Morris Manning & Martin, LLP

Statutory Accounting Standards; Some Insurers are Receiving Permitted Accounting Practices Rejected by the NAIC

04.01.2009

Recently proposed changes to relax solvency and reserving requirements for life insurance companies which were roundly rejected by the Executive Committee of the NAIC are quickly finding a more receptive audience among individual state Commissioners of Insurance. As you may recall, in December 2008 the ACLI proposed nine changes to statutory accounting standards. The ACLI proposals were designed to help insurers cope with the current volatility in the financial markets.

Various NAIC working groups narrowed the original nine requested changes down to six and held a public hearing on January 27 chaired by the NAIC Capital & Surplus Relief Working Group. Following the public hearing, the working group quickly gave its approval of the six proposed changes. The six proposals would have amended mortality tables for certain products, provided additional regulator discretion for allowing collateral for reinsurance, revised the standalone asset adequacy for variable annuities and followed generally accepted accounting protocols for deferred tax assets, among other changes. However, on January 29, the NAIC Executive Committee overwhelmingly rejected the proposed changes which had been approved by the Capital & Surplus Relief Working Group only two days earlier.

The NAIC Executive Committee’s swift action in voting down the ACLI proposals has not put an end to this issue. Responding to domiciled insurers, a number of states have now begun to grant permitted accounting practices along the lines of the ACLI proposal. This has the practical effect of giving insurers some of the relief sought by the ACLI proposal, but in an ad hoc and non-unified fashion.

Under the NAIC Accounting Practices & Procedures Manual, states have always had the ability to grant permitted accounting practices that allow insurers to vary their accounting from what is prescribed by the statutory accounting principles. Prior to granting a permitted accounting practice, a domiciliary state is required to provide 30 days’ advance notice to all other states where an insurer is licensed. States can provide a shorter notice period with an explanation for the shorter notice, but never less than five days. However, if states fail to provide this notice, the permitted accounting practice is still valid. The notice is made through a regulator only database within the NAIC Exam Tracking System. The notice must disclose: (1) the nature and a clear description of the permitted accounting practice request; (2) the quantitative effect of the permitted accounting practice with all other previously approved permitted accounting practices then in effect for the insurer; (3) the effect of the requested permitted accounting practice on a legal entity basis and on all parent and affiliated insurance companies; and (4) identify the potential effects on, and quantify the potential impact to, each financial statement line item affected by the request.

So far, regulators in at least four states, Illinois, Iowa, Kansas and Ohio, have recently granted permitted accounting practices. As expected, the permitted accounting practices can have a substantial effect on the balance sheet of an insurer. For example, the Illinois Department of Insurance approved accounting changes that had a positive impact in excess of $700 million for its domestic property and casualty writer Allstate Insurance Company.

Because the permitted accounting practices are generally not disclosed to the public until insurers make a disclosure in the notes to their annual financial statement, it is difficult to immediately compare the quality of insurance company balance sheets from state to state. In addition, some states, most notably New York, have announced that they are not willing to consider permitted accounting practices along the lines of the ACLI proposals. New York has gone so far as to issue a Circular Letter requiring insurers receiving permitted accounting practices to back out the effect of the permitted practice when filing financial statements with New York. Rating agencies are taking notice of these additional assets on insurance company balance sheets and are evaluating how to handle the different qualities of capital present on insurance companies’ balance sheets. Meanwhile, the uneven application of accounting practices is adding more fuel to the fire for advocates of a federal charter on the grounds that a federal charter would create regulatory consistency and common capital requirements for all insurers.

Currently, there is no prohibition on the use of permitted accounting practices in the NAIC state accreditation procedure, so it would appear that currently the NAIC has little ability to enforce uniformity. Consumer groups continue to insist that in a weak economy, the public needs strong financial standards to limit the effect of any insolvencies or rehabilitations. The tension from this issue is far from being resolved, and we expect to see more states granting permitted accounting practices in the near future to ensure that their domestic insurers are not at a competitive disadvantage, vis-à-vis their competitors.

Anthony C. Roehl is an Associate in the firm’s Insurance and Reinsurance and Corporate Practices. Mr. Roehl’s principle areas of concentration are insurance regulation and corporate matters involving entities within the insurance industry. Mr. Roehl received his bachelor’s degree from the University of Florida and his law degree from the University of Michigan.