According to the Insurance Information Institute, U.S. insurance companies in the aggregate hold about $8.5 trillion of cash and invested assets. These assets support insurers' ability to pay claims to policyholders. In recent years, government bodies have attempted to influence these investments using the levers of insurance regulation—from state "name and shame" laws on investments in coal, to restrictions on investments in Iran, to calls from the Trump Administration to ease infrastructure investments. Understanding the background and interplay of the insurance laws that govern investments by carriers can provide some context to these developments and also shed light on a key aspect of solvency regulation of this critical U.S. industry.
Regulatory restrictions on insurance company investments are motivated by the risk that, if an insurer were to experience greaterthan- expected losses on invested assets, the insurer might not be able to pay claims by policyholders. State legislatures and regulators cannot guarantee the performance of investments, of course, but they can and do impose guardrails on investment activity that, theoretically, reduce risk. Although often aligned with one another, the statutory tools and mechanisms used by regulators to conduct this oversight are not fully integrated, which can lead to some regulatory uncertainty and can affect investment activity.
Insurers are required to file annual and quarterly statements, referred to variously as statutory statements, "blanks" (because they are in the nature of a fillable form) and "blue books" and "yellow books", for the color of the cardstock paper in which they are bound (blue for life insurers, yellow for property-casualty). Among the voluminous quantitative information required to be provided in annual statutory statements are detailed schedules, asset-byasset, of the financial instruments held for investment and acquired or divested over the prior year. These are classed in one or more investment schedules by type, e.g., Schedule B for mortgage loans, Schedule D for bonds and stocks and Schedule BA for "other invested assets."
Which schedule a particular investment falls on usually determines how much additional capital the insurer will be legally required to hold on its balance sheet against that investment (that is, against the risk that the investment fails) under state "risk-based capital" (RBC) laws. For example, all other things being equal, the insurer will be required to hold more capital against shares of stock included on Schedule D than mortgages included on Schedule B, insofar as equity investments by their nature carry more economic downside risk than do debt obligations such as mortgages.
Second, insurance companies are required to maintain accounts using statutory accounting principles (known as SAP or Stat), as opposed to Generally Accepted Accounting Principles (GAAP), the standard accounting regime for public companies in the United States (Note that, for insurance companies that are subsidiaries of a publicly-traded holding company—a typical ownership structure—the parent or group will have GAAP financials, and each regulated insurer downstream will maintain its own accounts in Stat.) SAP provides guidance on, among other things, how an insurer must account for and include a particular investment on its balance sheet. In setting forth these requirements, SAP often provides definitions of particular types of investments. For example, Statutory Statement of Accounting Principles (SSAP) No. 37 (on mortgages) defines "mortgage" as a debt obligation "that is not a security, which is secured by a mortgage on real estate", including "mortgages acquired through assignment, syndication or participation." It also defines "security" as a "share, participation or other interest" of an issuer that is (1) represented by a bearer or registered instrument, (2) of a type traded on a securities exchange or (3) divisible into a class or series. Other SSAPs define such categories as mezzanine loans, affiliate investments and derivative instruments.
The two regimes described above—(1) annual statement reporting/RBC and (2) statutory accounting—are essentially uniform nationwide across all states and administered by the National Association of Insurance Commissioners (the NAIC), the preeminent standard-setting body for the insurance industry in the United States. The third regime, permitted investment laws, reveals much more differentiation among the states despite the presence of NAIC model laws on this topic as well. These state laws, such as Article 14 of New York's insurance law (NYIL), impose detailed diversification requirements on the investments of an insurer domiciled in the state. (There are NAIC model laws on permitted investments, but they have not been uniformly adopted by the states.) For instance, New York's provisions prohibit a life insurer from investing in a single mortgage in an amount that exceeds two percent of all admitted assets (or $30,000 if greater); under Delaware law the aggregate value of an insurer's stock investments (other than subsidiaries) may not exceed 40 percent of the insurer's assets; and so on. Investments that do not conform to the qualitative or quantitative standards of state investment laws cannot be counted toward ("admitted to") the insurer's capital and surplus, a key metric of financial strength. Some states also prohibit specific types of investments (as opposed to merely "non-admitting" them); acquiring such an investment can result in the regulator's ability to compel the insurer to divest itself of it. Examples of prohibited investments for New York-domiciled property-casualty insurers include shares of the insurer's parent company and securities issued by a corporation that is majority-owned by the insurer's officers or directors.
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Originally published by NYLJ
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