NAIC Catastrophe Reserve Working Group Meeting Report: August 14

On Thursday, August 14, 2008, the National Association of Insurance Commissioners (“NAIC”) held a Catastrophe Reserve Working Group (“Working Group”) meeting to discuss comments received on the Voluntary Tax-Deferred Pre-Event Catastrophe Reserve Proposal (“Proposal”). To view a copy of the Proposal, click here.

The meeting was called to order by Chairman Joseph Fritsch (NY), with a quorum of members in attendance. Also in attendance were interested parties, some of whom provided written comments on the Proposal.

Consideration of the Proposal, which was created in the 1990s and re-visited in 2001, was postponed by the NAIC “unless and until” the Internal Revenue Service (“IRS”) Tax Code is amended to grant a federal tax deduction for funds placed into a catastrophe reserve.

Current federal tax law discourages companies from specifically allocating assets to pay for future catastrophic losses. Instead, payments for these losses are made from general policyholder surplus funds after the losses are incurred. According to Michael Moriarty, a regulator from New York, the IRS has stated that it will not consider revising its Tax Code until the NAIC and states set up a mandatory catastrophe reserve fund, thus presenting a “Catch-22” situation.

Potential re-activation of the Proposal would come at the request of New York regulators and would accompany other NAIC efforts to help insurers cope with potentially massive capital demands in the wake of a large catastrophic event.

The Working Group has been tasked with reviewing the Proposal and making a recommendation on whether to re-activate it, even if the IRS Tax Code ultimately is not amended.

To view interested party written comments on the Proposal, click on the names below:

• Jim Olsen, Director, Insurance Accounting and Investment, Property Casualty Insurers Association of America (“PCI”)
• William Boyd, Financial Regulation Manager, National Association of Mutual Insurance Companies (“NAMIC”)
• Dennis Burke, Vice President, State Relations, Reinsurance Association of America (“RAA”)

Representatives from all three of the above-listed organizations spoke against re-activating the Proposal until the IRS Tax Code has been amended and agreed that financing catastrophe risk through a pre-event reserve would add undue expense to insurance companies. It also could result in the “trapping” of capital within unaffected insurers in the event of a large-scale catastrophe. This would greatly reduce affected companies’ claims-paying abilities.

PCI representatives stated that requiring insurers to set aside after-tax assets dedicated to future catastrophic losses is not beneficial to consumers, nor would it provide a financial incentive for companies to write additional catastrophe policies, which would, in turn, decrease competition in the market.

It is PCI’s position that the levels and forms of solvency review currently required by state regulators, independent auditors and rating agencies already take into consideration the proper amount of surplus an insurer should maintain for a catastrophic loss. By requiring funds to be segregated without additional capital provided from a tax deduction, the insurer’s ability to pay claims would be severely limited, thus harming consumers.

It is NAMIC’s position that if a federal tax deferral for pre-event catastrophe reserves was available, and if a method was determined for utilizing excess capital created by such a reserve fund that also would not result in trapped funds, the Proposal’s efforts could be useful. NAMIC added that the industry’s current strategy of purchasing reinsurance and pooling risk presents a more efficient system.

NAMIC identifies the following as relevant considerations when weighing the usefulness of pre-event reserving in the absence of a federal tax-deferral:

• Any capital committed to an insurer’s catastrophe reserve on an after-tax basis would be expensive to the company, and would therefore be reflected in the insurer’s premium. Rates would reflect not only the taxes remitted to the U.S. Treasury, but the after-tax amounts that the insurer is required to hold in reserve.
• Under current federal tax law, insurers also would be liable for investment earnings of all capital committed to a catastrophe reserve fund.

The RAA believes the Proposal may have significant unintended consequences, and likely would interfere with the way companies underwrite risk and allocate capital. It is the RAA’s position that the Proposal could increase market instability by converting a portion of an insurer’s potential profits into a liability (or, if the insurer has no profits, a deeper loss), negatively impacting the price and availability of catastrophe insurance.

Instead of re-activating the Proposal, it is the RAA’s opinion that the NAIC should concentrate on mitigation by further educating policymakers on the benefits of land use planning, risk-focused building codes and enforcement, and strengthening existing properties to reduce losses.

Interested parties also expressed concern about the Proposal’s potential impact on insurance rates. Mr. Moriarty said that if the Proposal is re-activated, any potential rate impact would be a topic for heavy discussion.

The Working Group will make its formal recommendation to the Property and Casualty Insurance (C) Committee at the NAIC Fall 2008 National Meeting to be held in Washington, DC from September 22 – 24, 2008.

If you have any questions or comments, please do not hesitate to contact Colodny Fass.

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