Economy causes greater scrutiny of insurers

December 1, 2008

In the midst of current financial turmoil, the industry entrusted with the greatest accumulation of funds is the insurance industry. MCOs and HMOs should expect greater scrutiny of their finances.

In the midst of the current U.S. financial turmoil, there are many uncertainties with respect to the future of our nation's financial institutions. A significant upgrade in the monitoring powers and examination authority of regulatory agencies is going to be unleashed. The enhancement of regulatory powers is going to trickle down to other government entities that are supposed to protect the public trust.

Health insurers and MCOs, primarily regulated at the state level, fall under the jurisdiction of state health and insurance departments, with the latter being charged with oversight of the financial component. The size of the insurance department staffs vary from state to state.

The financial well-being of these companies is measured and evaluated primarily by monitoring their capitalization, the investment of their assets, their transactions with affiliated entities, and their risk-sharing and reinsurance arrangements. The standards required with respect to each of these functions are set by each state and are conditions for doing business in each state. We are seeing more uniformity in regulation, due in large part to the National Association of Insurance Commissioners (NAIC) promoting greater consistency.

The required capitalization of regulated entities is set at a specific dollar amount by statute in each state. This minimum statutory capital and surplus amount ranges from as low as $1 million in some states to as high as $10 million in others. However, as an additional measure, most states have now adopted a complicated formulaic approach to determining a company's required capital-the NAIC Risk-Based Capital (RBC) regulation. This law looks at several factors, including the risk and diversification of assets and the volume of business underwritten, to come up with an individualized calculation of required minimum capital for each regulated entity. As a general rule, the regulated entity should have total capital and surplus that is no less than 25% of its annual premium volume (on a net basis).

Each regulated entity, whether public or privately held, is required to submit financial statements each quarter, with the year-end statement being audited. These financial reports must set forth the RBC calculation and include several exhibits that provide detailed analyses of the company's liquidity, profitability and underwriting activities.

Each regulated entity also is limited in the way that it invests its assets. Each state has regulations to limit the types of assets that may be invested in as well as the percentage that may be invested in any one asset. Furthermore, the regulated entity is prohibited from pledging its assets to secure its debts or the debts of any other person, and generally it may not guarantee the debts of any other person.

The Insurance Holding Company Act, adopted in each state, regulates the activities that an insurer or an HMO may engage in with its unregulated affiliates. These laws prevent the unregulated activities of affiliates from dragging down the regulated entity.

This column is written for informational purposes only and should not be construed as legal advice.

Barry Senterfitt is a partner in the insurance industry practice of Akin Gump Strauss Hauer & Feld LLP in the firm's Austin, Texas, office.