Barry Senterfitt
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The meltdown in financial services industries is being viewed as a product of regulatory failures. Congress and various federal
regulators already have indicated that new, tighter regulations are coming. This backlash on the regulatory front will ultimately
filter down to similarly situated industries—those that are entrusted with large sums of money from the public. Thus, there
will be a renewed interest in solvency regulation for insurance companies and MCOs.
At this juncture, we will review the current panoply of regulatory tools used to evaluate the financial condition of health
insurers, HMOs and other MCOs. This oversight function is performed by state insurance regulatory bodies.
TOOLS OF THE TRADE
Solvency regulation begins with requirements for minimum capital and surplus. Typically, most states will have a minimum statutorily
required level of capitalization. This requirement may range from a low of $1 million to as high as $10 million depending
on the state of incorporation and the lines of business to be written. It must be maintained at all times or the regulated
entity is otherwise viewed as being "impaired." If impaired, the regulatory body in its state of incorporation will take action
to supervise its activities with its own personnel on site or seize control of the company and displace management. State regulators also look at various financial ratios and formulas for determining whether the company is adequately capitalized.
One key financial ratio is the ratio of premiums to surplus. As a general rule, a company's net retained premiums on an annualized
basis should not exceed 400% of its total capital and surplus.
The most common measurement of required capitalization now used by regulators is the National Association of Insurance Commissioners
(NAIC) Risk-Based Capital (RBC) formula. This formula is now in effect in most states. It requires a company to compare its
total capital and surplus, with certain prescribed adjustments, to a formulaic calculation of capital required for the company.
The RBC formula takes into consideration the company's asset mix, lines of business, and volume of business. The resulting
calculation is referred to as the "Authorized Control Level" RBC. If the company's adjusted capital is less than 100% of the
Authorized Control Level RBC, regulators may intervene and place the company under control. If the company's adjusted capital
is between 100% and 150% of Authorized Control Level RBC, regulators will require the company to take corrective actions to
improve its financial condition. In most cases, a company will be considered sufficiently capitalized if its adjusted capital
in comparison to the Authorized Control Level RBC is 250% or above.
In addition to the tools regulators have to evaluate capitalization levels, there are significant limitations on the investments
that are permitted for these regulated entities. Generally speaking, most of their assets must be invested in highly liquid
securities.
Finally, regulators also have oversight on dividends and distributions and may disapprove of such payments that are deemed
to be "extraordinary." In most states, annualized dividends that exceed the greater of 10% of capital and surplus or net income
are deemed extraordinary. If determined to be extraordinary, such dividends require regulatory approval.
Barry Senterfitt is a partner in the insurance industry practice of Akin Gump Strauss Hauer & Feld LLP in the firm's Austin,
Texas, office.
