the new world order in insurance regulation: what boards and management need to know and why

What Boards & Management Need to Know and Why

August 4, 2014Stephen J. Johnson, CPA, Deputy Insurance Commissioner

Office of Corporate and Financial Regulation - 1 -

The New World Order in Insurance Regulation:

What Boards and Management Need to Know and Why

What the Regulator is Expecting

Mid-Atlantic Mutual Advantage ConventionBaltimore, Maryland




What is Happening in the Regulatory World There have been seismic shifts in regulatory approach by the NAIC and Insurance Departments

Retrospective Prospective

Company Enterprise

Financial Statement Governance

Rules Principles

Regulators are expecting more Board involvement in this new regulatory approach

Is your management ready?




What are Regulators Looking at NowCorporate Governance – Group level as well as Legal entity level

Interviews with Chairman of the Board and Head of Audit Committee as part of Financial Examinations

Importance of Audit Committee

NAIC Corporate Governance Annual Disclosure Model Act

Enterprise Risk Management

How does the process work?

Is it effective?

Is it used by Management and Boards?

“Risk Management became Risk Justification”




What are Regulators Looking at Now

Own Risk and Solvency Assessment (ORSA)

NAIC Guidance Manual

The Proposed NAIC Model Law (first one due in 2015)

NAIC Pilot Program

Control Environment

Board’s need to take on more responsibility

Effective or not

Boards need to make certain representations to Insurance Departments within Amended Holding Company Law




What are Regulators Looking at Now (Cont’d.)

Capital Management

How is this done by Management and Boards

Effective or not

Group Capital (ORSA)

Strategic Management

Does the Board have a plan?




Risk Management Initiatives

Form B –Annual registration statement new requirements:

Financial statements of holding company

Statement that the insurer’s board of directors is responsible for and oversees corporate governance




Risk Management InitiativesNew Form F—Enterprise Risk Report

Annual confidential supplement identifying material risks within the insurance holding company system that could pose financial and/or reputational contagion to the insurer (enterprise risk management)

Form F shall provide information regarding the following areas that could produce enterprise risk:

Any material developments regarding strategy, internal audit findings, compliance or risk management affecting the insurance holding company system;

Acquisition or disposal of insurance entities and reallocating of existing financial or insurance entities within the insurance holding company system;

Any changes of shareholders of the insurance holding company system exceeding ten percent (10%) or more of voting securities;




Risk Management InitiativesNew Form F—Enterprise Risk Report

Developments in various investigations, regulatory activities or litigation that may have a significant bearing or impact on the insurance holding company system;

Business plan of the insurance holding company system and summarized strategies for next 12 months;

Identification of material concerns of the insurance holding company system raised by supervisory college, if any, in last year;





New Form F—Enterprise Risk Report

Identification of any negative movement, or discussions with rating agencies which may have caused, or may cause, potential negative movement in the credit ratings and individual insurer financial strength ratings assessment of the insurance holding company system (including both the rating score and outlook);

Information on corporate or parental guarantees throughout the holding company and the expected source of liquidity should such guarantees be called upon; and

Identification of any material activity or development of the insurance holding company system that, in the opinion of senior management, could adversely affect the insurance holding company system.





ERM Framework

Description of the Risk Management Policy

Quantitative Measurements of Risk Exposure in Normal and Stressed Environments

Group Risk Capital Assessment

Prospective Solvency Assessment

Who is required to File (Exemptions)

ORSA will be unique for each

company

Evergreen Approach to ORSA

Group or Legal Entity Level

Own Risk and Solvency Assessment (ORSA) proposal





Risk Management and Own Risk and Solvency Assessment Model Act

Vehicle that will be used to require the ORSA Summary Report to be filed

Will provide for confidentiality provisions

Lead State Concept

Effective date-1/1/2015 (Will you be ready??)





ORSA Key Questions

What is our strategy?

What level of risk are we willing to assume in pursuit of this strategy?

What are the key risks that could hinder our ability to achieve our strategy?

How much capital do we need to cover those key risks?

What risks—individually or collectively—would subject us to losses that exceed our tolerance levels?

What risk scenarios would cause us to fail or stop operating as a going concern?




Risk Management InitiativesHow will Regulators use the ORSA?

Details to be worked out

Reviewed Company’s ORSA Summary Reports that were submitted voluntarily in 2012 and 2013

Should fit like a glove with our Risk Focus Exam Process

Rating Agencies want to know about your ERM Process and I am sure your ORSA/Regulators want to know what Rating Agencies are thinking

Quality ORSA and ERM starts with governance and ends with quality of your data





What can smaller companies take away from all of this?

It is scalable

Has your management thought about this




Why are Regulators Doing This?

It is a better regulatory process-looking out of the front of the car window (prospective risk) then looking out of the back window.

AIG-Reputational Risk/Group Risk

My International Friends (EU, IAIS, G-20)




What Boards Should Be Doing About All This Change

Get educated

Set up a Risk Committee of the Board

Should we hire or designate a Chief Risk Officer (CRO Council of North America)

Is the Board receiving proper Risk Summary Reports from Management




What Boards Should Be Doing About All This Change (Cont’d.)

How does the Board know that the Company’s ERM System is working

AIG-Derivatives operation

JPMorgan Chase $2B trading loss (Now $5.8B)

UBS-Rogue Trader

How do we learn from the ERM failure?




What Boards Should Be Doing About All This Change (Cont’d.)

Boards need more individuals with an Insurance Regulatory Background-Where do we find them?

Should the CEO and Chairman of the Board be split roles?

Is your Board receiving updates on Regulatory Issues (Regulatory Risk)?

Has your Board ever thought about inviting your Domestic Regulatory to one of your Board Meetings?




Concluding Thoughts from your Regulator:

Boards Can Never Fall Asleep




What Can Happen if a Board is Asleep at the Switch

Information discussed today and the new regulatory model is to prevent Boards from falling asleep

Boards should never stop getting educated and asking the right questions

What questions were never asked by Boards in the past that should have been:

Why are we always reserving at the low end of the actuary’s range?

Why are our reserves always deficient?

Why does our actuary not give the Board a presentation?




Questions (Cont’d.)

Why do we take so much risk on our investments?

How do we know we are pricing right?

Why do we do business with reinsurers we never heard of?

What are we doing about our RBC being below 300%?

How often do we waive our underwriting standards?

Why are we using an accounting firm we never heard of?

Why are we expanding so fast?




Questions (Cont’d.)

Why did we get into a new line of business?

Do we need to change management?

What is our future?

Insolvency




Solvency Update




Solvency UpdateLow insolvency level (low severity also)

7 straight calendar years (2005-2011) without an insolvency of a Pennsylvania domestic insurer

First Time in 64 Years!

Last Liquidation of a P/C PA domestic: 7/28/2003Last Liquidation of a Life PA domestic: 7/2/2004Companies saved in PA since 1997: 102

Streak ended on February 8, 2012-First Sealord (a surety only company) placed into liquidation

GAO Report (June 2013)-States did a great job during meltdown




Insolvencies 2008 2009 2010 2011 2012 2013

P & C 3 7 10 12 15 13

L & H 5(1 caused

by economic

crisis)

10(1 caused

by economic

crisis)

3 3 2 3

Title 2 0 2 0 0 1

Fraternal 0 0 0 1 0 0

Total 10 17 15 16 17 17




Number of

Bank Failures Year Bank Failures

2008 25

2009 140

2010 157

2011 92

2012 51

2013 24Source: FDIC Failed Bank List www.fdic.gov




Low interest rate environment

CATS

Reserve adequacy

ComFrame

Group supervision

Regulatory Change

Execution of Regulatory Change

The many things that keep me up at nightThe Future of Reinsurance

Affordable Health Care Act

Feds getting more involved

Run-off companies

Long-term care insurance

Regulatory talent

Cyber Risk

Can I make it to retirement




Questions?

the new world order in insurance regulation: what boards and management need to know and why

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