Mandatory Catastrophe Reserves for Property/Casualty Insurance Companies.
Purpose:
This rule requires insurers to set up a reserve fund to cover losses that occur in New York related to a natural catastrophe.
Text of proposed rule:
Section 111.0 Statement of purpose.
This Part requires authorized property/casualty insurers to establish reserve funds for the payment of losses that occur in New York, arising out of natural catastrophes. Insureds currently pay for catastrophe coverage every year as part of their property insurance premiums, yet catastrophic events generally happen infrequently. This results in higher underwriting gains for insurers for years in which no catastrophe occurs. The portion of these underwriting gains generated from premiums being charged to insureds for catastrophe coverage should be retained by insurers in the event of future catastrophe losses, and not be distributed to shareholders or otherwise re-collected from policy holders through the premium on an annual basis. This reserve will have a stabilizing effect on insureds' premiums over time, and will facilitate the ability of insurers to fund catastrophic losses and mitigate the exposure of insurers' surplus to policyholders to large fluctuations resulting from such losses.
Section 111.1 Applicability and scope.
Every authorized property/casualty insurer issuing a policy of insurance or contract of reinsurance covering losses resulting from a natural catastrophe to property located in this State, and receiving New York subject premiums, shall establish a New York mandatory contingent catastrophe reserve, which shall only be used toward the payment of claims from qualifying losses.. The New York mandatory catastrophe reserve shall apply to New York subject premiums of personal and commercial policies as defined in Section 111.2(b) of this Part.
Section 111.2 Definitions.
(a) Catastrophe shall mean a natural event designated as a catastrophe by the Property Claims Service, a division of the Insurance Services Office, Inc., and:
(1) which causes $250 million or more in industry-wide direct insured losses in the United States and results in a qualifying loss to property located in this State; or
(2) which causes $25 million or more in direct insured losses results in a qualifying loss to property located in this State, and results in a 10% reduction in the insurer's surplus to policyholders in any calendar year.
(b) New York subject premiums shall mean premiums on policies or reinsurance contracts insuring property located in this State with respect to the kinds of insurance specified in Section 1113(a)(4), (5), (6), (12), or (20) or pursuant to Section 4102(c) of the Insurance Law, that are written on a direct or assumed reinsurance basis.
(c) New York mandatory contingent catastrophe reserve shall mean a liability account established to fund losses that result from a catastrophe that has not yet occurred.
(d) Property/casualty insurer shall mean an insurer licensed pursuant to Article 41, 61, 66, 67 or 70 of the Insurance Law.
(e) Qualifying losses shall mean losses and loss adjustment expenses incurred, net of reinsurance, resulting from loss to property located in this State and which are directly attributable to a catastrophe in this State.
(f) Aggregate catastrophe load shall mean the total dollar amount of all catastrophe loads, net of non-hurricane catastrophe provisions and excess of loss reinsurance ceded, charged to all rating territories.
(g) Event-specific catastrophe loss reserve shall mean a loss reserve established to fund losses resulting from a particular catastrophe that has actually occurred.
(h) Natural event shall mean an occurrence that is not man-made, including but not limited to wind, hail, hurricane, earthquake, winter storms (including snow, ice, freezing rain), tsunami, or flood.
Section 111.3 Annual contribution to the New York mandatory catastrophe reserve.
(a) Every property/casualty insurer shall annually fund its mandatory catastrophe reserve in an amount equal to the aggregate catastrophe load, included in the New York subject premiums, for the calendar year.
(b) Notwithstanding subdivision (a) of this section, an insurer need not fund its mandatory catastrophe reserve with respect to assumed reinsurance premiums on excess of loss reinsurance contracts.
(c) The funding described in subdivision (a) of this section shall be net of any federal, state and local income tax incurred on the reserve.
(d) Any investment income earned from the funds held in the mandatory catastrophe reserve shall be included in the reserve to the extent provided in section 111.4 of this Part.
Section 111.4 Accumulation of the New York mandatory catastrophe reserve.
The New York mandatory catastrophe reserve shall have a 30-year rolling term. At the end of the 30th year, the first year's annual contribution including investment income, to the extent not used to fund qualifying losses, shall be taken into income, and the 30th year's annual contribution, including investment income, shall be added to the reserve. At the end of the 31st year, the second year's contribution shall be taken into income to the same extent and in the same manner as the first year's, and the 31st year's annual contribution, including investment income, shall be added to the reserve. This pattern of practice shall continue each year thereafter.
Section 111.5 Conversion of the New York mandatory catastrophe reserve.
(a) When a property/casualty insurer incurs a qualifying loss on property located in this State, it may convert its New York mandatory catastrophe reserve, or a portion thereof, to an event specific catastrophe loss reserve.
(b) Within 30 days of converting funds from the New York mandatory catastrophe reserve arising out of a catastrophe defined in Section 111.2(a)(1) of this Part, a property/casualty insurer shall provide the superintendent with written notice of the conversion. The notice shall be in a form specified by the superintendent showing the amount of the conversion, calculation of the source of all funds being converted, and the catastrophe that necessitated the conversion. With respect to a catastrophe defined in section 111.2(a)(2) of this Part, the amount converted shall be the lesser of: (1) the reduction in the insurer's surplus to policyholders in that calendar year; or (2) the total amount held in the mandatory catastrophe reserve.
(c) A property/casualty insurer shall promptly return to the New York mandatory catastrophe reserve any event-specific catastrophe loss reserve converted from the New York mandatory catastrophe reserve that is not ultimately expended to pay for qualifying losses.
(d) Notwithstanding subdivision (a) of this section, the superintendent may approve funds for release from the New York mandatory catastrophe reserve:
(1) to mitigate potential impairment of the property/casualty insurer;
(2) when the property/casualty insurer no longer has exposure to losses resulting from a catastrophe;
(3) where the release of funds is authorized pursuant to section 111.7 of the Part; or
(4) where the release of the funds would be in the best interests of the policyholders of this State.
(a) For a domestic property/casualty insurer, or the United States branch of an alien insurer entered through New York, the New York mandatory catastrophe reserve shall be shown as a write-in liability item on the property and casualty quarterly and annual statements regularly submitted to the Insurance Department.
(b) For a foreign property/casualty insurer, or the United States branch of an alien insurer entered through a state other than New York, the New York mandatory catastrophe reserve shall be shown as a write-in liability item on the New York supplement to the property and casualty annual statement regularly submitted to the Insurance Department.
Section 111.7 Agreements with other states.
The superintendent may enter into a reciprocal agreement with another state that has established substantially similar catastrophe reserve requirements. If the superintendent enters into a reciprocal agreement with another state that has established catastrophe reserve requirements, whereby the reserves held by the insurer in the other state will be available for release when such insurer incurs a loss resulting from a catastrophe on property located or resident in any state that is a party to the agreement, the New York mandatory catastrophe reserve shall be available for release as if the loss occurred in this State. However, the release of funds from the New York mandatory catastrophe reserve to pay for such losses occurring outside of New York may not be considered in the development of rates in New York.
Text of proposed rule and any required statements and analyses may be obtained from:
Andrew Mais, NYS Insurance Department, 25 Beaver Street, New York, NY 10004, (212) 480-2285, email: amais@ins.state.ny.us
Data, views or arguments may be submitted to:
Buffy Cheung, NYS Insurance Department, 25 Beaver Street, New York, NY 10004, (212) 480-5587, email: bcheung@ins.state.ny.us
Public comment will be received until:
45 days after publication of this notice.
Summary of Regulatory Impact Statement
1. Statutory authority: Sections 201, 301, 1113(a)(4), (5), (6), (12), and (20), 1306, 4102(c), 4117(e), and Articles 41, 61, 66, 67, and 70 of the Insurance Law. These sections establish the superintendent's authority to promulgate regulations governing reserve requirements for property/casualty insurers.
Sections 201 and 301 of the Insurance Law authorize the Superintendent to effectuate any power accorded to him by the Insurance Law, and prescribe regulations interpreting the Insurance Law.
Section 1113 establishes the kinds of insurance that may be authorized to be written by insurers in this state. Except as otherwise specifically provided in the Insurance Law, an insurer may not write any kind of insurance not specified in section 1113.
Section 1306 requires that, in addition to liabilities and reserves on contracts of insurance issued by it, every insurer shall be charged with the estimated amount of all its other liabilities, including any special reserves required by the superintendent pursuant to the provisions of this chapter.
Article 41 sets forth the kinds of insurance that stock and mutual property/casualty insurance companies ("p/c insurers") may be organized and licensed to write, as well as the financial requirements for stock p/c insurers and mutual p/c insurers based upon the specific kinds of insurance for which they are requesting licensure.
Section 4102(c) establishes that a property/casualty insurance company organized and licensed to write any basic kind of insurance, may be licensed, except with respect to life insurance, annuities and title insurance, to reinsure risks of every kind or description, including those specified in Section 1113(a) (4), (5), (6), (12), or (20).
Section 4117(e) provides that, whenever in the judgment of the superintendent, the loss and loss expense reserves of any property/casualty insurance company doing business in this state are inadequate or excessive, he may prescribe any other basis which will produce adequate and reasonable reserves.
Article 61 provides the definition, organization, and financial requirements of reciprocal insurers licensed in New York.
Article 66 regulates the formation and operation of Assessment Co-Operative Property/Casualty Insurance Companies and Advance Premium Co-Operative Property/Casualty Insurance Companies.
Article 67 provide for the organization and licensing of a nonprofit property/casualty insurer (or nonprofit reciprocal insurer) to insure nonprofit organizations.
Article 70 provides for the formation, operation and regulation of New York domiciled captive insurance companies.
2. Legislative objectives: Section 4117(e) of the Insurance Law grants the superintendent discretion to modify the formula for calculating loss and loss expenses reserves or prescribe any other basis which will produce adequate and reasonable reserves whenever in his judgment loss and loss expense reserves, calculated in accordance with the section, are inadequate or excessive.
It is apparent that in enacting sections 4117(b), (c), (d) and (e), the legislature recognized the multitude of factors considered in calculating reserves. The legislature has granted the superintendent the authority to determine the adequacy of the reserves set by insurers. Section 4117(e) authorizes the superintendent to review the adequacy of reserves and, if necessary, to exercise discretion and modify the reserve formulas or prescribe any other basis which will produce adequate reserves. Sections 4117(b), (c) and (d) acknowledge the superintendent's power.
3. Needs and benefits: Generally, insurance companies establish loss reserves only to cover claims for incidents that have occurred but that have not been paid, up to the current financial statement reporting date. These reserves cover incidents that have occurred in the current or prior reporting periods.
Insurers do not establish loss reserves to cover events (e.g., catastrophes), that have not occurred, yet every year property insurance premiums include a charge to their policyholders for possible catastrophe losses. For catastrophes, such as hurricanes, there are a very small number of very large events resulting in claims by a large number of policyholders all at once. It can generally be predicted how often hurricanes will occur but not exactly when. Effectively spreading the risk of hurricane losses requires not only sharing among many people, but also across several years.
In determining the rates charged by insurers, insurers are permitted to include a catastrophe load in the premiums charged to insureds. This catastrophe load is meant to cover catastrophes that may occur and affect the solvency of the insurer. Catastrophic events generally happen infrequently, especially in a northeastern state such as New York, and insurers have been charging insureds for this coverage for years without establishing a corresponding reserve. In order to ensure the continuing solvency of insurers in the event of a catastrophe, this rule requires insurers to set up a reserve funded by the catastrophe load.
The new reserve required by this rule would cover losses that occur in New York, related to natural catastrophes such as hurricanes, wind, hail, earthquake, winter storms (including snow, ice, freezing) or tsunami. This rule requires companies to reserve the amount they now charge policyholders for catastrophe protection (including any investment income earned on such amounts), net of any reinsurance purchased to mitigate the impact of catastrophe(s), and net of any federal, state and local income tax incurred on such reserves. Without such a reserve, the catastrophe load is reported as pure profit by the insurer if the catastrophe does not occur in the policy year and goes to the capital of the insurer. A catastrophe reserve will allow the setting aside of these premiums and can be used to fund the huge catastrophe losses when they occur. The reserve will have a stabilizing effect on the amount of premiums paid by insureds.
The rule also increases transparency, which would benefit the insurance industry's standing by enabling consumers to track more directly what happens to the catastrophe portion of the premium that they pay. If the catastrophe reserves established by insurers prove insufficient in amount, consumers will better understand the need for increased costs following a catastrophe. But if such were large and untouched, consumers will have a clearer basis for questioning continued rate increases based on concern about future catastrophe losses.
In summary, the premium side of the insurance accounting equation recognizes that there is the potential for catastrophes to occur in any given policy year. This rule requires the reserve liabilities also to recognize that fact. This approach will allow the insurer to accumulate more adequate reserves to pay claims, when a catastrophe occurs.
4. Costs: This rule imposes no compliance costs on state or local governments. There will be no additional costs incurred by the Insurance Department.
Insureds pay for catastrophe coverage every year as part of their property insurance premiums, yet catastrophic events generally happen infrequently. This results in significant underwriting gains for insurers for years in which no catastrophe occurs. This rule requires authorized property/casualty insurers to establish reserve funds for the payment of losses that occur in New York, arising out of natural catastrophes. This rule requires that the underwriting gains and investment income earned on such reserve funds be retained in the reserve by insurers as a means of further accumulating funds to help pay the huge catastrophe losses when they occur. This will represent an "opportunity cost" to the insurer because the catastrophe premiums must be retained for payment of future losses, rather than being made available for other purposes. The Department would not, however, consider the loss of this opportunity cost to be a justifiable reason for a rate increase under Article 23 of the Insurance Law.
Section 111.7 of the rule permits the Superintendent to enter into a reciprocal agreement with another state that has established substantially similar catastrophe reserve requirements. However, the release of funds from the New York mandatory catastrophe reserve to pay for such losses occurring outside of New York may not be considered in the development of rates in New York.
For the first year, the amount to be set aside by each insurer was determined by taking five percent of each company's 2007 written premium volume for homeowners' insurance. Based upon the calculation method set out above, the Department estimates that the catastrophe reserve fund will accumulate approximately $196 million in the first year. It should be noted that this calculation method only takes into account written premium volume for homeowners' insurance, whereas the proposed regulation is not limited to homeowners' insurance. This is an inexact method at best for three reasons: First, the written premium data we have includes all homeowners policies, including owners forms as well as renter, condo and co-op forms, the latter three of which have significantly lower catastrophe loads associated with them; second, individual insurer's catastrophe loads vary significantly by territory or region, with the upstate territories generally being assigned a much lower catastrophe load than downstate, and Long Island being assigned a higher catastrophe load than the five boroughs; and third, catastrophe loads vary, sometimes significantly, from one insurer to another based upon the particularities of each insurer's book of business. In all three instances described above, the Department does not capture or have ready access to information that would enable us to further refine these estimates.
In the event of a catastrophe, as defined under this part, insurers may convert the reserve funds for use in payment of catastrophe claims. In that instance, the insurer shall provide the superintendent with written notice of such conversion within 30 days of converting the funds. The cost of complying with the new requirement to notify the Department should be minimal.
5. Local government mandates: None.
6. Paperwork: Paperwork associated with the submission of a filing by an insurer should be minimal. If, in the event of a catastrophe, an insurer converts the reserve funds for use in payment of catastrophe claims, it shall provide the superintendent with written notice of such conversion within 30 days.
7. Duplication: None.
8. Alternatives: In developing this rule, the Department reviewed the research of the National Association of Insurance Commissioners - Catastrophe Insurance Working Group, Casualty Actuarial Society, and performed outreach to property/casualty insurers, consumer groups, and other interested parties.
The NAIC proposal, which creates a voluntary catastrophe reserve fund, provides for a reserve "cap" based upon a percentage of the premium written by each insurer. When the reserve cap is reached the reserve must be drawn down by the insurer. The NAIC proposal is based upon the assumption that Federal tax law will be amended to allow insurers to take a tax deduction for these reserves. There is no indication that Congress intends to make such a change to the Federal tax law and the NAIC proposal will need to be re-worked to take that into account.
Under the Department's proposal, every property/casualty insurer shall annually fund its mandatory catastrophe reserve in an amount equal to the aggregate catastrophe load, included in the New York subject premiums, for the calendar year. The New York mandatory catastrophe reserve shall have a 30-year rolling term. At the end of the 30th year, the first year's annual contribution including investment income, to the extent not used to fund qualifying losses, shall be considered income, and the 30th year's annual contribution, including investment income, shall be added to the reserve. The Department also considered the appropriate length of time for the rolling term of the reserve. The Department determined that a period of less than 30 years would not allow the reserve to accumulate sufficient funds and that a period of more than 30 years would be more restrictive than necessary.
The Department considered creating a single "state run reserve fund". All insurers would make contributions and the funds would be available to pay claims submitted by any member company. The Department would likely need legislative authorization to take such action. In addition, the Department decided against this method because it would not encourage sound underwriting practices, since companies could rely upon the availability of fund assets to pay claims.
The Department received comments from two leading property-casualty insurance trade organizations, two large property and casualty insurance groups, and a non-profit trade association of U.S. property and casualty reinsurers and reinsurance brokers. A complete discussion of the comments submitted can be found at the Department's website (http://www. ins.state.ny.us).
9. Federal standards: None.
10. Compliance schedule: This rule applies to financial statements filed on or after July 1, 2009. Insurers are already collecting a portion of their premiums for catastrophe coverage every year. The rule requires insurers to retain this portion of the premiums, establish a catastrophe reserve, convert the reserve to pay claims in the event of a catastrophe, and provide the superintendent with written notice of such release within 30 days. Insurers should have ample time to achieve full compliance.
Regulatory Flexibility Analysis
The Insurance Department finds that this rule would not impose reporting, recordkeeping or other requirements on small businesses. This rule applies to stock property/casualty insurance companies authorized to do business in New York State and self-insurers, none of which falls within the definition of "small business" contained in section 102(8) of the State Administrative Procedure Act, because there are none that are both independently owned and that employ fewer than 100 persons. The Insurance Department has reviewed filed Reports on Examination and Annual Statements of authorized property/casualty insurers and determined that none of them falls within the definition of "small business".
The regulation does not impose any impacts, including any adverse impacts, or reporting, recordkeeping, or other compliance requirements on any local governments.
Rural Area Flexibility Analysis
1. Types and estimated number of rural areas: Insurers affected by this rule do business in every county in this state, including "rural areas" as defined under Section 102 (1) of the State Administrative Procedure Act.
2. Reporting, recordkeeping and other compliance requirements: In the event of a catastrophe, if an insurer releases the reserve funds for use in payment of claims, it shall provide the superintendent with written notice of such release within 30 days. The cost of complying with the new requirement to notify the Department should be minimal.
3. Costs: This rule imposes no compliance costs upon state or local governments.
Insureds pay for catastrophe coverage every year as part of their property insurance premiums, yet catastrophic events generally happen infrequently. This results in significant underwriting gains for insurers for years in which no catastrophe occurs. This rule requires authorized property/casualty insurers to establish reserve funds for the payment of losses that occur in New York, arising out of natural catastrophes. This rule requires that the underwriting gains and investment income earned thereon be retained by insurers in the event of future catastrophe losses. This will represent an "opportunity" cost to the insurer because the catastrophe premiums must be retained for payment of future losses, rather then being available for other purposes.
The reserve funds required by this rule will facilitate the ability of insurers to fund catastrophic losses and mitigate the exposure of insurers' surplus to policyholders to large fluctuations resulting from such losses. In the event of a catastrophe, as defined under this part, insurers may release the reserve funds for use in payment of claims. In that instance, the insurer shall provide the superintendent with written notice of such release within 30 days of releasing the funds. Section 111.5(d) of the regulation establishes additional circumstances where insurers may release the reserve funds for use in payment of claims, if granted approval to do so by the Superintendent. The cost of complying with the new requirement to notify the Department should be minimal.
4. Minimizing adverse impact: The regulation applies to regulated parties that do business throughout New York State and does not impose any adverse impact on rural areas.
This rule requires insurers to establish and maintain catastrophe reserves, and will facilitate the ability of insurers to fund catastrophic losses, when such losses occur. The catastrophe reserve will benefit policyholders, by creating an additional source for payment of catastrophe losses, and will mitigate the exposure of insurers' surplus to policyholders to large fluctuations resulting from such losses.
The rule also increases transparency, which would benefit the insurance industry's standing by enabling consumers to track more directly what happens to the catastrophe portion of the premium that they pay. If the catastrophe reserves established by insurers prove insufficient in amount, consumers will better understand the need for increased costs following a catastrophe. But if such were large and untouched, consumers will have a clearer basis for questioning continued rate increases based on concern about future catastrophe losses.
Under current accounting and federal tax rules, insurance companies may not set up a reserve to fund losses from events that have not yet occurred, such as those from future catastrophes. Companies can deduct from this year's revenues money reserved for claims resulting from events that occur this year, which would reduce its current year's tax liability. Statutory accounting considers those reserves an operating expense. But if a company does not know when the event will occur, then money placed in reserve is not considered an expense in the current year by statutory accounting, and is subject to federal and state taxes because it is treated as income to the company.
In order to address the fact that this reserve is subject to taxation absent amendments to the federal tax law, the Department revised its proposal to require that the reserve be established net of any federal and state taxes incurred, thus fairly recognizing the taxability of these reserves and not penalizing the insurer for that expense.
A comment received by the Department expressed concern that the catastrophe reserve may not be sensitive to the needs of small companies, because the impact of the reserve definitions may require some small insurers to purchase additional reinsurance to protect them against a "catastrophe" that does not meet the definition set forth in the regulation. Thus, such companies' reinsurance costs could, it is asserted, increase unnecessarily. But the rule does not require insurers to purchase additional insurance, and New York insureds already pay for catastrophe coverage every year as part of their property insurance premiums, regardless of the size of the entity insuring the risk.
A comment received by the Department noted that if insurers are required to hold more capital due to the fact that a portion of the surplus is dedicated to 50 different catastrophe reserves, insurers will need to increase their property insurance rates to earn the target rate of return underlying their current rate structure. The commenter added that if carriers are unable to obtain the necessary rate increases for either marketplace reasons or regulatory limitations, many carriers likely will reduce their catastrophe exposures so as to limit the need for additional capital. However, New York insureds already pay for catastrophe coverage every year as part of their property insurance premiums. The catastrophe reserve required by this rule merely builds upon the catastrophe load already charged by insurers to policyholders, and therefore should not increase an insured's rates. In the rate making process, the catastrophe load is not considered profit; it is a specific charge associated with the payment of a specific type of expected loss.
5. Rural area participation: In developing this rule, the Department reviewed the research of the National Association of Insurance Commissioners - Catastrophe Insurance Working Group, Casualty Actuarial Society, and conducted outreach to property/casualty insurers, consumer groups, and other interested parties, including those located or domiciled in rural areas.
Job Impact Statement
The Insurance Department finds that this rule should have no impact on jobs and employment opportunities since it only modifies some of the requirements placed on insurers with respect to establishment and maintenance of catastrophe reserves. Compliance should not require the employment of additional personnel or outside contractors.
