The Implications of Prompt Corrective Action for Insurance Firms

Abstract

S. 40, the National Insurance Act of 2007, requires the development of a system of Prompt Corrective Action (PCA) for federally chartered insurers. This paper discusses the issues associated with developing a system of PCA and makes recommendations regarding its structure. First, the paper considers the historical motivation for the development of PCA in banking and insurance. Second, the paper provides an overview of PCA in banking and reviews the evidence regarding the extent to which banking regulators rely on PCA and its effects on FDIC costs. Third, the paper provides an overview of the risk-based capital requirements in insurance, and compares those requirements with PCA in banking. Fourth, the paper considers the banking requirements related to Least Cost Resolution (LCR) and related language in S. 40. The paper concludes that PCA requirements should be included in any Optional Federal Charter (OFC) legislation, and that NAIC RBC requirements provide a good initial structure. Second, the paper concludes that other regulatory authority giving the Commissioner discretion to intervene beyond PCA is essential in any OFC system. S. 40 would benefit from the inclusion of a provision requiring review of costly insolvencies and transparency with respect to the results of that review and the costs of resolving insolvent insurers. Finally, S. 40 provides a clear objective for resolving insolvencies, a positive change from current insurance laws, but the appropriateness of the objective is dependent on the continued existence of the current guaranty fund system.