Session 7: Regulatory Update T HOMAS PASUIT, M E T L I F E J I M F RASHER, N O RT HWEST ERN M U T UA L

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1 Session 7: Regulatory Update M O D E R ATO R : PA N E L I STS: PATRICK H UGHES E R I C D I NALLO, D E B EVOISE & PLIMPTON L L P T HOMAS PASUIT, M E T L I F E J I M F RASHER, N O RT HWEST ERN M U T UA L 1

2 INTERNATIONAL REGULATORY UPDATE: CAPITAL STANDARDS AND RESOLUTION Tom Pasuit MetLife

3 BACKGROUND Financial Stability Board (FSB) established in 2009 by the G-20 in the wake of the financial crisis with a mandate to: assess vulnerabilities affecting the global financial system and propose regulatory, supervisory and related actions promote coordination and information exchange among authorities responsible for financial stability FSB membership includes: Governmental representatives from over 20 member jurisdictions (including the Treasury, the Fed and the SEC) International financial institutions (including the World Bank and the IMF) International standard-setting bodies 3

4 BACKGROUND (CONT.) FSB implements policies through its member organizations, including: International Association of Insurance Supervisors (IAIS) Committee for Banking Supervision (BCBS) International Organization of Securities Commissions (IOSCO) Primary international focus to date: capital standards and resolution 4

5 REGULATORY WEB UNITED STATES Federal Deposit Insurance Corporation (FDIC) Members: Independent agency of the federal government, led by a 5 member Board Mission: Maintain stability and public confidence in the nation s financial system by insuring deposits, examining/supervising financial institutions and Members: G-20 nations managing receiverships Financial Stability Oversight Council (FSOC) Members: Voting representatives from federal agencies, including Treasury, the Fed, the FDIC and an independent member with insurance experience. Nonvoting representatives include the FIO and a state insurance commissioner Mission: Identify risks and respond to emerging threats to financial stability National Association of Insurance Commissioners (NAIC) Members: 56 U.S. State/territory insurance regulators Mission: Standard-setting and Regulatory support organization for U.S. State/territory regulators Federal Reserve Board (the Fed) Members: Central Bank of the U.S, led by a 5 member Board Mission: Conduct U.S. monetary policy, supervise banking institutions, maintain the stability of the financial system and contain systemic risk, provide financial services to depositary institutions, the U.S. government, and foreign official institutions Federal Insurance Office (FIO) Members: Office of the U.S. Treasury Dept. Mission: Monitor all aspects of the insurance industry and coordinate/develop federal policy on international insurance matters INTERNATIONAL Financial Stability Board (FSB) Members: G-20 nations Mission: Monitor and make recommendations about the global financial system International Association of Insurance Commissioners (IAIS) Members: Insurance regulators in over 200 jurisdictions Mission: Set international standards for insurance supervision 5

6 GROUP CAPITAL STANDARDS The IAIS is developing three group-wide capital requirements: Basic (or Backstop) Capital Requirement Higher Loss Absorbency Insurance Capital Standard 6

7 BASIC CAPITAL REQUIREMENT (BCR) Factor-based approach, calculated on consolidated, group-wide basis Applicable to all global systemically important insurers (G-SIIs) Covers all group activities, including non-traditional, non-insurance (NTNI) business Market valuation approach current estimate of liabilities using IAIS-adjusted discount rate, and valuation of assets using IFRS/GAAP values, adjusted to market value 7

8 BASIC CAPITAL REQUIREMENT (CONT.) BCR approved by FSB/G-20 in Fall 2014 G-SIIs will begin reporting confidentially to their supervisors in 2015, then share with the IAIS for purposes of further refining the BCR BCR will serve as foundation for Higher Loss Absorbency requirements for G-SIIs 8

9 HIGHER LOSS ABSORBENCY (HLA) HLA will build on the BCR and impose additional capital requirements in connection with those activities that make a G-SII systemically important Applicable only to G-SIIs In early design stage; IAIS considering several HLA design options First consultation scheduled for end June/early July 2015 Initial proposal reportedly will be published this Summer 9

10 INSURANCE CAPITAL STANDARD (ICS) Risk-based global capital standard that applies to G- SIIs and internationally active insurance groups (IAIGs) ICS will apply on group-wide, consolidated basis Will be informed by, but will be much more sophisticated than, the BCR (and will eventually replace the BCR) ICS presently the subject of an IAIS consultation and is due for completion in

11 CAPITAL STANDARDS: POTENTIAL SCOPE As noted, the capital standards outlined above would potentially apply only to companies that have been designated as a G-SII or an IAIG Potential for creep into broader segments of the industry? U.S. regulators may decide that higher capital levels constitute a best practice Rating agencies may decide to incorporate the international capital levels into their rating criteria Companies that are not G-SIIs or IAIGs may nevertheless feel competitive pressure to maintain capital at levels consistent with the international standards 11

12 CAPITAL STANDARDS: IMPACT ON INVESTMENTS Given the status of the proposals, impact on investments remains unclear Key issues affecting asset side of the balance sheet under the BCR/ICS: Valuation Approach Ratings Will international capital standards discourage longterm investments? 12

13 RESOLUTION STANDARDS In addition to capital standards, international community has been keenly focused on improving insurance resolution regimes Recent FSB/IAIS consultative publications include: Insurance Annex to FSB Key Attributes of Effective Resolution Regimes of Financial Institutions Cross-Border Recognition of Resolution Action Consultation Recovery and Resolution Planning for Systemically Important Insurers: Guidance on Identification of Critical Functions and Shared Services Consultation Guidance on Cooperation and Information Sharing with Host Jurisdictions Not Represented on CMG 13

14 RESOLUTION STANDARDS (CONT.) The Key Attributes of Effective Resolution Regimes for Financial Institutions set out the core elements that the FSB considers necessary for an effective resolution regime Implementation should allow authorities to resolve financial institutions in an orderly manner without taxpayer exposure to loss from solvency support, while maintaining continuity of their vital economic functions Regime applicable to any insurer that could be systemically significant in failure, as well as any G-SII 14

15 RESOLUTION STANDARDS (CONT.) Prescribes, among other things, range of resolution options that authorities should have in toolkit, including several that do not presently exist under state insurance insolvency law, such as the powers to: Create bridge financial company for single-point-of-entry resolution Unilaterally restructure/limit liabilities and allocate losses Divide policyholders into sub-classes for distribution purposes 15

16 INTERSECTION OF CAPITAL AND RESOLUTION STANDARDS International community seems to favor bankcentric single-point-of-entry resolution strategy for insurers Resolution strategies informing development of capital and debt requirements for G-SIIs? How much and where? Two sides of same coin 16

17 LOOKING FORWARD Once finalized, capital standards will only have the force of law in the United States if adopted by a U.S. regulator Unclear whether U.S. States will embrace proposed enhancements to resolution regimes in view of Orderly Liquidation Authority Impact of international standards on insurance company investments remains to be seen 17

18 The Northwestern Mutual Life Insurance Company Milwaukee, WI FORM F (NY REG 203) & OWN RISK SOLVENCY ASSESSMENT ( ORSA ) James Frasher Assistant General Counsel May 1, 2015

19 NAIC Focus on Enterprise Risk Management ( ERM ) NAIC s focus turned to enterprise risk management after the financial crisis Desire to expand beyond the regulated insurance entity State insurance regulators wanted to better understand the risk posed to insurance legal entities: By Affiliates: Form F The insurer s own assessment of its risk: ORSA 19

20 Form F Enterprise Risk Report Model Regulation: Model Act: New requirement under revised NAIC Model Holding Company Act States are in the process of adopting now; typically file with domestic regulator Most initial filings anticipated in 2015 Purpose: Identify material risks within the insurance holding company system that could pose enterprise risk to the insurer 10 specific issues to address to determine if enterprise risk is identified Allows for a determination of no enterprise risk 20

21 Form F Definition of Enterprise Risk As defined by Section 1(F) of Act: Enterprise risk shall mean any activity, circumstance, event or series of events involving one or more affiliates of an insurer that, if not remedied promptly is likely to have a material adverse effect upon the financial condition or liquidity of the insurer or its insurance holding company system as a whole including, but not limited to, anything that would cause the insurer s RBC to fall into company action level as set forth in [reference RBC Act] or would cause the insurer to be in hazardous financial condition [insert appropriate reference]. (emphasis added) 21

22 NY Reg 203 Enterprise Risk Management Enterprise Risk Report Similar to Form F Appears to apply to some non-ny domestic companies Scope may include risk at insurer, not just affiliates Already effective: First filing made in

23 ORSA: New Regulatory Filing to Insurance Departments Model Act: New regulatory requirement Most states have already adopted; first filings to domestic departments will be made in 2015 Goals: Foster an effective level of ERM at all insurers Provide group level perspective on risk and capital 23

24 ORSA: Entity s Own Perception of Risk ORSA Own Risk and Solvency Assessment Own : Generally non-prescriptive guidance NAIC had developed a Guidance Manual that has the effect of law Risk : Identification and evaluation of risks Solvency : Assessment of solvency under normal and stressed environments Internal assessment of material and relevant risks focused on business plan and adequacy of capital Appropriate to nature, scale and complexity of insurer 24

25 ORSA Summary Report Requirements: NAIC Guidance Manual Section 1: Description of insurer s risk management framework Section 2: Insurer s assessment of risk exposure Section 3: Group assessment of risk capital Prospective solvency assessment (3 5 years) Includes investment risk CROs may require tighter documentation of existing processes Expect questions as others in the enterprise try to understand and evaluate the risk involve with certain investments 25

26 ERM Requires Cross-functional Involvement Actuarial Investment Risk Controllers Enterprise Risk Management Audit Legal Review Board (or committee) review 26

27 Confidentiality Given the proprietary and sensitive nature of the information disclosed in the Form F and ORSA, very high confidentiality protections were included to protect this information: Form F: Model Act section 8 ORSA: Model Act section 8 27

28 What s next at the NAIC? We expect group supervision to remain a hot topic MHCA was amended last year to give state insurance commissioners the power to act as group supervisors of Internationally Active Insurance Groups ( IAIGs ) State Participation in Supervisory Colleges Corporate Governance Disclosures are coming All of this will require additional resources for the states 28