NAIC. September 18, 2012

UPDATE ON RRGs/NAIC Tom Brumgardt Nelson Mullins Leslie Jones SC Department of Insurance Julie Robertson Honigman Miller Schwartz and Cohn LLP Septem...
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UPDATE ON RRGs/NAIC Tom Brumgardt Nelson Mullins Leslie Jones SC Department of Insurance Julie Robertson Honigman Miller Schwartz and Cohn LLP

September 18, 2012

Topics for Today • The NAIC’s role • Current NAIC Initiatives – Governance Standards – Risk-Focused Examinations – Risk Based Capital Standards – Credit for Reinsurance

• Other Developments Affecting RRGs – The GAO Report – State vs State – FIO Report

The NAIC’s Role • What is the NAIC and how does it operate? • How does the NAIC affect state regulation of RRGs? • The NAIC doesn’t regulate RRGs – It provides accreditation to state insurance departments that do

• Why accreditation is important to a state – And why a state (eg New York) might forego it

The NAIC’s Role • NAIC RRG (E) Task Force – Considers what accreditation standards should apply to Risk Retention Groups chartered under captive laws.

• NAIC RRG (C) Working Group – Monitors case law, rehabilitation proceedings and GAO report findings and makes appropriate changes to the Risk Retention and Risk Purchasing Group Handbook.

• Membership of both groups includes captive and non-captive states

A Current Controversy • Congressman Edward Royce (R-CA) sends letter to NAIC 2/28/12 questioning NAIC purpose – Is it a trade association or “standard-setting organization”? • Implications – Trade association: cannot regulate – Cites $70M budget, 501(c)(3) status, not subject to governmental accountability mechanisms • Criticizes NAIC statements that it will be integral in forming national system of regulation of insurance under Dodd-Frank/FIO • Asks FIO to review NAIC activities 7/12/12

NAIC Governance Standards • Included in the Model Risk Retention Act – Adopted by NAIC in December 2011 – In March 2012, Financial Regulation Standards and Accreditation (F) Committee exposed for 1 year comment – Likely to be an accreditation standard, as early as 2015

• Included in "Special Exam Considerations" as part of risk focused examinations • Included in Risk Retention Modernization Act

NAIC Governance Standards • RRG Board must have a majority of “independent directors” – Independent: director has “no material relationship” with RRG • Receipt of compensation by director/family member/business of greater of (i) 5% of RRG’s gross written premium; or (ii) 2% surplus in 12 month period • Certain relationships with auditor/related companies • Note: insureds can be independent

– Board must make affirmative determination

NAIC Governance Standards • Listing of "material relationships" is non-exclusive • Must consider all facts and circumstances • Board free to set categorical standards of its own

NAIC Governance Standards • Adopt code of business conduct and ethics • Adopt written policy within Plan of Operation and governance standards • Captive Manager, President or CEO of RRG must notify regulator of material non-compliance • Have an audit committee with at least three independent directors and no non-independent directors – Adopt a written charter – Auditor rotation

NAIC Governance Standards • Contracts with “material service providers” – "Material" if amount to be paid at least equals greater of (i) 5% of annual gross written premium or (ii) 2% of surplus – Cannot exceed five years – Approved by majority of RRG independent directors – Must have for cause termination provisions – 30 days notice (without objection) to regulator – Oversight governed by new written policy in Plan of Operations

South Carolina Response • Will adopt by amendment to SC RRG Act – Will depend on timing of accreditation – Likely will not adopt audit committee requirements since Regulation 69-70 already covers

• SCDOI already looking for these as "best practices" during examinations

Practical Implications • RRGs should review governance structure • RRGs should at least follow "best practices" contained in special exam considerations

Risk-Focused Exams (RFE) • RRGs subject to RFEs for examinations commencing January 1, 2011 and later. • 2012 Charge of RRG (E) Task Force – Work with captive states and RRG examiners to develop best-practices that may be considered when performing risk-focused examinations of RRGs. – Risk-Focused Examinations (E) Subgroup is developing the best practices and is awaiting the results of a Peer Review Project that may impact its work.

Risk Based Capital • Subgroup formed to address RBC standards for RRGs • Recommendation: Part A RBC standards should apply to RRGs but regulators should have discretion NOT to take action in specific circumstances – Comment period expired – To be effective 1/1/14 • Subgroup of Capital Adequacy Task Force addressing accounting issues – Example: LOCs counting as capital, discounting of reserves – Some recommendations to be incorporated into NAIC blanks

The Practical Implications • South Carolina – Will be included in 2013 accreditation bill and will apply to SC RRGs by 1/1/2014 – Already have to submit RBC report – Likely to result in change in regulation??

• Generally

Credit for Reinsurance • Captive RRGs are required to follow Credit for Reinsurance Model Law/Regulation subject to Reinsurance Guidelines developed for captive RRGs • 7/21/10 passage of NRRA • NAIC Reinsurance Task Force – Revised credit for reinsurance standards to allow for reduced collateral requirements for reinsurers that are licensed and domiciled in qualified jurisdictions

• NAIC Financial Regulation Standards & Accreditation (F) Committee has exposed revised the revised reinsurance standards for accreditation purposes • RRG (E) TF is considering whether/how this development may affect credit for reinsurance for captive RRGs

The GAO Report • Congress requested a report in response to industry concerns regarding discriminatory regulation of RRGs by nondomiciliary states • Report released 1/9/12 • Those in the RRG industry were hoping for clear rebuke of discriminatory practices from GAO • We can tell from the title that didn’t happen! – “Risk Retention Groups: Clarifications Could Facilitate States’ Implementation of the Liability Risk Retention Act”

The GAO Report • Recommendation: Congress should clarify certain provisions of the LRRA to resolve disputes between states and RRGs – Whether RRG registration requirements beyond those currently specified in LRRA are permitted in nondomiciliary states – Whether fees in addition to premium and other taxes could be charged to RRGs by non-domiciliary states in which they operate • Recommendation: Revise the LRRA to provide a more specific definition of the types of “liability” coverages

State vs State • Possibly in an attempt to over-regulate/discriminate against RRGs, some states have taken a liberal approach to interpreting and applying the allegedly “ambiguous” provisions of the LRRA – Significant matters on which state approaches have been inconsistent include: – What forms of “liability insurance” can be written? • Stop loss coverage – Even though the coverage was not being written in the state, California recently threatened to de-register a Nevada-domiciled RRG if it did not agree to amend its business plan to remove the reference to employee benefits stop loss coverage as a permissible line of coverage • Contractual liability coverage (i.e., warranty coverage) – National Warranty Insurance Company RRG v. Greenfield • Automobile liability coverage – A federal court in Nevada recently determined that the state could not prohibit Alliance of Nonprofits for Insurance Risk Retention Group from writing auto liability coverage for its members (the case has been appealed)

State v. State (Cont.) • What constitutes the impermissible regulation of insurance business by a non-domiciliary state? – Some states require RRGs to comply with the malpractice claim payment reporting requirement – Florida requires RRGs to appoint an insurance agent or broker licensed in the state as a condition of writing coverage – Some states use fees (i.e., registration, annual examination, desk audit) as a way to discourage RRGs from writing coverage in the state

• What authority does a non-domiciliary state have as part of the RRG registration process? – Some states view RRG registration as an approval process, rather than a mere filing obligation – Certain states require RRGs to file documents to become foreign corporations

FIO Report • FIO report on improving U.S. insurance regulatory system due in January 2012 • No projected release date as of August 2012 • 150 comment letters received during comment period • Will FIO report address Royce comments on NAIC • Will FIO report have any impact on the LRRA or RRG regulation?

Questions

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