During 2017, a significant number of states across the U.S. will see the introduction and enactment of laws requiring insurers to make an annual filing describing their corporate governance structure and practices in extensive detail.
Within a few years, it's likely that every state will pass essentially the same bill.
The laws, requiring the filing of a “Corporate Governance Annual Disclosure” (or CGAD, for short, in our acronym-loving industry) will soon become a requirement of the financial solvency accreditation program of the National Association of Insurance Commissioners (NAIC). The program requires that each state's insurance department adopt certain model laws and regulations relating to insurer financial matters for the state to maintain accreditation with the NAIC.
If a department loses its accreditation, the financial exams that it conducts on its own domestic companies will not be recognized by other states that will then have to conduct their own exams, resulting in needless expense. Loss of accreditation status would also be a black eye for both the individual state and the whole accreditation program, which was developed as a means of staving off federal regulation of insurance.
The CGAD model law follows on the heels of two other significant model laws, the Own Risk and Solvency Assessment Model Act and amendments to the Holding Company Model Act. All three were developed as part of the NAIC's Solvency Modernization Initiative, which was the regulators’ response to the 2008 financial crisis. All three either are or will soon become NAIC accreditation standards.
The Corporate Governance model law is fairly concise. The official version on the NAIC website runs just over five pages, including sections on definitions, rules and regulations, and confidentiality. The issue of confidentiality is an important one for the insurers submitting the disclosure document because the content may be proprietary and is not the kind of information that is typically made public.
Model regulation PLUS model law
But the model law itself does not tell insurers what must be in the disclosure. That information is contained in a model regulation that goes along with the model law and that also will be an accreditation standard. That is significant because once the law is on the books, it will be much easier for insurance regulators to make modifications to the regulation, changing what's required, than to change the statute.
Changing a statute requires convincing a majority of legislators plus a governor that the changes are warranted. Changing a regulation simply requires that a regulator followed administrative procedures and did not exceed the regulator's authority. When a regulation is challenged, courts typically give great deference to administrative agencies such as insurance departments. Where the regulation outlines the required disclosure, it gets extremely specific and extensive. In part, it requires companies to disclose:
Their corporate governance framework and structure, including duties and structure of the board of directors and committees;
The policies and practices of their boards of directors and significant committees, including appointment practices, the frequency of meetings held and review procedures;
The policies and practices directing senior management, including a description of defined suitability standards, the insurer's code of conduct and ethics, performance evaluation and compensation practices, and succession planning; and
The processes by which boards of directors, committees and senior management ensure an appropriate level of oversight to the critical risk areas affecting the insurers’ business activities.
In the disclosure, insurers must tell regulators how many board meetings they held in a year and provide information regarding director attendance. They must disclose whether board members are subject to term limits, whether there is a board diversity policy and, if so, how it functions.
Insurers are asked to explain how the qualifications, expertise and experience of each board member meet the needs of the insurer and how the nomination process works. The disclosure must also contain information regarding senior management compensation and oversight, compliance efforts, business conduct and ethics, and reporting responsibilities for critical risk areas, which include almost every aspect of an insurer's operations.
The law requires a company's chief executive officer or corporate secretary to sign an attestation that, to the best of that individual's belief and knowledge, the insurer has implemented the corporate governance practices and that a copy of the CGAD has been provided to the insurer's board or an appropriate committee. The model provides for insurers that fail to file a CGAD by the date required to pay a fine, though it does not specify what amount the fine should be.
Significant new regulatory requirement
The disclosure thus represents a pretty significant new regulatory requirement, but it could have been even more burdensome. As it was the subject of deliberations within the NAIC bureaucratic process, it included a scoring template that examiners would use to subjectively evaluate insurance companies’ corporate governance practices.
We at NAMIC along with other industry groups objected to that concept, noting that given the diversity within the industry, practices and procedures in this area can vary greatly and still be appropriate for the company. The result of those objections is that the model calls only for disclosure, not any kind of evaluation, although there are still ongoing issues regarding standards within an official NAIC examination handbook that are being worked out at the NAIC in this area.
By the end of 2016, the model law had been adopted in 11 states: California, Connecticut, Florida, Indiana, Iowa, Louisiana, Nebraska, New Hampshire, Ohio, Rhode Island and Vermont. Given the vagaries of legislative processes, there is no way to know for sure how many states will see the model introduced and enacted, but there will be plenty. If all goes as planned, every state will have to enact the model by January 1, 2020, and most commissioners don't like to wait till the last minute while the accreditation status of their department hangs in the balance.
Paul Tetrault is state and policy affairs counsel for the National Association of Mutual Insurance Companies.