BILL ANALYSIS
SENATE COMMITTEE ON BANKING, FINANCE,
AND INSURANCE
Senator Ronald Calderon, Chair
AB 2002 (Huffman) Hearing Date: June 16, 2010
As Introduced: February 17, 2010
Fiscal: No
Urgency: No
VOTES: Asm. Floor(04/15/10)70-0/Pass
Asm. Ins. (04/07/10)12-0/Pass
SUMMARY Would provide for across-the-board application of
Risk-Based Capital (RBC) financial oversight to insurers
operating in California by repealing a pre-RBC statute that
mandates a statutory minimum level of capital reserving for
certain non-auto and automobile bodily injury liability insurers
as an exception to the reserving practices and law which would
otherwise apply.
DIGEST
Existing law
1.Provides that reserves for each of the three previous years
for lines of insurance described on insurers' annual
statements as "liability other than automobile bodily injury"
and "automobile bodily injury" be not less than 60% of the
earned premiums for each of those three years, and that the
Insurance Commissioner's regulations reflect this rule for
these lines of insurance;
2.Grants the Insurance Commissioner a broad range of powers to
regulate the solvency of insurance companies doing business in
California, including the right to examine any insurer's books
and records, to evaluate the quality of its investments, to
evaluate the type of insurance risk it has assumed, and to
evaluate the reinsurance it has purchased, among other tools;
3.Establishes a financial analysis tool formulated under the
guidance of the National Association of Insurance
Commissioners (NAIC) called "risk-based capital" (RBC) which
AB 2002 (Huffman), Page 2
involves an analysis of each insurer's risk profile, including
its underwriting risks, its investment risks, its credit
risks, and other factors designed to evaluate the ability of
the insurer to meet its obligations. Depending on an insurer's
RBC "score," an escalating level of regulatory intervention is
authorized;
4.Requires insurers generally to comply with the Accounting
Practices and Procedures Manual (APPM) adopted by the National
Association of Insurance Commissioners (NAIC), unless a
specific statute overrides this rule. The 60% reserve rule,
which predates both the RBC law and the NAIC APPM law,
operates in California as an exception to this requirement.
This bill
1. Would repeal a 41 year old pre-RBC statute specifying a
mandatory fixed reserve level for seven lines of liability
insurance in favor of adherence to the NAIC's current
Risk-Based Capital approach to solvency monitoring and
regulation.
COMMENTS
1.Purpose of the bill To repeal California Insurance Code
section 11558, thereby allowing the California Department of
Insurance and insurers to apply the National Association of
Insurance Commissioners Accounting Practices and Procedure
Manual reserving standards to all lines of business when
preparing annual statements.
2.Background The National Association of Insurance
Commissioners established the Risk-Based capital framework to
provide a methodology by which insurance regulators could
identify weakly capitalized companies. The RBC system is a
regulatory tool which permits regulatory action based on RBC
ratios, which are not designed to compare capital strength of
companies. In general, RBC-based minimum capital requirements
are expected to be sufficient to protect insurer solvency 95%
of the time.
3.The result of the AB 2002's adoption will be elimination of an
arbitrary requirement governing the levels of mandatory
financial reserves which was enacted decades before insurance
regulators, operating under the auspices of the NAIC,
instituted the Risk-Based Capital reserving methodology now in
AB 2002 (Huffman), Page 3
general use to monitor insurer capital adequacy. The author
that argues imposing the current statutory requirement, even
when the NAIC's RBC methodology indicates a lesser amount is a
sufficient hedge against potential insolvency, leads to the
unproductive sequestering of scarce capital. The author argues
this can lead to restricted capacity to write insurance in
California as unneeded mandatory reserves obligate the insurer
to set funds aside that could otherwise be used to support
expanded writing of insurance.
4.With respect to the lines of liability insurance in question
there are no concerns regarding their solvency or financial
strength -- concerns, which, if they existed, might provide a
reason to maintain current law.
5.A "reserve" is an amount set aside representing actual or
potential liabilities kept by an insurer to cover obligations
to policyholders and third party claimants and setting
reserves appropriately is a highly sophisticated process. At
it's simplest, setting reserves for high frequency, low
severity lines of coverage where claims close quickly, such as
auto collision coverage, reserves may be set based on past
average claims costs, as adjusted by known trends affecting
the cost of this class of claims. Even this "simple approach"
will be monitored over time to ensure that it is actually
capturing how the claims history is developing. For lines of
insurance with greater potential for variability, the setting
of reserves involves careful examination of data and a high
degree of professional actuarial judgment. The actuary must
have a high degree of familiarity with the insurer's methods
of operation, it's mix of business and changes in that mix
that are occurring, how the particular coverage is priced,
claims administration practices of the insurer and overall
management philosophy. In addition, a competent actuary will
be well-informed concerning trends that are outside the
company, such as key court decisions, the rate of inflation
generally or as it affects key cost factors for the claims
involved, legislative developments, and so forth. Effective
actuarial analysis and methods are central to the operation of
every insurance company.
6.SB 316 (Yee), Statutes 2007, chapter 431, repealed a similar
"65% reserve rule" applicable to workers' compensation
insurers. SB 316 was passed unanimously by both the Assembly
and Senate.
AB 2002 (Huffman), Page 4
7.The current statute establishing the fixed minimum level of
reserving for specified lines is a vestige of pre-RBC
financial solvency oversight and the proposed repeal will not
materially affect the public's confidence of the soundness of
the affected insurers. If AB 2002 is enacted into law, the
insurers affected by this change will continue to rely on
professional actuarial talent for their reserving and
ratemaking, both of which are deeply anchored in the
particulars of the insurer's book of business, claims trends,
and management philosophy and key external trends impinging on
the particular line of business and the regulator will
continue to monitor solvency within the modern Risk-Based
capital framework.
8.While the current troubled financial environment nationally
and internationally has posed a significant challenge to
insurance regulators, no less than for other financial
regulators, the NAIC's ongoing solvency modernization
initiative includes as one of its central elements a capital
adequacy task force that is building upon the existing RBC
Framework. On this basis, the reliance AB 2002 places on the
RBC methodology appears to be appropriate.
9. Support Fireman's Fund Insurance Companies, which is the
sponsor, notes it has made its home in California for 147
years and is the state's second largest domestic insurer with
nearly 2000 employees in the State. In support of the bill,
Fireman's Fund states:
"Section 11558, while useful decades ago, no longer serves
its intended purpose; allocation of financial reserves
necessary to pay claims for specific lines of liability
insurance. Unlike California, other state insurance
regulatory laws do not use minimum reserves of the type
found in Section 11558. Instead, Risk Based Capital (RBC)
standards which are far more comprehensive are now used by
state regulators and the National Association of Insurance
Commissioners to track and ensure that insurers are able to
pay their claims. Use of consistent, national RBC
standards allows regulators in all states to apply
consistent financial strength tests to insurers.
Not only is Section 11558 inconsistent with the standards
used all other states, but it is inconsistent with the RBC
standards applied by the CDI for evaluation of all other
insurance lines of business within Fireman's Fund own
AB 2002 (Huffman), Page 5
operations. This puts California domiciled insurers at a
disadvantage relative to insurers from outside of the state
to whom Section 11558 does not apply.
The changes proposed by AB 2002 will foster consistency in
financial oversight for California based insurers, while
not impacting the financial oversight provided under
California's RBC rules.
For these reasons Fireman's Fund, as its sponsor, supports
AB 2002."
10. Opposition None
11. Questions None
12. Suggested Amendments None
13. Prior and Related Legislation
SB 316 (Yee), Statutes 2007, chapter 431, repealed a similar
"65% reserve rule" applicable to workers' compensation
insurers. SB 316 was passed unanimously by both the Assembly
and Senate.
POSITIONS
Support
Fireman's Fund Insurance Company (Sponsor)
Oppose
None
Consultant: Kenneth Cooley (916) 651-4102