NAIC Group Solvency Issues Working Group Rejects Proposed MGA Accounting Standard

Apr 13, 2010


Reacting to recent allegations by critics that insurers may be hiding profits by shifting cash to affiliated service providers, a group of state insurance commissioners last week considered – but then rejected – a proposed standard that would have forced insurers to account for such money transfers at flat cost or less.

The Group Solvency Issues Working Group (“Working Group”) of the National Association of Insurance Commissioners (“NAIC”) met by teleconference on Friday, April 9  to discuss revisions to the NAIC’s Insurance Holding Company System Regulatory Act (Model #440).  The Working Group comprises insurance commissioners from 11 states, including Florida.

Fees paid by insurers to managing general agents (“MGAs”) have stirred controversy lately in a number of states.  Industry representatives say the transfers are proper to cover legitimate business expenses.  Critics, however, allege the transfers can serve as a mechanism for moving profits, which would normally be subject to regulation as dividends, to unregulated affiliates.  This could allow the regulated insurer to appear to be losing money, with the apparent losses used to justify rate increase requests, critics claim.  

The Working Group has been considering language to address this issue.  In December 2009, Wisconsin’s Office of the Commissioner of Insurance suggested a standard that would limit such transfers to the actual cost of the services rendered, or to market rates for those services if the latter were less than cost.  The Wisconsin Insurance Commissioner’s Office argued that pricing affiliated service agreements only according to “market rates” would necessarily allow for profitability to offset normal business risks.  However, Wisconsin regulators noted, many MGAs serve only, or primarily, their affiliated insurer – a guaranteed “market” carrying little or no business risk.  In such cases, Wisconsin regulators said, transfers should be explicitly limited to the actual cost of the services rendered by the affiliate, or the market rate of those services if that were lower.  The proposed standard would apply to affiliates that derive 20 percent or more of their revenue from affiliated companies.

Current standards included in the Insurance Holding Company System Regulatory Act empower state regulators to determine if such transfers are “fair and reasonable,” but do not dictate a specific formula for evaluating what is appropriate.  The proposed wording would have added new, stricter language to Section 5 A (1) (c) of the Regulatory Act.

“It’s a big loophole in regulatory authority if [an insurer] can pay any amount to service providers,” Peter Medley, Chief of Financial Analysis and Examination for the Wisconsin Office of the Commissioner of Insurance, told the teleconference participants.  “I was using as a principle that the affiliate shouldn’t make profit off the regulated industry.  If you say it’s a perfectly legitimate way to do it, you’re providing incentive to companies to game it further.”

Other commissioners participating in the meeting balked at endorsing such a strict standard.  Several suggested that state regulators already have the ability to declare certain inter-affiliate expenses as extraordinary, and could simply rule that what the insurer calls a legitimate expense is, in fact, a dividend subject to regulation.  

“I haven’t seen the gaming,” said Steve Johnson, Deputy Commissioner of the Pennsylvania Insurance Department.  “If I saw someone doing this in excess; if I believe the structure is such that they really are gaming to take what amounts to dividends out of it, we say ‘No.’  I think we have the flexibility within the ‘fair and reasonable’ standard.”

Several industry representatives present for the conference call also urged the Working Group not to endorse the tougher standard, saying current standards give regulators sufficient control.

“We think that is a limitation that is going to be unduly restrictive,” said Steve Broadie, vice president for tax and financial issues for the Property Casualty Insurers Association of America.

“The language that we have existing now would give you the kind of authority and flexibility you need,” said Randi Reichel, a consultant with America’s Health Insurance Plans.  “If a company gives documentation as to why they’re entering into this agreement, you have the power to amend it if something doesn’t look right to you.”

All 11 Working Group members present – including Mr. Medley of Wisconsin, who had presented the recommendation – rejected the proposed change and endorsed maintaining the current standard.  

The matter of insurance company profit regulation is considered to be particularly volatile in hurricane-threatened Florida. 

In the middle of this debate is Florida’s publicly-run Citizens’ Property Insurance Corporation (“Citizens”), once intended to be the insurer of last resort, but which now is the state’s single largest property insurer with more than a million policy holders.  Critics have charged that Citizens’ current reserve of $12.9 billion is insufficient to cover even a single large event such as a major hurricane, and that its authority to tax Floridians to pay for damage claims in the event of a disaster could cripple the state’s financial health.  Florida TaxWatch, a private, nonprofit research institute, in April called the state’s homeowners’ insurance system “broken,” adding that “one major hurricane has the potential to bankrupt private insurers and the state’s self-insurance programs…” 

The Working Group is tasked, among other duties, with studying the interaction between state and federal financial regulators and any changes that would be necessary to improve regulatory oversight provided by the Insurance Holding Company System Regulatory Act.  At the conclusion of its study, recommendations will be provided to the NAIC’s Financial Condition Committee.

To view the April 16 Working Group agenda and meeting materials, click on the hyperlinks below:


Should you have any questions or comments, please contact Colodny Fass.


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