A Continuing Dilemma: The Insurance Industry Wrestles with Risk-Based Capital Requirements
As many readers that follow the insurance industry know, the National Association of Insurance Commissioners ("NAIC") met this last summer and went through a series of sometimes heated discussions over what modifications should be made to NAIC Risk-Based Capital rules. Specifically, the current NAIC mortgage loan portfolio quality measure known as the "Mortgage Experience Adjustment Factor" ("MEAF") can and does cause a sudden and substantial increase in capital requirements for insurance companies. The "factor" could be a seven-fold multiplier for reserve purposes, if an insurance company's portfolio delinquency rate rises significantly above industry averages, creating a dramatic negative effect upon reserve requirements. It is conceivable that a company with modest delinquencies in its portfolio might be way above "industry averages," causing reserve requirements to be greatly increased for the entire portfolio (ranging from .5 to 3.5 times).
Last summer the NAIC agreed to a more tightly-bracketed multiplier (.75 to 1.25). They did that because they believed that too many companies were being forced to either sell problem loans at "artificially distressed" prices to avoid the application of the MEAF factor or simply transferring these loans to non-insurance based affiliates within a holding company so that the delinquent loan did not increase capital reserve requirements at the insurance company level.
Interestingly, the relief that the NAIC gave to Risk-Based Capital requirements only applies to 2009 financial statements. If no further action is taken, the 2010 financial statements will revert back to the old rules requiring artificially high level of reserves. Hopefully, the NAIC will proactively address the 2010 reporting requirements and avoid insurance companies having to make state by state exception requests to their principal regulators.
It is especially important for the NAIC to act, as the political pressure for federal regulation of the insurance industry seems to be abating. It's looking more and more likely that it will be left up to the NAIC to deal with Risk-Based Capital changes in a realistic, but still prudent way
