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FIO still lacks faith in state regulators' ability to monitor use of reinsurance captives

The Federal Insurance Office has taken note of the effortsmade by state regulators to check up on captive reinsurers, but maintains thatthe regime is still not stringent enough, according to its released Sept. 30.

While state regulators have improved their monitoring oflife insurers with the implementation of the captive framework, reinsurancecaptives are still not regulated as strictly as required, according to the FIOreport.

In 2014 and 2015, state regulators came up with a captiveframework to enhance regulations that govern the transfer of risk for term lifeand secondary guarantee products to a reinsurance captive. Although stateinsurance regulators went on to implement the framework, the changes continueto be indirect and focus mainly on ceding life insurers, the report said.

In its 2015 annual report, the FIO, part of the U.S.Treasury Department, flagged the increasing use of reinsurance captiveinsurance subsidiaries, which subjected life insurance contract holders torisks associated with reserve credit and higher capital.

Reinsurance captives will continue to be under lessstringent requirements than life insurers, the latest report said. Captivesalso lacked transparency and remained exempt from a proper disclosure frameworkwhen compared to life insurers.

"State insurance regulators should continue to developa nationally consistent and appropriately tailored capital, solvency, anddisclosure framework for reinsurance captives," the FIO stated. It pressedthe need for rigorous and nationally uniform regulation.

The FIO also remains concerned about the implications ofprinciple-based reserving, or PBR, the NAIC's formula-based approach to calculatinglife reserves. The method is expected to be implemented over three years,starting Jan. 1, 2017, but the FIO cautioned that it may not completely do awaywith the use of captive reinsurers by life insurers seeking to offload whatthey feel are redundant reserves.  

Despite the NAIC's belief that implementing PBR couldpotentially eliminate the industry's use of captive reinsurers for certain lifeinsurance products, the industry might still feel the need to use captiveinsurers, the FIO said, citing a report by Fitch Ratings. Fitch's report gavePBR a mixed review on its ability to eliminate these types of captives.

An added challenge is the ability of state regulators toimplement PBR effectively given the limited number of trained workers in the stateinsurance departments. Despite assurance from state regulators that they candelegate tasks to the NAIC, or NAIC-hired consultants, the FIO expressedreservations about handing over regulatory functions to private entitieswithout sufficient monitoring.

The report highlighted the growing interest ininfrastructure investment in the U.S. and Europe. Investors globally are tryingto mitigate the risk from interest rates by entering public-privatepartnerships. The report appeared to recognize that regulators could try torecalibrate the traditionally high regulatory capital charges associated withinfrastructure projects so they are more attractive to insurers, if thoseinvestments are well-performing.

The 85-page annual report also touched on other ongoingissues in the insurance industry, including persistent low interest rates andtheir impact on life insurers.

Although the low interest rate climate has lasted a while,the insurance industry felt the worst impact from it in 2015, the FIO stated.Insurers, including those in the life and health and P&C sectors, sawstagnating investment income, and their invested assets were at an all-time lowin that year.

"Insurers have taken measured steps to address theeffect of low interest rates, but those steps may not be adequate if interestrates continue to remain historically low," the FIO warned in its report.