Federal Reserve’s insurance capital standards release anticipated soon

Insurers with federally insured depository institutions such as State Farm, TIAA and USAA will soon — perhaps by mid-September — be subject to minimum consolidated capital requirements from the Federal Reserve Board, according to sources, in a long-anticipated move coming more than eight years after the Dodd-Frank Act gave the Fed certain insurance oversight powers.

The capital rules are colloquially known as the “Building Block Approach,” or BBA, and cleave close to the existing state regulatory insurance capital framework for the insurance subsidiaries of the holding company. A proposal for the BBA was first unveiled by then-Fed Gov. Danel Tarullo in May 2016.

The Fed will calculate the insurer’s total minimum capital requirement by generally adding up the capital positions of the subsidiaries, insurance, banking or otherwise and scaling them under a unified capital requirement.

Under Dodd-Frank, the Fed has regulatory responsibilities for insurance holding companies with savings and loan and thrifts as well as those deemed systemically important.

For example, TIAA Direct is the banking front of TIAA’s bank-created trust company and is headquartered in St. Louis, Missouri. The three insurers who received latter designation have since shed their label, leaving a handful or more of insurance savings and loan holding companies. According to the Fed, these insurance thrift holding companies “represent just under 10% of U.S. insurance industry assets and span a wide range of sizes, structures, and business activities.”

The Fed’s capital regime would not go so far as to recognize the “permitted accounting practices” that  states grant, such as in the high-profile case of GE Capital (no longer subject to any Fed supervision), which won approval it said in a March 2018 filing from Kansas insurance regulators to recognize reserve increases over a seven-year period . GE was permitted by Kansas to do so to address an almost $15 billion long-term care insurance reserve shortfall.

The BBA aggregation process would prevent the double-counting that could stem from intercompany transactions, according to Fed Vice Chairman for Supervision Randal Quarles, speaking early this year at a life insurance industry roundtable event in Naples, Florida.

As Quarles explained in his speech, the aggregation of the building blocks’ capital “requires a further step after adjustments are applied,” a methodology called scaling to create an apples to apples risk measurement for the different ratios and thresholds of the subsidiaries. This measurement would result in the minimum capital requirement for the entire enterprise.

“Our goal with the BBA is to capture all material risk of each supervised organization, leverage existing legal-entity standards, and minimize burden,” Quarles stated in his speech to the American Council of Life Insurers at its Jan. 9 event.

Because the BBA is derived from the state-based insurance capital standards of the National Association of Insurance Commissioners, it will reinforce “the important role that insurers’ investments play in our economy,” Quarles stated.

The insurance industry has long-clamored for rules that would respect its particular business model, not one that was designed for banks. The Collins Amendment to Dodd Frank allowed the Federal Reserve Board the flexibility to apply these insurance-based l standards to domestic insurers in crafting the rules.

However, the insurer’s depository institutions would get the bank regulatory regime treatment as would nonbank and noninsurance activities or e building blocks of the whole enterprise. These are expected to include derivatives and some hedging activities.

Once the enterprise’s entities are grouped into building blocks, and capital resources and requirements are computed for each building block, the enterprise’s capital position is produced by generally adding up the capital positions of each building block.

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Work on the capital standards of the Fed has been under development alongside the work it and members of the NAIC together with the Federal Insurance Office at the Treasury Department, or “Team USA,” have been doing to advance a U.S.-friendly global group capital calculation through the International Association of Insurance Supervisors or IAIS.

Meanwhile, the NAIC is working in its liquidity stress testing framework for large life insurers through its Macroprudential Initiative (MPI).

The Fed did not comment on the proposed rules or their release.


Pending in Pennsylvania: Updates on ‘those’ LTC insurance companies

Aug. 22, 2019: Months have quietly passed for three Pennsylvania long-term care insurance companies seeking to resolve their solvency status. Here’s a quick look at where they stand even as a fourth in liquidation, Penn Treaty* is undergoing benefit battles between health insurers and its liquidators over funding benefits beyond the guaranty associations. 

While regulators continue to work with the other state-domiciled distressed LTC companies, the lack of a public and regulator-approved plan for the largest of the three points to unresolved issues at a time when its solvency is in question.

Senior Health Insurance Company of Pennsylvania, commonly known as SHIP,  was running a surplus deficit of $466.9 million at year-end 2018, an amount which analysts say is only growing. When the statutory numbers revealing the ballooning deficit came in at the beginning of March, it had to submit a plan to the Pennsylvania Insurance Department, which was expected in 90 days. Thus far, that has not happened. 

A spokeswoman for the insurance department said Aug 21 that SHIP “has not submitted a plan that remedies the shortfall. We continue working closely with the company on a plan to resolve the deficit issue. “

As Fitch Ratings shared in an Aug. 20 note on overall LTC industry health, SHIP is among a few LTC companies with below-average reserve adequacy. SHIP, the former Conseco Health Insurance Co., became an independent trust  in 2008, with $3 billion in reserves to its name. Governed by five trustees including former insurance commissioners, SHIP was designed to run off the closed book of LTC business.  

 Fitch warned in its research note that it sees SHIP “as remaining on-track to becoming the industry’s next insolvent LTC writer requiring guarantee fund assessments from the industry.”  In various state rate filing requests seeking 40% premium increases, SHIP reported it had 76,165 active member policies comprised of 70 distinct policy forms  including home health care, nursing home care, and comprehensive plans, covering both home health care and nursing home care back in 2016.

SHIP’s policies “are among the oldest in the industry with much richer benefit schedules than would be found in more recently designed policies,” it stated in a rate filing in Pennsylvania a few years ago

Fitch believes that in the industry overall, “statutory LTC reserves continue to be based on a number of overly aggressive assumptions, despite recent risk management efforts taken by insurers to strengthen reserves through the implementation of premium rate increases and benefit reductions on legacy-related blocks of business.”

The petition for liquidation for another distressed LTC insurer in Pennsylvania, Senior American Life Insurance Co., or SAIC, was originally filed June 18. This follows from a case management order issued by Pennsylvania’s Commonwealth Court. An amended petition was filed July 31.  The court issued an order on  Aug.15, 2019 with an effective liquidation date for SAIC of Sept. 3, 2019.

The spokeswoman for the Pennsylvania Department said that the SAIC petition for liquidation is proceeding in Commonwealth Court and that the company has consented to liquidation. [Post-August UPDATE: SAIC Liquidation Date: Sept. 3, 2019]

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The third Pennsylvania long-term care insurer under solvency scrutiny is SAIC’s affiliated company, AF&L. The AF&L petition for liquidation has been stayed and the regulators in the state “continue to work with the company for a resolution,” the department’s spokeswoman said.

The Pennsylvania Insurance Department petitioned for liquidation of both SAIC and AF&L in April 2018. Both AF&L Insurance and SAIC have the same address in Fort Washington, Pa. and have the same CEO, Benedict Iacovetti, named. They are both subsidiaries of AF&L Inc. 

*Penn Treaty refers to the combined Penn Treaty and American Network insurers. On March 1, 2017, the Commonwealth Court of Pennsylvania issued orders placing them in liquidation.

LTC solvency warning sounded by a few states almost 30 years ago

Aug. 16, 2019 — Some states knew…

 “Three state insurance regulators and two consumer advocates expressed concerns about the future fiscal solvency of LTC insurance companies,” warned a report by the inspector general of the Department of Health and Human Services — in 1991. “They are concerned because the market is new and policyholders may not start filing claims in large numbers for many years. Insurance companies may not be pricing policies appropriately. By the time they recognize insolvency, it may be too late to take corrective action.” 

Contrast that with the dire warnings from the life insurance industry on the hardship LTC policyholders face if their benefits are not fulfilled—or filled beyond what the state guaranty funds can offer in liquidation.

The judge’s decision from the Commonwealth Court of Pennsylvania in the Penn Treaty case “has the potential to profoundly impact the life and long-term care industry … for both insurers and insureds,” the American Council of Life Insurers wrote in a May filing to the Commonwealth Court of Pennsylvania in Penn Treaty, formerly known as Penn Treaty Network American Insurance Co. and American Network Insurance Co. liquidations. The ACLI went on to explain how many policyholders caught short by benefit caps in the state guaranty funds will suffer.

The cautionary note in 1991 is just a small section of a larger report scrutinizing state regulation of LTC insurance.The report, completed during the President George Bush era, largely focused on consumer protections and the need to enforce existing laws rather than creating new ones while noting that minimum standards would allow flexibility and innovation. The HHS report painted the affordability of LTC insurance and what were described as very strict requirements in New York, Massachusetts and Minnesota as drawbacks. 

The report was done at the request of by then-Oregon Congressman Ron Wyden. Wyden was chairman of the House Small Business Subcommittee on Regulation, Business Opportunities and Energy. He is now the senior senator from Oregon.

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The 1991 report didn’t identify the states or the consumer advocates who cautioned on future solvency problems, although it named the eight advocacy organizations participating, including AARP, Families USA and Consumers Union and the insurance commissioners’ offices listed are: Kentucky; Maryland; Massachusetts; Minnesota; New York; Texas; Utah and Wisconsin. Massachusetts, Minnesota, New York, and Wisconsin had strong state laws while Kentucky, Maryland, Texas, and Utah had weak laws and regulations on LTC, according to the vintage report. 

The battle over fulfilling policyholder claims in the Penn Treaty companies’ insolvency is being waged between a mega-health insurer coalition and the state liquidator/insurance commissioner, who has support from the life insurance industry. 

In Pennsylvania, the Penn Treaty liquidation benefits battle lurches forward with implications for LTC policyholders nationwide not just in this case but in future liquidations.

Nationwide, market speculators wonder anew what is happening within GEs LTC insurance block after a whistleblower came forward in mid-August alleging its reserves are far too low for its LTC liabilities.

Meanwhile, LTC giant Genworth Financial’s consolidated risk-based capital ratio for its life insurance companies fell squarely below 200% by the second quarter 2019 from 277% in the year-ago quarter, driven partially by the growth of new LTC claims. Industrywide, equity analysts and industry observers fret about how much morbidity improvement is really factored into the reserves of larger insurers with significant LTC legacy blocks of business. 

The scope of problems that LTC is wreaking for companies and policyholders now stems from old actuarial assumptions that have been oft-repeated in recent years — assumptions that were wrong from top to bottom. Interest rates over time, policyholders’ mortality, policy lapse rates and morbidity/benefits usage were all gravely miscalculated by underwriters in previous decades. Thin premiums idling in an unanticipated low interest rate environment relative to the rich claims benefits the policies are expected to furnish now and in the future is not considered sustainable without rate hikes and cutbacks in benefits along with changes in health and usage.

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One industry source does not see any health improvement among those living longer, zeroing out any morbidity improvement companies have factored in. 

On March 1, 2017, the Penn Treaty companies were declared insolvent by the court and placed them into liquidation. The ACLI is supporting the liquidator, in this case the state insurance commissioner, in her bid to extend policyholder claim benefits beyond the varying but sometimes skimpy state guaranty associations’ (GA) statutory limits. 

The case involves whether the insurers’ estate assets cane be used for benefits if they are available, even they exceed the GA coverage limits.

Health insurers, including Aetna Life Insurance Co, Anthem Inc., Cigna Corp., QCC Insurance Co. and United Healthcare Insurance Co., want to eliminate the use of estate assets to pay uncovered benefits. 

The liquidator, Pennsylvania insurance commissioner Jessica Altman, wants to establish a captive insurer that would take some of the assets of the estate of the insolvent insurers and provide benefits to policyholders once they have maxed out on their  GA limits, which are smaller in some states than others, but run around $300,000, with New Jersey having no cap. This captive set up worked in other life insurance and health insurance liquidations such as Executive Life of New York. However, the health insurers say there is “no way to read these statutes allowing a receiver to take assets out of the estate” and give them to a trust to pay claims beyond the  GA limit.

Both life and health insurers are on the hook to pay into the GAs to fund claims. Health insurers say that’s it, but life insurers are concerned about repetitional risk and policyholder welfare. 

Limiting the policyholders to the GA will “almost surely impose a financial hardship upon many people,” the ACLI said in a May 22 court filing. 

If people who purchased LTC insurance from Penn Treaty “are relegated to guaranty association limits, many will suffer irreparable financial hardship,” the ACLI wrote. 

The Pennsylvania-based ACLI lawyer argued that the insurers contributing to the GA funds whose costs would increase due to the reallocation of money could spread the increase over a large population of insureds. This more diluted burden is less than the burden that will be borne on the fragile and vulnerable Penn Treaty policyholder population, he argued. 




NAIC’s results of CLO stress-testing expected early next month

Aug. 7, 2019– The National Association of Insurance Commissioners expects to have the results of stress tests on collateralized loan obligations in early September as the standard-setting organization is finding CLOs have recently been using more aggressive earnings assumptions and fewer guardrail conditions, known as covenants.

That’s according to prepared remarks from Eric Cioppa, NAIC’s president for 2019 and Maine’s insurance superintendent. Cioppa hilighted the issue as part of his opening remarks at the NAIC’s summer meeting in New York the first weekend in August.

The remarks come on the heels of a special  report released July 23 by the NAIC’s Capital Markets Bureau assessing exposure to CLOs by the insurance industry for 2018. The remarks also come soon after state insurance regulators, coordinated by the NAIC,  have made changes to better scrutinize the risk of certain financial instruments such as CLOs.

Fitch Ratings announced Aug. 7 that U.S. and European CLO issuance was higher in the second quarter of 2019  than the first quarter, helped by ” flexible structures and spread stability” and brisk activity in April.

The vast majority–90% to 95% of CLO transactions are arbitrage CLOs where equity  investors get the cash  flows after the debt on the bank loans are paid to the note holders, based on an NAIC primer on the subject.

CLOs are structured securities sold in tranches by asset managers and collateralized  mainly by leveraged bank loans. They are collateralized by what the Bureau identifies as a pool of below investment grade first lien, senior secured, syndicated bank loans as well as smaller pools of  middle market (MM) loans and second lien loans.

According to Fitch Ratings’ statement on its new report, Global CLO Chart Book: Market Review – 2Q19, the portfolio quality for CLOs has been “fairly stable” in  both the U.S. and Europe, but the  U.S. MM CLOs’  wearer reveled to be “comparatively weaker,” Fitch stated. This because of a lower portfolio rating-mix, it said Aug. 7.

The NAIC’s Capital Markets Bureau found that at year-end 2018, the amount of CLO investments in book value held by U.S. insurers totaled $122 billion, with about a third of that exposure in the top 10 U.S. life  insurance companies.

However, even this amount of exposure represents but 2% of the total cash and invested assets of the insurance industry in the U.S., the NAIC’s capital markets research arm found.  For 2018, CLO issuance overall reached $128.1 billion, up from $118 billion in 2017, and surpassed the previous high, set in 2014, by more than $4 billion. Middle market loans comprised about $62 billion of the new 2018 issuance, according to the NAIC, citing Securities Industry and Financial Markets Association data.

Most U.S. insurers’ CLO investments were of a high credit quality, rated single A or higher,” said Eric Kolchinsky, director of NAIC Structured Securities in a statement accompanying the report’s release.

“However, recently underwritten leveraged loans are adopting more aggressive EBITDA [earnings before interest, taxes, depreciation, and amortization] assumptions and have fewer covenants. These trends call for a closer examination of this type of investment,” Kolchinsky stated.

The NAIC has been working to make some structured finance products less attractive to insurers with changes to investment incentives at the rating level through its Securities Valuation Office in New York. 

 A report by PineBridge Investments  back in August 2017 identified three “vintages” of  modern CLOs, the latest version appearing in 2014 and characterized by risk reductions such as elimination of high yield bonds and the advent of new regulations. PineBridge noted that CLOs there are about 250 CLO managers globally with about 75% in theU.S. the remaining asset managers of CLOS are in Europe, the report, entitled Seeing Beyond the Complexity: An Introduction to Collateralized Loan Obligations, noted.

This report also found that insurance companies top the list of largest CLO owners in the mezzanine tranches, rated A/BBB/BB. In the higher-rated senior tranches, insurance companies are the third-most prevalent owner, following banks and institutional asset managers, according to PineBridge’s research.

The NAIC’s Capital Markets Bureau said in its special report that CLOs “have the potential to be more volatile in an unstable economic environment, such as at the turn of a credit cycle,” but as of yet, they haven’t gone through anything alarming or too severe and withstood the financial crisis.

The credit quality of U.S. insurer CLO exposure was mostly BBB or higher, with the majority in the A to AAA range, according to the NAIC chart on CLO credit quality.

Even though U.S. insurers’ high credit quality exposure is expected to thwart major CLO problems if the securities go sideways, a cautious NAIC said it would “continue to closely monitor insurers’ CLO exposure.”

The anticipated early September–or even early fall  — results of the stress testing should show just how closely the NAIC needs to monitor CLOs going forward. 

There appears to be time to weigh the options presented by stress testing.

Deborah Ogawa, senior director  ofU.S. Structured Credit for Fitch Ratings said in a statement accompanying the inaugural Global CLO Quarterly market review that  European CLO asset recovery expectations are for those in the U.S. , on average for a variety of reasons. However, she said that the research shows  the CLO product to be stable, while Fitch round that not many CLOs failed their covenant quality tests in the second quarter.

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More potential LTC pain ahead, but growth & innovation, as well?

Aug. 3 –Certain assumptions made by U.S. long term care insurance carriers might lead to another reserve blow to the industry, drawing even more involvement from state insurance regulators, according to a new research note from equity analysts attending the National Association of Insurance Commissioners meeting in New York this week.

A higher-than-expected claims duration coupled with an increase in the steepness of the morbidity curve — where more older policyholders are claiming more benefits — could vex the already shaky LTC industry, especially when mixed with the uncertainty around these developments. That’s the concern expressed by the new research note from Evercore ISI global life insurance analysts.

The concerns center on the LTC insurers’ assumptions on morbidity, which refers to claim incidence rates, length of claim, and claim utilization under the NAIC’s Actuary Guideline 51 or AG 51.

Thee factors and other related ones “could cause a greater amount of scrutiny from regulators and potentially result in more pain for the industry,” they wrote in a report dated Aug. 2.

The analysts comments follow a review of submissions from the top 50 LTC blocks of business submissions on AG 51 by the NAIC’s LTC Valuation Subgroup.  

The NAIC adopted AG 51 in 2017 to hone in on long-term care insurance reserve practices. The standard-setting organization has been ever more vigilantly monitoring the LTC industry’s challenges. It has been working on a multi-tiered solution that includes uniformity in reserve adequacy tests for enforce LTC insurance and, most recently, an effort to harmonize rate increase approval processes across states so that rate increase approvals are driven by roughly the same rhyme and reason.

But “some fundamental differences across states … may take time to fix,” Evercore analysts noted, pointing to state specific actuarial data, reliance on third party actuaries in some states and the use in some states of age-based premiums increases. 

The NAIC ‘s LTC Valuation Subgroup “noticed a higher than expected variance among insurers on their baseline morbidity assumptions creating a high degree of uncertainty, particularly around older-aged morbidity,” the Evercore analysts wrote in their note. However, most of these companies are leaning toward the conservative side in their assumptions on improvement in morbidity, according to the analysts.

Yet, mortality is still underreported, according to a Society of Actuaries and an American Academy of Actuaries joint presentation at the meeting, so it is difficult to tell if policies are lapsing or ending due to death, Evercore said. A table from the actuarial presentation looked at 48,000 deaths from companies with “reasonable data during the experience period 2008-2011.” A chart contained a note that said 10 companies’ data were deemed to be reasonably reliable and had less than 25% of unknown terminations.

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The NAIC subgroup is striving to develop a new mortality table for LTC life reserves. 

Even if some companies lag in gaining approvals for needed premiums, Genworth Financial, the largest LTC writer in the U.S., recently reported that it has made a lot of progress on rate increases as it continues to educate state regulators on the need for premium hikes.

Most state insurance regulators now acknowledge “the need for significant actuarily justified premium increases on long-term care insurance policies. Genworth and I are now actively engaged with the new … [NAIC] Long-Term Care Insurance Task Force … to develop a more consistent national approach for reviewing long-term care insurance premium rates,” Tom McInerney, Genworth’s president and CEO said on a July 31 conference call to discuss second quarter results.

However, the CEO, who is engaged in an almost three-year long quest to sell the Richmond-based insurer to China Oceanwide Holdings Group Co. Ltd., acknowledged that there are still “some states that are behind on approving rate actions.”

Genworth has gained about $11.5 billion of approved LTC premium rate increases since 2012 on a cumulative net present value basis, McInerney told investors.

Separately, a segment of the industry is now experiencing somewhat of a comeback through the hybrid policy model.

About 85% of LTC sales are now through these long term care/life insurance combination, according to the SOA’s presentation on combo products, Evercore noted.  The amount of these hybrid policies sold has doubled in the last three years, the analysts added. There are now but a dozen or so companies, like Genworth that still sell stand-alone LTC insurance.   

A key benefit of these hybrid products is that adverse mortality experience — more policyholders dying earlier — “reduces the life insurance profits but increases the LTC rider profits, as fewer people will survive to claim LTC benefits,” the SOA and the AAA said in a combo product valuation presentation at the same NAIC meeting Aug. 2.



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