 In 1985, the NAIC and other insurance regulatory officials began to plan an Interna onal Insurance Symposium. On June 11, 1985, the NAIC Interna onal Insurance Rela ons (G) Task Force met in Kansas City, MO, where a progress report on the Interna onal Insurance Symposium was dis-tributed to the members. Minutes from the mee ng note efforts to establish an interna onal symposium of insurance


By Shanique (Nikki) Hall, CIPR Manager I Globaliza on of the world’s economy has not only changed the way businesses operate, but also the way insurance is regulated. Over the past several decades, con nuous ad-vancements in technology—aided by increased compe -

on, liberaliza on of trade barriers and widespread deregu-la on—have contributed to an evolving insurance system.1 Recognizing the evolu on of globaliza on taking hold in the insurance sector, the NAIC first sponsored an “Interna onal Conference of Insurance Regulatory Officials” (the Interna-

onal Conference) in 1986 in conjunc on with the NAIC Na onal Mee ngs. During this me, the insurance industry was also experi-encing a record number of insolvencies, which caused some to ques on if state insurance regula on was up to the task of overseeing this increasingly complex and global enterprise.2 These conferences, which brought together insurance regulatory officials from across the globe, were the genesis behind the forma on of the Interna onal Asso-cia on of Insurance Supervisors (IAIS). This ar cle will pro-vide a historical background on how the NAIC was integral in the IAIS forma on. E R G E 1980 The U.S. economy experienced a severe recession in the early 1980s. At the me, the 1981-1982 recession was the worst economic downturn in the United States since the Great Depression and was triggered by ght monetary poli-cy by the Federal Reserve in an effort to fight moun ng in-fla on. The severity of the recession effected financial ins -tu ons and exacerbated a crisis in the savings and loan in-dustry (dubbed the S&L crisis). Between 1980 and 1994, more than 1,600 banks insured by the Federal Deposit In-surance Corpora on (FDIC) were closed or received FDIC financial assistance. Insurance companies were not immune. A string of large insurer insolvencies occurred in the mid-1980s and early 1990s. These insurance company failures, including that of the infamous Execu ve Life, brought scru ny on the U.S. insurance regulatory system and prompted a Congressional report tled Failed Promises: Insurance Company Insolven-cies, also known as the Dingell Report.3 Subsequently, state insurance regulators, working together through the NAIC, implemented significant changes in state-based solvency regula on. These changes included, inter alia, the develop-

1 Cummins, David. “Handbook of Interna onal Insurance: Between Global Dynamics and Local Con ngencies.” March 28, 2007.

2 “Insurance Regula on: Issues, Background, and Legisla on in the 113th Congress. Congressional Research Service. September 14, 2014.

3 United States. Congress. House. Commi ee on Energy and Commerce. Subcom-mi ee on Oversight and Inves ga ons. 1990.

4 “Globaliza on: A Brief Overview.” IMF Issues Brief. Retrieved from: www.imf.org/external/np/exr/ib/2008/053008.htm.

5 Much of the background informa on documented below was retrieved from the NAIC historical proceedings of the Interna onal Insurance Rela ons (G) Task Force mee ngs from 1985–1994.


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regulators were under way, and addi onal help from other states was requested to help complete the task.6 Several foreign insurance regulators—from the United Kingdom, Bermuda and the Cayman Islands—were present at this mee ng. According to one of the foreign regulators, it was decided “to ask as many interna onal insurance supervisors as possible to come to NAIC mee ngs for the purpose of exchanging informa on on cross-border transac ons.”7 Significant progress was made shortly therea er towards launching the Interna onal Conference. An “NAIC Working Group on Interna onal Associa on of Insurance Regulatory Officials” met Feb. 28, 1986, in Chicago and finalized the invita onal le er to be mailed to foreign insurance regula-tory officials invi ng them to the NAIC 1986 Summer Na-

onal Mee ng and subsequent Interna onal Conference. The invita on le er sent to the foreign insurance regulatory officials stated the primary goal of the Interna onal Confer-ence was to “obtain a be er understanding and apprecia-

on of the insurance regulatory framework and the issues and problems confron ng [our] colleagues throughout the world.” The le er further stated the NAIC hoped the confer-ence would “provide a forum for such discussion and be a catalyst for crea ng an interna onal associa on.” The first Interna onal Conference officially took place June 13–19, 1986, in conjunc on with the NAIC Summer Na onal Mee ng in Boston. Each foreign regulator in a endance was asked to submit prior to the conference a brief over-view of the regulatory structure in their country as well as a summary of the country’s issues and problems of concern. The overviews were distributed to each of the a endees and discussed during the Interna onal Conference. The conference agenda included a breakfast with U.S. state in-surance regulators, an overview of the NAIC and a recep on dinner. From 1986–1993, the NAIC hosted and sponsored each In-terna onal Conference. The conferences were held annual-ly in conjunc on with each NAIC Summer Na onal Mee ngs. Among the charges of the NAIC Interna onal Insurance Rela ons (G) Task Force included a charge to pro-vide “support for the annual Interna onal Conference by way of par cipa on in the Interna onal Conference Plan-ning Group.” The conferences were successful, with par cipa on increas-ing significantly over the years. In 1992, the conference wel-comed 83 par cipants represen ng 55 countries, including 11 countries as first- me a endees; this compared to 60 par cipants from 50 countries in 1991 and representa ves

from 30 countries in 1989. In 1991, the conference wel-comed for the first me regulators from Hai , Japan, Mala-wi and Turkey. The Organisa on for Economic Coopera on and Development (OECD) also par cipated for the first me in 1991. John Darwood, a former NAIC staff person, noted “the Planning Group would examine the conference pro-gram and format because a endance has greatly in-creased.”8 Darwood was vital in the success of the confer-ences. He coordinated the conferences and played a large role in encouraging people to a end and se ng the agen-das and schedules. Moreover, the conference itself lengthened from originally a one-day mee ng following the NAIC Na onal Mee ng to a mul ple-day mee ng held simultaneously with the NAIC Na onal Mee ngs. In addi on, the Interna onal Conference agenda significantly expanded to include roundtables, panel discussions, workshops, regulator educa on and training, as well as various presenta ons by state insurance regulators, insurance companies and federal regulatory agencies. Regu-lator-to-regulator commi ee mee ngs were also scheduled. In 1992, the par cipants of the seventh annual Interna onal Conference took the first significant steps to “form an Inter-na onal Associa on of Insurance Supervisors.”9 Subse-quently, a Working Group was appointed—consis ng of Australia (represen ng Asia/Pacific), Bahamas (Caribbean), Belgium (Europe), Mexico (La n America), South Africa (Africa) and the United States—to define the proposed ob-jec ves and by-laws of what was to become the IAIS. In ad-di on, the NAIC Interna onal Insurance Rela ons (G) Task Force charges in 1992 were expanded to include con nued support of the “annual Interna onal Conference by way of the Interna onal Conference Planning Group and to encour-age the conference in its plan to develop an Interna onal Associa on of Insurance Supervisors.” The IAIS held its first Forma ve mee ng during the eighth annual Interna onal Conference in 1993. During this mee ng, an “independent associa on of insurance regula-tory officials and an elected execu ve commi ee” was ap-proved on a 12-month interim basis.10 The IAIS by-laws were also dra ed, revised and released for comment dur-ing the conference.


6 NAIC Proceedings – 1985 Vol. II 7 “Reminiscence from a founding father of the IAIS.” The Insurance Supervisor, the News-le er of the IAIS. Third Quarter 2003. 8 NAIC Proceedings, 1991, 9 NAIC Proceedings, 1992. 10 NAIC Proceedings, 1993 Q2.


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The IAIS was officially incorporated March 3, 1994, in the U.S. state of Illinois. The first two IAIS mee ngs in 1994 and 1995 con nued to be held in connec on with the NAIC Summer Na onal Mee ngs. Former Alaska Insurance Director David Walsh was elected to serve as the first president of the IAIS. In addi on, the NAIC served as Secretariat from 1994–1995, which included providing the seed money, ini al staffing and office resources for the IAIS. As Secretariat, the NAIC assisted “in the forma on of IAIS and con nued the tradi on of the yearly mee ngs with interna onal regulators.” The IAIS held its first annual mee ng outside of the United States in 1996, in Paris. At the conference and general mee ng in Paris, it was decided the IAIS would become an interna onal standard se er, establish an independent Sec-retariat and relocate to Basel, Switzerland. S From 1985 to 1993, U.S state insurance regulators were extensively engaged with interna onal counterparts though the Interna onal Conference of Insurance Regulatory Offi-cials, which met concurrently with the NAIC Summer Na-

onal Mee ngs. These conferences provided an excellent opportunity for insurance supervisors, industry members and other par cipants to discuss and exchange ideas on important issues related to the supervision of insurance, developments in insurance markets and industry, as well as in the financial sector as a whole.

The NAIC is extremely proud to be a founding member of the IAIS. The growth of the IAIS and its achievements in insurance supervision since it was incorporated in 1994 has been significant, and the Associa on con nues to define its role in insurance regula on. In this era of increased regula-tory change and necessary regulatory coopera on, the fo-rum of the IAIS is cri cal to ensuring that these changes reflect the unique nature of insurance and its regulatory approaches.

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Shanique (Nikki) Hall is the manager of the NAIC Center for Insurance Policy and Research. She joined the NAIC in 2000 and currently oversees the research, pro-duc on and editorial aspects of the CIPR Newsle er and website, among other responsibili es. Ms. Hall has more than 20 years of capital markets and insurance exper se and has authored numerous

ar cles on insurance regulatory issues. She began her career at J.P. Morgan Securi es in the Global Economic Research Division where she worked closely with the chief economist to publish research on the principal forces shaping the economy and finan-cial markets. Ms. Hall has a bachelor’s degree in economics and an MBA in financial services. She also studied abroad at the London School of Economics.


T E L I C I R R : A E P F C

By Dimitris Karapiperis, CIPR Research Analyst III I State insurance regulators are keenly aware life insurers’ financial health depends, to a great extent, on their ability to overcome the challenges posed by the current extended period of low interest rates, in addi on to the uncertainty surrounding the magnitude and the pace of the an cipated rate increases. In different stress scenarios, the op ons em-bedded in life insurance products, such as yield guarantees and early surrender op ons, can expose life insurers to ad-di onal and significant financial risk. Specifically, a spike in interest rates could cause substan al disintermedia on effects on life insurers, as a great number of policyholders may decide to exercise their op on to surrender their lower-yielding life products for compe ve investments offering higher interest rates. Cognizant of the cri cal importance of interest rate risk for life insurance companies, the CIPR hosted an event tled Naviga ng Interest Rate Risk in the Life Insurance Industry during the NAIC 2014 Fall Na onal Mee ng in Washington, D.C. In addi on, the CIPR is currently examining interest rate risk, par cularly the liquidity and disintermedia on risk faced by life insurers, and plans to release the results/analysis in a study later this year. This ar cle has two purposes. It aims to inform the reader regarding the research underway at the CIPR on interest rate risk as well as present the commentary from panelists par cipa ng in the CIPR Interest Rate Risk Event. CIPR I R R E The CIPR event took place Nov. 19, 2014, and it was a end-ed by more than 100 people, among them state insurance regulators, as well as representa ves from various federal agencies, ra ng agencies, industry associa ons and aca-demic ins tu ons. The discussion panel was comprised of five seasoned and highly knowledgeable professionals se-lected for their work and exper se in interest rate risk in the life insurance industry. The two-hour panel discussion was moderated by Doug Hartz, principal consultant of Insurance Regulatory Con-sul ng Group and former NAIC senior counsel. Hartz’s ex-tensive background and knowledge of issues involving trou-bled and/or insolvent insurers helped sharpen and focus the ques ons and direct the discussion to cover the issues from all angles. Hartz split his ques ons in two segments: 1) discussion of the current interest rate environment; and 2) ques ons on the future direc on of interest rates. He opened the discussion by no ng that, although life insurers have been naviga ng the low interest rate environment

well, there are ques ons about how they would react to changes; e.g., a sudden spike or a “new normal” of low in-terest rates. The insights provided by the panelists are wo-ven into the ar cle. T C I R E The panelists at the CIPR Interest Rate Risk Event did an admirable job of explaining the current environment and discussing how it has affected life insurers. Responding to the first ques on about how the low interest rate environ-ment has affected life insurers, Richard Rosen, vice presi-dent and research advisor in the Federal Reserve Bank of Chicago’s Insurance Ini a ve, pointed to a study conducted by the Fed’s Insurance Ini a ve looking at the macro view of the market regarding the interest rate risk sensi vity of life insurers.1 The study examined how life insurers’ stock returns varied with the returns of the 10-year Treasury note and examined the pre-crisis period (2002–2007) as well as the immediate post-crisis period (2010–2012). During the baseline pre-crisis period, life insurers’ stock prices changed li le when the interest rate changed. However, in the 2010–2012 peri-od, interest rate changes had a significant impact on life insurers’ stock returns. Stock prices dropped 4.6% for each 100 basis points (bps) increase of the 10-year note (the sim-ilar number for the pre-crisis period was just 0.4%.). Rosen also noted demand for annui es sharply declined in the 2010–2012 period, as life insurance products with a savings component were not as a rac ve in the low interest rate environment. Thomas Girard, senior managing director of New York Life Investors, turned the a en on to the asset side by poin ng out the material impact prolonged low interest rates have had on life insurers’ investment yields across the board. Life insurers’ investment strategy in a low interest rate environ-ment should be focused on how to slow the rate of descent of the investment yield. In order to keep the yield descent from being too steep, Girard suggested insurers have four levers they can use: 1) investment strategy; 2) risk manage-ment; 3) product design; and 4) opera onal efficiency. In terms of investment strategy, life insurers can alter their asset alloca on by including more higher-yielding invest-ments, like private equity. With their fixed-income invest-ments, life insurers can earn higher yield by taking on addi-

onal credit risk.


1 Berends, K., McMenamin, R., Ples s, T., and Rosen, R. 2013. “The Sensi vity of Life Insurance Firms to Interest Rate Changes.” Federal Reserve Bank of Chicago, Economic Perspec ves, Volume 37, Second Quarter, 2013.


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Girard added liquidity risk should be prudently managed, however, as high-yield investments may not be as liquid as high credit quality investments. Life insurers need to be cau ous in their calcula ons of how much of their por olio they can afford to dedicate to higher-risk assets. Further-more, life insurers should work to strengthen their enter-prise risk management (ERM) processes and to see how to adjust or eliminate certain product guarantees and what type of products they should keep. Ma hew Carroll, senior director at Standard & Poor’s (S&P) and a lead analyst for the life Insurance ra ngs team, con-curred by no ng life insurers in S&P’s rated universe of companies experienced, in aggregate, a decline in their in-vestment yield over the past five years from about 5.5% in 2008 to 4.9% in 2013 as bond yields dropped from 6.0% to 5.0% during the same period. Life insurers responding to declining investment yield increased the por olio share of less liquid assets, such as private placements, commercial mortgage loans, private equity as well as some picking up more structured securi es. At the same me, life insurers, despite searching for yield, have not overreached with ra ngs migra ng mostly within the investment grade space, to NAIC-2 from NAIC-1, with the majority of holdings s ll NAIC-1. Also, in terms of product design, Carroll said annui-

es with market value adjustments (MVA) can be an effec-ve tool in managing interest rate risk.

Lori Helge, senior consultant in Tower Watson’s Risk Con-sul ng, reasoned the design of new life insurance products as part of the adjustment to the sustained low interest rate environment can only have a gradual effect on insurers’ books. Long-tailed exis ng lines of business which are sensi-

ve to interest rates—such as long-term care, structured se lement annui es and other payout annui es—weigh heavily on insurers’ books. Products sold not long ago (i.e., in the 1990s) that are s ll on the books were priced with assumed investment returns of 8% and 9%. William Harrington, chief examiner at the Ohio Department of Insurance, stressed the importance of effec ve risk man-agement and noted regulators, in their collabora ve risk-focused surveillance of life insurance companies, try to as-sess both the appropriateness and the effec veness of their ERM processes. During regulatory examina ons, a key ques-

on must be about insurers’ specific strategies in place to deal with the low interest rate environment. Carroll added S&P is closely looking at life insurance compa-nies’ risk controls, their ERM approach and the internal models they use. As it relates specifically to the investment management func on, S&P looks primarily at the credit and interest rate risk controls across five main dimensions: 1)

how well life companies iden fy their risk exposures; 2) how well they measure and manage these exposures; 3) what their risk limits are and how well their controls keep them within these limits; 4) what their formal policies are in the event the established limits are breached; and 5) how life insurers are learning from past events. Helge pointed to life insurers’ cash flow tes ng, done annu-ally to evaluate asset adequacy, and the scenarios built in to the models given the six years of unprecedented low inter-est rates. Life insurer appointed actuaries should con nue to monitor cash flow tes ng results in a range of future in-terest rate environments, and be cau ous about adop ng an overly op mis c view of future interest rate levels. Har-rington added insurance regulators use a priority system looking for emerging trends and closely monitoring life in-surers that may be in trouble due to the prolonged low in-terest rate environment. E L D R One of the areas for study is exploring liquidity and disinter-media on risk for life insurers. As it was highlighted by the panelists in the CIPR interest rate risk event, there may be a

pping point in rising interest rates where policyholders may opt to surrender their policies en masse and withdraw their cash value. Girard responded to a ques on on sudden future interest rate spikes by first reflec ng on what may cons tute a spike. He pointed out a rate increase must be at least 200 bps to 300 bps in a short period in order to be ac-tually considered a spike. An increase of such magnitude could cause significant disintermedia on for life insurers if policyholders surrender their products for higher yielding investments. Carroll emphasized a spike is a low probability but poten al-ly stressful event. On the other hand, a more measured rise of 100 bps to 200 bps over me could be beneficial for life insurers. At the same me, even a gradual increase in inter-est rates could cause unrealized losses in life companies’ fixed-income por olios, leading to reduced GAAP equity. Rosen underscored forward markets are indeed indica ng a small probability of an interest rate spike, but it would be a mistake to discount the risk just because it is a low probabil-ity event. It was also noted it has been nearly impossible to accurately forecast interest rates in the past few years. In-terest rates could increase either because there is a strong and sustained belief the economy is going to grow signifi-cantly or if there is a sudden pick-up in infla onary expecta-

ons. The cause of a jump in interest rates is important as it provides a great deal of informa on about how sustained it may be and how policyholders may react. He added surren-




ders have been small and ques oned if there is a pping point where policyholders would be eager to withdraw the cash value in their life insurance products. An addi onal issue is the reduced liquidity of the bond market, which may be a huge problem in the event life insurers need to liquidate assets fast in the event of a run-like scenario. Harrington stressed that regulators are always looking at life insurers’ strategies in dealing with present and emerging risks. Considering the financial risks life insurers face, it is cri cally important to know if life companies are adequately capitalized and how liquid their assets are at any given me. The low interest rate environment presents a troubling sce-nario for life insurance companies, which must also consider the liquidity of their assets in a me, as it was also noted in the panel discussion, when the bond market is dealing with reduced liquidity. As vola lity and uncertainty are rising, a change in monetary policy which could launch interest rates much higher could be very distressing to life insurers. Considering the importance of these risks, the CIPR is work-ing on a study exploring both issues of disintermedia on and liquidity for life insurance companies. How, or if, these risks manifest—in addi on to their impact on life insurers—depend on the unfolding of the different future interest rate scenarios. Presented in this ar cle are some interes ng insights gained from the data analysis so far. The objec ve of the analysis is to iden fy the insurers most vulnerable to large unscheduled withdrawals of life products with guaran-tees, such as annuity and deposit funds, and a empt to iden fy the most liquid assets available in their balance sheets to meet these unscheduled funding demands. Moreover, in studying the low probability but real risk of mass withdrawals, it is cri cal to examine the factors driving surrenders and when, if ever, it is op mal for policyholders to actually withdraw their money prematurely. Although op ons and guarantees in annuity products allow, in some cases, withdrawal without any early surrender fees or pen-al es, the propensity of policyholders to surrender early is greatly moderated by transac on costs and even more by tax considera ons. The tax-preferred treatment of annuity products not only mo vates policyholders to purchase but also provides a strong disincen ve for premature withdraw-als. The tax penalty incurred in the event of an early with-drawal is o en significant enough to act as a deterrent against the withdrawal of life products, even without any market value adjustments or surrender fees. Thus, in the situa on where a withdrawal is a ra onal policy-holder response to a jump in interest rates and not forced by extreme financial strain, it usually involves the replacement

of an annuity or life insurance policy for a new one from a compe tor without suffering any tax consequence for the exchange. Under this scenario, although an individual life insurer may experience serious strain due to large early withdrawals, the risk is largely contained within the industry. L I D The economic disloca on that took place as a result of the 2007–2008 financial crisis confirmed once again how signifi-cant liquidity is for the wellbeing of financial ins tu ons and as the lifeblood of the economy as a whole. As the pan-elists in the CIPR event stressed, a sudden increase in inter-est rates is what keeps most life insurance risk managers awake at night. When interest rates rise, par cularly in a short period of

me, insurance companies may find it difficult to increase their guaranteed credi ng rates in many of their products to match their investment returns. In this case, policyhold-ers may opt to surrender their policies in great numbers to take advantage of higher yields elsewhere. Mass withdraw-als can trigger an asset-liability mismatch, causing a poten-

ally serious liquidity strain for life insurers having to sell assets, poten ally in a fire-sale mode, to meet rapidly rising obliga ons. The occurrence of disintermedia on places life insurers in the unenviable posi on of having to liquidate assets in a period when the values of these assets are de-clining. In addi on to these losses, life insurers must also report at the same me unrealized losses in their remaining investment por olio asset. A historic precedent of an interest rate spike can be found in the infla onary 1970s, providing a cau onary tale for today’s life insurers and state insurance regulators. With rates hi ng 15%, life insurers were faced with policy sur-renders rising to previously unan cipated levels. As a conse-quence, many life insurers were forced to liquidate assets in order to meet surrender demand. More recently, in 1991, nine large life insurers failed, in part, due to losses from overinvestments in real estate and junk bonds, and their large amounts of contracts with high fixed guarantees.2 L L The main liabili es of life insurers are product claims with different liquidity characteris cs. Understanding the liquidi-ty of life insurers’ liabili es is cri cal in assessing the degree of liquidity risk. Liabili es are categorized in terms of liquidi-ty based on their withdrawal characteris cs ranging from the most liquid, which are available for withdrawal at book

(Continued on page 28) 2 Grossman, Robert, Mar n Hansen, and Peter Patrino, 2012. “The ‘Bond Bubble’: Risks and Mi gants.” Fitch Ra ngs. Dec. 19, 2012.



value with no market value adjustments and li le to no surrender charges, to the least liquid, which are not availa-ble for discre onary withdrawals. As of year-end 2013, about $829 billion (or 28%) of life in-surers’ liabili es consisted of annuity products not subject to discre onary withdrawals and accident and health poli-cies, which are not liquid at all. Approximately $979 billion (or 33%) of the liabili es were life insurance reserves. Many life insurance policies (except term) allow policyholders the op on to withdraw the cash surrender value (the savings component) before maturity. Because life insurance policies tend to have low and predictable redemp on rates and replacement costs, they are unlikely to be subject to mas-sive surrenders and withdrawals. Therefore, life insurance liabili es are categorized as low liquidity. About $538 billion (or 18.3%) of life insurers’ reserves were of medium liquidi-ty, as they consisted of annui es subject to discre onary withdrawal at market value or less a surrender charge of 5% or more. Finally, about $595 billion or nearly 20.3% were highly liquid liabili es made up of annui es and deposit-type products, which allow discre onary withdrawals at book value without any fees or adjustments (Figure 1). Observing how these life insurance products, categorized by liquidity, have trended since 2007, the decline of the illiquid liabili es (from 33.3% in 2007 to 28.2% in 2013) is as nota-ble as the increase of the most highly liquid liabili es. There has been a slight shi toward more liquid liabili es since 2007, with medium- and high-liquidity liabili es accoun ng for about 38.5% of the total reserves at the end of 2013 from approximately 33.5% in 2007 (Figure 2).

M L L A The intent of the analysis is not to specifically dictate how the insurer should address these funding needs but, rather, a empt to match the funding needs with an orderly liquida-

on of assets. At first, assets must be categorized in terms of liquidity. First in order are cash and cash-type assets, spe-cifically cash, cash equivalents and short-term investments. Even though some cash equivalents, specifically commercial paper and some short-term investments, are not readily conver ble into cash, for the purposes of this work, these assets are assumed to be all readily conver ble into cash without any discoun ng or loss. Given that an insurer may not maintain sufficient cash, cash equivalents and short-term investments to meet these dis-cre onary funding needs, the next step is to see how suffi-cient the U.S. government bond holdings (Treasuries and agency bonds) are to meet the remaining funding obliga-

ons. U.S. government bonds, due to their high credit quali-ty and strong liquidity represent the likeliest of assets to be readily conver ble into cash for the insurer at or near their carrying value. Finally, any remaining cash funding needs are matched with all other investment-grade bonds and then the balance of the bond por olio. It is worth no ng the investment manag-er of the insurer may have to decide which securi es to liq-uidate, as certain bond classes may reflect significant poten-

al losses due to deteriora on in credit markets which may have led to the discre onary withdrawals in the first place.


Source: NAIC.

F 1: L L I L (2013 Y -E )

Source: NAIC.

F 2: L I L W C (2007-2013)



The poten al liquidity from the equity, mortgage loan, real estate, Schedule BA assets or any other invested asset clas-ses is not factored in, as it is being assumed that, at a me of credit concerns, these asset classes would either be illiq-uid or the insurer would incur much higher losses if it need-ed to liquidate these assets in swi or rapid order. Howev-er, the insurer may be forced to consider other asset classes or possibly consider reques ng support from a parent com-pany or affiliate should the discre onary withdrawals reach unsupported propor ons. From all life insurers with annui es on their books as of 2013 year-end, 77.5% had liabili es that were more than 100% of their cash and cash equivalent and short-term in-vestments (22.5% had liabili es of less than 100%). About 56% of life insurers had liabili es represen ng more than 100% of their cash, cash equivalent and short term invest-ments and government securi es (44% of life insurers had liabili es of less than 100%). Only when investment-grade bonds were added, the majority of life insurers (75.6%), had liquid withdrawable liabili es that were less than 100% of those assets (a s ll significant 23.4% of life insurers had more than 100%.) When the en re bond por olio was add-ed, only approximately 7% of life insurers had liabili es ex-ceeding 100% of their invested assets (Figure 3). For the top 34 life insurance companies with over $10 bil-lion in annuity and deposit contracts, accoun ng for about 73% of the industry aggregate, all but three companies had liabili es of more than 100% of their total cash and cash equivalents, short-term investments, Treasuries and agency obliga ons, while seven companies' liabili es were over 1000%. If their investment grade bonds were added, then only 14 companies were below 100% and, if all bonds were included, all but five companies' liabili es were less than 100% of these suppor ng assets. C The panelists presented some concluding observa ons at the CIPR event. Girard noted life insurance industry overall is prepared to manage through a sudden rate spike. However, one concern s ll remains: if rates stay low for a while longer there may be people who will view it as a permanent situa-

on, leading to discoun ng the risk of a spike and, therefore, have a number of insurers caught unprepared. Rosen said the key is if life insurers can maintain their discipline in a changing world. If companies do decide to shi strategies, it is cri cally important for regulators to be on top of it. Harrington, offering some final thoughts, stressed the Own Risk and Solvency Assessment (ORSA) requirement will help insurers be er examine and manage their risks, while al-lowing state insurance regulators to be er assess the ade-

A A

quacy of their risk-management framework. Carroll closed the panel discussion by emphasizing life insurers’ balance sheets are strong and insurers are well-capitalized and very liquid. However, if the current low rate environment per-sists another four or five years, it could put substan al pres-sure on the industry. As the CIPR studies the impact of interest rates on life insur-ance, it will keep in mind that significant economic shocks help highlight the risks associated with financial assets and liabili es highly correlated with macroeconomic condi ons. The op on to withdraw annuity and deposit contracts ex-poses life insurers to macroeconomic ac vity which may result in disintermedia on and possible financial distress, and even insolvency in some extreme cases. Given the po-ten al for significant cash ou lows for life insurers, it is cri cally important to assess the degree to which economic factors—such as adverse economic condi ons and changing interest rates, as well as household financial strain, demo-graphic changes and re rement uncertainty—relate to withdrawal ac vity.

Dimitris Karapiperis joined the NAIC in 2001 and he is a researcher with the NAIC Center for Insurance Policy and Research. He has worked for more than 15 years as an economist and analyst in the financial services industry, focusing on economic, financial market and

insurance industry trends and developments. Karapiperis studied economics and finance at Rutgers University and the New School for Social Research, and he developed an extensive research background while working in the public and private sector.

Source: NAIC.

F 3: L I W A P I A (2013 Y -E )


D G : P/C C P

By Jennifer Gardner, NAIC Research & Actuarial Manager This issue features an analysis of market concentra on and profitability for several property/casualty lines of business. Insurer profitability results can be used in con-junc on with concentra on sta s cs to determine whether a market is a rac ve to insurers to enter (i.e., thereby crea ng greater compe on) or una rac ve (i.e., causing insurers that are in the market to leave). Persistently high levels of profitability could indicate that a market is failing to a ract compe tors, thus enabling non-compe ve rates of return to be earned. The data was derived from the Compe on Database Report and compiled using informa on contained in the NAIC database, as well as informa on contained in the NAIC Report on Profitability by Line by State (Profitability Report). The Compe on Database Report provides data for five personal lines and 10 commercial lines country-wide, as well as by state and territory. M C Market concentra on reflects the degree of compe on in a market. There are several methods that exist to ex-amine market concentra on. The Compe on Database Report u lizes methods contained in the Property and Casualty Commercial Rate and Policy Form Model Law (#777) for determining compe on. One method, the concentra on ra o, assesses the market share of the four largest groups in an insurance line. This tradi onal measure of market concentra on is o en used as a rough indicator of market compe on. While there is no formal way to determine market compe veness based on this calcula on, values above 50% suggest that con-centra on at least be given a closer look in judging the overall compe veness of a market. Figure 1 shows the market share of the four largest groups, denoted as a percentage, for private passenger auto, homeowners mul ple peril, medical professional liability and commercial auto. As illustrated in Figure 1, none of these lines exceed the 50% concentra on threshold. However, the private passenger auto and homeowners mul ple peril lines of business exhibit high-er concentra ons of 46.75% and 41.59%, respec vely. Another widely used measure of compe veness listed in the Compe on Database Report is the Herfindahl-Hirschman Index (HHI). The HHI measures the size of firms in rela on to the industry and indicates the amount

25.15%

26.60%

41.59%

46.75%

0% 10% 20% 30% 40% 50%

Commercial Auto Total

Medical Professional Liability

Homeowners' Multiple Peril

Private Passenger Auto Total

F 1: M S F L G

of compe on among them. It is calculated by summing the squares of the market shares (as a percentage) of all groups in the market. Although there is no precise point at which the HHI indicates a market or industry is concentrated high-ly enough to restrict compe on, the U.S. Department of Jus ce (DOJ) has developed objec ve guidelines with re-gard to corporate mergers. Under corporate merger guidelines used by the DOJ, a post-merger market with an HHI of less than 1,000 is consid-ered to be a compe ve marketplace, a post-merger mar-ket with an HHI between 1,000 and 1,800 is considered to be a moderately concentrated marketplace, and a post-merger market in excess of 1,800 is considered a highly concentrated market. It is important to note that, because these numbers are guidelines, judgment must be used to interpret what informa on is provided for a par cular mar-ket by its HHI. Figure 2 on the following page illustrates the HHI for these same four lines by wri en premiums. Based on the HHI guidelines, all four markets are considered rela vely uncon-centrated and the DOJ would most likely not challenge a merger that would leave the HHI in that range.


1 More informa on concerning the homeowners and personal automobile insur-ance lines can be found in the Auto Insurance Database report and the Dwelling Fire, Homeowners Owner-Occupied, and Homeowners Tenant and Condominium/Coopera ve Unit Owner’s Insurance report published by the NAIC. These reports include addi onal data concerning average premiums and expenditures and might be useful in studying the compe veness of those markets. Along with the Compe-

on Database Report and the Profitability Report, these reports are available for free from the NAIC store at www.naic.org/store_pub_sta s cal.htm.


D G (C )

P The Compe on Database Report also includes infor-ma on by line by state on premiums wri en, number of sellers (groups), number of entries in the past five years, number of exits in the past five years, market growth over the past 10 years, market shares for risk reten on groups and surplus lines insurers, and a 10-year mean of return on net worth. The return on net worth stated in the Compe on Data-base Report is obtained from the Profitability Report. It is calculated to help regulators and others evaluate the profits earned in a par cular market in rela on to the net worth commi ed to that market. Figure 3 displays the 10-year mean return on net worth for the four largest prop-erty/casualty lines of business. Figure 4 shows the return on net worth in the property/casualty insurance industry over the past ten years. Over the period of 2004 to 2013, the property/casualty insur-ance industry had an average return on net worth of 6.9%. Several companies experienced an increase in surplus as favorable loss development trends and lower than an ci-pated claim costs led to reserve releases. Premium growth, be er accident year results and fewer cata-strophic events contributed to surplus growth and higher profits for the insurance industry in 2013.

F 2: HHI B P

F 3: R N W (10 Y M )

F 4: R R N W P /C I

A A

Jennifer Gardner is a manager in the NAIC Research and Actuarial Department. Jen-nifer joined the organiza on in 2011. She conducts economic and sta s cal research for the NAIC and its members. She is re-sponsible for publishing various sta s cal reports including the Report on Profitabil-

ity By Line By State and the Compe on Database Report. She provides support for numerous NAIC working groups and assists the state insurance departments in data collec on related to catastrophe. Jennifer earned a bachelor’s degree in business administra on with an emphasis in finance from the University of Missouri-Kansas City. Prior to joining the NAIC Research and Actuarial Department, Jennifer worked on the State Based Sys-tems (SBS) products and services within the NAIC.

267 309

659 720

0100200300400500600700800

CommercialAuto Total

MedicalProfessional

Liability

HomeownersMultiple Peril

PrivatePassengerAuto Total

9.15%

13.23%

6.62% 7.12%

0%

2%4%

6%

8%

10%

12%

14%

CommercialAuto Total

MedicalProfessional

Liability

HomeownersMultiple Peril

PrivatePassenger Auto

Total

8.0% 8.3%

12.2%

9.7%

2.2%

5.7%

6.0%

3.4%

5.2%

8.0%

0%

2%

4%

6%

8%

10%

12%

14%

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

Rates of Return on Net Worth 10 Year Average Rate of Return


For copies of the latest CIPR Newsle er and other CIPR/NAIC For copies of the latest CIPR Newsle er and other CIPR/NAIC

publica ons, please visit our booth at the next NAIC publica ons, please visit our booth at the next NAIC Na onal Mee ng in Phoenix, Arizona!Na onal Mee ng in Phoenix, Arizona!


© Copyright 2015 Na onal Associa on of Insurance Commissioners, all rights reserved. The Na onal Associa on of Insurance Commissioners (NAIC) is the U.S. standard-se ng and regulatory support organiza on created and gov-erned by the chief insurance regulators from the 50 states, the District of Columbia and five U.S. territories. Through the NAIC, state insurance regulators establish standards and best prac ces, conduct peer review, and coordinate their regulatory oversight. NAIC staff supports these efforts and represents the collec ve views of state regulators domes cally and interna onally. NAIC members, together with the central re-sources of the NAIC, form the na onal system of state-based insurance regula on in the U.S. For more informa on, visit www.naic.org. The views expressed in this publica on do not necessarily represent the views of NAIC, its officers or members. All informa on contained in this document is obtained from sources believed by the NAIC to be accurate and reliable. Because of the possibility of human or mechanical error as well as other factors, however, such informa on is provided “as is” without warranty of any kind. NO WARRANTY IS MADE, EXPRESS OR IM-PLIED, AS TO THE ACCURACY, TIMELINESS, COMPLETENESS, MERCHANTABILITY OR FITNESS FOR ANY PARTICULAR PURPOSE OF ANY OPINION OR INFORMATION GIVEN OR MADE IN THIS PUBLICATION. This publica on is provided solely to subscribers and then solely in connec on with and in furtherance of the regulatory purposes and objec ves of the NAIC and state insurance regula on. Data or informa on discussed or shown may be confiden al and or proprietary. Further distribu on of this publica on by the recipient to anyone is strictly prohibited. Anyone desiring to become a subscriber should contact the Center for Insur-ance Policy and Research Department directly.

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EBRUARY 2015 Inside this Issue › cipr_newsletter_archive › vol14.pdf · 2015-10-29 · Sharing...

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Transcript of EBRUARY 2015 Inside this Issue › cipr_newsletter_archive › vol14.pdf · 2015-10-29 · Sharing...