Insurance Markets: Impacts of and Regulatory Response to the 2007-2009 Financial Crisis
Published: 2013-06-27T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: Insurance plays an important role in ensuring the smooth functioning of the economy. Concerns about the oversight of the $1 trillion life and property/casualty insurance industry arose during the 2007-2009 financial crisis, when one of the largest holding companies, AIG, suffered severe losses that threatened to affect its insurance subsidiaries. GAO was asked to examine any effects of the financial crisis on the insurance industry.
This report addresses (1) what is known about how the financial crisis of 2007-2009 affected the insurance industry and policyholders, (2) the factors that affected the impact of the crisis on insurers and policyholders, and (3) the types of actions that have been taken since the crisis to help prevent or mitigate potential negative effects of future economic downturns on insurance companies and their policyholders.
To do this work, GAO analyzed insurance industry financial data from 2002 through 2011 and interviewed a range of industry observers, participants, and regulators.
section_title: What GAO Found
paragraphs: The effects of the financial crisis on insurers and policyholders were generally limited, with a few exceptions. While some insurers experienced capital and liquidity pressures in 2008, their capital levels had recovered by the end of 2009. Net income also dropped but recovered somewhat in 2009. Effects on insurers' investments, underwriting performance, and premium revenues were also limited. However, some life insurers that offered variable annuities with guaranteed living benefits, as well as financial and mortgage guaranty insurers, were more affected by their exposures to the distressed equity and mortgage markets. The crisis had a generally minor effect on policyholders, but some mortgage and financial guaranty policyholders--banks and other commercial entities--received partial claims or faced decreased availability of coverage.
Actions by state and federal regulators and the National Association of Insurance Commissioners (NAIC), among other factors, helped limit the effects of the crisis. First, state insurance regulators shared more information with each other to focus their oversight activities. In response to transparency issues highlighted by American International Group, Inc.'s securities lending program, NAIC required more detailed reports from insurers. Also, a change in methodology by NAIC to help better reflect the value of certain securities also reduced the risk-based capital some insurers had to hold. To further support insurers' capital levels, some states and NAIC also changed reporting requirements for certain assets. These changes affected insurers' capital levels for regulatory purposes, but rating agency officials said they did not have a significant effect on insurers' financial condition. Several federal programs also provided support to qualified insurers. Finally, insurance business practices, regulatory restrictions, and a low interest rate environment helped reduce the effects of the crisis.
NAIC and state regulators' efforts since the crisis have included an increased focus on insurers' risks and capital adequacy, and oversight of noninsurance entities in group holding company structures. The Own Risk and Solvency Assessment, an internal assessment of insurers' business plan risks, will apply to most insurers and is expected to take effect in 2015. NAIC also amended its Insurance Holding Company System Regulatory Act to address the issues of transparency and oversight of holding company entities. However, most states have yet to adopt the revisions, and implementation could take several years.

section_title: Letter
paragraphs: The U.S. life and property/casualty (P/C) insurance industries wrote over  $1 trillion in total premiums in 2011 and play an important role in ensuring  the smooth functioning of the economy. Concerns about the oversight of  the insurance industry arose during the 2007-2009 financial crisis, when  one of the largest U.S. holding companies that had substantial insurance  operations, American International Group, Inc. (AIG), suffered large  losses. These losses were driven in large part by activities conducted by  a non-insurance affiliate, AIG Financial Products, but also included  securities lending activity undertaken by some of its life insurance  companies which created liquidity issues for some insurers. The losses  threatened to bankrupt the company, and AIG was one of the largest  recipients of assistance by the Federal Reserve Bank of New York and  the federal government under the Troubled Asset Relief Program (TARP)  set up during the crisis.advantage of federal assistance, raising concerns about their financial   Some other insurance companies also took  position and regulators’ response to and preparation for future financial  crises that might affect insurers and their policyholders.
The report responds to your request to examine any effects of the  financial crisis on the insurance industry and policyholders. The report  addresses (1) what is known about how the financial crisis affected  insurance industry and policyholders, (2) the factors that affected the  impact of the crisis on insurers and policyholders, and (3) the types of  actions that have been taken since the crisis to help prevent or mitigate  potential negative effects of future economic downturns on insurance  companies and their policyholders.
For all objectives, we reviewed relevant laws and regulations, conducted  a literature search and reviewed literature and past GAO reports on the  financial crisis. To address how the financial crisis affected the insurance  industry and policyholders, we consulted academic papers, government  reports, industry representatives, and regulatory officials to identify the  key characteristics associated with the financial crisis. We obtained and  analyzed financial data from a variety of data sources including SNL  Financial, a private financial database that contains publicly filed  regulatory and financial reports, the Global Receivership Information  Database from the National Association of Insurance Commissioners  (NAIC), and A.M. Best’s U.S. Life Insurance Index (AMBUL) and U.S.  Property Casualty Insurance Index (AMBUPC). We determined that the  data reviewed were sufficiently reliable for our purposes. To assess  reliability, we compared select data reported in individual companies’  annual financial statements to that reported in SNL Financial. We also  obtained information from A.M. Best and NAIC staff about their internal  controls and procedures for data collection.
To address the factors that affected the impact of the crisis on insurers  and policyholders and insurance regulatory actions taken during and  since the crisis, we reviewed and analyzed relevant state guidance,  NAIC’s model investment act, reports and documents such as the  Statements of Statutory Accounting Principles, information on securities  lending and permitted practices and the Solvency Modernization Initiative  including associated guidance manuals and model laws such as the  Insurance Holding Company System Regulatory Act. We reviewed our  prior work and other sources to identify federal programs that were  available to insurance companies to increase access to capital. Appendix  I contains additional information on our scope and methodology.
We conducted this performance audit from June 2012 to June 2013 in  accordance with generally accepted government auditing standards.  Those standards require that we plan and perform the audit to obtain  sufficient, appropriate evidence to provide a reasonable basis for our  findings and conclusions based on our audit objectives. We believe that  the evidence obtained provides a reasonable basis for our findings and  conclusions based on our audit objectives.
subsections: section_title: Background
subsections: section_title: Insurance Industry Overview
paragraphs: Generally, insurers offer several lines, or types, of insurance to  consumers and others. Some types of insurance include life and annuity  products and P/C. An insurance policy can include coverage for  individuals or families, (“personal lines,”) and coverage for businesses,  (“commercial lines”). Personal lines include home owners, renters, and  automobile coverage. Commercial lines may include general liability,  commercial property, and product liability insurance. The U.S. life and  P/C industries wrote, or sold, an annual average of $601 billion and $472  billion, respectively, in premiums from 2002 through 2011. Figures 1 and  2 illustrate the percentage of premiums written for selected lines of  insurance, compared to total premiums written in the life and P/C  industries, for that time period.largest portion of business (32 percent) in the life industry, while private  passenger auto liability insurance was the largest portion of business (20   Overall, individual annuities made up the  percent) in the P/C industry. In the P/C industry, financial and mortgage  guaranty insurance represented less than 2 percent of premiums written  on average during the period.we reviewed because they facilitate liquidity in the capital markets. By  protecting investors against defaults in the underlying securities, financial  and mortgage guaranty insurance can support better market access and  greater ease of transaction execution.
section_title: Effects of the Crisis Were Limited Largely to Certain Products and Lines of Insurance
paragraphs: The financial crisis generally had a limited effect on the insurance industry  and policyholders, with the exception of certain annuity products in the life  insurance industry and the financial and mortgage guaranty lines of  insurance in the P/C industry. Several large insurers—particularly on the  life side—experienced capital and liquidity pressure, but capital levels  generally rebounded quickly. Historically, the number of insurance  company insolvencies has been small and did not increase significantly  during the crisis. Also, the effects on life and P/C insurers’ investments,  underwriting performance, and premium revenues were limited. However,  the crisis did affect life insurers that offered variable annuities with  optional guaranteed living benefits (GLB), as well as financial and  mortgage guaranty insurers—a small subset of the P/C industry. Finally,  the crisis had a generally minor effect on policyholders, but some  mortgage and financial guaranty policyholders received partial claims or  faced decreased availability of coverage.
subsections: section_title: The Financial Crisis Had a Limited Effect on Most Insurers’ Operations
subsections: section_title: Insurers Experienced Some Capital and Liquidity Pressure, but Insolvencies Were Limited
paragraphs: Many life insurance companies experienced capital deterioration in 2008,  reflecting declines in net income and increases in unrealized losses on  investment assets. Realized losses of $59.6 billion contributed to steep  declines in life insurers’ net income that year. The realized losses  stemmed from other-than-temporary impairments on long-term bonds  (primarily mortgage-backed securities, or MBS) and from the sale of  equities whose values had recently declined. A dozen large life  insurance groups accounted for 77 percent of the total realized losses in  2008, with AIG alone, accounting for 45 percent of the realized losses.
As illustrated in figure 3, life insurers’ net income decreased from 2007 to  2008, from positive income of $31.9 billion to negative income (a loss) of  $52.2 billion. However, it rebounded back to positive income of $21.4  billion in 2009, largely as a result of decreased underwriting losses and  expenses. Income increased further to $27.9 billion in 2010 but fell  again—to $14.2 billion—in 2011, reflecting increased underwriting losses  and expenses.
Total unrealized losses of $63.8 billion in the life insurance industry,  combined with the decline in net income, contributed to a modest capital  decline of 6 percent, to $253.0 billion, in 2008. As with realized losses,  AIG accounted for 47 percent of total unrealized losses, and seven large  insurance groups accounted for another 35 percent (see app. II). The  majority of the unrealized losses occurred in common stocks and other  invested assets (e.g., investments in limited partnerships and joint  venture entities). However, the unrealized losses and declines in net  income were addressed by a substantial increase in capital infusions from  issuance of company stock or debt in the primary market, transfer of  existing assets from the holding company, or, notably, from agreements  with the U.S. Treasury or Federal Reserve (see paid in capital or surplus  in fig. 4). AIG accounted for more than half (55 percent) of the capital  infusions in 2008, reflecting an agreement with the U.S. Treasury for the   Some other large life  Treasury’s purchase of about $40 billion in equity.insurance companies—through their holding companies—were also able  to raise needed capital through equity or debt issuance, or through the  transfer of existing assets from the holding companies. As shown in figure  4, many publicly traded life insurers or their holding companies continued  to pay stockholder dividends throughout the crisis. Life insurers’ capital,  increased by 15 percent, to $291.9 billion, from 2008 to 2009, partly as a  result of the increase in net income. By 2011, life insurers had net  unrealized gains of $20.8 billion, indicating improvements in the value of  their investment portfolios.
During the crisis, aggregated stock prices of publicly traded life insurers  declined substantially. As figure 5 illustrates, aggregate stock prices  (based on an index of 21 life insurance companies) began falling in  November 2007 and had declined by a total of 79 percent by February  2009. Although prices rose starting in March 2009, they had not  rebounded to pre-2008 levels by the end of 2011. In comparison, the New  York Stock Exchange (NYSE) Composite Index declined by a total of 55  percent during the same time period. See appendix II for additional  analysis of stock prices.
P/C insurers also experienced a steep decline in net income during the  crisis, with a drop of 94 percent from 2007 to 2008, although the  industry’s net income remained positive at $3.7 billion (see previous fig.  3). Realized losses of $25.5 billion contributed to the decline in net  income. Seven P/C insurance groups, including six large groups and one  smaller financial guaranty insurance group, accounted for 47 percent of  the realized losses in 2008. The realized losses resulted primarily from  other-than-temporary impairments taken on certain bonds and preferred  and common stocks. Net underwriting losses of $19.6 billion (compared  to net underwriting gains of $21.6 billion in 2007) also affected net income  for the P/C industry in 2008, as did declines in net investment income and  other factors. Many of the insurers with the greatest declines in net  income from 2007 to 2008 were primarily financial and mortgage guaranty  companies.
P/C insurers’ capital also declined from 2007 to 2008, to $466.6 billion (a  12 percent decline). Although the reduction in net income was a major  factor in the capital decline, unrealized losses of $85.6 billion also played  a role. The greatest unrealized losses occurred in common stocks and  other invested assets. Three large P/C insurance groups accounted for  55 percent of the losses. Capital infusions mitigated the decline in capital,  as illustrated in figure 6, and P/C insurers or their holding companies  continued to pay stockholder dividends. P/C insurers’ capital increased by  11.6 percent and 8.3 percent from the previous year, respectively, in 2009  and 2010.
Aggregated stock prices of publicly traded P/C companies declined less  severely than those of life insurance companies during the crisis. As  figure 5 demonstrates, P/C companies, like life insurance companies, saw  their lowest stock prices in February 2009, representing a 40 percent  decline from the highest closing price in December 2007. However, prices  had rebounded to 2006 levels by mid-to-late 2009 and remained there  through 2011. See appendix II for additional analysis of stock prices.
While regulators we interviewed stated that most life and P/C insurers’  strong capital positions just before the crisis helped minimize liquidity  challenges during the crisis, many still experienced pressures on capital  and liquidity. For example, a representative of the life insurance industry  and a regulator noted that it was extremely challenging for most  insurers—as well as banks and other financial services companies—to  independently raise external capital during this time, which led to some  insurers’ participation in federal programs designed to enhance liquidity.  In addition, some life insurers were required to hold additional capital  because of rating downgrades to some of their investments. Mortgage  and financial guaranty insurers with heavy exposure to mortgages and  mortgage-related securities experienced liquidity issues later in the crisis,  when mortgage defaults resulted in unprecedented levels of claims. In  addition to maintaining the ability to pay claims, it is important for insurers  to meet minimum capital standards to maintain their credit ratings, which  help them attract policyholders and investors.
During this period few insurance companies failed—less than 1 percent.  The number of life and P/C companies that go into receivership and  liquidation tends to vary from year to year with no clear trend (see table  1). While the number of life insurers being placed into receivership  peaked in 2009, receiverships and liquidations for P/C companies in 2009  were generally consistent with other years (except 2008, when incidences  declined). Specifically, throughout the 10-year review period, life  insurance receiverships and liquidations averaged about 6 and 4 per  year, respectively. In 2009, there were 12 receiverships and 6  liquidations. P/C receiverships and liquidations averaged about 15 and 13  per year, respectively; in 2009, there were 15 receiverships and 13  liquidations. However, these companies represented a small fraction of  active companies in those years. There were more than 1,100 active  individual life companies and 3,000 active individual P/C companies from  2007 through 2009. Appendix II provides information on the assets and  net equity (assets minus liabilities) of insurers that were liquidated from  2002 through 2011.
Some regulators and insurance industry representatives we interviewed  stated that receiverships and liquidations that occurred during and  immediately after the financial crisis were generally not related directly to  the crisis. While one regulator stated that the crisis might have  exacerbated insurers’ existing solvency issues, regulators said that most  companies that were placed under receivership during that time had been  experiencing financial issues for several years. Regulators and industry  officials we interviewed noted two exceptions to this statement; both were  life insurance companies that had invested heavily in Fannie Mae and  Freddie Mac securities and in other troubled debt securities. See  appendix III for a profile of one of these companies.
As noted above, for most insurers investment income is one of the two  primary revenue streams. Insurers’ net investment income declined  slightly during the crisis but had rebounded by 2011.
In the life and P/C  industries in 2008 and 2009, insurers’ net income from investments  declined by 7 percent and 15 percent respectively from the previous year  (see fig. 7). For life insurers, these declines primarily reflected declines in  income on certain common and preferred stock, derivatives, cash and  short term investments, and other invested assets. For P/C insurers, the  declines primarily reflected declines in income on U.S. government  bonds, certain common stock, cash and short-term investments, and  other invested assets.
Table 2 illustrates the percentages of life and P/C insurers’ gross  investment income derived from various types of investments. Bonds  were the largest source of investment income in both industries, and they  increased as a percentage of gross investment income during the crisis.  Life and P/C insurers’ income from other types of investments, such as  contract loans, cash, and short-term investments, decreased during the  crisis as a percentage of their gross investment income. According to  insurance industry representatives and a regulator, going forward, low  interest rates are expected to produce lower investment returns than in  the past, reducing insurers’ investment income and likely pressuring  insurers to increase revenue from their underwriting activities. Although  life and P/C companies had some exposure to MBS (including residential  and commercial MBS, known respectively as RMBS and CMBS) from  2002 through 2011, as part of insurers’ total bond portfolios, these  securities did not present significant challenges. In both industries,  investments in derivatives constituted a negligible amount of exposure  and investment income and were generally used to hedge other risks the  insurers faced.
Life and P/C insurers’ underwriting performance declined modestly during  the crisis. In the life industry, benefits and losses that life insurers incurred  in 2008 and 2009 outweighed the net premiums they wrote (see fig. 8).  A few large insurance groups accounted for the majority of the gap  between premiums written and benefits and losses incurred during these  2 years. For example, one large life insurance group incurred $61.3 billion  more in benefits and losses than it wrote in premiums in 2009.  variable annuities with guarantees purchased before the crisis were “in  the money,” meaning that the policyholders’ account values were  significantly less than the promised benefits on their accounts, so the  policyholders were being credited with the guaranteed minimum instead  of the lower rates actually being earned. Thus, policyholders were more  likely to stay in their variable annuities during the crisis because they  were able to obtain higher returns than they could obtain on other  financial products.
From 2007 to 2008, the P/C industry’s underwriting losses increased as a  percentage of their earned premiums (loss ratio), and the average  combined ratio—a measure of insurer underwriting performance—rose  from 95 percent to 104 percent, indicating that companies incurred more  in claims and expenses than they received from premiums. However, as  illustrated in figure 9, the ratios during the crisis were not substantially  different from those in the surrounding years. As discussed later in this  report, financial and mortgage guaranty insurers’ combined ratios were  particularly high and contributed to the elevated overall P/C industry  combined ratios from 2008 going forward. P/C insurance industry  representatives we interviewed told us that the P/C market was in the  midst of a “soft” period in the insurance cycle leading into the crisis. Such  soft periods are generally characterized by insurers charging lower  premiums in competition to gain market share. In addition, timing of  certain catastrophic events in the P/C industry overlapped with crisis- related events. For example, one state regulator noted that in the same  week in September 2008 that AIG’s liquidity issues became publicly  known, Hurricane Ike struck the Gulf Coast. According to NAIC analysis,  this resulted in significant underwriting losses for many P/C insurers.  NAIC determined that Hurricane Ike, as well as two other hurricanes and  two tropical storms, contributed to more than half of the P/C industry’s  estimated $25.2 billion in catastrophic losses in 2008, which represented  a threefold increase from the prior year. While the crisis may have  exacerbated certain aspects of this cycle, it is difficult to determine the  extent to which underwriting losses were a result of the crisis as opposed  to the existing soft market or the weather events of 2008.
As noted previously, a few industry representatives and a regulator we  interviewed stated that decreased investment returns may place more  pressure on insurers to increase the profitability of their underwriting  operations. As shown in figures 10 and 11, life and P/C insurers’ net  investment gains have historically outweighed their net underwriting  losses. As shown in figure 10, life insurers experienced net underwriting  losses during every year of our review period, with the greatest losses  occurring in 2008.
Effects on premium revenues were primarily confined to individual  annuities in a handful of large insurers. In the life industry, net premiums  written declined by 19 percent from 2008 to 2009 to $495.6 billion,  reflecting decreases in all four of the lines we reviewed—group and  individual life insurance and group and individual annuities—with the  largest decline in individual annuities (see fig. 12).
Individual annuity premium revenues decreased more than for other life  products because these products’ attractiveness to consumers is based  on the guarantees insurers can provide. During the crisis, insurers offered  smaller guarantees, because insurers generally base their guarantees on  what they can earn on their own investments, and returns on their  investments had declined. A small group of large companies contributed  heavily to the decreases in this area. For example, one large life  insurance group accounted for 6 percent of all individual annuity  premiums in 2008 and 65 percent of the decreases in that area from 2008  to 2009. Another seven life insurance groups accounted for an additional  29 percent of individual annuity premiums and 25 percent of decreases in  that area from 2008 to 2009. By 2011, net premiums in individual  annuities had rebounded beyond their precrisis levels.
P/C insurers’ net premiums written declined by a total of 6 percent from  2007 through 2009, primarily reflecting decreases in the commercial lines  segment. In the lines we reviewed, auto lines saw a slight decline in net  premiums written, but insurers actually wrote an increased amount of  homeowners insurance. One insurance industry representative we  interviewed stated that the recession caused many consumers to keep  their old vehicles or buy used vehicles rather than buying new ones, a  development that negatively affected net premiums written for auto  insurance. Financial and mortgage guaranty insurers experienced  respective declines of 43 percent and 14 percent in net premiums written  from 2008 to 2009.
As noted, many life insurers that offered variable annuities with GLBs  experienced strains on their capital when the equities market declined  during the crisis. Specifically, beginning in the early 2000s many life  insurers began offering GLBs as optional riders on their variable annuity  products. In general, these riders provided a guaranteed minimum benefit  based on the amount invested, and variable annuity holders typically  focused their investments on equities. From 2002 through 2007, when the  stock market was performing well, insurers sold a large volume of  variable annuities (for example, as table 3 shows, they sold $184 billion in  2007). As illustrated in table 3, as of 2006 (the earliest point for which  data were available), most new variable annuities included GLBs. These  insurers had established complex hedging programs to protect  themselves from the risks associated with the GLBs. However, according  to a life insurance industry representative and regulators we interviewed,  when the equities market declined beginning in late 2007, meeting the  GLBs’ obligations negatively impacted insurers’ capital levels as life  insurers were required to hold additional reserves to ensure they could  meet their commitments to policyholders. According to a few regulators  and a life insurance industry representative we interviewed, ongoing low  interest rates have recently forced some life insurers to raise prices on  GLBs or lower the guarantees they will offer on new products.
In the P/C industry, the financial and mortgage guaranty lines were  severely affected by the collapse of the real estate market. As noted  earlier, these lines represented less than 2 percent of the total P/C  industry’s average annual written premiums from 2002 through 2011 and  are unique in that they carry a high level of exposure to mortgages and  mortgage-related securities. Mortgage guaranty insurers primarily insured  large volumes of individual mortgages underwritten by banks by  promising to pay claims to lenders in the event of a borrower default  (private mortgage insurance). Financial guaranty insurers also were  involved in insuring asset-backed securities (ABS), which included  RMBS. Additionally, these insurers insured collateralized debt obligations  (CDO), many of which contained RMBS. These insurers guaranteed  continued payment of interest and principal to investors if borrowers did  not pay. These credit protection products included credit default swaps.
Financial and mortgage guaranty insurers we interviewed stated that prior  to the crisis, these two industries operated under common assumptions  about the real estate market and its risk characteristics—namely, that  housing values would continue to rise, that borrowers would continue to  prioritize their mortgage payments before other financial obligations, and  that the housing market would not experience a nationwide collapse. As a  result of these common assumptions, these insurers underwrote  unprecedented levels of risk in the period preceding the crisis. For  example, according to a mortgage guaranty industry association annual  report, the association’s members wrote $352.2 billion of new business in  2007, up from $265.7 billion in 2006. A financial guaranty industry  representative told us that the industry had guaranteed about $30 billion  to $40 billion in CDOs backed by ABS.
The unforeseen and unprecedented rate of defaults in the residential  housing market beginning in 2007 adversely impacted underwriting  performance significantly for mortgage and financial guaranty insurers. As  shown in table 4, combined ratios—a measure of insurer performance— increased considerably for both industries beginning in 2008, with  mortgage guaranty insurers’ combined ratios peaking at 135 percent in  both 2010 and 2011. In 2008 and later, several insurers in these two  industries had combined ratios exceeding 200 percent.
Financial and mortgage guaranty insurers are generally required to store  up contingency reserves in order to maintain their ability to pay claims in  adverse economic conditions. However, during the crisis, many insurers  faced challenges maintaining adequate capital as they increased  reserves to pay future claims. This led to ratings downgrades across both  the financial and mortgage guaranty insurance industries beginning in  early 2008. For example, in January 2008, Fitch Ratings downgraded the  financial strength rating of Ambac Financial Group, Inc., a financial  guaranty insurer, from AAA to AA, and Standard & Poor’s placed  Ambac’s AAA rating on a negative rating watch. Standard & Poor’s  downgraded the ratings of AMBAC and MBIA, Inc. (also a financial  guaranty insurer) from AAA to AA in June 2008, and Fitch Ratings  downgraded MGIC Investment Corp. and PMI Group, Inc.—the two  largest mortgage insurers—from AA to A+ in June 2008. These  downgrades had a detrimental impact on insurers’ capital standing and  ability to write new business. For example, because ratings reflect  insurers’ creditworthiness (in other words, their ability to pay claims), the  value of an insurer’s guaranty was a function of its credit rating. Thus  when an insurer receives a credit rating downgrade, the guaranty it  provides is less valuable to potential customers. Additionally, credit  ratings downgrades sometimes required insurers to post additional  collateral at a time when their ability to raise capital was most  constrained.
According to industry representatives and insurers we interviewed,  financial and mortgage guaranty insurers generally had what were  believed to be sufficient levels of capital in the period leading into the  crisis, but they had varying degrees of success in shoring up their capital  in response to the crisis. Industry representatives and insurers also stated  that early in the crisis, liquidity was generally not an issue, as insurers  were invested in liquid securities and continued to receive cash flows  from premium payments. However, as defaults increased and resulted in  unprecedented levels of claims in 2008 and 2009, the pace and  magnitude of losses over time became too much for some insurers to  overcome, regardless of their ability to raise additional capital. As a result,  several financial and mortgage guaranty insurers ceased writing new  business, and some entered rehabilitation plans under their state  regulator. In addition, insurers we interviewed told us that those  companies that continued to write new business engaged in fewer deals  and used more conservative underwriting standards than before the  crisis.
The case of one mortgage insurer we reviewed illustrated some of the  challenges that financial and mortgage guaranty insurers experienced  during the crisis. By mid-2008, the insurer had ceased writing new  mortgage guaranty business and was only servicing the business it  already had on its books. This insurer is licensed in all states and the  District of Columbia. Previously, the insurer provided mortgage default  protection to lenders on an individual loan basis and on pools of loans. As  a result of continued losses stemming from defaults of mortgage loans— many of which were originated by lenders with reduced or no  documentation verifying the borrower’s income, assets, or employment— the state regulator placed the insurer into rehabilitation with a finding of  insolvency. See appendix III for a more detailed profile of this distressed  mortgage guaranty insurer.
section_title: The Effect of the Crisis on Policyholders Was Generally Small
paragraphs: NAIC and guaranty fund officials told us that life and P/C policyholders  were largely unaffected by the crisis, particularly given the low rate of  insolvencies. The presence of the state guaranty funds for individual life,  fixed annuities and the GLBs on variable annuities, and P/C lines meant  that, for the small number of insolvencies that did occur during or shortly  after the crisis, policyholders’ claims were paid up to the limits under  guaranty fund rules established under state law. However, financial and  mortgage guaranty insurers typically are not covered by state guaranty  funds and, as described below, some policyholders’ claims were not paid  in full.
According to industry representatives, the crisis generally did not have a  substantial effect on the level of coverage that most life and P/C insurers  were able to offer or on premium rates. An insurer and industry  representatives told us that due to the limited effect on most insurers’  capital, the industry maintained sufficient capacity to underwrite new  insurance. As described earlier, P/C industry representatives told us that  the crisis years coincided with a period of high price competition in the  P/C insurance industry when rates generally were stable or had  decreased slightly (soft insurance market). However, P/C industry  representatives indicated that separating the effects of the insurance  cycle from the effects of the financial crisis on premium rates is difficult.  Moreover, insurers and industry representatives for both the life and P/C  industries noted that because investment returns had declined, insurers  were experiencing pressure to increase underwriting profits that in some  cases could result in increased premium rates.
In the annuities line, which was most affected by the crisis in the life  insurance industry, effects on policyholders varied. Policyholders who had  purchased variable annuities with GLBs before the crisis benefited from  guaranteed returns that were higher than those generally available from  other similar investments. However, as described previously, a few  regulators and a life insurance industry representative told us that the  prevailing low interest rates had forced some insurers to either lower the  guarantees they offer on GLBs associated with variable annuities or raise  prices on these types of products. According to data from LIMRA, the  percentage of new variable annuity sales that offered GLB options  declined from about 90 percent to 85 percent from 2011 to 2012. As a  result, some consumers may have more limited retirement investment  options.
Financial guaranty and mortgage guaranty policyholders were the most  affected among the P/C lines of insurance, although these policyholders  were institutions, not individual consumers. While most insurers have  continued to pay their claims in full, some insurers have been able to pay  partial claims.no longer writing new business. This fact, combined with tightened  underwriting standards and practices, may have made it more difficult for  some policyholders to obtain coverage. On the other hand, industry  officials have told us that the market for financial guarantees has declined  because of the absence of a market for the underlying securities on which  the guarantees were based; the current low-interest-rate environment;  and the lowered ratings of insurers, which have reduced the value of the  guarantees.
section_title: Actions by State Regulators, Federal Programs, and Insurance Business Practices Helped Mitigate Some Effects of the Crisis
paragraphs: Multiple regulatory actions and other factors helped mitigate the negative  effects of the financial crisis on the insurance industry. State insurance  regulators and NAIC took various actions to identify potential risks, and  changed the methodology for certain RBC provisions and accounting  requirements to help provide capital relief for insurers. In addition, several  federal programs were also made available that infused capital into  certain insurance companies. Also, industry business practices and  existing regulatory restrictions on insurers’ investment and underwriting  activities helped to limit the effects of the crisis on the insurance industry.
subsections: section_title: State Regulators Took Actions to Identify and Address Potential Risks
paragraphs: During the crisis, state regulators focused their oversight efforts on  identifying and addressing emerging risks. Initially, insurers did not know  the extent of the problems that would emerge and their effect on the  insurance industry and policyholders, according to officials from one  rating agency we spoke to. Further, as the financial crisis progressed, the  events that unfolded led to a high degree of uncertainty in the financial  markets, they said. To identify potential risks, state regulators said they  increased the frequency of information sharing among the regulators and  used NAIC analysis and information to help focus their inquiries. For  example, an official from one state told us that, during the crisis, state  regulators formed an ad hoc advisory working group on financial guaranty  insurance. The group consisted of state regulators that had oversight of at  least one domestic financial guaranty insurer in their state. The group’s  purpose was to keep its members informed about the status of specific  insurers and stay abreast of developments in the financial guaranty  insurance sector. The official stated that the regulators also shared advice  and details of regulatory actions they were implementing for specific  financial guaranty insurers. Another state regulator increased its usual  oversight activities and increased communications with companies  domiciled in the state.
In addition to using information from other state regulators, state  insurance regulators said they also used information from NAIC to identify  potential risks. Three state regulators we interviewed said they used  NAIC’s information to identify potential problem assets and insurers with  exposure to such assets. For example, one state regulator said it used  reports on RMBS and securities lending from NAIC’s Capital Markets  Bureau to better focus its inquiries with insurers about their risk  management activities.
According to state regulators and industry representatives we spoke with,  with the exception of mortgage and financial guaranty insurers, they did  not identify serious risks at most insurers as a result of the crisis. A risk  they did identify, although they said not many insurers were engaged in  the practice, was securities lending. Two state regulators told us that to  address potential risks, they created new rules covering securities lending  operations. For example, one state regulator said that during the crisis it  sought voluntary commitments from life insurers to limit their securities  lending operations to 10 percent of their legal reserves, thereby limiting  any risk associated with securities lending activities.regulator stated that it also enacted legislation extending to all insurers  certain securities lending provisions. Both states took these actions after  AIG’s securities lending program was identified as one of the major  sources of its liquidity problems in 2008.
section_title: NAIC Also Took Steps to Identify Potential Risks and Share Information with States
paragraphs: NAIC officials stated that NAIC increased its research activities to identify  potential risks and facilitated information sharing with state regulators.  NAIC operates through a system of working groups, task forces, and  committees comprised of state regulators and staffed by NAIC officials.  These groups work to identify issues, facilitate interstate communication,  and propose regulatory improvements. NAIC also provides services to  help state regulators—for instance, maintaining a range of databases and  coordinating regulatory efforts. NAIC officials said that they identified  potential risks and other trends through their regular analyses of statutory  financial statement filings, which contain detailed investment data. For  example, during the crisis NAIC’s analysis of insurers’ investment data  identified companies with exposure to certain European markets that  posed potential risks for the companies. NAIC passed this information  along confidentially to the relevant state regulators for further monitoring.  As discussed above, a state regulator we interviewed said they used  NAIC’s in-depth analyses to help monitor their domiciled insurers for  potential risks such as RMBS. To facilitate information sharing about  private mortgage insurance, NAIC officials said it formed an informal  working group comprised of domestic regulators of private mortgage  insurance companies. These regulators, in turn, kept other states  informed about the status of private mortgage insurers. NAIC officials said  this informal working group was later made permanent as the Mortgage  Guaranty Insurance Working Group, which continues to assess  regulations for private mortgage insurance companies for potential  improvements.
NAIC officials said its Financial Analysis Working Group (FAWG), a  standing working group comprised of staff from various state insurance  departments, identified insurers with adverse trends linked to developing  issues during the crisis and helped ensure that state regulators followed  through with appropriate oversight activities. The group shares  information about potentially troubled insurers and certain insurance  groups, market trends, and emerging financial issues. It also works to  help ensure that state regulators have taken appropriate follow-up  actions. For example, NAIC officials said that FAWG analyzed each  insurer’s exposure to subprime mortgage assets, identified those with the  most exposure, and then took steps to ensure that domestic state  regulators followed up with them.used FAWG information to help identify emerging issues, potentially  troubled companies, and best practices, among other things. Also, NAIC  officials said that FAWG had informed state regulators about the current  status of financial guaranty and private mortgage insurance companies  on a regular basis as these sectors experienced more financial distress  than the rest of the insurance industry during the crisis. Regulatory  officials from one state said that they relied on information collected by  FAWG to monitor financial guaranty and private mortgage insurers  operating in their state because none of these insurers were domiciled  there. They added that the private mortgage insurers doing business in  their state had large exposures because of the large housing market in  their state.
State regulators told us that they had  NAIC also expanded its Capital Markets Bureau activities during the crisis  to help analyze information on the insurance industry’s investments, such  as exposure to potential market volatility, said NAIC officials. According to  NAIC’s website, the mission of the bureau is to support state insurance  regulators and NAIC on matters related to the regulation of insurers’  investment activities. The bureau monitors developments and trends in  the financial markets that affect insurance companies, researches  investment issues, and reports on those that can potentially affect  insurance company investment portfolios. State regulators said they used  these reports during the crisis. For example, one state said that the report  on the effects of the European debt crisis on U.S. insurers was useful and  another state said the reports on securities lending helped focus their  dialogue with domiciled insurers about their risk management practices.  As discussed later in this report, the bureau also worked with third parties  to model the values of insurers’ portfolios of RMBS and CMBS.
To increase transparency regarding insurers’ securities lending  reinvestment activities, NAIC made changes to the statutory accounting  rule and added disclosure requirements to address risks that were  highlighted by AIG’s securities lending program, which was a major  source of its liquidity problems in 2008. According to an NAIC report,  AIG’s problems in 2008 highlighted the lack of transparency of securities  lending collateral—specifically when the collateral was cash. The report  stated that the statutory accounting rule that addresses cash collateral,  among other things, was subject to liberal interpretations in the insurance  industry and that consequently some companies had not disclosed their  cash collateral in their statutory financial statements. To increase  transparency, NAIC made changes to the statutory accounting rule in  2010 and subsequently replaced it with the Statement of Statutory  Accounting Principles (SSAP) No. 103—Accounting for Transfers and  Servicing of Financial Assets and Extinguishments of Liabilities. SSAP  No. 103, which took effect on January 1, 2013, increases the details  about cash collateral that companies report on statutory financial  statements, such as the maturation of investments obtained with it and  instances in which counterparties can call it back. NAIC also added a new  reporting requirement, Schedule DL which requires insurance companies  to provide more details to support the aggregate information about  invested collateral reported on an insurer’s statutory financial statements.
section_title: Changes to Certain Risk- Based Capital Provisions and an Accounting Requirement Helped Reduce Pressure on Insurers’ Capital
subsections: section_title: NAIC Changed the Method of Calculating Risk-Based Capital Charges for MBS
paragraphs: NAIC changed the methodology it used in its guidance to state insurance  regulators to determine the amount of risk-based capital (RBC) that state  regulators should require insurers to hold for nonagency MBS  investments. As discussed earlier, life insurance companies saw a  decline of almost 6 percent in capital in 2008. Prior to the change, NAIC’s  methodology for calculating RBC charges for nonagency MBS relied on  agency ratings. For example, capital charges were lower for RMBS with a  relatively high agency rating than for those with a lower rating. During the  crisis, the historically high levels of failed mortgages across the nation  were followed by rating agency downgrades of nonagency RMBS that  required insurers to increase their capital levels. NAIC officials told us  that, in hindsight, using agency ratings to help determine the amount of  capital an insurer should hold for their nonagency MBS investments was  not appropriate because these securities were rated too highly before the  crisis and overly pessimistic after the crisis. As a result, NAIC moved to a  methodology for calculating RBC charges for nonagency MBS that  determined an expected recovery value for each security based on a set  of economic scenarios. NAIC contracts with BlackRock and PIMCO to  conduct these analyses. NAIC reported that this change in methodology  not only had eliminated reliance on agency ratings, but also had  increased regulatory involvement in determining how RBC charges were  calculated for nonagency MBS. NAIC officials saw both of these results  as positive.
Although this change in methodology did result in a change in RBC  charges for more than half of insurers’ RMBS holdings, the change did  not significantly affect insurers’ financial statements. Because the new  methodology resulted in estimated recovery values that were higher than  the amortized values of RMBS shown on financial statements, in 2010  capital requirements for 59 percent of the insurance industry’s nonagency  RMBS were reduced. However, almost 88 percent of industrywide CMBS  holdings in 2011 were not affected by these changes. Officials from one  rating agency said the change was appropriate because the new  methodology was actually similar to the one used by the rating agency  itself. Officials from another rating agency said that the switch to the new  modeling method reduced transparency to insurers because NAIC did not  release its modeling results for insurers to use until late in the year.
During the financial crisis, some state regulators granted some insurers  permission to use prescribed and permitted accounting practices that  helped the insurers improve their capital positions. These practices  included allowing alternative methods of calculating an insurer’s assets or  liabilities that differ from statutory accounting rules and can result in a  higher amount of assets admitted to an insurer’s statutory financial  statements. Based on data from NAIC, insurers did request modifications  to statutory accounting practices. From 2005 to 2007, about 30 such  requests were made each year nationwide. In 2008, however, there were  over 130 such requests.
For each year that an insurer has used a prescribed or permitted practice,  statutory accounting rules require it to disclose in its statutory financial  statements specific information about each practice it used, including the  net effect on its net income and capital. For example, an insurer could  request a permitted practice to use a different method of valuing its  subsidiary, and a higher valuation would increase the capital reported on  its statutory financial statements. Table 5 shows the net effect of  prescribed and permitted practices on life and P/C insurers’ net income  and capital from 2006 through 2011. In 2009, the life insurance industry’s  aggregate net income was about $1 billion less given the effects from  prescribed and permitted practices, while P/C insurers’ was about $5  billion more. In terms of capital, both life and P/C insurers experienced a  substantial positive impact from prescribed and permitted practices in  2008 compared to 2007; these positive effects remained through 2011.
One permitted practice in particular that was sought during the crisis  could generally help insurers increase the amount of admitted assets that  could be included in their statement of financial position by increasing the  percentage of deferred tax assets (DTA) that could be classified as an  admitted asset. Admitted assets are those that are available for paying  policyholder obligations and are counted as capital for regulatory  purposes. Statutory accounting provisions do not allow insurers to include  assets in their statutory statements of financial position unless they are  admitted assets.determining the percentage of DTAs that could be classified as admitted   Specifically, insurers requested that the limits for  assets be raised.permitted practices that states granted to insurers in 2008 were related to  increasing the limits, which in turn increased the amount of DTA that  insurers could classify as admitted assets. This change enabled some  insurers to improve their reported capital positions by increasing the  amount of assets that were admitted to their statutory financial  statements.
NAIC officials said that more than half of the 119  Industry stakeholders had mixed views on the effects of state regulators  granting permitted practices on a case-by-case basis. A state regulator  and an industry representative said insurance companies complained that  granting case-by-case permission created an uneven playing field  because some insurers were allowed to use the increased limits while  others were not. However, one rating agency official said the effects were  insignificant because DTAs represent a very small percentage of admitted  assets. Another rating agency official added that while the case-by-case  permissions might result in differences across different insurers’ statutory  financial statements, the financial effects of the changes were disclosed  in the financial statements. Therefore, they could be easily adjusted using  the disclosures to facilitate comparison of financial statements across  different insurers.
In 2009, NAIC issued Income Taxes – Revised, A Temporary  Replacement of SSAP No. 10 (SSAP 10R), which generally adopted the  increased limits that some states had granted to individual insurers and  made them available to all life and P/C insurers that met certain eligibility  requirements. SSAP 10R, which superseded SSAP 10, had a sunset  provision to expire at the end of 2010 and took effect for statutory  financial statements filed for year-end 2009. A new feature of SSAP 10R  was its eligibility requirements, which were based on certain RBC  thresholds that would trigger regulatory action if they were reached. To be  eligible to apply SSAP 10R, insurers were to exceed 250 to 300 percent  of these thresholds. As a result, only companies at or above certain  minimum capital standards were eligible to include expanded portions of  DTAs in their admitted assets. NAIC officials said that troubled insurance  companies that had violated the threshold for regulatory action were  typically troubled and would not be eligible to include higher portions of  their DTAs as admitted assets. However, they added that state insurance  regulators have the authority to determine if the financial conditions of a  troubled company affect the recoverability of any admitted assets,  including admitted DTAs, and may disallow the company from classifying  certain ones as admitted assets. On January 1, 2012, the Statement of  Statutory Accounting Principles No. 101, Income Taxes, a Replacement  of SSAP No. 10R and SSAP No. 10 (SSAP 101) went into effect. It  permanently superseded the original principle and generally codified the  increased limits of SSAP 10R. However, SSAP 101 has tiered eligibility  requirements, which provide a more gradual reduction in the portion of an  insurer’s DTA that can be included as an insurer’s admitted assets.  NAIC officials said that this more gradual reduction can help prevent a  sudden drop in capital at a time when an insurer is already experiencing a  decline in capital. That is, rather than suddenly losing the ability to count  any DTAs as admitted assets, the tiered eligibility requirements can  spread these reductions over time.
Based on an actuarial study, among other things, NAIC increased the  limits of SSAP 10, which could provide insurers with capital relief.  According to this study, one of the major contributing factors to DTAs was  the large amounts of write-downs on impaired investments during the  crisis. As previously discussed, in 2008, life insurers had $64 billion in  unrealized losses, as well as other-than-temporary impairments of $60  billion in realized losses on investments. To the extent that an insurer’s  DTA increased due to impairments that were taken on its investments,  expanding the limits on the admittance of DTA would help to increase  their capital. From 2006 to 2011, admitted DTA generally rose from over 4  percent to about 9 percent of capital for life insurers while fluctuating from  about 3 percent to over 4 percent for P/C insurers (see figs. 13 and 14).  The limits of SSAP 10 were intended to be conservative, explained an  NAIC official, admitting far fewer years of DTAs than insurers had  accumulated over the years.
Industry groups we spoke to had mixed views about expanding the limits  of SSAP 10. A consumer advocacy group official stated that while  expanding the limits could help insurers show greater amounts of  admitted assets and capital in their statutory financial statements, in  reality, no actual additional funds were made available to protect  policyholders because the additional capital came from DTAs, a non- liquid asset. However, one rating agency official said the increased limits  have not significantly affected insurer capital because DTAs are generally  a relatively small line item on insurers’ financial statements. The rating  agency also said the effects of the expanded limits were insignificant and  did not affect the agency’s ratings, nor were they enough to make  insolvent companies appear solvent. Officials from one rating agency also  explained that insurers pursued the expanded DTA limits even though  they were relatively small because, during the crisis, companies were not  certain how long the financial crisis would last and therefore sought  various avenues to help reduce stress on their capital. According to an  actuarial association’s report, the limits in SSAP 10R were low and  therefore conservative.
section_title: Federal Programs Have Increased Access to Capital
paragraphs: During the crisis, several federal programs were available to insurance  companies to ease strain on capital and liquidity. Several insurers— among the largest life companies—benefited from these federal  programs.
Troubled Asset Relief Program, the Capital Purchase Program. The  U.S. Department of the Treasury’s Troubled Asset Relief Program, the  Capital Purchase Program, was created in October 2008 to  strengthen financial institutions’ capital levels. Qualified financial  institutions were eligible to receive an investment of between 1 and 3  percent of their risk-weighted assets, up to a maximum of $25  billion. Eligibility was based on the applicant’s overall financial  strength and long-term viability. Institutions that applied were  evaluated on factors including their bank examinations ratings and  intended use of capital injections. The program was closed to new  investments in December 2009. The Hartford Financial Services  Group, Inc. and Lincoln National Corporation, holding companies that  own large insurers as well as financial institutions that qualified for  assistance from the Capital Purchase Program, received $3.4 billion  and $950 million, respectively. A few other large insurance companies  with qualifying financial institutions also applied for this assistance and  were approved but then declined to participate. Both Hartford and  Lincoln bought a bank or thrift in order to qualify for the federal  assistance.
Commercial Paper Funding Facility. The Federal Reserve’s  Commercial Paper Funding Facility became operational in October  2008. The facility was intended to provide liquidity to the commercial  paper market during the financial crisis. The facility purchased 3  month unsecured and asset-backed commercial paper from U.S.  issuers of commercial paper that were organized under the laws of  the United States or a political subdivision or territory, as well as those  with a foreign parent. The facility expired on February 1, 2010. Ten  holding companies of insurance companies participated in the facility.
In 2008 and 2009, the 10 holding companies issued approximately  $68.8 billion in commercial paper through the facility. AIG issued  about 84 percent of this total. Of the 9 other insurance companies that  participated in the facility, several became ineligible for further  participation by mid-2009 because of downgrades to their credit  ratings.
Term Auction Facility. The Federal Reserve established the Term  Auction Facility in December 2007 to meet the demands for term  funding. Depository institutions in good standing that were eligible to  borrow from the Federal Reserve’s primary credit program were  eligible to participate in the Term Auction Facility. The final auction  was held in March 2010. By virtue of its role as a bank holding  company, MetLife, Inc., the life industry’s largest company in terms of  premiums written, accessed $18.9 billion in short-term funding  through the Term Auction Facility.
Term Asset-Backed Securities Loan Facility. The Federal Reserve  created the Term Asset-Backed Securities Loan Facility to support the  issuance of asset-backed securities collateralized by assets such as  credit card loans and insurance premium finance loans. The facility  was closed for all new loan extensions by June 2010. Prudential  Financial, Inc., Lincoln National Corporation, the Teachers Insurance  and Annuity Association of America (a subsidiary of TIAA-CREF),  MBIA Insurance Corp. (a financial guaranty insurer subsidiary of  MBIA, Inc.), and two other insurance companies borrowed over $3.6  billion in 2009 through the Term Asset-Backed Securities Loan  Facility. These loans were intended to spur the issuance of asset- backed securities to enhance the consumer and commercial credit  markets.
Federal Reserve Bank of New York’s Revolving Credit Facility and  Treasury’s Equity Facility for AIG. The Federal Reserve Bank of New  York and Treasury made over $182 billion available to assist AIG  between September 2008 and April 2009. The Revolving Credit  Facility provided AIG with a revolving loan that AIG and its  subsidiaries could use to enhance their liquidity. Some federal  assistance was designated for specific purposes, such as a special  purpose vehicle to provide liquidity for purchasing assets such as  CDOs. Other assistance, such as that available through the  Treasury’s Equity Facility, was available to meet the general financial  needs of the parent company and its subsidiaries. Approximately  $22.5 billion of the assistance was authorized to purchase RMBS from  AIG’s life insurance companies.
A source of loans that eligible insurers have had access to, even prior to  the financial crisis, is the Federal Home Loan Bank System. It can make  loans, or advances, to its members, which include certain insurance  companies that engaged in housing finance and community development  financial institutions. The advances are secured with eligible collateral  including government securities and securities backed by real estate- related assets. According to a representative of a large life insurance  company we interviewed, the borrowing capacity from the Federal Home  Loan Bank System was especially helpful because it provided access to  capital during the crisis when other avenues to the capital markets were  relatively unavailable. In other words, they were able to use their  investment assets as collateral to access capital for business growth. The  number of insurance company members, as well as the advances they  took, increased during the crisis. In 2008, advances to insurance  companies peaked at a total of $54.9 billion for 74 companies, from $28.7  billion for 52 companies in 2007.
A variety of insurance business practices may have helped limit the  effects of the crisis on most insurers’ investments, underwriting  performance, and premium revenues. First, insurance industry  participants and two regulators we interviewed credited the industry’s  investment approach, as well as regulatory restrictions, for protecting  most companies from severe losses during the crisis. Typically, insurance  companies make investments that match the duration of their liabilities.  For example, life insurers’ liabilities are typically long term, so they tend to  invest heavily in conservative, long-term securities (30 years). According  to a life industry representative, this matching practice helped ensure that  life insurers had the funds they needed to pay claims without having to  sell a large amount of assets that may have decreased in value during the  crisis. A P/C industry representative said P/C insurers, whose liabilities  are generally only 6 months to a year, invest in shorter-term, highly liquid  instruments and did not experience significant problems paying claims. In  addition, P/C insurers’ higher proportion of assets invested in equities  (between about 17 to 20 percent from 2002-2011, as opposed to between  about 2 to 5 percent for life insurers in the same period) helps explain  their greater decline in net investment income during the crisis. Both  industries also derived their largest source of investment income from  bonds and these increased as a percentage of insurers’ gross investment  income during the crisis. Also, state regulations placed restrictions on the  types of investments insurers can make. For example, one of NAIC’s  model investment acts, which serves as a guide for state regulations,  specifies the classes of investments that insurers are authorized to make  and sets limits on amounts of various grades of investments that insurers  can count towards their admitted assets.
Second, industry participants we interviewed noted that the crisis  generally did not trigger the types of events that life and P/C companies  insure—namely, death and property damage or loss. As a result, most  insurers did not experience an increase in claims that might have  decreased their capital and increased their liquidity requirements. The  exception, as described earlier, was mortgage guaranty and financial  guaranty insurers, where defaults in the residential housing market  triggered mortgage defaults that, in turn, created claims for those  insurers.
Finally, low rates of return on investments during the crisis reduced  insurers’ investment income, and according to two insurers and two of the  state regulators we interviewed, these low yields, combined with  uncertainty in the equities markets, moved investors toward fixed  annuities with guaranteed rates of return. In addition, industry participants  and a state regulator we interviewed said that the guarantees on many  annuity products provided higher returns than were available in the  banking and securities markets, causing existing policyholders to hold  onto their guaranteed annuity products—fixed and variable—longer than  they might otherwise have done. In 2008 and 2009, the total amount paid  by insurers to those surrendering both individual and group annuities  declined. One industry representative we interviewed stated that, for  similar reasons, policyholders also tended to hold onto life insurance  policies that had cash value.
section_title: Regulators Have Continued Efforts to Strengthen the Regulatory System since the Crisis
paragraphs: State regulators and NAIC efforts to strengthen the regulatory system  include an increased focus on insurer risks and group holding company  oversight. Industry groups we spoke to identified NAIC’s Solvency  Modernization Initiative (SMI) and highlighted the Own Risk and Solvency  Assessment (ORSA) and the amended Insurance Holding Company  System Regulatory Act as some key efforts within SMI. Although these  efforts are still underway, it will likely take several years to fully implement  these efforts.
subsections: section_title: Solvency Modernization Initiative Places Increased Emphasis on Insurer Risks and Group Holding Company Oversight
paragraphs: Since the financial crisis, regulators have continued efforts to strengthen  the insurance regulatory system through NAIC’s SMI. NAIC officials told  us that the financial crisis had demonstrated the need to comprehensively  review the U.S. regulatory system and best practices globally. According  to NAIC, SMI is a self-examination of the framework for regulating U.S.  insurers’ solvency and includes a review of international developments in  insurance supervision, banking supervision, and international accounting  standards and their potential use in U.S. insurance regulation. SMI  focuses on five areas: capital requirements, governance and risk  management, group supervision, statutory accounting and financial  reporting, and reinsurance. The officials highlighted some key SMI efforts,  such as ORSA and NAIC’s amended Insurance Holding Company  System Regulatory Act, which focus on insurer risks and capital  sufficiency and group holding company oversight, respectively. Industry  officials pointed to NAIC’s SMI as a broad effort to improve the solvency  regulation framework for U.S. insurers.
NAIC, state regulators and industry groups identified ORSA as one of the  most important modernization efforts, because it would help minimize  industry risks in the future. ORSA is an internal assessment of the risks  associated with an insurer’s current business plan and the sufficiency of  capital resources to support those risks under normal and severe stress  scenarios. According to NAIC, large- and medium-sized U.S. insurance  groups and/or insurers will be required to regularly conduct an ORSA  starting in 2015. ORSA will require insurers to analyze all reasonably  foreseeable and relevant material risks (i.e., underwriting, credit, market,  operation, and liquidity risks) that could have an impact on an insurer’s  ability to meet its policyholder obligations. ORSA has two primary goals:  to foster an effective level of enterprise risk management at all  insurers, with each insurer identifying and quantifying its material and  relevant risks, using techniques that are appropriate to the nature,  scale, and complexity of these risks and that support risk and capital  decisions; and to provide a group-level perspective on risk and capital.
In March 2012, NAIC adopted the Own Risk and Solvency Assessment  Guidance Manual, which provides reporting guidance to insurers, and in  September 2012 adopted the Risk Management and Own Risk and  Solvency Assessment.domestic insurers participated in an ORSA pilot in which insurers reported  information on their planned business activities. NAIC officials told us that  as part of the pilot, state regulators reviewed the information that insurers  reported, made suggestions to improve the reporting, and helped develop  next steps. According to the officials, the pilot allowed states to envision  how they would use ORSA to monitor insurers. NAIC officials stated that  they also received public comments on the ORSA guidance manual and  were in the process of updating it to ensure greater consistency between  the guidance manual and the ORSA model law. NAIC officials told us that  they planned to conduct an additional pilot in the fall of 2013. The officials  added that state regulators still needed to develop their regulatory  guidance for reviewing ORSA.
Another issue that insurance industry participants identified as significant  was oversight of noninsurance holding companies with insurance  subsidiaries. For instance, industry groups we spoke with identified the  need for greater transparency and disclosure of these entities’ activities.  One industry association stressed the importance of having all regulatory  bodies look across the holding company structure rather than at specific  holding company subsidiaries, such as insurance companies. According  to NAIC, regulators reviewed lessons learned from the financial crisis—  specifically issues involving AIG—and the potential impact of  noninsurance operations on insurance companies in the same group. In  December 2010, NAIC amended the Insurance Holding Company System  Regulatory Act to address the way regulators determined risk at holding  companies. As part of this process, between May 2009 and June 2010,  NAIC held 16 public conference calls, five public meetings, and one  public hearing on the Insurance Holding Company System Regulatory  Act. Additionally, NAIC officials told us they also share regulatory and  supervisory information with federal regulators such as the Federal  Reserve, including information on the amended model act revisions, at  the Annual Regulatory Data Workshop.
According to NAIC, the U.S. statutory holding company laws apply  directly to individual insurers and indirectly to noninsurance holding  companies. The revised model act includes changes to (1)  communication among regulators; (2) access to and collection of  information; (3) supervisory colleges; (4) enforcement measures; (5)  group capital assessment; and (6) accreditation. Some specific changes  include: expanded ability for regulators to look at any entity in an insurance  holding company system that may not directly affect the holding  company system but could pose reputational or financial risk to the  insurer through a new Form F-Enterprise Risk Report; enhancements to regulators’ rights to access information (including  books and records), especially regarding the examinations of  affiliates, to better ascertain the insurer’s financial condition; and  introduction of and funding for supervisory colleges to enhance the  regulators’ ability to participate in the colleges and provide guidance  on how to conduct, effectively contribute to, and learn from them.
One state regulator stated that the revised Insurance Holding Company  System Regulatory Act was expected to make group-level holding  company data more transparent to state insurance regulators. Regulators  also told us that the amended model act gave them greater authority to  participate in supervisory colleges. U.S. state insurance regulators both  participate in and convene supervisory colleges. State insurance  commissioners may participate in a supervisory college with other  regulators charged with supervision of such insurers or their affiliates,  including other state, federal, and international regulatory agencies. For  instance, the same state regulator stated that the authority allowed for  international travel, with the insurers paying the costs. The act also  increases the regulators’ ability to maintain the confidentiality of records  that they receive or share with other regulators.
According to NAIC officials, as of April 2013, 16 states have adopted the  model law revisions. Additionally, some state regulators we spoke to  indicated that they were working with their state legislatures to introduce  the revised Insurance Holding Company System Regulatory Act to their  state legislatures. For instance, officials from one state regulator said that  the new model act had been introduced in the state legislature in January  2013 and that adopting it would mean rewriting the state’s existing  holding company law. As a result, they had decided to ask for the repeal  of the existing law and the adoption of the new statute for consistency.
Although the Solvency Modernization Initiative is underway, time is  needed to allow states to adopt requirements. For instance, NAIC officials  said that although they had completed almost all of what they saw as the  key SMI initiatives, implementing all SMI activities could take 2 or 3 years.  According to the officials, some decisions will be made in 2013, such as  how to implement governance activities and changes related to RBC. For  instance, the officials stated that they were looking to implement P/C  catastrophe risk data analysis later this year and would then consider how  to integrate their findings into RBC requirements. As mentioned earlier,  ORSA is not expected to be operational until 2015. Also, most states  have yet to adopt revisions to the Insurance Holding Company System  Regulatory Act. NAIC officials told us that getting changes adopted at the  state level was challenging because of the amount of time needed to get  all 50 states on-board. For instance, the adoption of model laws requires  state legislative change and is dependent on the frequency of state  legislative meetings. The officials explained that some states legislatures  meet only every 2 years, limiting the possibility of immediate legislative  change. As we have previously reported, NAIC operations generally  require a consensus among a large number of regulators, and NAIC  seeks to obtain and consider the input of industry participants and  consumer advocates.  Obtaining a wide range of views may create a  more thoughtful, balanced regulatory approach, but working through the  goals and priorities of a number of entities can result in lengthy processes  and long implementation periods for regulatory improvements. As noted  in our other work earlier, continued progress in a timely manner is critical  to improving the efficiency and effectiveness of the insurance regulatory  system.
section_title: Views Varied on Increased Oversight Efforts
paragraphs: Industry officials we spoke with had favorable views of NAIC’s and state  regulators’ efforts to strengthen the regulatory system. For example, one  insurance association stated that NAIC and states had been reevaluating  all regulatory tools beyond those that were related to the financial crisis.  Another insurance association noted that ORSA would be a good tool to  use to identify potentially at-risk companies before they developed  problems. A third insurance association stated that coordination between  domestic and international regulators was more robust now and actions  taken are more coordinated. The officials also pointed to the work  addressing supervisory colleges that involve regulatory actions by other  countries that might impact domestic insurers. However, some insurance  associations we spoke to voiced concerns about the increased oversight  of holding companies, and some insurance associations and insurers also  questioned the need for additional regulatory changes.
Two insurance associations and a federal entity we spoke to were  concerned with potential information gaps related to the increased  oversight of holding companies. For instance, one insurance association  told us that state insurance regulators do not have jurisdiction over non- insurance affiliates’ activities and as a result, do not have access to  information on these affiliates in order to evaluate if their activities could  jeopardize the affiliated insurers. Another insurance association stated  that there was a need to address holding company regulation, especially  potential gaps between the federal and state regulators in their oversight  roles. Some insurers also questioned the need for additional regulations  and a few suggested that the regulators need to allow time for  implementing recent financial reforms under the Dodd-Frank Act. One  P/C insurer stated that imposing additional requirements on the entire  insurance industry is not necessary especially within the P/C industry.  The official explained that there needs to be greater flexibility in reporting  and that the P/C industry fared well during the crisis as evident by the  lack of widespread insolvencies. The official suggested that NAIC needs  to re-evaluate whether the additional requirements are useful. Another  financial guaranty insurer told us that no additional changes are needed  in the regulatory structure or regulations for the financial guaranty  industry. The officials stated that they are now dealing with federal  regulators and regulatory changes related to the Dodd-Frank Act.  Additionally, one insurance association stated that whether more  regulatory coordination activities regarding holding companies are  needed is not yet known because federal regulators have not finished  implementing the recent Dodd-Frank reforms dealing with holding  company oversight.
section_title: Some Dodd-Frank Provisions That Address Financial Stability Include Insurance Oversight
paragraphs: While many factors likely contributed to the crisis, and the relative role of  these factors is subject to debate, gaps and weaknesses in the  supervision and regulation of the U.S. financial system, including the  insurance industry, generally played an important role. The Dodd-Frank  Act provided for a broad range of regulatory reforms intended to address  financial stability and the creation of new regulatory entities that have  insurance oversight responsibilities or an insurance expert’s view, among  other things. In our previous work, we noted that the act created the  Federal Insurance Office and the Financial Stability Oversight Council.
The act also seeks to address systemically important financial institutions  (SIFIs) and end bailouts of large, complex financial institutions. The  Dodd-Frank Act has not yet been fully implemented; thus, its impacts  have not fully materialized.
Federal Insurance Office. As mentioned earlier, the Dodd-Frank Act  created the Federal Insurance Office within Treasury to, in part,  monitor issues related to regulation of the insurance industry. The  Federal Insurance Office’s responsibilities include, among other  things, identifying issues or gaps in the regulation of insurers that  could contribute to a systemic crisis in the insurance industry or the  U.S. financial system. The Federal Insurance Office was tasked with  conducting a study on how to modernize and improve the system of  insurance regulation in the United States and to submit a report to  Congress no later than January 21, 2010. The report is to consider,  among other things, systemic risk regulation with respect to  insurance, consumer protection for insurance products and practices,  including gaps in state regulation, and the regulation of insurance  companies and affiliates on a consolidated basis. Additionally, the  Federal Insurance Office is to examine factors such as the costs and  benefits of potential federal regulation of insurance across various line  of insurance. As of May 2013, the Federal Insurance Office had not  yet issued their report to Congress.
Financial Stability Oversight Council. The council was created to  identify risks to the stability of the U.S. financial system, including  those that might be created by insurance companies. The council includes some representation with insurance expertise. Some  authorities given to the Financial Stability Oversight Council allow it to  collect information from certain state and federal agencies  regulating across the financial system so that regulators will be  better prepared to address emerging threats; recommend strict standards for the large, interconnected bank  holding companies and nonbank financial companies designated  for enhanced supervision; and facilitate information sharing and coordination among the member  agencies to eliminate gaps in the regulatory structure.
Additionally, the act provides that the Financial Stability Oversight Council  have 10 voting and 5 nonvoting members. The 10 voting members  provide a federal regulatory perspective, including an independent  insurance expert’s view. The 5 nonvoting members offer different insights  as state-level representatives from bank, securities, and insurance  regulators or as the directors of some new offices within Treasury—Office  of Financial Research and the Federal Insurance Office—that were  established by the act. The Dodd-Frank Act requires that the council meet  at least once a quarter.that Financial Stability Oversight Council members provided benefits—for  instance, they were able to discuss activities that could be concerns in  future crises and make recommendations to the primary regulators.
One industry association we spoke to stated
Bureau of Consumer Financial Protection (known as CFPB). The  Dodd-Frank Act established CFPB as an independent bureau within  the Federal Reserve System and provided it with rulemaking,  enforcement, supervisory, and other powers over many consumer  financial products and services and many of the entities that sell them.  CFPB does not have authority over most insurance activities or most  activities conducted by firms regulated by SEC or CFTC. However,  certain consumer financial protection functions from seven existing  federal agencies were transferred to CFPB. Consumer financial products and services over which CFPB has primary authority include  deposit taking, mortgages, credit cards and other extensions of credit,  loan servicing, and debt collection. CFPB is authorized to supervise  certain nonbank financial companies and large banks and credit  unions with over $10 billion in assets and their affiliates for consumer  protection purposes.
The financial crisis also revealed weaknesses in the existing regulatory  framework for overseeing large, interconnected, and highly leveraged  financial institutions and their potential impacts on the financial system  and the broader economy in the event of failure. The Dodd-Frank Act  requires the Board of Governors of the Federal Reserve System (Reserve  Board) to supervise and develop enhanced capital and other prudential  standards for these large, interconnected financial institutions, which  include bank holding companies with $50 billion or more in consolidated  assets and any nonbank financial company that the Financial Stability  Oversight Council designates. The act requires the enhanced prudential  standards to be more stringent than standards applicable to other bank  holding companies and financial firms that do not present similar risks to  U.S. financial stability. The act further allows the enhanced prudential  standards to be more stringent than standards applicable to other bank  holding companies and financial firms that do not present similar risks to  U.S. financial stability. In April 2013, the Federal Reserve issued a final  rule that establishes the requirements for determining when an entity is  “predominantly engaged in financial activities.” Among the criteria is  whether an institution is primarily engaged in financial activities, which  can include insurance underwriting. As of May 2013, the Financial  Stability Oversight Council had yet to publicly make any such  designations.
section_title: Agency Comments
paragraphs: We provided a draft of this report to NAIC for their review and comment.  NAIC provided technical comments which we have incorporated, as  appropriate.
As agreed with your offices, unless you publicly announce the contents of  this report earlier, we plan no further distribution until 30 days from the  report date.  At that time, we will send copies to the Chief Executive  Officer of the National Association of Insurance Commissioners. In  addition, the report will be made available at no charge on the GAO  website at http://www.gao.gov.
If you or your staffs have any questions regarding this report, please  contact me at (202) 512-8678 or cackleya@gao.gov. Contact points for  our Offices of Congressional Relations and Public Affairs may be found  on the last page of this report. GAO staff that made major contributions to  this report are listed in appendix IV.
section_title: Appendix I: Objectives, Scope, and Methodology
paragraphs: This report examines (1) what is known about how the insurance industry  and policyholders were affected by the financial crisis, (2) the factors that  affected the impact of the crisis on insurers and policyholders, and (3) the  types of regulatory actions that have been taken since the crisis to help  prevent or mitigate potential negative effects of future economic  downturns on insurance companies and their policyholders.
To address these objectives, we reviewed relevant laws and regulations  on solvency oversight such as the Dodd-Frank Wall Street Reform and  Consumer Protection Act and financial institution holding company  supervision such as the model Insurance Holding Company System  Regulatory Act. We conducted a literature search using ProQuest,  EconLit, and PolicyFile and reviewed relevant literature and past reports  on the financial crisis and the insurance industry, the general condition of  the U.S. economy in 2008, and the events surrounding the federal rescue  of American International Group, Inc. (AIG). We interviewed officials from  selected state insurance departments, the Federal Insurance Office, the  National Association of Insurance Commissioners (NAIC), the National  Conference of Insurance Legislators, insurance associations, insurance  companies, credit rating agencies, and consumer advocacy groups. We  interviewed or received written responses to our questions from insurance  regulators in seven states—California, Illinois, Iowa, Maryland, New York,  Texas, and Virginia. We used an illustrative sampling strategy to select  states based on the states’ geographic diversity, number of domiciled  insurers, and premium volumes, which ranged from small (Iowa) to large  (California). We interviewed regulators from six of the states and received  written responses to our questions from one of the states. We also met  with six industry associations representing insurance companies covering  life and property/casualty (P/C), including financial guaranty and  mortgage insurance; two associations representing agents and brokers;  and two national insurance guaranty fund associations. Additionally, we  met with six insurers covering life and P/C insurance lines, including  mortgage insurance and financial guaranty insurance. The insurers  represent different states of domicile and varying market shares in net  premiums written. Finally, we met with two credit rating agencies and two  consumer advocacy groups to obtain their perspective on how the  financial crisis impacted the insurance industry and policyholders. We  also reviewed congressional testimony and other documents from  industry participants, several of whom we interviewed for this study.
subsections: section_title: Determining the Effect of Crisis on Insurance Companies and Policyholders
paragraphs: To address how the financial crisis affected the insurance industry and  policyholders, we reviewed academic papers and government reports,  and interviewed industry representatives, regulatory officials, and internal  stakeholders to identify the key characteristics associated with the  financial crisis. This resulted in a list of five commonly identified major  characteristics of the crisis, which are declines in real estate values,  declines in equities values, lowered interest rates, increased mortgage  default rates, and changes in policyholder behavior. We reviewed industry  documents—including NAIC’s annual analyses of the life and P/C  industries—to identify commonly used financial measures for insurance  companies. These measures help demonstrate insurers’ financial health  in a number of areas including investment performance, underwriting  performance, capital adequacy, and profitability.
We selected specific lines of insurance within the life and P/C industries  for our analyses on net premiums written. In the life industry, we focused  on individual annuities, individual life insurance, group annuities, and  group life insurance. These lines accounted for 77 percent of average life  insurance premiums during our review period of 2002 through 2011, and  the policyholders were individual consumers (either independently or  through their workplaces). In the P/C industry, we focused on private  passenger auto liability, auto physical damage, home owners multiple  peril, commercial multiple peril, other liability (occurrence), other liability  (claims-made), financial guaranty, and mortgage guaranty insurance.  These lines of insurance accounted for 68 percent of average P/C  insurance premiums over our 10-year review period and involved  individual and commercial policyholders. We chose to review financial  and mortgage guaranty insurance despite their small percentage of  premiums (less than 2 percent of average P/C premiums from 2002  through 2011) because we had learned through research and preliminary  interviews that they were more heavily affected by the crisis. We obtained  input on the data analysis plan from NAIC and a large rating agency and  incorporated their suggestions where appropriate.
We obtained the financial data from insurers’ annual statutory financial  statements, which insurance companies must submit to NAIC after the  close of each calendar year. We gathered the data for all life and P/C  insurers for the period January 2002 through 2011 using SNL Financial, a  private financial database that contains publicly filed regulatory and  financial reports. We chose the 10-year time period in order to obtain  context for our findings around the period of 2007 through 2009, which is  generally regarded as the duration of the financial crisis.
We analyzed data for both operating and acquired or nonoperating  companies to help ensure that we captured information on all companies  that were operating at some point during the 10-year period. The  population of operating and acquired or nonoperating life insurance  companies from 2002 through 2011 was 937, while the population of  operating and acquired or nonoperating P/C companies from 2002  through 2011 was 1,917. We conducted most of our analyses at the SNL  group and unaffiliated companies level, meaning that data for companies  that are associated with a larger holding company were aggregated,  adjusted to prevent double counting, and presented at the group level.  We also ran a few selected analyses (such as our analysis of permitted  and prescribed practices) at the individual company level to obtain detail  about specific operating companies within a holding company structure.
To analyze the number and financial condition of insurers that went into  receivership during the 10-year review period, we obtained data that  NAIC staff compiled from NAIC’s Global Receivership Information  Database. The data included conservation, rehabilitation, and liquidation  dates, as well as assets, liabilities, and net equity (the difference between  assets and liabilities) generally from the time of the receivership action,   Our analysis of numbers of receiverships and  among other data items.liquidations included 58 life insurers and 152 P/C insurers. The NAIC staff  that compiled the data told us that data on assets, liabilities, and net  equity were not always available in either of their data systems. To  address this problem of missing data, NAIC staff pulled data when  available from the last financial statement before the company was  placed into receivership or the first available financial statement  immediately after being placed into receivership and replaced the missing  data. This was the case for 5 of 58 life insurance companies and 27 of  152 P/C companies. We believe these asset, liability, and net equity  levels would have changed little in the time between liquidation and when  the financial statements were prepared, and we determined that the time  difference was likely to have little effect on our estimate of the general  size and net equity levels of insurers at liquidation. However, the average  assets and average net equity we report might be slightly higher or lower  than was actually the case for each year. In addition, out of the 40 life  insurers and 125 P/C insurers that went into liquidation from 2002 through  2011, NAIC staff could not provide asset data for 7 life insurers and 19  P/C insurers, and they could not provide net equity data for 8 life insurers  and 29 P/C insurers. We excluded these companies from our analyses  and indicated in tables 10 and 11 (app. II) when data were not available.  Our analysis of assets at liquidation included 33 life insurers and 106 P/C  insurers, and our analysis of net equity at liquidation included 32 life  insurers and 96 P/C insurers.
To describe how publicly traded life and P/C insurers’ stock prices  changed during the crisis, we obtained daily closing price data for A.M.  Best’s U.S. Life Insurance Index (AMBUL) and U.S. Property Casualty  Insurance Index (AMBUPC). The indexes include all U.S. insurance  industry companies that are publicly traded on major global stock  exchanges and that also have an interactive A.M. Best rating, or that  have an insurance subsidiary with an interactive A.M. Best Rating. The  AMBUL index reflects 21 life insurance companies and the AMBUPC  index reflects 56 P/C companies. We compared the mean monthly  closing price for each index to the closing price for the last day of the  month and determined that they were generally similar, so we reported  the latter measure. Because 48 of the 77 life and P/C companies in the  A.M. Best indexes trade on the New York Stock Exchange (NYSE), we  also analyzed closing stock prices from the NYSE Composite Index  (NYA), obtained from Yahoo! Finance, to provide context on the overall  equities market. NYA reflects all common stocks listed on NYSE, (1,867  companies).2004 through December 2011 because A.M. Best did not have data prior  to December 2004.
For all indexes, we analyzed the time period December  To select the two distressed insurers that we profiled in appendix III, we  focused on life and P/C companies that were placed in receivership  during the crisis. Based on interviews with regulators and industry  officials, we learned that the effects of the financial crisis were limited  largely to certain annuity products (provided by life insurers) and the  financial and mortgage guaranty lines of insurance. Therefore, through  our interviews with industry associations and state regulators, we  selected one life insurer and one mortgage guaranty insurer that were  directly affected by the crisis to illustrate the effects of the crisis at the  company level. We obtained financial data through SNL Financial and  publicly available court documents to examine these insurers’ cases.
We determined that the financial information used in this report— including statutory financial data from SNL Financial, stock price data  from A.M. Best, receivership and permitted practices data from NAIC, and  annuity sales and GLB data from LIMRA—was sufficiently reliable to  assess the effects of the crisis on the insurance industry. To assess  reliability, we compared data reported in individual companies’ annual  financial statements for a given year to that reported in SNL Financial. We  also aggregated the individual company data for net premiums for two  SNL groups (one life and one P/C group) to verify that our results  matched SNL’s, because intercompany transactions would be rare in this  field.measures—such as net income, capital, net investment income, and  surrender benefits and withdrawals—to NAIC’s annual industry  commentaries and found that they were generally similar. We also  obtained information from A.M. Best, NAIC, and LIMRA staff about their  internal controls and procedures for collecting their respective stock price,  receivership, and annuities data.
section_title: Factors That Affected the Impact of the Crisis on Insurers and Policyholders
paragraphs: To address the factors that helped mitigate the effect of the crisis, we  reviewed NAIC’s model investment act, industry reports, and credit rating  agency reports to identify such factors. We also interviewed state  insurance regulators, insurance company associations, insurance  companies, and credit rating agencies to obtain their insights on the  mitigating effects of industry investment and underwriting practices,  regulatory restrictions, and effects of the crisis on policyholder behavior.  We also reviewed our prior work and other sources to identify federal  programs that were available to insurance companies to increase access  to capital, including the Troubled Asset Relief Program, the Board of  Governors of the Federal Reserve System’s and Federal Reserve Banks’  (Federal Reserve) liquidity programs, and the Federal Home Loan Bank  System, including assistance to help some of the largest life insurers such  as AIG during the crisis.
section_title: Regulatory Actions That Have Been Taken to Protect Insurers and Policyholders
paragraphs: To assess the state insurance regulatory response system in protecting  insurers and policyholders and the types of insurance regulatory actions  taken during and following the crisis, we reviewed and analyzed relevant  state guidance. This included NAIC documents such as Capital Markets  Bureau reports, statutory accounting rules such as the Statements of  Statutory Accounting Principles, and information on securities lending and  permitted practices. We also reviewed the Solvency Modernization  Initiative, including associated guidance manuals and model laws such as  the Insurance Holding Company System Regulatory Act. In addition, we  analyzed SNL Financial data and reviewed reports on deferred tax  assets, including actuary association reports, a consumer group’s public  comments, and information from state insurance regulator and industry  consultant websites. We interviewed officials from state regulators, NAIC,  FIO, industry associations, insurers, and others to obtain their  perspectives on state regulatory actions taken in response to the crisis  and impacts on insurers and policyholders and efforts to help mitigate  potential negative effects of future economic downturns. Additionally, we  reviewed past reports on the provisions of the Dodd-Frank Act and the  impacts on the insurance industry with regard to oversight responsibilities.
We conducted this performance audit from June 2012 to June 2013 in  accordance with generally accepted government auditing standards.  Those standards require that we plan and perform the audit to obtain  sufficient, appropriate evidence to provide a reasonable basis for our  findings and conclusions based on our audit objectives. We believe that  the evidence obtained provides a reasonable basis for our findings and  conclusions based on our audit objectives.
section_title: Appendix II: Additional Data on Life and P/C Industry Financial Performance, 2002-2011
paragraphs: This appendix provides some additional data on life and P/C insurers’  financial performance, including realized and unrealized losses, financing  cash flow, P/C premium revenues, assets and net equity of companies in  liquidation, and stock price data.
subsections: section_title: Realized and Unrealized Losses
paragraphs: In 2008 and 2009, a small number of large insurance groups generally  comprised the majority of realized and unrealized losses in the life and  P/C industries. Tables 6 and 7 lists the life insurers with realized or  unrealized losses exceeding $1 billion in 2008 and 2009, and tables 8  and 9 list the same data for P/C insurers. All of the insurers listed are  either life or P/C “groups” in the SNL Financial database, meaning that  they include all of the U.S. insurance companies in either the life or P/C  industry within the same corporate hierarchy.
Tables 8 and 9 list the P/C insurers with realized and unrealized losses  exceeding $1 billion in 2008 and 2009.
Financing cash flow reflects the extent to which insurers are willing or  able to access external capital to finance or grow their operations. It  represents the net flow of cash from equity issuance, borrowed funds,  dividends to stockholders, and other financing activities. With exceptions  in 2004 and 2007 for life insurers and 2005 for P/C insurers, both  industries had negative financing cash flows a few years before the crisis  began, indicating that insurers were reducing their outstanding debt and  equity. These reductions could have resulted from the insurers buying  back their stock and not issuing new debt as their existing debt matured.  The increasingly negative financing cash flows for both industries starting  in 2008 also reflect what we were told about the difficulty of obtaining  outside capital during the crisis. Insurers might not have been able to  raise money during the crisis even if they had wanted or needed to do so.
In the P/C industry as a whole, net premiums written declined from  $443.7 billion in 2006 to $417.5 billion in 2009—a total decline of 6  percent during the crisis years. In most of the lines of P/C insurance that  we reviewed, declines in premiums during the crisis were modest (see  fig.16). Financial and mortgage guaranty insurance (which combined  represent less than 2 percent of the P/C industry)—as well as other  liability (occurrence) (insurance against miscellaneous liability due to  negligence or improper conduct)—were the exceptions. For example,  financial guaranty insurers’ net premiums written fell from $3.2 billion in  2008 to $1.8 billion in 2009 (a 43 percent decline). By 2011, net financial  guaranty premiums written were less than $1 billion, reflecting a total  decline of 69 percent since 2008. Mortgage guaranty insurance premiums  fell from $5.4 billion to $4.6 billion (a 14 percent decline) from 2008 to  2009 and to $4.2 billion (another 8 percent decline) in 2010. Net  premiums written for other liability (occurrence) declined from $25.9 billion  to $24.3 billion (a 6 percent decline) in 2008 and to $20.9 billion (a 14  percent decline) in 2009. On the other hand, net premiums written for  homeowners’ insurance increased in every year of the 10-year review  period, including increases of about 2 percent annually in 2008 and 2009  with net premiums of $56.9 billion in 2009. Net premiums written for all  other lines of P/C insurance combined declined from $142.2 billion in  2007 to $129.0 billion in 2009, reflecting annual decreases of less than 1  percent in 2007, 3 percent in 2008, and 7 percent in 2009.
Based on the available data that NAIC provided us on companies that  were liquidated from 2002 through 2011, average assets and net equity of  liquidated life and P/C insurers varied by year. As tables 10 and 11  illustrate, average assets of liquidated companies were significantly  above the 10-year average in 2004 for the life industry and in 2003 and  2008 for the P/C industry. This was generally due to one or two large  companies being liquidated. For example, in 2004, London Pacific Life  and Annuity Company was liquidated with $1.5 billion in assets and  negative $126 million in net equity, meaning that its liabilities exceeded its  assets by that amount. Similarly, MIIX Insurance Company, a P/C insurer,  was liquidated in 2008 with assets of $510 million and negative $32  million in net equity. Average net equity, based on the available data, was  positive for liquidated life insurers in 2003, 2007, 2009, and 2010 (see  table 10). According to NAIC staff, this is not unusual, as regulators  typically try to liquidate distressed insurers before their net equity reaches  negative levels.
We analyzed the monthly closing stock prices of publicly traded life and  P/C insurance companies for the period December 2004 through  December 2011. We used two A.M. Best indexes—the A.M. Best U.S.  Life Index and the A.M. Best Property Casualty Index—as a proxy for the  life and P/C industries. According to A.M. Best, the indexes include all  U.S. insurance industry companies that are publicly traded on major  global stock exchanges that also have an A.M. Best rating, or that have  an insurance subsidiary with an A.M. Best rating. They are based on the  aggregation of the prices of the individual publicly traded stocks and  weighted for their respective free float market capitalizations. The life  index represents 21 life insurance companies and the P/C index  represents 56 P/C companies. Since more than 60 percent of the  companies on the A.M. Best indexes we selected trade on NYSE, we also  obtained monthly closing stock prices on the New York Stock Exchange  (NYSE) Composite Index, which, as of February 2012, represented 1,867  companies that trade on NYSE, to provide a contextual perspective on  the overall stock market during our review period.
As figure 17 illustrates, life and P/C insurers’ aggregate stock prices  generally moved in tandem with the larger NYSE Composite Index from  the end of 2004 through 2011, but life insurers’ aggregate stock prices fell  much more steeply in late 2008 and early 2009 than P/C insurers’ and  NYSE companies’ aggregate stock prices.
We selected several key time periods or events from the financial crisis  and identified the largest drops in life and P/C insurers’ aggregate stock  prices during those time periods (see fig.18). While many factors can  affect the daily movement of stock prices, we observed that changes in  life insurers’ aggregate stock prices tended to be more correlated with  several of the events that occurred during the crisis than P/C insurers’  aggregate stock prices.
section_title: Appendix III: Profiles of Distressed Insurers
paragraphs: This appendix provides more detail on two distressed insurers—one  mortgage guaranty insurer and one life insurer—during the financial  crisis.
subsections: section_title: Mortgage Guaranty Insurer
paragraphs: We studied a mortgage guaranty insurer operating in a run-off of its  existing book of business (that is, it had ceased writing new mortgage  guaranty business and was only servicing the business it already had on  its books). This insurer is licensed in all states and the District of  Columbia. Prior to its run-off, the insurer provided mortgage default  protection to lenders on an individual loan basis and on pools of loans. As  a result of continued losses stemming from defaults of mortgage loans,  the state regulator placed the insurer into rehabilitation with a finding of  insolvency in 2012.
During the financial crisis, the insurer began experiencing substantial  losses due to increasing default rates on insured mortgages, particularly  in California, Florida, Arizona, and Nevada. As table 12 shows, in 2007  and 2008, over 30 percent of the insurer’s underwritten risk—the total  amount of coverage for which it was at risk under its certificates of  insurance—was originated in these distressed markets, which  experienced default rates that peaked at more than 35 percent in 2009. In  addition, the insurer had significant exposure to Alt-A loans, which are  loans that were issued to borrowers based on credit scores but without  documentation of the borrowers’ income, assets, or employment. These  loans experienced higher default rates than the prime fixed-rate loans in  the insurer’s portfolio.
This insurer rapidly depleted its capital as it set aside reserves to meet  obligations resulting from the overall rising volume of mortgage defaults.  Rising defaults combined with unsuccessful attempts to raise additional  capital during the crisis adversely affected its statutory risk-to-capital ratio  starting in 2008. While state insurance regulations generally require this  relationship of insured risk to statutory capital (in this case, the sum of  statutory surplus and contingency reserves) to be no greater than 25 to 1,  this insurer’s statutory capital declined 85 percent from year-end 2007 to  year-end 2008, increasing the risk-to-capital ratio from 21 to 1 to 125 to  1. As a result, in 2008, this insurer entered into an order with its state  regulator to cease writing new business and operate in run-off status. Due  to continued increases in mortgage defaults, the regulator required a  capital maintenance plan in 2009 that allowed the insurer to maintain a  positive statutory capital position during the run-off and also to pay partial  claims.
According to court filings, the insurer reported to the state regulator that  its liabilities outweighed its assets by more than $800 million for the  second quarter of 2012. As a result, the state regulator entered an order  with the relevant county circuit court in late 2012 to take the insurer into  rehabilitation with a finding of insolvency. At that time, the court named  the state insurance regulator as rehabilitator, which means that it gave  the regulator authority over the insurer’s property, business, and affairs  until the insurer’s problems are corrected.
section_title: Life Insurer
paragraphs: We studied a life insurer that primarily writes life, annuity, and accident  and health business. Due to losses sustained from equity investments in  Fannie Mae and Freddie Mac in 2008, the state regulator placed the  insurer in rehabilitation in early 2009. In late 2011, the regulator  approved of the insurer’s acquisition by a third-party insurer. This  transaction facilitated the insurer’s successful exit from rehabilitation in  mid-2012.
The insurer was invested in Fannie Mae and Freddie Mac stock. In 2008,  the insurer sustained approximately $95 million in investment losses.  Approximately $47 million of those investment losses were related to  investments in Fannie Mae and Freddie Mac stock. These events  adversely affected the insurer’s capital, which declined by over 38 percent  from March 31, 2008 to September 30, 2008.  As of December 31, 2008,  the insurer had capital of $29 million, down from about $126 million as of  December 31, 2007.
On September 6, 2008, the Federal Housing Finance Agency (FHFA) placed Fannie Mae  and Freddie Mac into conservatorship out of concern that their deteriorating financial  condition would destabilize the financial system. company’s surplus and asset levels. According to the testimony, this  exemption allowed the insurer to report capital of $400,000 instead of a  $259 million deficit as of December 31, 2009.
In late 2009, the receiver issued a request for proposal for the sale of the  insurer. By mid-2010, the receiver was in negotiations with another life  insurance group. In 2011, policyholders and the receiver approved of a  purchase plan. The plan would recapitalize the insurer to allow it sufficient  surplus to meet state minimum requirements to resume writing new  business. The plan was executed in mid-2012, which allowed the insurer  to exit rehabilitation.
section_title: Appendix IV: GAO Contact and Staff Acknowledgments
subsections: section_title: GAO Contact
section_title: Staff Acknowledgments
paragraphs: In addition to the contact named above, Patrick A. Ward (Assistant  Director), Emily R. Chalmers, William R. Chatlos, Janet Fong, David J.  Lin, Angela Pun, Lisa M. Reynolds, Jessica M. Sandler, and Jena Y.  Sinkfield made significant contributions to this report.