From the November 22, 2010 issue of National Underwriter Life & Health Magazine •Subscribe!

Follow the Money: Bankrolling the NAIC

The NAIC is a growing, almost 140 year-old, $75 million-a-year plus organization that NPR recently called an "obscure group" on a Morning Edition show about implementing health care. If it is obscure, it certainly has more insurance data than any other known repository and has a deep relationship to every insurer underwriting the health, businesses, homes and retirements of lives in every U.S. state and territory. This relationship will only grow as the states work to implement health care reform and as the move to global insurance accounting standards requires the NAIC to dramatically increase its profile.

A crucial element to the makeup and direction of the NAIC is its funding. As its critics and supporters will agree, the NAIC makes an awful lot of money, and it spends an awful lot, too. So much so, in fact, that some critics have openly wondered why exactly a tax-exempt, nonprofit trade association--ostensibly meant to coordinate public officials for the benefit of insurance consumers--even needs to raise and wield the capital that it does. Why, indeed.

The NAIC is trade group of state insurance regulators, a 501c(3) that is undertaking a lot of business to sustain its multi-pronged efforts of efficient regulation, promoting solvency of insurers and more recently, its survival amid federal and international forces.

What is funding this large operation is apparent when reviewing the NAIC budget, although the different components of the revenue stream and the reserves all tell of the evolving nature of the organization. The NAIC has slightly more than 400 full-time employees in Kansas City, New York (home of its Securities Valuation Office) and Washington. The group is budgeting for more, and recently stopped the pay freeze it had instituted in 2009 and lifted a year later, this past July.

As most insurers are well aware, most revenue to the NAIC comes from database filing fees, which will bring in a projected $25.7 million in 2011, comprising 34.2% of its total revenue. That is down slightly from 35% or $25.8 million, in 2010's expected revenue.

State assessments, which vary by premium dollars written in each state, only make up 2.2% of revenue, although New York, California and Florida pay the heftiest share.

The NAIC has been trying to be less dependent on database filing fees for years, ever since the mid-1990s, when property/casualty insurers withheld the fees in protest. The growth of the organization under Cathy Weatherford, who was replaced by new CEO Terri Vaughan, had been criticized even as Weatherford was striving to become more independent of the filings through technology development and accompanying fees.

According to sources who spoke on background, the growth was part of a push to become more efficient, globally situated and relevant, especially with federal and international solvency and accounting pressures. This was compounded by health care reform and financial services reform demanding stronger marketplace oversight, considering AIG's implosion due to excessively risky behavior in its Financial Products division.

The NAIC budget even graphs the database fees in its budget proposal as a percentage of NAIC revenue, possibly to hold detractors at bay. The ratio is holding pretty steady, with a bump up in 2008, when Weatherford left mid-year. Database fees were nearly $23 million in 2002, and are projected to be only $25.7 million nine years later. (Database fee increases are based on a 2% premium growth).

The 2011 budget revenue is about $2.3 million more than the projected 2010 budget. Interestingly, the heftiest portion of that increase coming from State-Based Systems transaction fees (more NAIC staff in 2011 are budgeted to beef up the SBS team) and, to a lesser extent, insurance data product sales.

The extra staff will be added to reduce the NAIC's future reliance on consulting resources from its SBS business partner, Aithent, in anticipation of the expiration of that relationship in July 2012.

SBS is a web-based application, licensed in 20 jurisdictions so far by state insurance regulators, to process license applications, license renewals, consumer inquiries and enforcement actions, among other regulatory applications, as well as to remain compliant with uniformity initiatives.

The NAIC is also hoping added SBS staff can work on an initiative to increase continuing education revenues through incentives for providers to submit online course roster uploads, which generate additional transaction fees to SBS. Initial resource investments in this proposal are projecting to generate additional revenues of $472,661 in 2011 and $1.2 million in 2012.

Another recent funding source for the NAIC is the National Insurance Producer Registry. In January 2006, the NAIC began a service agreement with the NIPR, an affiliated entity. The NAIC receives a fee computed on 30% of certain NIPR revenues. In addition, the NAIC receives an administrative fee of $1 million and a transaction usage fee for the State Producer Licensing Reengineering Project.

Significant budget revenue line items are publication, insurance data revenue, and the growth of "services," such as SBS, the SERF, SVO (a blend of fee-for-services and a fee assessment on the industry's stock investments).

Sales of publications and insurance data comprise $18.7 million of the $75.2 million 2011 budget, or almost 25% of total revenue.

The NAIC's rich trove of data, culled from company filings, is an important source of information for aggregators and financial analytic companies: the NAIC has 400 million data elements in its Financial Data Repository, according to the proposed 2011 budget. The NAIC is no Google, but its butter, if not bread, is data. And it is always gathering more through its services and affiliate relationships.

The NAIC leverages its 400 million-plus data points in the market effectively. This magazine, National Underwriter, is owned by Summit Business Media, which also owns financial information provider Highline Data, a major NAIC customer in the multi-million dollar NAIC insurance data products business. Other customers include the Bloomberg Professional service, and SNL Financial.

Special insurance publications revenue will be lower than expected in 2010 because companies are trying to save money and buying fewer hard copies, explained NAIC CFO and Business Strategy Officer Brady Kelley. The NAIC expects to make $682,602 more in insurance data product sales in 2011 over 2010, but it is suffering from a $390,524 decrease in its publications business.

Services, like SERFF [System for Electronic Rate and Form Filing] and SBS, now comprise 23.3% of revenue, up from 21.3% in 2010, or $17.5 million versus about $16 million. SBS fees are expected to rise by almost $800,000 next year over 2010. SVO fees constitute the lion's share of those fees, although the 2011 budget is expecting a decrease in year-over-year revenue due to an anticipated decline in the volume of corporate security filings.

The NAIC and SERFF also get administrative fees and a license fee from the Interstate Insurance Product Regulation Commission for services.

SERFF was developed through the 1990s by the NAIC to provide a cost-effective method for handling insurance policy rate and form filings between regulators and insurance companies and its development hurried along under the Speed to Market initiative. Filings have ballooned from 3,694 in 2001 to more than half a million filings, although 2009 saw about 27,000 fewer filings than the previous year's 554,261 filings.

This coming year, the Speed to Market NAIC Task Force and SERFF are going to be expanding to PPACA [health care reform legislation] filings. "We have to enhance that system to our members to conform with that law," Kelley said.

License fees from states cover costs of enhancements. The states get federal grants for reform implementation and a portion of that will be remitted to the NAIC. "We are collecting some revenue from the states "to cover the cost of the work we do," he said. "But nine times out of 10, the states don't pay registration fees to national meetings and we fund a lot of their travel."

Insurance trade groups like NAMIC and the ACLI have historically protested the growth of the NAIC over the decade, asking why it is necessary for the nonprofit to maintain such a high net income when it has a large surplus already, and urged it to reign in costs for such "big-ticket" items, as database fees, SVO fees, salaries, employee benefits and travel, as an ACLI letter put it a little over year ago. Of course, there was a salary pay freeze, which was lifted at the end of July.

There will be a salary increase for 2011, but it is not larger than normal and employees won't recover the lost increase of the previous year, according to Kelley.

The surplus that groups like NAMIC have criticized as too large was intended to reach a total of 57.2% of the 2010 operating budget, with a standard goal of an 80% ratio of liquid operating reserve to operating expenses.

"The purpose of the operating reserve is to ensure adequate levels of NAIC net assets to fund and/or overcome risks and uncertainties in NAIC operations in future budget years," stated the leadership in a letter last fall, citing an independent consultant's analysis. NAIC leadership then pointed out the hefty liquid reserves of the industry trade groups, which, save for AIA were all high, or had been so the previous year before suffering an economy-driven dip.

As of year-end 2007, the NAIC maintained a liquid operating reserve ratio of 70%. This reserve reduced to 52% at year-end 2008 (down 18% over 2007), primarily due to big hits to long-term and defined benefit plan investment portfolios, which reduced net assets by $12.7 million in 2008 alone, illustrating, the NAIC explained, the need for a robust surplus.

Regarding costly international travel, some in the NAIC and insurance company representatives say it is necessary. Travel is critical for the NAIC to be involved in the International Association of Insurance Supervisors and the promulgation of global standards, Kelley explained.

"Given the new requirements being imposed on all financial companies, including insurance, by the G-20 and FSB, the world's regulators have a lot to do," said a source with vast international and state regulatory experience. "Now that the Basel Committee, IAIS and other groups of world regulators are raising the bar regarding solvency oversight to include Colleges of Supervisors, and will also include governance, compliance and market conduct as key components, the U.S. regulators need to be a part of the global community and be at many tables as these new standards are being established."

The source added, "One might be concerned if one looked around the table and saw the UK, Canada, France, Germany, Switzerland, Japan, Malaysia, Dubai, Brazil--and not the U.S." Indeed, the retiring head of the IASB recently observed that he anticipates the greatest leverage regarding such standards will likely come in the future from China.

Kelley also defended capital spending information technology, where the value added is exponential compared with the cost, creating savings in the industry and faster approvals for producers. Every insurer in the country files to the NAIC repository, he pointed out, and everything is loaded within 24 hours. The benefits are "monumental," he said, and the states can act faster than they would if they were processing one filing at a time.

Although the NAIC has also strengthened its D.C. office at the Hall of States, it is not, nor can it be, a lobbying body or a regulator, so sometimes it cannot go out on a limb in either direction. In 2009, the NAIC established the Center for Insurance Policy and Research within its D.C. office, which became its executive office under Weatherford, to support the collection of information and analysis for use by state and federal officials, agencies, and policymakers. CIPR coordinates the vast insurance data and research for the stated purpose of enhancing cooperation among federal, state and international agencies and regulators, by way of instructing federal policy makers (such as the Treasury Department, Department of Health and Human Services and federal banking regulators) on the ways of state-regulated insurers. It also allows itself and its members a seat at the table in federal public policy discussions and decisions.

The NAIC claims regulation and the model laws are the domain of its members, not its staff, but the organization is holding itself together with data, institutional knowledge, required assessments and fees, filings and indispensable services at a time when the membership of state insurance commissioners is increasingly unstable. Members are also under extreme pressure to be cohesive while tasked with implementation of federal health care reform. At the same time, the organization has seen its lunch get nibbled, if not eaten outright, by various federal financial oversight and consumer protection agencies under the Dodd-Frank Act.

The mid-term elections may result in as many as 20 new insurance commissioners among the states, according to a health insurance regualtory source. Indeed, NAIC President-Elect, Florida Insurance Commissioner Kevin McCarty, could be out of a job with the new Florida administration. Pass the bucket.

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