THE FORM F ENTERPRISE RISK REPORTING REQUIREMENT FOR INSURANCE HOLDING COMPANY SYSTEMS (The Form F Is Not ORSA, But It Is More Imminent)
Frances R. Roggenbaum, Esq. SAUL EWING LLP (717) 257-7526
Enterprise risk identification, management and reporting are key elements of the NAIC’s Solvency Modernization Initiative (the “NAIC SMI”). Indeed, hardly a day goes by without multiple articles on enterprise risk appearing in online and print publications. Most recently, much of the focus has been in the context of the NAIC’s Own Risk and Solvency Assessment (“ORSA”) initiative, which is anticipated to be effective in 2015. However, another enterprise risk requirement, the Form F Enterprise Risk Report, adopted under the 2010 revisions to the NAIC’s Insurance Holding Company System Regulatory Act (Model 440) and the corresponding Regulation (Model 450) (collectively, the “2010 Model Law”), will become effective as early as 2013 in some states.
With the current focus on ORSA, this article is intended as a reminder of the more imminent Form F enterprise risk reporting (“ERR”) requirement. Additionally, to assist in alleviating continuing confusion regarding the related, but distinguishable, enterprise risk concepts and requirements of ORSA and ERR,1 this article presents a primer on the applicability and exemption provisions of both of these NAIC initiatives.
ORSA vs. ERR – Targets, Applicability & Exemptions
As recently clarified by the NAIC Group Solvency Issues Working Group of the NAIC’s Solvency Modernization Initiative Task Force,2 ORSA and ERR have distinctly different requirements, and exemption from one does not constitute exemption from the other:
Targets & Applicability:
ORSA targets regulated entity risk, and the enterprise risk requirements apply to a regulated insurer (whether or not part of an insurance holding company system) or a group of regulated insurers.
ERR targets non-regulated entity risk of an insurance holding company system (“IHCS”), and the ERR requirement applies to the ultimate controlling person (“UCP”) of an insurer in an IHCS.
Exempted from ORSA are (1) individual insurers with annual direct written and unaffiliated assumed premium of less than $500 million and (2) groups of affiliated insurers with group annual direct written and unaffiliated assumed premium of less than $1 billion.3
If a regulated insurer is part of an IHCS, there are no exemptions from the ERR requirement as set forth in the 2010 Model Law (as indicated below, one state (Texas) has adopted several exemptions).
Thus, UCPs of one or more U.S. domiciled insurers (regardless of individual insurer or group premium volume) should be preparing to comply with the ERR requirement, but also should be monitoring individual state legislative action to determine if any deviations from the 2010 Model Law provisions are enacted.
The 2010 Model Law’s ERR & Related “Windows” Provisions - A Fundamental Change in Focus
The NAIC’s adoption of the 2010 Model Law was the culmination of nearly two years of discussions on how to address concerns that U.S. insurance regulators lacked the necessary authority to oversee and intervene when activities of non-insurance affiliates within an IHCS might pose material risks to an insurer. While the 2010 Model Law includes a number of revisions intended to strengthen existing disclosure and reporting requirements at the regulated insurer level, and in the circumstances of an acquisition or divestiture of control of an insurer, adoption of the ERR requirement and several related provisions marks a fundamental change in focus of IHCS regulation.
Traditional Focus of IHCS Regulation: The traditional focus of IHCS regulation was to build “walls” around an insurer to protect it from abuse by affiliates.4 This “walls” approach included the requirements, now strengthened in the 2010 Model Law, for prior approval by, or prior or post-transaction notification to, relevant insurance regulators on activities or transactions that directly affect an insurer, such as any acquisition of control of an insurer (by stock ownership or otherwise), intercompany transactions involving the insurer, and the payment of dividends by the insurer. Although primarily focused on the insurer, traditional IHCS regulation was not totally devoid of requirements for filing information about the IHCS that did not directly involve the insurer. For example, as part of an insurer’s Form B registration statement, the insurer has been required to file financial statements of the UCP and information about any litigation or administrative proceedings involving the UCP and its directors or executive officers. However, traditional IHCS regulation did not otherwise require the insurer or UCP to point out specified areas of enterprise risk in the IHCS filings or to disclose information on activities of non-insurance affiliates within an IHCS.
The Fundamental Change in Focus: As a result of “lessons learned”5 from the recent financial crisis, the ERR requirement and several related provisions of the 2010 Model Law are intended to add “windows” to group supervision of an IHCS where regulators are able to “assess the enterprise risk within a holding company system and its impact or contagion upon the insurers within that group.”6 Thus, when adopted by the states, the 2010 Model Law will significantly expand the scope of state insurance regulatory authority over IHCSs via reporting requirements and examination authority over controlling persons and non-insurance affiliates.
The ERR Requirement - Form F Enterprise Risk Report: The 2010 Model Act includes a new annual report that must be filed by the UCP of an insurer that is subject to Form B registration statement filing.7 The new Form F Enterprise Risk Report is designated as a confidential document in which a UCP must “identify the material risks within the insurance holding company system that could pose enterprise risk to the insurer.”8 For this purpose, “enterprise risk” is broadly (indeed, some claim ambiguously) defined as “any activity, circumstance, event or series of events involving one or more affiliates of an insurer that, if not remedied promptly, is likely to have a material adverse effect upon the financial condition or liquidity of the insurer or its insurance holding company system as a whole, including, but not limited to, anything that would cause the insurer’s Risk-Based Capital to fall into company action level . . . or would cause the insurer to be in hazardous financial condition . . . .”9
Within the Form F, the UCP must provide information, to the best of its knowledge and belief, on ten different areas of IHCS operations that could potentially pose enterprise risk to the regulated insurer:
Business plan of the IHCS and a summary of strategies for the next 12 months.
Material developments on strategy, internal audit findings, compliance or risk management affecting the IHCS.
Any developments in investigations, regulatory activities or litigation that may have a significant impact on the IHCS.
Identification of the IHCS capital resources and material distribution patterns.
Information on corporate or parental guarantees throughout the IHCS and the expected source of liquidity if guarantees are called upon.
Material activities or developments of the IHCS that, in the opinion of senior management, could adversely affect the IHCS.
Any material concerns raised by any supervisory college about the IHCS in the previous year.
Actual negative movement, or discussions with rating agencies that may cause negative movement, in the credit ratings and individual insurer financial strength ratings assessment of the IHCS.
Any acquisition or divestiture of insurance affiliates and reallocation of existing financial or insurance entities within the IHCS.
Any change of shareholders of the IHCS exceeding 10% of voting securities.
If any of the requested information is disclosed on the regulated insurer’s filed Form B, it need not be disclosed by the UCP on the Form F. In addition, if the UCP does not disclose information in response to any of ten areas of inquiry (and such information is not otherwise disclosed in the insurer’s Form B), the UCP must include a statement affirming that, to the best of its knowledge and belief, it has not identified any enterprise risk subject to disclosure. Further, if an IHCS has filed similar information with the SEC or is not domiciled in the U.S., the UCP may attach the appropriate SEC form or public audited financial statement filed in its country of domicile in lieu of fully completing the Form F, but must set forth specific references in the Form F on where the requested information is disclosed on such documents.
Finally, as part of any acquisition of control of an insurer that requires a Form A acquisition of control filing, an acquiring person is required to: (1) agree to provide a Form F annually; (2) acknowledge that it and all subsidiaries within its control in the IHCS will provide any information requested by the domestic insurer’s regulator to evaluate enterprise risk to the insurer being acquired; and (3) file a Form F within 15 days after the end of the month in which the acquisition occurs.
Related “Windows” Provisions: The 2010 Model Act includes additional “windows” to assist regulators in determining and evaluating enterprise risk posed by an IHCS:
Form B – Financial Statements of Non-Insurance Affiliates: As part of insurer registration requirements, regulators are given the authority to require an insurer to file, as part of the Form B registration statement, financial statements of its non-insurance affiliates if so requested by the regulator. This requirement may be satisfied by providing the most recent financial statement filed with the SEC by the parent corporation.
Examination Authority: The examination provisions were expanded to give insurance regulators authority to examine an insurer’s affiliates in order to ascertain the financial condition of the insurer, “including the enterprise risk to the insurer by the ultimate controlling party, or by any entity or combination of entities within the insurance holding company system, or by the insurance holding company system on a consolidated basis.”10 As part of this expanded authority, the regulated insurer may be ordered to produce not only information in its possession, but also information obtainable by the insurer “under contractual relationships, statutory obligations or other methods."11 If the insurer fails to produce such information without a reason acceptable to the regulator, the insurer may be subject to fines or suspension or revocation of its license. Further, the regulator is granted the authority to compel production by issuing subpoenas, examining persons under oath, and seeking a court order to enforce subpoenas, under penalty of contempt.
Status of State Adoption or Introduction of the ERR Requirement: Currently (as of 4/28/2012), six states (listed by general effective date) have adopted ERR requirements that are essentially the same as the 2010 Model Law, except as otherwise specifically noted below:
Rhode Island: Statutory provisions were effective 5/27/2011, except the Form F Enterprise Risk Report will not be effective until 7/1/2013, and corresponding regulations and reporting forms were effective 4/12/2012.
Texas: Statutory provisions were effective 9/1/2011, except the Form F Enterprise Risk Report will not be effective until 7/1/2013. No regulations or reporting forms have been proposed to date. Differences from the ERR requirement of the 2010 NAIC Model include the following:
Graduated Filing Implementation & Allowance for Requests for Exemption: The Form F filing requirement has a graduated implementation date based on premium size of an insurer (ranging from 7/1/2013 to 1/1/2016). Insurers in the smallest premium category (i.e. total direct or assumed annual premiums of $300 million or more but less than $500 million) may request exemption from the Form F filing requirement by demonstrating undue financial or organizational hardship.
Specified Exemptions: Exempted from the Form F filing are UCPs of insurers with total direct or assumed annual premiums of less than $300 million as well as UCPs of certain insurers organized before 1910 and those owned by charitable foundations or trusts.
West Virginia: Statutory provisions will be effective 7/1/2012 and corresponding regulations and reporting forms were effective 4/20/2012, except the Form F Enterprise Risk Report will not be effective until 7/1/2013.
Indiana: Statutory provisions will be effective 7/1/2012, except the Form F Enterprise Risk Report will not be effective until the first filing date after 6/30/2013. No regulations or reporting forms have been proposed to date.
Kentucky: Statutory provisions were enacted 4/11/2012 and will be effective 90 days after the Legislature adjourns, except the Form F Enterprise Risk Report will not be effective until 7/15/2014. No regulations or reporting forms have been proposed to date.
Nebraska: Statutory provisions will be effective 1/1/2013. No regulations or reporting forms have been proposed to date.
Eight additional state legislatures have proposed legislation that include the ERR requirement (including, with the exception of Florida, the NAIC’s specified definition of “enterprise risk”):
Adoption of the same or substantially similar provisions of the NAIC Insurance Holding Company System Regulatory Act (Model 440) and corresponding Regulation (Model 450) are required for state accreditation. With respect to the 2010 Model Law, the current “Draft Proposal for Substantially Similar Provisions”12 includes virtually all of revisions in the 2010 Model Law, including the ERR requirement and specified definition of “enterprise risk.” Thus, assuming all states choose to retain their current NAIC accreditation, insurers and their UCPs should be preparing to comply with the ERR requirement within the next several years,13 and, in some states, as early as next year.
However, preparations for implementation of the ERR requirement are likely to be complicated by any individual state deviations from the 2010 Model Law as well as the Form F’s use of undefined terms (i.e. “material distribution pattern”) and imprecision in the reporting standards themselves. UCPs and regulated insurers both would be well served to pay close attention to specific ERR provisions enacted by the states and any clarifications or guidance regarding the ERR requirement as may be offered by regulators in the future.
SOMETHING OF VALUE: THE SAFETY, SECURITY AND SANCTITY OF THE STATE INSURANCE GUARANTY SYSTEM
Stephen W. Still, Esq. MAYNARD COOPER & GALE PC (205) 254-1097
“If a man does away with his traditional way of living and throws away his good customs, he had better first make certain that he has something of value to replace them.“
With this African Basuto proverb, Robert Ruark began his acclaimed 1955 novel, Something of Value. Although this quote may be appropriate for any aspect of human endeavor, for the purpose of this article, we will consider its application to the existing state-based insurance guaranty system which serves to protect policyholders and beneficiaries of life insurance products in cases of insurance company insolvencies.
Since the onset of the financial crisis in 2008, there has been public discussion of whether the current state-based system is adequate to provide such financial protection to insurance consumers. This was raised during the deliberation of the Dodd-Frank Act, by policy makers, business and consumer organizations at hearings before the Federal Insurance Office, at Congressional hearings, and in other public arenas. This article will make the case that the existing state-based system of providing financial guarantees to consumers of life insurance products works very well. It is a “good custom” that should not be replaced!
This argument is based upon key fundamental differences between life insurance products and bank products. Likewise, I hope to demonstrate that the needs and systems for providing such financial guarantees to bank and life insurance consumers are totally different. The current state-based system for guaranteeing life insurance products should not be replaced with the FDIC system for insuring bank products, any more than the FDIC system should be replaced by a state-based system. The two systems are simply not interchangeable.
Here is an important fact to keep in mind. From the onset in 2008 of the greatest financial crisis since the Great Depression until the end of 2011, approximately 419 banks have been declared insolvent and taken over by the FDIC. During that same time period, only 8 life insurance companies were deemed insolvent and placed in liquidation by the state-based system, The National Organization of Life and Health Insurance Guaranty Associations.1 I would encourage readers, as well as public policy makers, to keep this important fact in mind going forward.
In its January 2, 2012 edition, The Wall Street Journal reported that,"Ninety-two banks failed in 2011, well below the previous two years totals. The list of what regulators call 'problem banks' is shrinking. And the latest two bank failures were the first in nearly a month—the longest failure-free period in almost three years. So is the era of troubled banks over? Don’t bet on it."
The business of banking is strikingly different from the business of life insurance. The fact that almost 40 times the number of banks than life insurance companies have failed since 2008 is a meaningful indicator of these differences.
At the simplest level, a bank is “any organization engaged in any or all of the various functions of banking, i.e., receiving, collecting, transferring, paying, lending, investing, dealing, exchanging, and servicing (safe deposit, custodianship, agency, trusteeship) money and claims to money both domestically and internationally.”2 By contrast, a life insurance company is a financial institution that provides life insurance, which is “a contract, under which the insurer agrees, in return for a stipulated consideration, to pay a certain sum of money upon the occurrence of a given contingency which, under the ordinary life insurance policy is the death of the insured.”3
The fact that the business of banking involves accepting of deposits and making loans, and the business of life insurance does not involve those functions, helps to explain why the banking sector experienced tremendous financial losses and insolvencies during the latest financial crisis, and why the life insurance sector did not.
It is important to understand these fundamental differences between these functions of banking and insurance. Bank “checking account deposits (individual, partnership, and corporation accounts) as demand deposits are subject to withdrawal by the depositor at any time, without notice, by check or in cash.”4 There are generally no restrictions on the withdrawal of deposits. Consequently, a major difference between the business of banking and the business of insurance is that banks can and do experience “bank runs.” A “run on the bank” is “a concerted movement of depositors to withdraw deposits from a bank, out of fear of its insolvency, especially in times of panic or money or credit disturbance.”5 As a bank run progresses, it generates its own momentum, in a kind of self-fulfilling prophecy as everyone rushes in to withdraw their deposits before the bank gives out all of its assets. As more people withdraw their deposits, the likelihood of default increases, and this encourages further withdrawals, which “can force the bank to liquidate many of its assets at a loss and to fail.”6 This can destabilize the bank to the point where it faces bankruptcy. By contrast, with respect to life insurance products, there is no such thing as a run on a life insurance company! This distinction is critical to understanding the differences between the state-based system for guarantying life insurance products, versus the FDIC-based system for guarantying bank products.
Essentially, life insurance products are long term contractual arrangements that are intended to pay benefits upon a future contingency. Typically, insurance consumers pay premiums over long periods of time, in exchange for the payment of a benefit or benefits upon the occurrence of the future contingency. Life insurance policies with cash accumulation policies “usually provide the insured the right to borrow from the insurer on the policy” as an “advance on the insurance proceeds,” but doing so will result in some loss of future financial benefits since “the proceeds that the insurer must ultimately pay under the policy is reduced by the amount of the policy loan.”7
Moreover, the payment of benefits to life insurance consumers occur at different times in the future, and not all at one time. Typically, life insurance policyholders die at different times; thus, death benefits are not all payable at the same time. This difference further helps to illustrate why there is no such thing as a run on an insurance company.
These fundamental differences between the business functions of life insurance versus banking make all the difference in the world in providing the rationale for the financial regulatory systems for guarantying insurance and banking products in the event of insolvency.
For example, in the case of a bank failure, the FDIC typically sweeps in as the “receiver” and takes over an insolvent bank and allocates the assets to other solvent banks. As the receiver, it is the “duty” of the FDIC to “realize upon the assets of the closed bank, having due regard to the condition of credit in the locality; to enforce the individual liability of directors thereof; and to wind up the affairs of such closed bank in conformity with the provisions of the law relating to the liquidation of national banks.”8 This system protects the bank's consumers and the remaining bank business.
The mechanism for unwinding an insurance company, by contrast, is different. As noted, all benefits due to consumers upon the insolvency of a life insurance company are not due and payable at the time of the insolvency, and they cannot be withdrawn like bank deposits. In fact, the state-based system actually allows for the infusion of capital through the assessment process which can enable an insolvent insurance company to continue to operate for “a decade or more”9 after it has been deemed insolvent.
Banks and insurance companies do fail. Just as the FDIC system seems to have worked well for providing financial protection for bank consumers in the event of bank failures, the state-based insurance guaranty system has worked well, and continues to work well, in providing financial protection to life insurance consumers in the event of life insurance company failures.
Hence, as the public debate moves forward, all interested parties should remember the old Basuto proverb quoted above. The “good custom” of the state-based insurance guaranty system should not be replaced with something that is not of value!
COMING FULL CIRCLE: FLORIDA LEGISLATURE SIDES WITH GOVERNOR IN AFFIRMING EXECUTIVE BRANCH CONTROL OVER RULEMAKING
Travis L. Miller, Esq. RADEY LAW FIRM (850) 425-6654
Last year Florida welcomed a new governor, Rick Scott, after he prevailed in the general election in the fall of 2010. Governor Scott's first official act was to issue Executive Order 11-01 suspending agency rulemaking and creating an Office of Fiscal Accountability and Regulatory Reform ("OFARR"). The Executive Order directed all gubernatorial agencies to immediately suspend rulemaking for new and pending rules. The order also specified that rulemaking would continue only after a review by OFARR and determination that the rules would not result in unnecessary regulatory costs or burdens. The Executive Order requested voluntary compliance by agencies not under the governor's supervision.
In an article appearing in this journal last year, I described the governor's Executive Order as part of an overview of Florida rulemaking. Since then, a case challenging Governor Scott's directives made its way to the Florida Supreme Court. The Supreme Court ruled against the governor, and he responded by issuing a subsequent Executive Order criticizing the court's decision. The Florida legislature then entered the dispute, passing legislation in the 2012 legislative session siding with the governor. This article summarizes the legal disputes arising from Executive Order 11-01 and culminating with the legislature's decision to resolve the issue through legislation earlier this year.
Agency Rulemaking Required:
Florida law defines a "rule" to include any statement by an agency that has general applicability and implements, interprets or prescribes law or policy.1 Rulemaking is not discretionary. Whenever a Florida agency develops a position that it intends to be one of general applicability, the agency is required by law to adopt the position as an administrative rule.2 The Florida Administrative Procedure Act ("APA") at Chapter 120, Florida Statutes, sets forth the process by which agencies must adopt administrative rules. This process entails publishing notice of a proposed rule's development; holding one or more workshops to solicit input from affected parties; publishing formal notice of the proposed rule; holding one or more public hearings; and providing certain windows during which affected parties may challenge the validity of the proposed rule.3
The formal process for developing, revising and adopting proposed rules serves several important public policy purposes. The rulemaking process ensures that affected parties are notified of positions Florida agencies intend to apply. This allows affected parties opportunities to provide feedback that might limit the adverse effects or unforeseen consequences of the rules. In addition, administrative rules provide public notice to potentially affected parties about conduct that is either allowed or prohibited. Rulemaking also fosters consistency in agencies' positions over time and across similarly situated parties. Although agency rulemaking is sometimes criticized as resulting from bureaucratic overreaching, rules can serve to level the proverbial playing field by fostering a well-publicized, consistent regulatory framework.
Rulemaking Affecting the Insurance Industry:
The insurance industry in Florida is governed by rules promulgated by several administrative agencies. The most widely recognized agency governing the industry in this state is the Florida Office of Insurance Regulation ("OIR"). The head of the OIR is the Commissioner of Insurance Regulation, who is appointed by the four-member Financial Services Commission ("FSC"). The FSC is composed of four constitutionally elected officials-- the Governor, the Chief Financial Officer ("CFO"), the Attorney General and the Commissioner of Agriculture. For purposes of rulemaking, the FSC is designated as the OIR's agency head.4 This means proposals to develop and adopt administrative rules originate from, and are made at the direction of, the FSC as a collegial body.
The Department of Financial Services ("DFS") also is a key participant in Florida's regulatory system. DFS is overseen by the state's CFO, and therefore is subject to the oversight and direction of a single individual. DFS is responsible for the licensing and discipline of insurance agents, agencies, adjusters; for some aspects of workers' compensation regulation; and for operating the state's division of rehabilitation and liquidation.
Several other agencies also can affect particular aspects of the insurance industry in Florida. The State Board of Administration ("SBA") administers the Florida Hurricane Catastrophe Fund ("FHCF"), which sells a form of reinsurance to residential property insurers. The SBA is a collegial body overseen by the Governor, CFO and Attorney General. The Agency for Health Care Administration ("AHCA") adopts rules that might affect health insurers, and AHCA is directed by a secretary appointed by the Governor.
Executive Oder 11-01 and Related Dispute:
Governor Scott's Executive Order 11-01 directed agencies under his control to suspend rulemaking while the newly created OFARR reviewed the rules to determine the impact of economic development.5 The governor campaigned on a platform of creating jobs, and he sought to keep administrative rules from unduly burdening businesses. The governor does not oversee some executive branch agencies, such as DFS, and he is just one member of a collegial body overseeing several others, like OIR and the SBA. Nonetheless, the governor requested voluntary compliance by the agencies that were not subject to his control. The governor's Executive Orders raised questions regarding the separation of powers between the executive and legislative branches of government. The governor is the administrative head of many agencies, but rulemaking authority must arise from a delegation from the legislature. This issue made its way to the Florida Supreme Court in the form of Whiley v. Scott, 79 So. 3d 702 (Fla. 2011). In this case, the petitioner sought to establish that Governor Scott exceeded his authority by directing agencies under his supervision to suspend rulemaking. In a 5-2 decision, the Supreme Court found that the governor indeed exceeded his constitutional authority. The Supreme Court accepted the case because it raised serious constitutional questions relating to the authority of the governor and the legislature relating to rulemaking. The Supreme Court found that the executive orders related to the governmental function of rulemaking, and in Florida the ability to promulgate rules is a derivative of lawmaking in that rules must implement a specific law and must be based on a legislative grant of rulemaking authority.6 The Supreme Court expressed concern with provisions in the executive orders inserting the Office of Fiscal Accountability and Regulatory Reform in the rulemaking process by requiring that it approve rules before they could be proposed. The governor, in essence, changed the Florida rulemaking process. The Supreme Court reasoned that the governor's actions then infringed on the legislature's delegation of rulemaking power.7 Two justices dissented and presented alternate analyses. These justices pointed to provisions of the Florida Constitution declaring that the governor is the head of the executive branch. Given that the executive orders were binding only on executive branch agencies, those executive orders had the effect of simply advising agencies under the governor's control that the governor would have an internal process for approving rules before the rules could be formally proposed. The dissenting justices argued that the executive orders were within the governor's authority to direct agencies under his control, and the majority's decision improperly limits the governor's ability to oversee the affairs of his own agencies. In the end, however, Whiley established that once the legislature has delegated rulemaking authority to an agency, not even the constitutional officer to whom the agency reports can alter its rulemaking process.
Executive Order 11-211:
Governor Scott responded to the Whiley decision by adopting Executive Order 11-211 clarifying the role of OFARR. The governor directed that his office and OFARR would continue to review the appropriateness of administrative rules and attempt to reduce unnecessary or burdensome regulations. In doing so, the governor voiced his disagreement with Whiley through a series of pointed "whereas" clauses establishing the background for his new order. Some of the background clauses set forth the following positions:
Government must be held accountable for efficient and effective performance
Continual review and assessment of existing and proposed regulations is necessary to ensure that the laws . . . are faithfully executed without unduly burdening the . . . economy and imposing needless costs and requirements. . .
While agency heads and personnel bring expertise to a particular subject matter, they are not directly accountable to the electorate and do not necessarily have an incentive to take a systemic approach to regulatory problems, to budget constraints, or to the overall regulatory burden imposed by the State on Citizens and businesses.
Review and oversight of agency rulemaking is encompassed by the Governor's powers and duties under the Constitution of the State of Florida to "take care that the laws be faithfully executed" and to serve as "the chief administrative officer of the state responsible for the planning and budgeting of the state."
The majority opinion in Whiley:
Failed to address and apply the plain meaning of . . . Article IV of the Constitution of the State of Florida, and thereby unreasonably restrains the power of the Governor with respect to the supervision of agency heads;
Failed to address the implications of [court precedent];
Failed to address persuasive caselaw from the United States Supreme Court and the highest courts of other states; and
Failed to address the precedent set by dozens or executive orders issued by prior governors of Florida;
In adopting Executive Order 11-211, Governor Scott agreed with the dissenting opinions in Whiley that it is nonsensical for a constitutionally elected officer to lack authority to suspend or alter rulemaking by agencies under his direct supervision and ultimate control. Still, recognizing the impact of the Supreme Court's decision, the governor tailored his office's rulemaking review to the restrictions approved by the court.
Florida Legislature Changes Rulemaking Authority
Like the governor, Florida's Republican-controlled legislature sought to ensure that agency rulemaking would not impede economic recovery and growth. The legislature therefore passed House Bill 7055 in the 2012 legislative session. After Governor Scott signed the bill into law, it became known as Chapter Law 2012-116.
The new Chapter Law includes findings relating to the authority of the executive branch similar to those recited by Governor Scott in his preamble to Executive Order 11-211. The legislature found that Article IV of the Florida Constitution vests in the governor the supreme executive power and specific substantive powers. Among these powers are the review and oversight of agency rulemaking, which fall within the governor's broad powers and duties under the State Constitution to "take care that the laws be faithfully executed" and to serve as "the chief administrative officer of the state responsible for the planning and budgeting for the state."8
The legislature observed that many agencies of state government are administered by an officer "appointed by and serving at the pleasure of the governor." The legislature then directly criticized the majority opinion in Whiley for failing to address the plain meaning of the Florida Constitution and for failing to address implications of precedent and other executive orders.9
The new law specifies that the administration of any executive branch agency under the supervision of an officer appointed by and serving at the pleasure of the governor shall at all times remain under the constitutional executive authority of the governor and generally will remain subject to oversight, direction and supervision by the governor. The new law clarifies existing rulemaking provisions to provide that these agency heads, despite their executive authority over the departments they oversee, remain subject to the supervision and direction of the governor. The legislature then specified that laws governing Florida rulemaking do not limit or impinge upon the assignment of executive power under Article IV of the State Constitution or the legal authority of an appointing authority to direct and supervise those appointees serving at the pleasure of the appointing authority.10
In a letter to Florida Secretary of State Ken Detzner, Governor Scott signed HB 7055 into law. Governor Scott wrote that the Florida Administrative Procedure Act and other laws "were not, and could not have been, enacted with the intent or effect of limiting the gubernatorial powers inherent in Article IV of the Florida Constitution." The governor described HB 7055 as a "course correction" for the deviation in law created by Whiley.
The governor affirmed that his earlier Executive Order 11-01, which was followed by Executive Order 11-72, was intended to implement a centralized method for reviewing and approving rules promulgated by gubernatorial agencies. The governor considers this rulemaking review to have been an integral part of his duty as chief administrative officer of the state to ensure that Florida's laws are faithfully executed. The governor then pointed out that the Florida legislature has now agreed "in no uncertain terms that Whiley was wrongly decided" and Whiley is now a "dead letter." He went further to point out that under a proper reading of the Florida Constitution, the new law is unnecessary. He suggested that although he was willing to sign the bill into law to correct the Whiley error, he remains convinced his earlier Executive Orders were valid.
The debate about executive branch control over Florida rulemaking has come full circle in barely over a year's time. Governor Rick Scott entered office in January 2011 with a pledge to create jobs and energize Florida's economy. His first official act was to suspend agency rulemaking, which served as both a symbolic and legal step to emphasize that he would not allow burdensome or unnecessary regulations to impede companies' ability to do business in Florida. His effort, however, started a year-long dispute over a governor's ability to influence rulemaking by administrative agencies he controls. Although on the surface one might expect that a governor clearly should be able to dictate the rulemaking practices of agencies he directly oversees, Florida law provided that agency rulemaking authority arose only from a delegation of power from the legislature. Oddly, this meant a governor would overstep his bounds by directing the agencies to suspend rulemaking or requiring them to have their proposed rules reviewed by his office. A Florida Supreme Court decision confirmed this to be the case, but the Florida legislature quickly responded by changing Florida laws relating to rulemaking. Thus, after a complicated, winding road, the Florida rulemaking process now allows an executive branch official to actively oversee and direct rulemaking activities at agencies under his or her control.
With the June 1, 2012, deadline for filing medical loss ratio (“MLR”) data reports under federal law fast approaching, health insurers need to be up to date with the federal MLR reporting requirements and new guidance issued by federal and state regulators regarding compliance with these mandates.
I. Overview of the Act
President Obama signed the Patient Protection and Affordable Care Act1 into law on March 23, 2010, and the Health Care and Education Reconciliation Act2 into law on March 30, 2010 (collectively, the “Affordable Care Act” or the “Act”). Section 2718 of the Act3 requires health insurers to spend at least 80% of every premium dollar on health care for patients with individual policies and small group plans. For large groups, the minimum to be spent on care is 85%.4 Recently promulgated federal regulations address the healthcare reimbursement and expense components permitted in the calculation of the applicable medical loss ratios.5 The MLR rules limit administrative costs, including certain taxes and agent commissions, to 15% or 20% of premium, depending on the type of policy or plan involved. If insurers do not meet these MLR thresholds, they must provide rebates to their policyholders, in the form of a premium credit, cash refund or benefit enhancement.6
MLR data reports are due to the Center for Consumer Information and Insurance Oversight (“CCIIO”) within the Centers for Medicare & Medicaid Services (“CMS”) by June 1 of each year; CCIIO’s data report submission window opened May 1.7 If applicable, rebates must be paid by August 1 of each year.8 A study published by the Kaiser Family Foundation on April 26, 2012, estimates that health insurers will pay $1.3 billion in rebates this August, with the amounts varying widely from state to state and from insurer to insurer, but the largest total amounts being refunded in Texas and Florida.9 The study is based on preliminary data provided by health insurers to their state Departments of Insurance in their 2011 Supplemental Health Care Exhibits.10
Certain issues have arisen in connection with the implementation of these new requirements. For example, the Act allows each state to apply for a downward adjustment to the federal MLR requirements and certain states have applied for, and received, MLR adjustments. Additionally, the inclusion of agent commissions within the non-claims costs required to be part of the MLR calculation has led to a reduction or restructuring of agent commissions for many individual and group programs, particularly small group plans. This has resulted in some alternative approaches for the payment of agent compensation, which have implicated possible state law compliance issues.
II. HHS Rulemaking and State-by-State Adjustments to MLR Requirements
The Act delegated implementation of its MLR requirements to the Department of Health and Human Services (“HHS”) and its rulemaking process. Most of the relevant guidance is set forth in the HHS’s Interim Final Rule.11 One of its more notable provisions is its formula for calculating MLR.
As a starting point, the numerator of the MLR calculation is the sum of the insurer’s incurred claims plus expenditures for activities that improve health quality. The denominator is the insurer’s premium revenue minus the insurer’s federal and state taxes and licensing and regulatory fees.12 For the 2012 reporting year, the numerator may also include any rebates paid for the 2011 MLR reporting year if the 2012 MLR reporting year experience is not fully credible.13 For the 2013 reporting year, the numerator of the insurer’s MLR calculation may include any rebates paid for the 2011 MLR reporting year or the 2012 MLR reporting year.14 In the denominator, earned premium includes “all monies paid by a policyholder or subscriber as a condition of receiving coverage from the issuer, including any fees or other contributions associated with the health plan.”15 Of course, this would include agent commissions that are typically a component of, and paid from, earned premium. Credibility adjustments are allowed, if applicable.16
The Interim Final Rule allows an insurer to include in the numerator its expenses for “quality improvement activities” but not other “non-claims costs,” such as agent and broker fees and commissions, which remain part of the denominator in the MLR calculation.17 It also requires insurer reports to include an explanation of how premium dollars are used for all non-claims costs, including agent and broker fees and commissions.18
The Interim Final Rule allows for a temporary downward adjustment to the MLR for a state’s individual market, if appropriate.19 To date, eighteen (18) applications have been filed with CCIIO. Seven (7) applications were granted, in whole or in part, ten (10) were denied and one (1) was not acted upon.20 In reviewing the applications, the CCIIO considered whether it was reasonably likely that enforcement of an 80% minimum standard would destabilize the applicable state’s market.21
The two most recent applications were filed by Wisconsin and North Carolina. Wisconsin’s application was denied and North Carolina’s application was granted, but only in part. The discussion in both determinations focused on the number of insurers reasonably likely to exit the state if the 80% federal minimum standard was to be implemented immediately.
In reviewing the Wisconsin application, which requested adjustments to the individual MLR thresholds to 71%, 74% and 77%, for the years 2011, 2012 and 2013, respectively, CCIIO noted that: (i) the four insurers that had expressed an intent to leave the state were basing their decisions on reasons other than the risk of having to pay rebates under the Act; (ii) most of the remaining insurers already meet or nearly meet the 80% minimum standard; and, (iii) the other remaining insurers not meeting the 80% standard appeared to be in the process of adapting their business models to meet the 80% standard and were likely to remain in the Wisconsin market. Accordingly, the CCIIO could not conclude that it would be “reasonably likely” that the Wisconsin market would be destabilized if the 80% standard were to be implemented in accordance with the Act. CCIIO also responded to some of the public comments it received and indicated that Wisconsin has a “highly competitive individual market, characterized by a large number of well-performing HMOs whose experience shows that efficient issuers are able to meet the statutory MLR standard while remaining solvent and profitable.” It further observed that the data submitted to CCIIO indicated that in 2010 the aggregate MLR for health insurers in the Wisconsin market was, in fact, approximately 82%.
North Carolina’s application requested MLR adjustments to 72%, 74% and 76% for its individual market for the years 2011, 2012 and 2013, respectively. CCIIO deemed the North Carolina market to be a highly concentrated one, with one dominant insurer accounting for more than 81% of the market share and with no other insurer having more than a 4.5% market share. Moreover, recent decisions by one-third of North Carolina’s other insurers to leave the state, while unrelated to the new federal MLR requirements, resulted in reduced consumer options. The CCIIO found that immediate implementation of the Act’s 80% minimum MLR requirements could lead to the destabilization of the North Carolina market. Therefore, CCIIO allowed North Carolina an adjustment to a 75% threshold in 2011, but did not permit any adjustments for 2012 or 2013.
In total, the states whose adjustment requests were granted for 2011 are Maine, Nevada, New Hampshire, Kentucky, Iowa, Georgia and North Carolina. Many of these applications were approved only in part, or conditionally, as CCIIO has expressed its intent to create a “glide path” for each state’s compliance with the new federal 80% standard.
Applications for temporary downward adjustments from the 80% standard submitted by North Dakota, Delaware, Louisiana, Indiana, Michigan, Kansas, Oklahoma, Florida, Texas and Wisconsin were all denied. For the most part, denials were founded upon a determination that if any insurers were to exit these jurisdictions, there would still be a sufficient number of carriers to sustain a robust market providing different options for consumers.
It is interesting to note that the Interim Final Rule established requirements regarding the distribution of rebates, and initially provided that they should be sent to group plan enrollees. It was later determined that this would have resulted in an unintended taxable event for each enrollee.22 After receiving input from the Departments of Labor and Treasury on this issue, HHS issued clarification in a Final Rule23 that the rebates should be distributed in a tax-free manner.24 Thus, for most employer-sponsored plans, the group policyholder / employer will receive the rebate and will have to distribute the rebate to the group plan enrollees/employees.25
Notably, the Final Rule did not contain any changes to the way agent and broker compensation is treated under the MLR requirements set forth in the Interim Final Rule.26
III. State Law Issues
There are two main issues that have arisen in view of the new federal MLR requirements: (i) alternative approaches to the payment of agent and broker commissions; and, (ii) the reservation of a state’s right to establish its MLR threshold under the Act.
A. Agent & Broker Compensation
An important state compliance issue that has developed relates to changes in agent and broker compensation approaches to accommodate the restrictions in the calculation of the MLR under the Act. The NAIC predicted, during the HHS rulemaking process, that the inclusion of agent and broker commissions as part of the non-claims component of the federal MLR calculation would result in the dramatic change in the structure of agent compensation from a commission-based model to a flat fee or fee per employee model.27 Agencies and producers have since claimed that their income has dramatically dropped and that they may be forced out of business at a critical time when insureds are in need of additional service and advice as to plan options.
Meanwhile, the Kentucky Department of Insurance, in an Advisory Opinion issued this year, has acknowledged that insurers in Kentucky have started having their agents collect a separate commission from the insured for group health plans, in an effort to avoid paying rebates under the new federal MLR requirements.28 This Advisory Opinion prohibits agents from doing so, unless they are acting as an insurance counselor and licensed as such.29 Under Kentucky law, insurance counselors owe fiduciary duties to the insured and cannot simultaneously act as an agent of the issuer and the insured.30 Thus, traditional producers may need to decide whether to remain an agent of the issuer or seek licensure as an insurance counselor providing specialized advice and representation to the insured. It remains to be seen whether there is a market for this type of specialized service in Kentucky, or any other jurisdiction, or an appetite of insureds to separately pay for services that have been traditionally provided at no additional charge above or beyond the premium paid by the insured.
The Advisory Opinion also advises health insurers of the Kentucky Department of Insurance’s long-standing position that agent compensation must be included in an insurer’s rate filing as part of premium. 31
Since the promulgation of the HHS’s Final Rule, there have been three principal federal bills filed that would change the treatment of agent and broker commissions. First, HR 1206 would exclude producer compensation from federal MLR calculations entirely. Despite having 200 co-sponsors, this bill has languished in the House since March 2011. More recently, S. 2068 and S. 2288, the Access to Independent Health Insurance Advisors Act of 2012, were filed in the Senate in February and April of 2012, respectively. These bills are similar to HR 1206 but would apply to the individual and small group markets only, and would leave producer compensation in the large group market subject to existing federal MLR requirements. Both Senate bills are currently with the Senate Committee on Health, Education, Labor and Pensions.
B. State MLR Thresholds
Some state statutes require a higher minimum MLR for purposes of providing rebates, or reviewing insurer rates, than is required under federal law. Thus, another important issue that has been raised relates to the continuing applicability of these standards in light of the Act.
The CCIIO has indicated that a higher state MLR standard would not automatically apply. While 45 C.F.R. § 158.211(a) provides for a higher state MLR threshold, it is CCIIO’s position that states must satisfy certain requirements before enforcing higher thresholds.32 In support of this position, CCIIO cites 45 C.F.R. § 158.211(b) which requires each state to “seek to ensure adequate participation by health insurance issuers, competition in the health insurance market in the state, and value to consumers so that premiums are used for clinical services and quality improvements.” Since states could not have considered these factors in formulating a higher MLR threshold prior to passage of the Act, CCIIO has determined that the HHS will only accept a higher state MLR from states that exercised their option under 45 C.F.R. § 158.211 after the Affordable Care Act was signed into law.33 States that have gone through this exercise include Massachusetts, New Mexico and New York.34
Massachusetts recently issued an insurance bulletin indicating that carriers must file “separate and distinct” financial reports and MLR rebate calculation forms to the state and federal governments.35 Additionally, all Massachusetts carriers subject to federal rebate requirements were requested to submit copies of their federal rebate calculation forms to the Massachusetts Division of Insurance as informational filings, and include materials that describe the carrier’s rebate plan.36 Massachusetts law requires a 90% MLR for the individual and small group markets for reporting year 2011.37
New Mexico had passed its own MLR law that became effective May 19, 2010, and required a minimum MLR of 75% for the individual market and 85% for all other markets.38 It deferred enforcement of the New Mexico law until the federal regulations were published.39 Ultimately, on April 8, 2011, it decided to adopt the 80% and 85% federal MLR standards, in lieu of different state-mandated ratios.40
The New York Department of Financial Services has indicated that it is exercising its right to adopt a higher MLR requirement and is implementing an 82% minimum MLR standard for the small group and individual markets for purposes of calculating rebates.41 It has also indicated that carriers who follow the federal standards for reporting and rebate distribution, and provide a copy of their federal reports to the New York Superintendent of Financial Services, will have satisfied their state reporting obligations under New York law.42 However, for rate review purposes, the New York Superintendent of Financial Services has retained discretion to review rates under state law standards that require a minimum MLR of 82%.43 The Superintendent’s stated position is that Section 2718 of the Affordable Care Act and CFR Part 158 do not address rate review issues.44 Thus, it appears the Superintendent has discretion to require an 82% MLR threshold in rate filings for the individual, small group and large group markets.
As the foregoing examples illustrate, there are many different approaches a state can take with respect to implementation of the new federal MLR requirements. As might be expected, some states have simply indicated that health insurers are responsible for complying with applicable state and federal law.45
At this point in time, all states that intended to apply for a temporary downward adjustment to the new federal 80% MLR standard for the individual market should have already done so. A small number of states received a reprieve from the federal MLR standard for 2011, while Maine was the only state that was granted a downward adjustment for 2011, 2012 and (conditionally) 2013. Health insurers and producers should be aware that state Departments of Insurance are monitoring changes to the way agent commissions are structured. Meanwhile, twenty-six (26) states have asked the U.S. Supreme Court to overturn the controversial Act and several pieces of proposed federal legislation regarding agent commissions remain pending. Thus, many significant developments are sure to arise as these complicated issues continue to crystallize and be discussed by our state and federal governments.
The FORC Journal is designed to provide practical and useful information, but not legal advice. If legal advice is required, please seek professional counsel. FORC does not endorse the views expressed in any of the articles contained in the FORC Journal.