Session 10, AG 48 and Beyond: What Does the Future Hold for Captive Reinsurance in the PBR Era? Moderator: Russell B.

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1 Session 10, AG 48 and Beyond: What Does the Future Hold for Captive Reinsurance in the PBR Era? Moderator: Russell B. Menze, FSA, MAAA Presenter: Thomas Colbrook, FSA, MAAA Alan J. Routhenstein, FSA, MAAA Xueli Zhang, FSA, MAAA

2 AG 48 and Beyond What Does the Future Hold for Captive Reinsurance in the PBR Era? Thomas Colbrook, FSA, MAAA Actuary, Financial Solutions 2016 SOA Valuation Actuary Symposium August 29, 2016

3 Redundant Reserve Financing Solutions Front-End (Coinsurance to Captive) Back End (Alternative Capital) Non-Recourse Notes (Securitization) Traditional LOCs and Asset Transactions (Bilateral Credit) Operating Company Coinsurance Captive Reinsurer Credit-Linked Notes Conditional LOCs (Derivatives) Structured Reinsurance 2

4 Capital Structure for Typical Pre-AG 48 Captive Capital and Surplus (e.g. Multiple of CAL RBC) Funded with traditional NAIC-eligible securities Total XXX/AXXX Statutory Reserve Redundant Reserve Economic Reserve Financed Portion Backed by Alternative Asset Funded with traditional NAIC-eligible securities 3

5 How does AG 48 change captive transactions? Some companies will choose to finance both the Other Security Layer and the Mezzanine Layer Capital and Surplus (e.g. Multiple of CAL RBC) Other Security Layer (Excess of XXX/AXXX Reserve over AMR) Mezzanine Layer (Excess of AMR over Economic Reserve) Economic Reserve Some companies will only finance the excess of the XXX/AXXX Reserve over the Actuarial Method Reserves (AMR) AMR supported by Primary Security 4

6 2015 Transactions and Challenges Encountered Post-Rector Many companies executed 2014 transactions in advance of uncertainty created by AG 48, Rector and grandfathering. As such, 2015 deals were accelerated into Completed Transactions AG 48 Compliant Deals Other Security Layer: Pre-Rector arrangements are still viable Mezzanine Layer: Self-financed by direct insurer Pre-existing captives Inclusion of Post-Rector business in Pre-Rector facility Block acquisitions Transactions Not Completed Mezzanine Layer financing Outside financing arrangements for Mezzanine Layer Increased scrutiny from regulators resulted from certain aggressive structures 5

7 Captive Arrangements for 2016 Other Security Layer As seen in 2015, less scrutiny in financing this tranche Mezzanine Layer financing solutions Options include: A. Funding from operating company s internally generated funds B. Financing from operating company s affiliates C. Reinsurer (or other financing provider) provides financing D. Financing provided by a 3 rd party, backed by guarantee from reinsurer (or other financing provider) Several insurers are working on deals, and thus far, at least one has been completed that is not type A or B above Restructure of existing financing facilities 6

8 AG 48 Captive Arrangements Operating Company Funds Primary Security Parent Company Operating Company Coinsurance Captive Financing of Other Security Layer Reinsurer/ Other Financing Provider 7

9 AG 48 Captive Arrangements Financing Provided by Reinsurer (or Other Financing Provider) Parent Company Operating Company Coinsurance Captive Financing of Other Security Layer Provides Assets to Support Mezzanine Layer Reinsurer/ Other Financing Provider 8

10 AG 48 Captive Arrangements 3 rd Party Provides Financing Parent Company Operating Company Coinsurance Captive Financing of Other Security Layer Reinsurer/ Other Financing Provider Provides Assets to Support Mezzanine Layer 3 rd Party Financing 9

11 Principles-Based Reserves (PBR) In 2009, the NAIC revised the Model Standard Valuation Law (SVL) to authorize the implementation of PBR and developed VM-20 to prescribe PBR calculations and other requirements To become effective, PBR must be adopted by no fewer than 42 of 55 U.S. jurisdictions accounting for at least 75% of industry premium Once effective, VM-20 will apply to all life insurance policies, except credit life and pre-need life, issued on or after effective date Provisions included in VM-20 3 year transition period Exclusion tests Small Company, Stochastic Reserve, Deterministic Reserve 10

12 Current Status of Principles-Based Reserves (PBR) Map of State Adoption 1 As of July 2016, 46 states representing over 85% of premium have adopted In June of 2016, NAIC adopted PBR with an effective date of January 1,

13 PBR Impact on XXX/AXXX Captive Financing Pre-AG 48 Compliant Facilities Existing facilities may be restructured in order to refinance or accommodate block acquisition transactions AG 48 Compliant Facilities Applicable to insurers that choose to delay implementing PBR during the 3-year transition period Option for insurers that meet criteria of Small Company Exclusion Test and file statement of exemption VM-20 Compliant Facilities PBR still viewed as fairly conservative and is only prospective Opportunities will still exist post PBR Financing transactions are common in other jurisdictions with principles based reserving (e.g. European EV Deals) 12

14 Questions?

15 Disclaimer The information provided in this presentation does in no way whatsoever constitute legal, accounting, tax or other professional advice. While Hannover Rück SE has endeavoured to include in this presentation information it believes to be reliable, complete and up-to-date, the company does not make any representation or warranty, express or implied, as to the accuracy, completeness or updated status of such information. Therefore, in no case whatsoever will Hannover Rück SE and its affiliated companies or directors, officers or employees be liable to anyone for any decision made or action taken in conjunction with the information in this presentation or for any related damages. Hannover Rück SE. All rights reserved. Hannover Re is the registered service mark of Hannover Rück SE.

16 AG48 and Beyond Introductory Remarks Session 10 PD 2016 SOA Valuation Actuary Symposium Hollywood, FL Alan Routhenstein, FSA, MAAA August 29, 2016

17 Introductory Remarks - Agenda Why do many insurers and reinsurers use reserve financing? Common forms of Grandfathered Policy reserve financing transactions 2

18 Many banks and reinsurers are willing to finance the excess of statutory over economic reserves The definition of economic reserves has historically been a negotiated deal term that for XXX/AXXX financing deals has often been GPV determined with best estimate assumptions. The graph below shows how XXX ( TL ) economic and excess reserves can vary over time % 100.0% 80.0% 60.0% 40.0% Statutory Excess Economic 20.0% 0.0% New transactions financing policies not grandfathered under Actuarial Guideline 48 ( AG48 ) involve an Actuarial Method reserve ( AMR ). 3

19 TL AMR is often closer to best estimate economic reserves than to statutory reserves For TL, the AMR is a modified VM-20 reserve equal to the larger of two reserve calculations For TL, the AMR generally peaks at 30% to 50% of statutory reserves 120.0% 100.0% 80.0% 60.0% 40.0% Statutory AMR Economic 20.0% 0.0% That compares with best estimate economic reserves that generally peak at 20% to 40% of statutory 4

20 Universal Life AMR Relative to Statutory and Economic Reserves For universal life with secondary guarantees ( UL ), the AMR is a modified VM-20 reserve equal to the largest of three reserve calculations For UL, the relationship between statutory reserves, the AMR and economic reserves is highly dependent on policy design, the nature of the reinsurance treaty, the degree of asset/liability matching and the definition of economic reserves For UL blocks of policies that have been financed, best estimate economic reserves have generally peaked at 55% to 85% of statutory For UL AMR our sample size is still too small to generalize 5

21 Why do most large stock life insurers and reinsurers use reserve financing? Product pricing: Reserve financing enables insurers to assume debt-like or hybrid (rather than equity) financing costs for TL and UL reserves to be financed Capital management: Reserve financing creates free surplus that can be used to improve RBC ratios, finance sales growth, or invest in acquisitions Rating agency relations: Reserve financing can be structured to be viewed more favorably by rating agencies than surplus note and holding company senior debt financing 6

22 Introductory Remarks - Agenda Why do many insurers and reinsurers use reserve financing? Common forms of Grandfathered Policy reserve financing transactions 7

23 Non-recourse LOC financing can have only a few boxes & arrows, and has been popular since 2010 Bank Cash Drawn on LOC if needed LOC Fees Life Insurer or Professional Reinsurer Reinsurance Premiums Reinsurance Claims Captive Reinsurer Some banks have additional features (with extra boxes and arrows) to differentiate their solutions Most non-recourse LOCs to date have been conditional, whereby a draw is only permitted after economic reserve assets are depleted 8

24 Deal model based recourse LOC financing requires a comprehensive parent guarantee Holding company Reimbursement obligation Bank Cash Drawn on LOC if needed LOC Fees Life Insurer or Professional Reinsurer Reinsurance Premiums Reinsurance Claims Captive Reinsurer In addition to an obligation to reimburse amounts drawn, the guarantor might be required upon certain adverse events to post collateral or contribute additional capital to the captive 9

25 If guaranty of a parent financing is used instead of an LOC, a bank is not involved Holding company Cash Drawn on parent guaranty if needed Life Insurer or Professional Reinsurer Reinsurance Premiums Reinsurance Claims Captive Reinsurer A guaranty of a parent was first permitted for Iowa insurers under a 2010 Limited Purpose Subsidiary ( LPS ) law and regulation Similar laws have passed in GA, IN, NE and TX The beneficiary could potentially be the cedant and/or the captive 10

26 Some reinsurers offer non-recourse XOL reinsurance to compete with non-recourse LOC financing Professional Reinsurer Cash Drawn on XOL if needed XOL Fees Life Insurer Reinsurance Premiums Reinsurance Claims Captive Reinsurer The beneficiary could potentially be the cedant or the captive Some reinsurers have additional features to differentiate their solutions Most non-recourse XOLs to date have been conditional, whereby a draw is only permitted after economic reserve assets are depleted 11

27 A form of non-recourse financing that emerged in 2012 involves an SPV that issues a credit linked note Captive issues a Surplus Note bought by the SPV, and Captive buys the credit linked note ( CLN ) with a lower coupon In good times, the coupon difference is paid to financing provider as a fee Life Insurer or Professional Reinsurer Reinsurance Premiums Reinsurance Claims CLN interest & principal SPV ` Captive Reinsurer Fee=Surplus Note interest CLN interest SPV s CF shortfall Surplus Note interest & principal Financing Provider In bad times, financing provider covers SPV s CF shortfall 12

28 Non-ILS debt reserve financing often involves holding company issuance of senior debt Alternatively, an affiliate of the cedant could issue senior debt or vanilla surplus notes, and then use the proceeds to purchase surplus notes issued by the captive Holdco or Affiliate Surplus Note proceeds Life Insurer or Professional Reinsurer Ceding company is beneficiary Senior debt interest & principal Sr. debt proceeds Reinsurance Premiums Reinsurance Claims Senior Debt Investors Surplus Note interest & principal Surplus Note proceeds Captive Reinsurer Investment income Reserve Credit Trust 13

29 A recourse funded solution is usually a captive surplus note guaranteed by the holding company Holding company Guarantee Surplus Note Investor(s) Surplus Note proceeds Surplus Note interest & principal Life Insurer or Professional Reinsurer Ceding company is beneficiary Reinsurance Premiums Reinsurance Claims Surplus Note proceeds Captive Reinsurer Investment income Reserve Credit Trust 14

30 A non-recourse funded solution usually involves an SPV in between the captive and investors Some structures have additional features (with extra boxes and arrows) whereby the holding co. or an affiliate insulates the cedant, captive or SPV from certain risks Life Insurer or Professional Reinsurer Ceding company is beneficiary Reinsurance Premiums Reinsurance Claims Surplus Note proceeds Surplus Note proceeds SPV ` Captive Reinsurer Reserve Credit Trust Debt interest & principal Proceeds Surplus Note interest & principal Investment income Debt Investor(s) 15

31 A wrapped funded solution usually involves a guarantee to investors from a financial guarantor Life Insurer or Professional Reinsurer Ceding company is beneficiary Reinsurance Premiums Reinsurance Claims Surplus Note proceeds Surplus Note proceeds SPV ` Captive Reinsurer Reserve Credit Trust Debt interest & principal Surplus Note interest & principal Investment income Proceeds Debt Investor(s) Guarantor Fee Guarantee of interest & principal Financial Guarantor 16

32 Milliman Contact Information Alan Routhenstein

33 AG 48 and Recent Developments Xueli Zhang CFA, FSA, MAAA Executive Director and Actuary, Pricing Global Financial Solutions RGA August 29, 2016

34 Agenda What is Actuarial Guideline (AG) 48 Recent Developments Related to AG 48 2

35 What is Actuarial Guideline (AG) 48 3

36 A Brief History of AG 48 Negative media reports on captive reinsurance starting 2011 NAIC Actions In 2011, NAIC initiated study on insurers' use of captives and SPVs What is Actuarial Guideline (AG) 48 In 2013, NAIC hired Rector & Associates, Inc. to assist NAIC s consideration on regulating captives o Initial Rector Report (September 2013) and revised report (March 2014) o On 6/30/2014, NAIC adopted the conceptual framework in the final Rector Report o On 12/16/ 2014, NAIC adopted AG 48 with a 1/1/2015 effective date AG 48 is the main work product of the Rector Framework implementation 4

37 AG 48 Defines Actuarial Method Reserve (AMR) Using VM-20 definition After PBR is implemented (i.e. starting 1/1/2017), VM-20 without modification Before PBR is implemented (i.e. before 2017) o XXX policies: Max (Deterministic Reserve, % of Net Premium Reserve) o AXXX policies: Max (Deterministic Reserve, % of Net Premium Reserve, Stochastic Reserve) o No exemption testing allowed Net Premium Reserve (NPR) % After 2015, 100% using the 2017 CSO table Before 2016, prescribed % using the 2001 CSO table o XXX NPR % = 55% to 100% o AXXX NPR % = 80% to 100% What is Actuarial Guideline (AG) 48 5

38 AG 48 Asset Requirement What is Actuarial Guideline (AG) 48 Statutory reserve is split into two parts, but the total reserve amount does not change 1 st part: AMR is required to be backed by Primary Security 2 nd part: Excess of AMR to be backed by Other Security that may qualify as Primary Security Primary Security Cash and SVO-listed securities (funds withheld, trust or mod-co basis) o exclusion: synthetic LOC, contingent note, CLN Assets in funds withheld or mod-co o commercial loans, policy loans and hedge derivatives Other Security Assets qualified as Primary Security Assets acceptable to the Commissioner XXX / AXXX Statutory Reserve Liabilities Redundant Reserve AMR over Economic Reserve Economic Reserve Assets Other Security Primary Security 6

39 AG 48 Intended Scope What is Actuarial Guideline (AG) 48 XXX / AXXX redundant reserve financing on new policies issued on or after 1/1/2015, and on pre 1/1/2015 policies not reinsured or reinsured to an exempted facility before 1/1/2015 Intent to make the guidance as prospective as possible Exempted reinsurance arrangements YRT Certified reinsurer Trust fund Reinsurer without any departures from NAIC statutory accounting practices and procedures Exemption granted by the ceding insurer s domiciliary regulator 7

40 AG 48 Requirements Appointed actuary must render a qualified actuarial opinion if AG 48 asset requirement not met Remediation by March 1 st each year AG 48 sunset provision AG 48 recommended to become an accreditation standard What is Actuarial Guideline (AG) 48 8

41 Recent Developments Related to AG 48 9

42 Revised Credit for Reinsurance Model Law (#785) On 1/8/2016, revision was adopted by the NAIC to give the commissioners authority to adopt regulations related to Valuation of assets or reserve credits Amount and forms of security supporting reinsurance arrangements Circumstances pursuant to which credit will be reduced or eliminated Types of reinsurance arrangements under this revision XXX / AXXX business covered by AG 48 VA with guaranteed death or living benefits LTC policies Other life and health insurance and annuity products Recent Developments Related to AG 48 10

43 New XXX / AXXX Credit for Reinsurance Model Regulation to Sunset AG 48 page 1/3 Still a draft: Credit for Reinsurance of Life Insurance Policies Containing Nonlevel Gross Premiums, Nonlevel Gross Benefits and Universal Life With Secondary Guarantees Term and Universal Life Insurance Reserve Financing Model Regulation To substantially replicate AG 48 Recent Developments Related to AG 48 Continuity of requirements for the amounts and forms of security held Not intended to change the scope of, or collateral requirements for policies and treaties covered 11

44 New XXX / AXXX Credit for Reinsurance Model Regulation to Sunset AG 48 page 2/3 Consequence of shortfalls On 10/26/2015, NAIC Reinsurance Task Force elected all-or-nothing consequence through a majority vote In June, consequence revised to dollar-for-dollar reduction with regard to Primary Security and all-or-nothing regard to Other Security Frequency of shortfall measurements Quarterly Remedy to shortfall Remedy period changed to the statutory statement due date in August, a drafting note was added on permitted practice Recent Developments Related to AG 48 12

45 New XXX / AXXX Credit for Reinsurance Model Regulation to Sunset AG 48 page 3/3 Professional reinsurer exemptions Additional exemptions for professional reinsurers Scope of the new model regulation YRT exemptions were limited to policies issued before the ceding company adopts VM- 20 but no later than 1/1/2020 AG 48 related RBC charges remain Recent Developments Related to AG 48 13

46 Revisions of the Preamble to Part A of the NAIC Accreditation Program Manual Revisions adopted on 11/22/2015 Recent Developments Related to AG 48 New preamble includes a safe harbor for reinsurance transactions that satisfy the XXX / AXXX Reinsurance Framework requirements preamble discusses the scope of the Part A standards (Part A: Laws and Regulations) o purpose is to assure that an accredited state has sufficient authority to regulate the solvency of its multi-state domestic insurance industry in an effective manner multi-state insurer definition is expanded to include certain captive reinsurers o XXX / AXXX captives under AG 48 o VA and LTC captives, but notes that those provisions are not yet effective 14

47 AG 48 Related Disclosures Recent Developments Related to AG 48 Supplemental XXX / AXXX Exhibit Disclosure of all XXX / AXXX reserve financing transactions Disclosure of AMR on transactions covering non-grandfathered Policies XXX / AXXX Captive Reinsurance Consolidated Exhibit Disclosure of RBC Shortfall for transactions covered by AG 48 For 2016, if captive files RBC reports, RBC Shortfall = zero For 2016, if captive does not file RBC reports, RBC Shortfall is based on AMR, at 300% ACL, with a credit for the C-0 charge For 2016, any assets not normally admitted are excluded in the captive s TAC calculation 15

48 AG 48 Related RBC Charges Recent Developments Related to AG 48 Primary Security Shortfall: increase the ceding company s ACL RBC RBC Shortfall: decrease the ceding company s Total Adjusted Capital Qualified Actuarial Opinion: based solely on AG 48 will not impact all lines of business of the ceding company 16

49 Other Regulatory Development Definition of Securities Listed by the SVO VOS TF adopted definition of Securities Listed by the SVO (Purposes & Procedures Manual) o Includes U.S. government securities and insurers investment securities o Excludes any individual insurer s bespoke regulatory transactions in June, Reinsurance Task Force began deliberating on whether NAIC should further clarify the concept of investment security vs. regulatory transaction Enhanced NAIC Financial Analysis Handbook (FAH) guidance Specifies procedures for regulatory review Confidential feedback from NAIC FAWG starting in 2014 Recent Developments Related to AG 48 17

50 Summary Recent Developments Related to AG 48 Revision to the Credit for Reinsurance Model Law Pending new XXX / AXXX Credit for Reinsurance Model Regulation Expanded accreditation standard Additional disclosures and RBC charges 18

51 Reserve Financing after PBR Adoption VM (PBR) becomes operative on January 1, 2017 Will there be reserve financing after PBR adoption? Different views between regulators and industry participants Perceived redundancy in VM-20 Assumptions o No mortality improvement after valuation date o Explicit PADs o Grading to industry tables Methodologies o Benefits of reinsurance o Recent Developments Related to AG 48 19

52 2016 RGA. All rights reserved. No part of this publication may be reproduced in any form without the prior permission of RGA. The information in this publication is for the exclusive, internal use of the recipient and may not be relied upon by any other party other than the recipient and its affiliates, or published, quoted or disseminated to any party other than the recipient without the prior written consent of RGA.