One need look no further than the Texas, Florida and Puerto Ricohurricanes to appreciate the compelling public policy thatinsurance companies should have sufficient resources to pay claimswhen due.

Having all the insurance coverage in the world matters little ifthe carrier lacks sufficient funds to satisfy its policyobligations when triggered.

Insurance solvency

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

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Capital requirements for insurers are currently undergoingfar-reaching changes across numerous jurisdictions as policymakersand regulators strive to keep up with evolving macroeconomicpressures and variables. These changes, in turn, could have aprofound impact on some of the most fundamental business decisionsmade 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 lessinterchangeably to refer to assets on an insurance company'sbalance sheet that are in excess of the amount needed for legalliabilities including expected policy claims. "Capital and surplus"is often used synonymously, particularly in a more technical legalor accounting sense.

All states — the jurisdictional level at which insurers areregulated, as opposed to the federal government — impose minimumcapital and surplus requirements for new insurance companies.These, however, are relatively modest amounts and are "one sizefits all" in their application insofar as each insurer writing aparticular line of business is subject to the same minimum capitaland surplus requirement as any other.

Risk-Based Capital

Supplementing these basic requirements is the Risk-BasedCapital, or RBC, regime, a more sophisticated tool for measuringcapital. Applicable to most types of insurers, RBC is governed bymodel laws promulgated by the National Association ofInsurance Commissioners (NAIC) and adopted in each of thestates. Under RBC, each insurance company performs a set ofprescribed calculations that measure needed capital as a functionof the particular risks to which that insurer is uniquelyexposed.

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Specifically, the RBC instructions ascribe quantitative factorsto 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 necessaryfor that insurer in order to carry on its business. The RBCguidelines also tally the actual amount of "total adjusted capital"of the insurer, a modified version of surplus. The resulting ratioof total adjusted capital to authorized control level is a keyregulatory ratio, which insurers actively monitor and manageto.

The RBC laws also define certain multiples of ACL and providethat, should an insurer's capital fall below any such multiple,enforcement powers (which becomes more potent at each successivelylower threshold level of RBC) are available to the state insuranceregulator to compel the insurer to take remedial actions.

RBC examines capital at the legal entity level; thesemeasurements do not directly take into account financial health atany affiliates of the particular reporting insurer. Affiliateshistorically were outside the direct purview of insuranceregulators, although "insurance holding company" laws generallyrequired disclosures about relationships between insurers and theiraffiliates.

Laws toughened

Beginning in 2010, as a response to the 2008 crash, the NAIC andstate legislators toughened these laws in order to requireinsurance 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 motivatedby a perception that, while an insurer itself might have robustcapital, there may be a reason to conclude that insufficientcapital at the group level, even outside the insureritself, could harm policyholders.

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

Trump Administration involvement

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 September 22, the Trump Administration, in guidancerelating to the recently completed "Covered Agreement" oninsurance-law reciprocity between the United States and theEuropean Union, wrote that the United States "expects" that theNAIC's group capital standards will satisfy the agreement'srequirement that cross-border insurance groups be subject tocomprehensive group capital assessments.

Separately, the Dodd-Frank Wall Street Reform and ConsumerProtection Act empowered the Federal Reserve Board of Governors toregulate risk-based capital standards for two types of insurancebusinesses — those groups determined by the federal government tobe crucial to the economy (so called systemically importantfinancial institutions, or SIFIs) and certain insurance companiesthat own federally insured depositary financial institutions.According to the Fed, these two categories of insurance businessesin the aggregate account for $2 trillion in assets and compriseone-third of the assets of the nation's insurance industry.

In 2014, these provisions of Dodd-Frank were amended to clarifythat the Fed could tailor such standards to take into account thedistinctive features of the insurance business. This clarificationwas in response to concerns that the Fed, which among other thingsregulates bank holding companies, would apply assumptions andunderstandings to insurer capital rules that are more appropriatefor banks.

In 2016, the Federal Reserve announced proposed rulemaking toimplement capital requirements for insurers under its remit thatseemed to take into account the distinctive businesscharacteristics of insurers as opposed to banks. Although publiccomments have been registered, the Fed has not taken any furtheraction on these proposed standards.

The election of both a Republican president and a Republicancongress in 2016, as well as recent judicial developments, hasintroduced some uncertainty into the federal role in regulatingcapital for these two types of insurers.

• For example, one of the insurers that had beendetermined to be a SIFI, MetLife, successfully challenged its SIFIdesignation in D.C. district court in 2016. Although the federalgovernment has appealed this decision, during 2017 MetLife hasreceived two favorable rulings from the D.C. Circuit Court,including one this past August, effectively delaying theappeal.

• On September 29, the Trump Administration rescinded the SIFI designationof American International Group.

These developments followed a presidential memorandum issued inApril implementing a review of the SIFI designation process as awhole and requiring a report from the Treasury Secretary by October18 on such review.

This move was seen as consistent with Republican ambitions toweaken or even repeal Dodd-Frank, also evident in the TrumpAdministration's February Executive Order on financial regulationand the introduction during the spring of two bills in Congress —the International Insurance Capital Standards Accountability Actintroduced in the Senate (imposing standards on the federalgovernment's ability to agree to standards with internationalstandard-setting bodies such as the International Association ofInsurance Supervisors, or IAIS, discussed below) and the FinancialCHOICE Act of 2017, which passed the House in June 2017 and wouldrepeal much of Dodd-Frank.

Beyond the U.S.

Looking beyond the United States, with increasing globalizationof insurance and reinsurance sectors, insurance groups thatstraddle national boundaries are commonplace. Policymakers havebegun to develop methodologies of determining the right amount ofcapital across these groups, despite the limits posed by nationalsovereignty, and, in the case of the United States, the primacy ofstate rather than federal government in regulating insurance.

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As part of its ongoing Common Framework, or "ComFrame," forcodifying insurance regulatory principles generally, the IAIS hasundertaken to establish capital guidelines for so-calledInternationally Active Insurance Groups, or IAIGs. In its 2016 and2017 publications detailing a proposed "risk-based global insurancecapital standard," the IAIS details two alternative methods fordetermining group capital, one based on market valuations of assetsand liabilities and the other aligned with existing accountingregimes such as GAAP or IFRS.

NAIC new collaboration

In August 2017, the NAIC announced new collaboration betweenitself and the Fed to create a unified U.S. approach to capitalstandards for insurer groups, in order to strengthen the U.S.'sposition at the IAIS on these matters.

With developments across multiple jurisdictions, capitalstandards for insurers are an increasingly dynamic andconsequential) area of insurance law. The choices made bypolicymakers and regulators in the various work-streams describedabove could determine whether the next Hurricane Harvey, Irma orMaria finds an insurance industry ready to pay claims — or withoutenough money in the till.

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Daniel A. Rabinowitz ([email protected])is a partner at Kramer Levin Naftalis & Frankel. From 2011 to2014, he served as chair of the Insurance Law Committee of the NYCBar Association.