Federal Insurance Office Issues
Recommendations for the Modernization andImprovement of Insurance Regulation
January 2, 2014
On December 12, 2013, the Federal Insurance Office of the U.S. Department of the Treasury(“FIO”) released “How to Modernize and Improve the System of Insurance Regulation in theUnited States” (the “Report”), a report required by Section 502 of the Dodd-Frank Act. DoddFrank created the FIO and gave it the authority to monitor aspects of the insurance industry,
identify issues or gaps in regulation that could have financial stability consequences,recommend to the Financial Stability Oversight Council that it designate an insurer as anonbank financial company supervised by the Federal Reserve and represent the U.S.
government in prudential aspects of international insurance matters, among other powers.
The Report is a broad survey of U.S. insurance regulation, covering topics from prudential
regulation to consumer protection. It identifies two types of improvements that should be madein the near term:•direct federal involvement in (i) creating a centralized multi-state license for insurance
agents and brokers that would preempt state licensing laws, (ii) regulating mortgage
insurance, and (iii) other limited areas; and•greater uniformity among state regulations.

This memorandum briefly discusses the Report’s most significant recommendations, many ofwhich would, if implemented, reduce compliance burdens for insurers by reducing inconsistentand duplicative state regulations.
A.

FEDERAL INVOLVEMENTThe Report recommends certain limited areas for direct federal involvement in the near term:•Agent and Broker Licensing — Insurance agents and brokers are licensed at the state level
and are subject to varying requirements in different states, resulting in barriers to doing
business in multiple states with little consumer benefit. The Report recommends thatCongress pass the National Association of Registered Agents and Brokers Reform Act of2013, legislation that has passed in the House and is pending in the Senate, which would
create a body tasked with developing uniform licensing requirements.

•Mortgage Insurance — Mortgage insurers provide credit enhancement to mortgages
guaranteed by government-sponsored enterprises (GSEs). Three of the eight U.S.

Memorandum – January 2, 2014

mortgage insurers failed during the housing crisis of 2007-2009. The GSEs and just 16
states have regulations specific to mortgage insurers, and during the housing crisis, theseregulations were waived or relaxed when insurers were no longer able to comply. The
Report recommends the adoption of robust national solvency and business practicestandards, without providing specifics.
•Recognition of Foreign Reinsurance — State regulations allow insurers who transfer risk toU.S.-based reinsurers to receive 100% credit on their financial statements for cededliabilities. However, regulations typically require foreign reinsurers to post qualifying
collateral in order for ceding insurers to receive 100% credit. The amount and quality ofcollateral varies among the states, depending on factors such as the creditworthiness of
the reinsurer and the perceived strength of the reinsurer’s home-country regulation, bothof which are assessed at the discretion of the state regulator. Without providing specifics,
the Report recommends that the FIO and the United States Trade Representative negotiate
and enter into agreements with foreign governments and/or regulators relating to therecognition of reinsurance prudential regulation. The Report also recommends that theFIO, rather than the states, determine whether a foreign country has sufficiently effective
regulation of reinsurance.

•Group Supervision — State regulators supervise insurers at an entity-specific level and lackthe power to regulate or request certain important information relating to affiliatedentities operating and domiciled outside the state. This prevents any particular regulator
from supervising the overall operations of a multi-jurisdictional firm. The Report
recommends the FIO create supervisory “colleges” for insurance groups that would
consist of every functional regulator of an insurance group, including international
regulators, as well as the FIO itself. The colleges would be a forum for regulators to meetand identify regulatory gaps and potential weaknesses of the group.

•Nonadmitted Insurance Tax — Surplus lines insurance brokers provide insurance by aninsurer not admitted to engage in the business of insurance in a particular state. The
Nonadmitted and Reinsurance Reform Act, a part of Dodd-Frank, prohibits any stateother than the home state of an insured from taxing surplus lines policies, and permits
states to enter into agreements to allocate premium taxes among the states in which
coverage is actually provided. To date, states have not achieved consensus on whether
and how to allocate premium taxes on nonadmitted insurance. The FIO will monitor
progress on the issue and warns that further federal action may be necessary.

•Rate Regulation — The FIO will monitor different approaches to rate regulation in thestates to help identify best practices.

•Access to Insurance — The FIO will monitor state insurance activity to improve theaccessibility and affordability of insurance by minority communities, particularly NativeAmericans, and will review whether certain factors that determine a consumer’s
insurability, such as marital status and creditworthiness, should factor into insurers’

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Memorandum – January 2, 2014

underwriting standards. The FIO will also work with regulators to develop personal auto
insurance policies for U.S. military personnel that are enforceable across state lines.
In addition to these topics, the Report notes that a forthcoming report by the FIO will provide apolicy analysis of issues involved with insuring natural catastrophes.
B.

STATE UNIFORMITYThe Report notes that a lack of uniformity in state regulation subjects insurers operating
nationally in the U.S. to significantly higher compliance costs compared to insurers operating
solely abroad, creates safety and soundness concerns because no one regulator is responsible foroversight of large, complex institutions and because of regulatory arbitrage, and impedes
cooperation with international regulatory bodies. Accordingly, the Report identifies several
areas in which states should harmonize their regulations:•Solvency Standards — The Report notes that some state regulators have made certain
discretionary decisions affecting solvency oversight, including permitting deviations fromrisk-based capital requirements and standard accounting practices set forth by the
National Association of Insurance Commissioners (“NAIC”) for certain types of insurers(e.g., monoline insurers and fraternal benefit societies operating as life insurers). The
Report recommends that state regulators develop a process whereby before implementing
a discretionary practice involving important solvency matters, a state regulator must
notify and obtain the consent of regulators from other states in which the insurer operates.
Additionally, the Report notes that current risk-based capital standards are not tailored to
the risks of different types of institutions, and should be revised to integrate best practices
developed through international consensus.

•Reserves — Reserves are currently calculated based on a standardized NAIC model lawthat is not tailored to the specific risks of different types of institutions. Regulators haveconsidered moving toward principles-based reserving (“PBR”), which would rely on aninsurer’s internal risk modeling, including the insurer’s experience with specific portfolios
or products. While some regulators support a revised model law that would govern PBR,
implementation of the revisions requires a supermajority of state legislatures to adopt therevisions. The Report recommends adoption of PBR.

•Enforcement of Market Conduct Regulation — The Report recommends that states coordinate
their efforts and defer to “lead” regulators in multi-state market conduct examinations.

•Receivership — State receivership laws vary significantly, including in their treatment ofderivatives and other qualified financial contracts (“QFCs”). While federal bankruptcy
law and FDIC receivership law (with respect to depository institutions) both exempt QFCs
from the automatic stay, thus allowing QFC counterparties to close out their positions
with an insolvent entity, only some state insurance receivership laws do so. The Report
recommends a uniform approach to QFC treatment. The Report also notes that financial
reports of failed institutions vary in their level of detail and accounting treatment, andrecommends that states should adopt uniform standards for disclosure.
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Memorandum – January 2, 2014

•Reinsurance Captives — Commercial insurers have increasingly formed and transferred risk
to captive reinsurance vehicles to reduce reserve obligations and free up capital of theprimary insurers. However, certain states that have competed to be the domestic
regulators of reinsurance captives do not impose rigorous or consistent capital rules on thereinsurance entities. The Report recommends uniform, robust and transparent oversightof reinsurance captives, including the development of a uniform capital requirement and aprohibition on transactions that do not constitute a legitimate transfer of risk to thereinsurance captives.

•Product Approval — A number of states participate in the Interstate Insurance Product
Regulatory Commission (“IIPRC”), an organization that offers standards and a centralized
approval process for new insurance products in the areas of life insurance, annuity,
disability income, and long-term care. However, uniformity in product approval has notbeen achieved because (1) several states, including New York, California and Florida have
not joined the IIPRC scheme, (2) the number of product lines eligible for IIPRC review islimited, and does not include group plans and (3) insurers may opt-out of IIPRC review,
allowing them to submit contracts for approval to the less stringent of IIPRC and state
review. To fix these problems, the Report recommends that: (1) non-participating states
join the IIPRC, (2) the IIRPC expand its product coverage and (3) IIPRC standards serve asa floor, and not an alternative, to state product approval standards.

•Guaranty Fund Pay-outs — Insurers contribute to state guaranty funds that protect
policyholders in the event of insurer insolvency. The Report recommends that guaranty
funds adopt identical maximum pay-outs for similar types of policies.

•Sale of Annuities — The Report recommends that states adopt the NAIC’s model regulation
governing annuity sales, which consists of standards designed to ensure that annuity
products are suitable for the consumers that purchase them.

•Corporate Governance — The Report recommends that the NAIC propose, and states adopt,
model laws relating to corporate governance, including standards of fitness for insurers’
officers and directors.

While the Report does not recommend full federal regulation of insurance, it warns that should
states fail to reform particular areas of regulation in the near term, Congress should “stronglyconsider” direct federal involvement to fill those regulatory gaps, by the federal government
serving as either a coordinating body (and possibly preempting state law that fails to conformto uniform standards) or direct regulator of select aspects of the industry, such as large complex
institutions or institutions that seek a federal charter.
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Memorandum – January 2, 2014

For more information about the Report, please contact a member of Simpson Thacher’s
Insurance or Financial Institutions groups.
Gary Horowitz(212) 455-7113
ghorowitz@stblaw.com

Peter Gordon(212) 455-2605
pgordon@stblaw.com

Steven DeLott(212) 455-3426
sdelott@stblaw.com

Randy Benjenk(212) 455-2307
randy.benjenk@stblaw.com

This memorandum is for general information purposes and should not be regarded as legal advice. Pleasecontact your relationship partner if we can be of assistance regarding these important developments. The
names and office locations of all of our partners, as well as our recent memoranda, can be obtained fromour website, www.simpsonthacher.com.
IRS Circular 230 disclosure: To ensure compliance with requirements imposed by the IRS, we informyou that any tax advice contained in this memorandum was not intended or written to be used, andcannot be used, for the purpose of avoiding tax-related penalties under federal, state or local tax law.
Each taxpayer should seek advice based on the taxpayer’s particular circumstances from an independenttax advisor.
The contents of this publication are for informational purposes only. Neither this publication nor the lawyers who authored it are
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any person constitute the establishment of an attorney-client relationship. Simpson Thacher & Bartlett LLP assumes no liability inconnection with the use of this publication.

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