An aerial view shows a home damaged by Hurricane Harvey in Rockport, Texas, Aug. 28, 2017. Army National Guard photo by Sgt. 1st Class Malcolm McClendon.



One need look no further than the Texas, Florida and Puerto Rico hurricanes to appreciate the compelling public policy that insurance companies should have sufficient resources to pay claims when due. Having all the insurance coverage in the world matters little if the carrier lacks sufficient funds to satisfy its policy obligations when triggered.

This principle of insurance solvency has been one of the bedrocks of insurance law for decades, giving rise to a myriad of regulatory requirements and processes designed to ensure that insurance companies have sufficient capital to absorb losses.

Capital requirements for insurers are currently undergoing far-reaching changes across numerous jurisdictions as policymakers and regulators strive to keep up with evolving macroeconomic pressures and variables. These changes, in turn, could have a profound impact on some of the most fundamental business decisions made by carriers, such as pricing policies, investing assets, entering or exiting lines of business and others.

This article uses the terms “capital” and “surplus” more or less interchangeably to refer to assets on an insurance company’s balance sheet that are in excess of the amount needed for legal liabilities including expected policy claims. “Capital and surplus” is often used synonymously, particularly in a more technical legal or accounting sense.

All states—the jurisdictional level at which insurers are regulated, as opposed to the federal government—impose minimum capital and surplus requirements for new insurance companies. These, however, are relatively modest amounts and are “one size fits all” in their application insofar as each insurer writing a particular line of business is subject to the same minimum capital and surplus requirement as any other.

Supplementing these basic requirements is the Risk-Based Capital, or RBC, regime, a more sophisticated tool for measuring capital. Applicable to most types of insurers, RBC is governed by model laws promulgated by the National Association of Insurance Commissioners (NAIC) and adopted in each of the states. Under RBC, each insurance company performs a set of prescribed calculations that measure needed capital as a function of the particular risks to which that insurer is uniquely exposed. Specifically, the RBC instructions ascribe quantitative factors to each component of risk to which that insurer is subject—e.g., investment assets, liabilities, underwriting risk, credit risk, interest rate risk and others, yielding an amount of capital (“authorized control level”) that is deemed the minimum necessary for that insurer in order to carry on its business. The RBC guidelines also tally the actual amount of “total adjusted capital” of the insurer, a modified version of surplus. The resulting ratio of total adjusted capital to authorized control level is a key regulatory ratio, which insurers actively monitor and manage to. The RBC laws also define certain multiples of ACL and provide that, should an insurer’s capital fall below any such multiple, enforcement powers (which becomes more potent at each successively lower threshold level of RBC) are available to the state insurance regulator to compel the insurer to take remedial actions.

RBC examines capital at the legal entity level; these measurements do not directly take into account financial health at any affiliates of the particular reporting insurer. Affiliates historically were outside the direct purview of insurance regulators, although “insurance holding company” laws generally required disclosures about relationships between insurers and their affiliates. Beginning in 2010, as a response to the 2008 crash, the NAIC and state legislators toughened these laws in order to require insurance groups to assess their own group risks across entities. These changes, known as Enterprise Risk Management requirements (ERM) and Own Risk and Solvency Assessments (ORSA), were motivated by a perception that, while an insurer itself might have robust capital, there may be a reason to conclude that insufficient capital at the group level, even outside the insurer itself, could harm policyholders.

Once ERM and ORSA model provisions were adopted in 2010 and 2012 respectively, and generally adopted by the states in the years thereafter, the NAIC began to focus more granularly on quantitative measurements of group capital. In recent months the NAIC has considered possible ways of calculating group capital requirements, including such variables as how to account for non-insurers within the affiliated group, how to risk-weight non-U.S. companies and how to treat special purpose insurers that are not themselves subject to entity-level RBC requirements. These discussions are ongoing and are widely watched.

Concurrently with these developments, the federal government, despite not being a primary source or enforcer of insurance law, has also become involved in aspects of insurer capital standards. For example, on Sept. 22, the Trump administration, in guidance relating to the recently completed “Covered Agreement” on insurance-law reciprocity between the United States and the European Union, wrote that the United States “expects” that the NAIC’s group capital standards will satisfy the agreement’s requirement that cross-border insurance groups be subject to comprehensive group capital assessments.

Separately, the Dodd-Frank Wall Street Reform and Consumer Protection Act empowered the Federal Reserve Board of Governors to regulate risk-based capital standards for two types of insurance businesses—those groups determined by the federal government to be crucial to the economy (so called systemically important financial institutions, or SIFIs) and certain insurance companies that own federally insured depositary financial institutions. According to the Fed, these two categories of insurance businesses in the aggregate account for $2 trillion in assets and comprise one-third of the assets of the nation’s insurance industry.

In 2014, these provisions of Dodd-Frank were amended to clarify that the Fed could tailor such standards to take into account the distinctive features of the insurance business. This clarification was in response to concerns that the Fed, which among other things regulates bank holding companies, would apply assumptions and understandings to insurer capital rules that are more appropriate for banks. In 2016, the Federal Reserve announced proposed rulemaking to implement capital requirements for insurers under its remit that seemed to take into account the distinctive business characteristics of insurers as opposed to banks. Although public comments have been registered, the Fed has not taken any further action on these proposed standards.

The election of both a Republican president and a Republican congress in 2016, as well as recent judicial developments, has introduced some uncertainty into the federal role in regulating capital for these two types of insurers.

• For example, one of the insurers that had been determined to be a SIFI, MetLife, successfully challenged its SIFI designation in D.C. district court in 2016. Although the federal government has appealed this decision, during 2017 MetLife has received two favorable rulings from the D.C. Circuit Court, including one this past August, effectively delaying the appeal.

• On Sept. 29, the Trump administration rescinded the SIFI designation of American International Group.

These developments followed a presidential memorandum issued in April implementing a review of the SIFI designation process as a whole and requiring a report from the Treasury Secretary by Oct. 18 on such review. This move was seen as consistent with Republican ambitions to weaken or even repeal Dodd-Frank, also evident in the Trump Administration’s February Executive Order on financial regulation and the introduction during the spring of two bills in Congress—the International Insurance Capital Standards Accountability Act introduced in the Senate (imposing standards on the federal government’s ability to agree to standards with international standard-setting bodies such as the International Association of Insurance Supervisors, or IAIS, discussed below) and the Financial CHOICE Act of 2017, which passed the House in June 2017 and would repeal much of Dodd-Frank.

Looking beyond the United States, with increasing globalization of insurance and reinsurance sectors, insurance groups that straddle national boundaries are commonplace. Policymakers have begun to develop methodologies of determining the right amount of capital across these groups, despite the limits posed by national sovereignty, and, in the case of the United States, the primacy of state rather than federal government in regulating insurance. As part of its ongoing Common Framework, or “ComFrame,” for codifying insurance regulatory principles generally, the IAIS has undertaken to establish capital guidelines for so-called Internationally Active Insurance Groups, or IAIGs. In its 2016 and 2017 publications detailing a proposed “risk-based global insurance capital standard,” the IAIS details two alternative methods for determining group capital, one based on market valuations of assets and liabilities and the other aligned with existing accounting regimes such as GAAP or IFRS. In August 2017, the NAIC announced new collaboration between itself and the Fed to create a unified U.S. approach to capital standards for insurer groups, in order to strengthen the U.S.’s position at the IAIS on these matters.

With developments across multiple jurisdictions, capital standards for insurers are an increasingly dynamic and consequential area of insurance law. The choices made by policymakers and regulators in the various work-streams described above could determine whether the next Hurricane Harvey, Irma or Maria finds an insurance industry ready to pay claims—or without enough money in the till.

Daniel A. Rabinowitz is a partner at Kramer Levin Naftalis & Frankel. From 2011 to 2014, he served as chair of the Insurance Law Committee of the NYC Bar Association.