Public Comment Open Until April 29, 2013 on Commercial Insurers’ Use of Captives and Special Purpose Vehicles Draft White Paper

Apr 17, 2013


A National Association of Insurance Commissioners (“NAIC”) subgroup draft white paper on commercial insurers’ use of captives and special purpose vehicles (“SPVs”) is open for public comment until April 29, 2013.   To view the draft, click here.

The draft was created after a formal study conducted by the NAIC’s Captive and Special Purpose Vehicle Use Subgroup (“Subgroup”) evaluated insurers’ use of captives and special purpose vehicles to transfer insurance risk (other than self-insured risk), in relation to existing state laws and regulations.

Ultimately, the NAIC’s goal will be to establish appropriate regulatory requirements to address concerns identified in this study. These regulations may involve modifications to existing NAIC model laws and/or generation of a new NAIC model law.

Commercial insurers, the study concluded, cede business to captives for a variety of business purposes. The Subgroup determined that the vast majority use of captives and SPVs by commercial insurers was related to the financing of XXX and AXXX-perceived reserve redundancies.  (The NAIC Model Regulation XXX requires insurers to establish heightened statutory reserves for term life insurance policies with long-term premium guarantees. Likewise, Actuarial Guideline XXXVIII, also known as Regulation AXXX or AG38, requires insurers to establish heightened statutory reserves for certain universal life insurance policies with secondary guarantees.)

Regulators believe the implementation of principle-based reserving and, more immediately, Actuarial Guideline (“AG”) 38 could reduce the need for commercial insurers to create new captives and SPVs to address these perceived reserve redundancies; but existing captives and SPVs that are not addressed by the guidance in AG 38 are likely to remain in existence for several years or even decades, until the existing blocks of business are run-off.

Therefore, according to the white paper draft, regulators need to be able to assess and monitor the risks that captives and SPVs may pose to a holding company system.  To do so, enhancing the current regulatory process is recommended by providing standardized tools and processes to be used by all regulators when reviewing such transactions.  Commercial insurer-owned captives and SPVs should not be used to avoid statutory accounting, the draft white paper explains.  To the extent that insurer affiliated captives and SPVs may be created in the future for unforeseen purposes, the Subgroup recommends the development of additional guidance by the NAIC to assist the states in a uniform review of transactions.

In the draft white paper, the Subgroup offered detailed explanations of the following recommendations to the Financial Condition Committee for its consideration and or/further possible study:

1. Accounting Considerations

The NAIC should form a separate subgroup to develop possible solutions for addressing any remaining XXX and AXXX perceived redundancies.  Due to changes made to AG 38 by the NAIC in 2012, the creation of new captives and SPVs should no longer be needed for such financing transactions; but, if there are XXX and AXXX issues that have not been addressed, those issues should be addressed directly, as opposed to through the use of captives and SPVs.  Possible solutions could include changes similar to the AG 38 solution, or disclosed prescribed or permitted accounting practices.  The NAIC should also consider modifications to the statutory accounting framework to recognize, in strictly limited situations, alternative assets, such as “tier 2″ type assets” to support specific situations (e.g., less likely to develop liabilities), thereby eliminating the need for the separate transaction outside of the commercial insurer.

2. Confidentiality

The Subgroup recommends that the NAIC study the issue of confidentiality related to commercially owned captives and SPVs more closely.  This study would pursue greater clarity regarding the specific reasons for and against the use of confidentiality for such entities. The Subgroup believes it may be necessary to develop a framework that would provide greater uniformity in this area.  More specifically, it may be appropriate to consider the type of information that should, and should not, be held confidential.  This outcome may be more easily achieved in the context of a new framework for alternative market solutions as discussed in recommendation #3 below.

3. Access to Alternative Markets

The Subgroup supports the use of solutions designed to shift risk to the capital markets or provide alternative forms of business financing.  The NAIC should consider re-evaluating Model #789 and updating it as necessary to reflect alternative markets solutions acceptable to state insurance regulators to ensure there is a uniform framework for the implementation of alternative market solutions.  The NAIC should further encourage the states to adopt Model #789 and should consider making the model an accreditation standard.

4. IAIS Principles, Standards and Guidance

The Subgroup recommends that the NAIC closely monitor the on-going developments with respect to International Association of Insurance Supervisors’ (IAIS) principles, standards and guidance, and consider where appropriate, enhancements to the U.S. captive and SPV regulatory framework in preparation for future Financial Sector Assessment Program reviews.

5. Credit for Reinsurance Model Enhancements

Transactions involving conditional Letters of Credit (“LOCs”) or parental guarantees effectively permit assets to support reinsurance recoverables, either as collateral or as capital, in forms that may be otherwise inconsistent with requirements under the credit for reinsurance models or other financial solvency requirements applicable to U.S.-domiciled commercial assuming insurers.  The Subgroup recommends consideration be given to study further the effects of, and potential limits on, the variability in qualified LOCs or any other security that might not provide the intended protections provided within the Credit for Reinsurance Model Law (#785).

6. Disclosure and Transparency

The Subgroup recommends enhanced disclosure in ceding company statements regarding the impact of the transactions on the financial position of the ceding insurer. Development of Note to Financial Statement 10M should be made to provide for disclosure of non-trade-secret captive information and disclosure of the overall utilization of captives.

7. Financial Analysis Handbook Guidance

The Subgroup recommends the development of guidance in the Financial Analysis Handbook for states’ review and on-going analysis of transactions involving captives and SPVs, including specific considerations of such transactions when performing holding company analysis.  The guidance should be developed for perspectives of the ceding state, the captive state and the lead state. 

Comments on the draft should be sent by April 29, 2013 to:

Dan Daveline
NAIC Assistant Director-Financial Regulatory Services

Phone: 816.783.8134
Fax: 816.460.7809


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