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January 31
08:32 2017

Public Policy Analysis & Opinion

NAIC developing new capital calculations for insurance groups

In 2017-2018, the National Association of Insurance Commissioners (NAIC) will continue development of a group capital calculation formula or framework. This aim arises in response to proposals from both the Federal Reserve System and international regulators.

In December 2016, the Group Capital Calculation Working Group (GCCWG) announced a five-phase timeline for developing a group capital calculation tool. At that time, the NAIC staff produced a memo on the project and circulated it for public comment.

The GCCWG leaned toward a bifurcated framework, which would create one formula for groups where the lead firm is an insurer and another method for groups where the lead firm is a non-operating holding company.

This project follows a recommended policy on capital requirements adopted by the NAIC in March 2016, at the urging of the nation’s largest insurers drawn from both the life insurance and property/ casualty sectors.

Industry support for state action in this policy area arose after the Fed announced several group-based regulatory initiatives. The Fed’s effort introduced uncertainty to the insurance sector. Specifically, the Fed’s efforts seemed to be festooned with terms and expectations drawn from the banking sector. Also, some industry advocates expressed concerns about the influence of overseas regulatory frameworks on the Fed’s deliberations.

The Fed’s interest in group-wide solvency assessment and reserves arises, in large part, from the financial collapse of American International Group in September 2008. Let’s face it: The American state-by-state system of insurance regulation botched the oversight of AIG. State regulators had authorityover the holding company and, at the very least, could have monitored, reported on, and demanded action
from regulatory agencies that held jurisdiction overthat the credit default swap business that brought down AIG was the “business of insurance,” over which insurance regulators hold jurisdiction through the functional regulation provisions of the Gramm-Leach-Bliley Act and the McCarran-Ferguson Act. State regulators simply ignored the cauldron of risk that was weighing down AIG.

Leading up to the financial failure of AIG, a plethora of regulatory agencies claimed jurisdiction over various parts of the “world’s largest insurance company,” while other dark closets of the tower of risk remained unclaimed by any regulatory agency. No one looked at the whole of AIG’s operations.  What resulted was a pretense of regulation that invited the financial collapse.

The Fed framework focuses on two kinds of insurers:  first, any firm that the Financial Security Oversight Council deems to present systemic risk to the economy, and second, any holding company that includes subsidiaries that fall under depository insurance programs.


In addition to the Fed, the International Association of Insurance Supervisors (IAIS), of which the NAIC is a member, is constructing a recommended capital requirement framework of its own. The IAIS proposal is still more fluid than the Fed’s approach. It appears to focus on the consolidated condition of firms and attempts to integrate multiple accounting platforms: i.e., U.S. GAAP, SAP, and IFRS.

The state system

The state-based system of capital requirements began in the 19th century.  In the antebellum era, states required insurance companies to present a list of “subscribers” who pledged financial contributions to the insurer before the firm received incorporation approval from a state legislature.

In the decades after the Civil War, states expanded the purpose of capital requirements. State officials began to use capital requirements to require regional and national insurers to make local investments. This approach included the purchase and retention of state-issued bonds or the deposit of funds or securities with favored state-chartered banks. Officials argued that they needed access to local assets to pay local claimants in the case of insolvency or fraud. In modern terms, these capital requirements compelled “community reinvestment,” which provided a financial impetus for states to admit more and more insurers.

Until the early 1990s, states usually established static capital requirements regarding fixed-dollar amounts associated with specific insurance lines. States rarely reviewed or updated these requirements, so over the decades they did not keep up with the growth of the insurance sector. In some jurisdictions, capital requirements proved laughable when an amount of several hundred thousand dollars was imposed on multi-billion-dollar concerns.

After a surge of insolvencies that arose from a binge of financial speculation in the 1980s, Congress launched investigations, and the NAIC offered an initiative known as the Solvency Policing Agenda. The NAIC’s review of capital requirements resulted in the establishment of the risk-based capital (RBC) framework. The framework involved formulas that were designed to require higher capital requirements in support of higher risk business. Although the NAIC represented the formulas behind the framework as a work product of NAIC and regulatory staff, a lobbyist for Aetna did most of the work.  The NAIC’s RBC framework remains in place today.


In late 2014 or early 2015, industry advocates began work on a proposal called aggregation and calibration (A&C). The effort was aimed at preserving generations of parochial definitions, guidelines, and rules, which state officials accepted and enshrined in public policies dating back to the era of Andrew Jackson.

In March 2016, representatives of the American Council of Life Insurers
and the American Insurance Association presented a report on the A&C project to
the NAIC.  The presentation explained: “The A&C approach is guided by overarching principles which ensure comparability and transparency, regardless of a group’s structure, activities or regimes.”

The aggregation component of the approach focused on the “the identification of regimes and adjustments to ensure appropriate reflection of capital across the group.”

The calibration component was intended to “ensure comparability when aggregating capital across regimes.” In addition, the ACLI/AIA report explained that the calibration component “applies scalars across regimes to produce comparable measures of risk which can be aggregated into a group-wide measure.”

The use of the term “scalars” draws the reader’s eye. Back in my Catholic school days, we referred to terms like “scalars” as “Nun Words.”  We applied that description because the good sisters used unusual words that we never heard at home or anywhere else. Furthermore, we assumed that the nuns’ only motivation was to drive us to seek out a dictionary—this was war!

The dynamic still works. The word “scalars” carries several definitions related to variable or alterable activity or worth; however, the word also means “fickle.” The “fickle part” raises concern when applied to a business based on trust.


Before the NAIC’s December 2016 convention, the Property Casualty Insurance Association of America (PCI) submitted comments to the commissioners’ association. The PCI expressed general support for the NAIC efforts if the regulators did not establish specific capital requirements. Nevertheless, the PCI did express concerns that NAIC was moving too fast.

“PCI strongly supports the NAIC’s Risk-Based Capital Aggregation Approach as the proper basis for this tool. It is critical, however, that the NAIC take the time necessary to get it right first, rather than developing a flawed tool quickly, and rely on improving it as time goes by,” concluded Steve Broadie, PCI’s vice president for financial policy.

The non-prescriptive group capital calculation tool “will allow the NAIC to more effectively understand and assess group risk and permit our time-tested and proven U.S. state-based insurance regulatory model to continue to serve as the most effective insurance regulatory system in the world,” said Broadie.

“The development of an effective and credible group capital assessment tool will enhance the primacy of state regulators’ roles as group-wide supervisors for U.S. groups, and assist our domestic industry by avoiding intrusive group regulation by foreign insurance regulators.”

So much time has passed since state insurance regulators initiated a regulatory action that few would recognize such an action if they saw one.  Even the term “supervisory” has no real meaning under the McCarran-Ferguson Act, which requires regulatory action. A supervisory function is nothing
more than voyeurism. At best, supervision provides a pretense of regulation, which is not the same as actual regulation.

The ACLI and AIA representatives recognized three areas of policy concern that the A&C approach presented for state officials:

  • What is [t]he necessity and appropriateness of a group capital calculation for all insurance groups;
  • How would state regulators implement and coordinate assessment of such a calculation; and
  • What is [t]he basis and scope of an insurance commissioner’s authority to adopt and act on the calculation?


Just before the NAIC meeting in December 2016, the American Insurance Association (AIA) reiterated its support for the regulators’ efforts.

“AIA supports an aggregation and calibration (A&C) approach for the group capital calculation tool—and this approach is reflected in the GCCWG’s inventory method proposal.  Regarding this proposal, AIA will comment on two NAIC suggestions for scaling capital requirements from different solvency regimes. The purpose of scalars is to address compatibility across jurisdictions. The treatment of non-insurance entities within arelated group of insurance companies
will also be discussed with the GCCWG.”

This effort deserves continued attention. As the world learned the hard way in 2007, insurance regulation is a high-stakes game.

The author

Kevin P. Hennosy is an insurance writer who specializes in the history and politics of insurance regulation. He began his insurance career in the regulatory compliance office of Nationwide Insurance and then served as public affairs manager for the National Association of Insurance Commissioners. Since leaving the NAIC staff, he has written extensively on insurance regulation and testified before the NAIC as a consumer advocate.


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