Financial Stability Board's Four Recommendations

Before delving into the report's recommendations, it is important to understand that its purpose was to provide an update on progress the U.S. has made in the aftermath of the 2010 Financial Sector Assessment Program (FSAP). This is an assessment undertaken every five years to evaluate a country's financial sector compared with accepted regulatory international standards. The evaluation of insurance supervision in the U.S. was based upon Insurance Core Principles (ICPs) established by the IAIS. The FSAP and subsequent peer review are part of a larger effort to manage and better regulate risk in the financial system.

The Report

The FSB's report addressed three general topics relevant to financial stability: 1) regulation of systemic risk oversight arrangements; 2) supervision and oversight of financial market infrastructures; and 3) insurance supervision. Recommendations addressing insurance supervision are discussed below.

When the U.S. insurance regulatory system was evaluated as part of the 2010 FSAP, it was found to observe most of the international ICPs. According to the FSB's report, significant progress had been made to address issues raised during the earlier assessment. Still, the FSB made four insurance-related recommendations that speak to the foundations of insurance regulation in the U.S.

Recommendation #1: Strive for Greater Regulatory Uniformity

A key message from the report was that U.S. federal and state authorities should promote greater regulatory uniformity throughout the insurance sector. The FSB commented that the decentralized architecture of the U.S.'s state-based insurance system inherently constrains the ability of the U.S. to ensure regulatory uniformity. Verifying the implementation of requirements in a state-based system with more than 50 separate authorities is a long-standing difficultly which was recognized in the FSAP.

The establishment of the Federal Insurance Office (FIO) under the Dodd-Frank Reform and Consumer Protection Act (Dodd-Frank Act) was viewed as a step in the right direction, but the FSB noted that the FIO currently lacks authority to actually bring about the desired consistency in insurance regulation. For instance, the FIO represents the U.S. on international insurance matters and can advise the Treasury Department on negotiating covered agreements, but only the states have the authority ' and no legal obligation ' to implement laws consistent with those agreements or international standards. The report suggested the FIO enhance its monitoring of the insurance sector through increased use of non-public information that it is able to access and be given more resources in order to fully address tasks mandated by the Dodd-Frank Act.

Recommendation #2: Enhance Insurance Group Supervision

The FSB's recommendation to enhance group supervision stems from the FSAP assessment finding that U.S. insurance regulation lacks a systemic focus and the capacity to exercise group-wide oversight. However, the report did acknowledge that the U.S. has made progress in developing the supervision of insurance groups through the National Association of Insurance Supervisor's (NAIC) revisions to its model holding company act and model regulation, the adoption of an Own Risk and Solvency Assessment model act, and the assignment of lead supervisors for each U.S. insurance group.

Still, the FSB believes that group supervision should be further improved by introducing requirements for consolidated financial reporting for all insurance groups. The report also suggested that lead supervisors be given additional powers to fully assess the financial condition of an entire insurance group, such as having direct powers over holding companies.

Recommendation #3: Continue to Modernize Solvency Requirements

Efforts are already being made to modernize solvency requirements in the U.S. insurance sector. Specifically, the NAIC has changed accounting and disclosure requirements for securities lending business and introduced principle-based reserving (PBR). The FSB encouraged state regulators to continue this pursuit, noting that if PBR is enacted by the states, strong actuarial expertise and regulatory tools will need to be developed to deal with its complexities. The NAIC has also modernized solvency requirements through the introduction of stress testing, but the FSB criticized the absence of target safety levels of reserving.

Recommendation #4: Reform Governance and Funding

Perhaps the least amount of change in response to the FSAP assessment has been with respect to the recommendations concerning governance and funding reforms. In order to reduce potential for political influence in insurance departments, the FSB recommended that commissioner appointments be for fixed terms and midterm dismissals only be possible for prescribed causes and with publication of the reason. It was further recommended that state insurance departments be fully self-funding and allowed greater flexibility to hire staff with specialist skills.

No NAIC-coordinated governance reforms have been made, or are planned, as the NAIC does not believe the commissioner selection process has any bearing on regulatory effectiveness. The NAIC and several state regulators have advised the FSB of their belief that funding and staffing reforms are not necessary at this time.

What Is Next?

What impact the report and its pointed recommendations may have on shaping the future of the U.S. insurance regulatory system is not entirely clear. The recommendations are advisory in nature and it is up to the U.S. to decide whether and how to implement them. While the FSB does not have regulatory authority, it is certainly influential and its recommendations challenge domestic authorities to evaluate where improvements could be useful in the existing regulatory system.

The recommendations in the report have been interpreted by some who have a state-based preference as unwarranted criticism. The call for a stronger role for the FIO ' or even a federal regulator ' has been vehemently opposed by many state-based authorities and industry groups. In fact, the FSB explicitly suggested that U.S. authorities consider and advise Congress as to whether migration toward a more federal, streamlined regulatory structure may be an effective means of achieving uniformity. The FIO will soon be releasing a mandated report on how to modernize and improve the system of insurance regulation in the U.S. The FSB's recommendations may be foreshadowing themes that will appear in the widely anticipated FIO report.

Still, for many, the bottom line is whether U.S. insurance regulation works. In June 2013, the Government Accountability Office issued a study on Impacts of and Regulatory Response to the 2007-2009 Financial Crisis, which noted that the insurance industry not only weathered the financial crisis well, but was a source of strength for the economy. Why then, proponents of the state-based system ask, is the FSB report critical of decentralized insurance regulation? One thing that is certain is that the debate on how to improve the U.S. insurance regulatory system will continue.

Michael R. Nelson, chairman of Nelson Levine, represents clients in matters related to insurance, class actions, corporate business practices, antitrust, coverage, regulation and extracontractual litigation. He can be reached in the New York office at 212-233-6251 or [email protected]. Molly Lang, partner, advises insurers and reinsurers on a broad range of compliance and regulatory matters. Reach her in the Columbus, OH, office at 614-456-1634 or [email protected].

Earlier this year, an international body known as the Financial Stability Board (FSB) made four recommendations on how to improve the United States' insurance regulatory system. The recommendations, which were published in the FSB's Peer Review of the United States (report) on Aug. 27, 2013, could influence the ongoing debate regarding the way insurance is regulated in the U.S.

Background

The FSB was created by the G-20 to promote the development and implementation of effective regulatory, supervisory and other financial sector policies. The U.S. is a member of the G-20 and is represented on the FSB by the Board of Governors of the Federal Reserve System, the Securities & Exchange Commission (SEC) and the U.S. Department of the Treasury. Although U.S. insurance regulators are not members of the FSB, they do belong to the International Association of Insurance Supervisors (IAIS), which is an FSB member. The FSB is not a regulator, but coordinates at the international level the work of national financial authorities and international standard setting bodies such as the IAIS.

Before delving into the report's recommendations, it is important to understand that its purpose was to provide an update on progress the U.S. has made in the aftermath of the 2010 Financial Sector Assessment Program (FSAP). This is an assessment undertaken every five years to evaluate a country's financial sector compared with accepted regulatory international standards. The evaluation of insurance supervision in the U.S. was based upon Insurance Core Principles (ICPs) established by the IAIS. The FSAP and subsequent peer review are part of a larger effort to manage and better regulate risk in the financial system.

The Report

The FSB's report addressed three general topics relevant to financial stability: 1) regulation of systemic risk oversight arrangements; 2) supervision and oversight of financial market infrastructures; and 3) insurance supervision. Recommendations addressing insurance supervision are discussed below.

When the U.S. insurance regulatory system was evaluated as part of the 2010 FSAP, it was found to observe most of the international ICPs. According to the FSB's report, significant progress had been made to address issues raised during the earlier assessment. Still, the FSB made four insurance-related recommendations that speak to the foundations of insurance regulation in the U.S.

Recommendation #1: Strive for Greater Regulatory Uniformity

A key message from the report was that U.S. federal and state authorities should promote greater regulatory uniformity throughout the insurance sector. The FSB commented that the decentralized architecture of the U.S.'s state-based insurance system inherently constrains the ability of the U.S. to ensure regulatory uniformity. Verifying the implementation of requirements in a state-based system with more than 50 separate authorities is a long-standing difficultly which was recognized in the FSAP.

The establishment of the Federal Insurance Office (FIO) under the Dodd-Frank Reform and Consumer Protection Act (Dodd-Frank Act) was viewed as a step in the right direction, but the FSB noted that the FIO currently lacks authority to actually bring about the desired consistency in insurance regulation. For instance, the FIO represents the U.S. on international insurance matters and can advise the Treasury Department on negotiating covered agreements, but only the states have the authority ' and no legal obligation ' to implement laws consistent with those agreements or international standards. The report suggested the FIO enhance its monitoring of the insurance sector through increased use of non-public information that it is able to access and be given more resources in order to fully address tasks mandated by the Dodd-Frank Act.

Recommendation #2: Enhance Insurance Group Supervision

The FSB's recommendation to enhance group supervision stems from the FSAP assessment finding that U.S. insurance regulation lacks a systemic focus and the capacity to exercise group-wide oversight. However, the report did acknowledge that the U.S. has made progress in developing the supervision of insurance groups through the National Association of Insurance Supervisor's (NAIC) revisions to its model holding company act and model regulation, the adoption of an Own Risk and Solvency Assessment model act, and the assignment of lead supervisors for each U.S. insurance group.

Still, the FSB believes that group supervision should be further improved by introducing requirements for consolidated financial reporting for all insurance groups. The report also suggested that lead supervisors be given additional powers to fully assess the financial condition of an entire insurance group, such as having direct powers over holding companies.

Recommendation #3: Continue to Modernize Solvency Requirements

Efforts are already being made to modernize solvency requirements in the U.S. insurance sector. Specifically, the NAIC has changed accounting and disclosure requirements for securities lending business and introduced principle-based reserving (PBR). The FSB encouraged state regulators to continue this pursuit, noting that if PBR is enacted by the states, strong actuarial expertise and regulatory tools will need to be developed to deal with its complexities. The NAIC has also modernized solvency requirements through the introduction of stress testing, but the FSB criticized the absence of target safety levels of reserving.

Recommendation #4: Reform Governance and Funding

Perhaps the least amount of change in response to the FSAP assessment has been with respect to the recommendations concerning governance and funding reforms. In order to reduce potential for political influence in insurance departments, the FSB recommended that commissioner appointments be for fixed terms and midterm dismissals only be possible for prescribed causes and with publication of the reason. It was further recommended that state insurance departments be fully self-funding and allowed greater flexibility to hire staff with specialist skills.

No NAIC-coordinated governance reforms have been made, or are planned, as the NAIC does not believe the commissioner selection process has any bearing on regulatory effectiveness. The NAIC and several state regulators have advised the FSB of their belief that funding and staffing reforms are not necessary at this time.

What Is Next?

What impact the report and its pointed recommendations may have on shaping the future of the U.S. insurance regulatory system is not entirely clear. The recommendations are advisory in nature and it is up to the U.S. to decide whether and how to implement them. While the FSB does not have regulatory authority, it is certainly influential and its recommendations challenge domestic authorities to evaluate where improvements could be useful in the existing regulatory system.

The recommendations in the report have been interpreted by some who have a state-based preference as unwarranted criticism. The call for a stronger role for the FIO ' or even a federal regulator ' has been vehemently opposed by many state-based authorities and industry groups. In fact, the FSB explicitly suggested that U.S. authorities consider and advise Congress as to whether migration toward a more federal, streamlined regulatory structure may be an effective means of achieving uniformity. The FIO will soon be releasing a mandated report on how to modernize and improve the system of insurance regulation in the U.S. The FSB's recommendations may be foreshadowing themes that will appear in the widely anticipated FIO report.

Still, for many, the bottom line is whether U.S. insurance regulation works. In June 2013, the Government Accountability Office issued a study on Impacts of and Regulatory Response to the 2007-2009 Financial Crisis, which noted that the insurance industry not only weathered the financial crisis well, but was a source of strength for the economy. Why then, proponents of the state-based system ask, is the FSB report critical of decentralized insurance regulation? One thing that is certain is that the debate on how to improve the U.S. insurance regulatory system will continue.

Michael R. Nelson, chairman of Nelson Levine, represents clients in matters related to insurance, class actions, corporate business practices, antitrust, coverage, regulation and extracontractual litigation. He can be reached in the New York office at 212-233-6251 or [email protected]. Molly Lang, partner, advises insurers and reinsurers on a broad range of compliance and regulatory matters. Reach her in the Columbus, OH, office at 614-456-1634 or [email protected].