IASA Northeastern Chapter Meeting

1. IASA Northeastern Chapter Meeting Corporate Governance & Its Role in Financial Regulation Newport, RI November 17, 2016

2. Agenda • Learning Objectives • Background • The NAIC Solvency Modernization Initiative • Overview of the Corporate Governance Annual Disclosure Model • The role of corporate governance in the U.S. Regulatory environment • Other NAIC initiatives

3. Learning Objectives • Discuss the factors leading to the development of the NAIC Model Corporate Governance Annual Disclosure Model Act and Regulation. • Understand the Solvency Modernization Initiative and the resulting changes to the current regulatory environment. • Overview of the Corporate Governance Working Group and Corporate Governance Annual Disclosure. • The role of corporate governance in other areas of financial regulation. • Other NAIC initiatives.

4. Background • The 2008 global financial crisis resulted in various regulatory agencies developing new guidelines and requirements. • These guidelines and requirements are intended to strengthen the regulatory oversight of financial institutions with an emphasis on preventing future financial crisis and to improve regulatory oversight of all financial institutions (with an emphasis on large, or “too big to fail” institutions). • One item noted resulting from the 2008 global financial crisis was that enhanced coordination of regulators across jurisdictions – within the U.S. and outside the U.S. – is essential to a robust regulatory framework. • Dodd-Frank Act was enacted in 2010 as a response to the financial crisis of 2008 and resulted in a number of new government agencies. • The Financial Stability Oversight Council (FSOC) and Orderly Liquidation Authority monitors the financial stability of large entities who could pose systemic risk to the economy (i.e., “too big to fail”). • The Federal Insurance Office was established to monitor all aspects of the insurance industry and to serve as an advisory member to FSOC.

5. Background • Solvency II (equivalence) and the International Monetary Fund Financial Sector Assessment Program (FSAP), led to formation of the NAIC Group Solvency Issues Working Group (GSIWG) and Solvency Modernization Initiative (SMI). • Considers possible enhancements to U.S. Group Supervision through coordination with the International Association of Insurance Supervisors (IAIS).

6. NAIC Solvency Modernization Initiative • The NAIC’s SMI began in June 2008 to provide a critical self-examination of the United States’ insurance solvency regulation framework. • This evaluation included a review of international developments regarding insurance supervision, banking supervision, and international accounting standards and their potential use in U.S. insurance regulation. • The SMI focused on key solvency areas: capital requirements, international accounting, insurance valuation, reinsurance, group regulatory issues, and corporate governance. • At its inception, the NAIC recognized that the SMI would cover a broad range, and would likely result in significant changes to U.S. regulation. • In 2012, the National Association of Insurance Commissioners (NAIC) Corporate Governance (E) Working Group reported to the Financial Condition (E) Committee. Prior to this time, the Corporate Governance Working Group reported to the Executive Committee as part of the SMI. • The Corporate Governance Working Group was disbanded at the 2014 Fall National meeting.

7. NAIC Solvency Modernization Initiative Summary of changes resulting from the SMI: • Revisions to the Model Insurance Holding Company System Regulatory Actand the Insurance Holding Company System Model Regulationas well as new Model Laws with a focus on group-wide supervision include: • Requirements for Enterprise Risk Management within the Annual Holding Company Registration (i.e., “Form F”); • Establishment of a Supervisory College, intended to facilitate over-sight of internationally active insurance companies at the group level for international and U.S. domiciled regulators (lead state coordinator); • Risk Management and Own Risk and Solvency Assessment (“ORSA”) Model (effective 2015); • Corporate Governance Annual Disclosure Model (effective 2016); and, • Revisions to Annual Financial Reporting Model Regulation to expand the corporate audit function to provide reasonable assurance of the effectiveness of ERM, internal control, and corporate governance (effective 2016). The SMI has resulted in changes to insurance regulation

8. Executive Summary of Corporate Governance Annual Disclosure Model (CGAD) • Corporate Governance Annual Disclosure Model Act (#305) and the Corporate Governance Annual Disclosure Model Regulation (#306) was passed at the 2014 Summer National Meeting and adopted by the Executive Committee and Plenary in November 2014. • The development of the model took approximately five years to complete. • Key items required to be described within the corporate governance disclosure include: • The insurer's corporate governance framework and structure including duties and structure of the Board of Directors and its committees; • The policies and practices of the insurer’s Board 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 the Board of Directors, its committees and senior management ensure an appropriate level of oversight to the critical risks impacting the insurer's business activities including risk management processes, the actuarial function, and investment, reinsurance and business strategy decision-making processes.

9. Executive Summary of CGAD • Must be signed by Chief Executive Officer or Corporate Secretary attesting that the group has implemented corporate governance practices and a copy has been provided to the Board. • The insurer or the insurance group has discretion in the format for providing the required information and is permitted to customize the response for the most relevant information. • While the insurer or the insurance group has discretion in determining the level the CGAD is completed, it is encouraged to complete the disclosures at the level the risk is determined, or at the level for which liability for the failure of corporate governance would be placed. • If the CGAD is completed at the insurance group level, the filing must be made with the lead state as determined by the procedures as outlined in the current NAIC Financial Analysis Handbook. • The CGAD permits the cross referencing to other externally filed documents (i.e., SEC Filings) or insurance department filings (i.e., Holding Company Annual Registration Statement, ORSA, Form F, etc.). • The lead state coordinates the CGAD with the other states of domicile for the insurance group. • Each year following the initial CGAD filing is made, the previous filing is amended with updates indicating where changes are made. If no changes are made, the filing should state that no changes are made.

10. Sections of the CGAD Model Act

11. Sections of the CGAD Model Regulation

12. Overview of CGAD • Corporate Governance Annual Disclosure Model Act (#305) and the Corporate Governance Annual Disclosure Model Regulation (#306). What is the Difference between the Model Act and Regulation? • The purpose of the act is to outline the requirements for completing a CGAD in order for the Commissioner to gain an understanding of the insurer’s corporate governance framework. • The act provides for the confidential treatment of the CGAD and the related information which contains confidential and sensitive information related to the insurer or the insurance group’s internal operations. This information is classified as proprietary and trade secret, which if made public could potentially cause the insurer or insurance group competitive harm or disadvantage. • The purpose of the model regulation is to set forth the procedures for filing the contents of the CGAD deemed necessary by the Commissioner to carry out the provisions of the model act.

13. Overview of CGAD Filing Procedures • The insurer or the insurance group must file the CGAD no later than June 1 of each calendar year. • While there is no prescribed format, the CGAD must contain the information as described in Section 5 of the Model. The insurer or the insurer group has discretion over the filing format, and is permitted to provide the most relevant information necessary for the regulator to gain an understanding of the corporate governance structure, policies and practices utilized by the insurer or the insurance group. • While the insurer or the insurance group has discretion in determining the level the CGAD is completed, it is encouraged to complete the disclosures (i) at the level the risk appetite is determined, (ii) the level at which the earnings, capital, liquidity, operations and reputation risk are overseen collectively (e.g., the supervision of these factors are coordinated and exercised), or (iii) the level for which liability for the failure of corporate governance would be placed. • If the CGAD is completed at the insurance group level, the filing must be made with the lead state as determined by the procedures as outlined in the current NAIC Financial Analysis Handbook.

14. Contents of CGAD • Describe the insurer’s or insurance group’s corporate governance framework and structure including: • The Board and committees with ultimate oversight; and • The duties of the Board and its significant committees and how it is governed (e.g., bylaws, charters, informal mandates, etc.) as well as how the Board’s leadership is structured (including the roles of the CEO and Chairman of the Board within the organization). • The insurer or insurance group shall describe the policies and practices including the following: • How the qualifications, expertise and experience of each Board member meet the needs of the insurer or the insurance group; and • How an appropriate amount of independence is maintained on the Board and its significant committees.

15. Contents of CGAD • Examples of how independence is maintained on the Board and its significant committees should be provided: • Whether a nomination committee is in place to identify and select individuals for consideration; • Whether term limits are placed on directors; • How the election and re-election processes function; and • Whether a Board diversity policy is in place; if so, how it functions. • The processes in place for the Board to evaluate its performance and the performance of its committees. • Describe policies and practices in place for directing senior management, including: • Suitability standards; • Code of business conduct; • Performance evaluation, compensation and corrective action; and • CEO and senior management succession planning.

16. Contents of CGAD • Describe the process how the Board (through committees and senior management) ensure oversight of critical risk areas. • Describe how reporting areas are organized for each critical risk area, such as: • Risk management process (may refer to ORSA summary report); • Actuarial function; • Investment decision-making processes; • Reinsurance decision-making processes; • Business strategy/finance decision-making processes; • Compliance function; • Financial reporting/internal auditing; and • Market conduct decision-making processes. • A copy of the completed CGAD is provided at any other state of domicile regulator’s request. • An insurer or insurance group may comply with the requirements by cross referencing existing documents (i.e., SEC Filings, Holding Company Annual Registration Statement, ORSA, Form F, etc.).

17. State Activity Regarding Model Act # 305 Source: NAIC

18. State Activity Regarding Model Reg. # 306 Source: NAIC

19. The U.S. Insurance Regulatory Environment • NAIC and State Based Regulation Continues to Evolve • The current developments continue to evolve from a solvency agenda adopted by the NAIC in 1989 to enhance solvency regulation in response to a number of insurer insolvencies that occurred during the 1980s. • The Solvency Agenda was updated in 1991 and is considered to be an on-going process. The following items were included in the original initiatives and provide the regulatory framework for the current developments: • Codification of Statutory Accounting Principles (SAP); • Revision of the NAIC Financial Condition Examiners Handbook; • Develop Risk-Based Capital; • Develop a model investment law; • Create a centralized financial analysis unit; • Develop computerized financial analysis routines; and • Create an NAIC education fund. • The NAIC began discussing and shaping the Financial Regulation Standards and Accreditation Program in September 1988.

20. The U.S. Insurance Regulatory Environment • NAIC Financial Examinations & Financial Analysis • The financial examination and financial analysis process have evolved over time to better assess the underlying risk of the insurance entity and the group with an emphasis on understanding corporate governance (i.e., Exhibit M within the NAIC Financial Condition Examiners Handbook and group-wide supervision within the NAIC Financial Analysis Handbook). • The risk-focused examination has evolved to incorporate prospective risks, and focus on the areas of higher risk. • The current process includes interviews of C-level officers, as well as an evaluation of information technology controls and enterprise risk management (ERM). • Annual Financial Reporting Model Audit Regulation (MAR) • In 1991, the NAIC’s MAR required CPA audits,following extensive deliberation in the preceding years: • Greater reliance on independent CPA audits would be a valuable supplement to the examination system. • Annual Statement instructions were modified, effective for the 1991 blank, requiring a CPA audit. • Required to be adopted by all states.

21. The U.S. Insurance Regulatory Environment • Annual Financial Reporting Model Audit Regulation (MAR) • MAR was amended to include additional requirements for governance, including independence requirements for audit committees and Managements Report on Internal Controls over Financial Reporting for insurers meeting certain requirements effective for 2010 annual reporting. • MAR was again amended with a January 1, 2016 effective date requiring insurers meeting certain requirements to establish an internal audit function to provide independent, objective and reasonable assurance to the Audit Committee and management regarding the insurer’s governance, risk management, and internal controls. • NAIC and State Based Regulation – Continues to Evolve • Continues to evolve as evidenced by additional requirements (e.g., Model Holding Company, ERM, ORSA, Supervisory Colleges, and Corporate Governance Annual Disclosure). • The previous “legal entity” approach has evolved into a “group-wide” approach, while also retaining the legal entity oversight. • Each significant change has followed either significant insolvencies, changes to the regulatory environment, or a financial crisis.

22. The U.S. Insurance Regulatory Environment:Timeline of Industry and Regulatory Changes • Amendments to MAR • Dodd-Frank • FSOC/FIO • NAIC GSIWG • Amendment to MAR • ORSA NAIC Accreditation Process Codification of SAP Risk-Based Capital 1991 2001 2010 2002 2015 1990 1993 1999 2016 2012 Corporate Governance Annual Disclosure Model • Update to Model Holding Company Law/Regulation • Supervisory College • MAR Update • Solvency Agenda Update from 1989 Version Sarbanes-Oxley Act Graham-Leach Bliley Act

23. Other Current NAIC Initiatives • Group Capital • NAIC Group Solvency Issues Working Group

24. Link to NAIC Website http://www.naic.org/prod_serv_model_laws.htm

25. Link to NAIC Website

26. Questions/Discussion