National Harbor, Md.-- Amid criticism that the NAIC was moving too hastily into a worrisome reserving regime involving "black box" models, the Valuation Manual was narrowly adopted by the NAIC plenary today with 43 votes, allowing principles-based reserving (PBR) to move forward to state legislatures.
Champions of PBR and the valuation manual pointed toward adoption as the way forward for state regulation, noting a failure to adopt would have been a failure of state regulation.
NAIC President and Florida Insurance Commissioner Kevin McCarty called the passage a “huge achievement” after many years of getting the project closer to the goal line.
The goal has always been to have the manual ready before the 2013 legislative season, and the adoption has been a moving target all year, with revisions and edits powering through to the understood finish line of year-end 2012.
The passage of the Valuation Manual will strengthen solvency monitoring, said President-Elect and Louisiana Commissioner James "Jim" Donelon, noting that this is the cornerstone of insurance regulation—protecting policyholders. It is also getting a lot of attention now with reserve issues gaining attention on many fronts beyond the exam tables as new products require new evaluations or a second look and companies burdened with redundant reserves look for ways to offload them to free up necessary capital.
Champions of PBR and the Valuation Manual pointed towards adoption as the way forward for state regulation, noting a failure to adopt would have been a failure of state regulation.
However, PBR will not be instituted until adopted by 42 states and until state adoption reflects 75 percent of written life premium in the United States, meaning New York and California, the most vehement objectors, could, with another state, derail the process. California and New York oversee the largest segment of life premiums written in the U.S.
For the "first time," we are not going to have an (actuarial) checklist and the result will vary by product design, noted Julie Mix McPeak, Tennessee insurance and commerce commissioner and chair of the Life Insurance and Annuities Committee as it ushered through the Valuation Manual successfully this summer and fall.
“It will give us a better idea of how a company is doing,” she said, in comments to reporters after the vote.
"As state regulators, we take insurance company solvency very seriously. It is vital that consumers get the benefit of the promises made by their insurers," McCarty said in a statement. "The adoption of this manual is a win-win for life insurance consumers, as we expect it will lead to more choices in the marketplace. Additionally, PBR was a key initiative identified by our members this year and its passage signifies our commitment to modernizing our regulatory system to meet the needs of the market. We are committed to providing all the resources necessary for a successful transition."
Critics said passing it would be a failure of state regulation, with New York’s Deputy Insurance Superintendent and General Counsel Robert H. Easton arguing that PBR will lead to lower reserves “in the aggregate” at a time when the economy is still fragile, when interest rates are low for the foreseeable future and, most interestingly, when Easton said some carriers are “facing stress” because of guarantees currently on their books. Easton did not elaborate on who those companies are and how stressed they may indeed be.
Critics and some concerned state regulators also raised the state resource issue for implementing and understanding the new models with all the training necessary, most explicitly described by California Insurance Commissioner Dave Jones.
“There is no fiscal analysis now. We have no idea what this will cost,” Jones said. “It requires a different skill set to look at these black boxes,” said Jones, who discussed all the unknown and known resources and expertise needed at the state level.
NAIC leadership sought to explain that resources would be devoted and that reserves would be right-sized, not reduced--reserves on some products that have been in an over-reserved position for years, stifling innovation and keeps rates high, could be lowered, and some products that needed higher reserves would be increased under the application of PBR, as Donelon and others close to the project explained.
NAIC leadership said later to reporters that there would be a “ramp-up” of resources that would be explored by a new NAIC joint working group of commissioner reporting to the Executive Committee, as yet uncharged and formed, of the Life and the Financial Condition Committees as was created to deal with Actuarial Guideline 38 (AG 38) issues.
Donelon said with his average-sized department, he felt comfortable that Louisiana departmental staff could be trained to address PBR. Smaller insurance departments will need help.
Texas Insurance Commissioner Eleanor Kitzman, who shepherded through the AG 38 updating through a joint life committee, said the resource issues raised are concerns she has had for quite some time.
Joe Torti III, Rhode Island’s banking and insurance commissioner, who has been very critical of how life insurance companies are allegedly short-circuiting statutory accounting and playing a dodgy game by shoveling excess reserves into captive special purpose vehicles, apparently due to what they see as too- conservative reserving requirements , was very supportive of PBR.
“The formulaic approach is formulaic and inaccurate—we have worked long and hard…we realized a long time ago that if we fail to act at this point and time, it could be viewed as a failure of our regulatory framework…This is not deregulation in any way. It will result in stronger reserves, not weaker reserves. Nine years is plenty of time. Holding off any longer will not help things,” Torti told the assembled body of state regulators.
Insurers believe the formulaic approach leads to redundant reserves under XXX reserving for level-premium term life and AXXX (AG 38) reserving for universal life with secondary guarantees (USLG, leading to what SNL Financials report shows is a significant use of captive reinsurers and special purpose vehicles to remove the redundant reserves from the books and free up capital). New York’s Department of Financial Services (DFS) is investigating the use of these captive reinsurers, and the NAIC, under Torti, is heavily involved in examining the issue, as well, with an updated white paper expected early next year.
“It is safe to say this is not a three year process but five to seven-year process,” so we have plenty of time to address concerns of New York and California, she said. She noted that New York and California and Texas (because of its size) may stop this process in its tracks at any time. Supporters hoped that PBR could be live in 2015 after at least 42 state legislatures had adopted it and states began meting out the guidelines for it.
But, Kitzman said, she agreed to vote for the Valuation Model adoption because, “we can move forward while still having time to address these very serious issues.” Also, because of her experience with the NAIC and department staff and the NAIC process, “I have confidence ... that we can do this right,” she said.
McPeak explained that consultants or another group could work on tests and modeling, and possibly updated the actuarial numbers, as requested by some states, incorporating the new AG 38 guidelines. She also intends to confer with consumer advocates.
Life insurance industry reserving could be an area of particular concern at the federal level, said Washington, D.C., Insurance, Securities and Banking Commissioner William White, who also is involved in the EU-US Dialogue and the Federal Advisory Committee on Insurance (FACI) at the U.S. Treasury. "By not taking action [today], it will erode our credibility," White told fellow commissioners at the NAIC plenary meeting.
"In adopting the Valuation Manual December 2, the NAIC took an important step toward a PBR methodology for life insurance reserves...Under PBR, regulators will have access to more information about companies' risks than ever before. And appropriate reserve standards will be available for new product designs right from the inception of the design," stated the American Council of Life Insurers (ACLI).
"The larger point is the need to have a consolidated approach to the balance sheet has always been a part of why PBR is important, so having the group primarily responsible for implementation comprised of regulators who focus on reserve issues on the one side and financial and accounting issues on the other side is a positive," said Scott Harrison, director of the Affordable Life Insurance Alliance (ALIA.)
“We think Commissioner Jones raised some valid concerns, -- our industry has raised these issues and supported various proposals to address them and we look forward to working with Commissioner Jones and others to ensure that states have the resources they need to implement PBR,” Harrison said.
"The test of it becoming a regulatory reality will ultimately depend on the member states to adopt both the manual and its enabling model law (Standard Valuation Law) in their respective jurisdictions, so, it remains to be seen how soon this will have actual impact,” said Thomas Sullivan, partner, PwC, who chaired the NAIC Life Insurance Committee as Connecticut insurance commissioner until 2010 said.
“Notwithstanding, the change to reserving methodology would only apply to newly written business so given the long tails in many products lines the true financial impact is many years from being recognized," Sullivan said.
The manual contains reserve requirements that are both the PBR & non-PBR as enabled by the Standard Valuation Law (SVL) when adopted. It also contains other requirements including mortality & interest coordination with the Standard Nonforfeiture Law for life insurance (SNFL).
Votes against the Valuation Manual's adoption included Guam, Maryland, New Mexico, North Carolina, Oregon, Wyoming, in addition to New York and California, who were most public about their concerns. Abstaining were Oklahoma and Minnesota. The measure required 42 votes to pass.
The proposed Joint Committee served to act as a balm for some concerned state commissioners that might not otherwise have voted "yes."
While industry representatives were congratulalting each other after the vote otuside the meeting room, the New York superintendent, Benjamin Lawsky, who did not attend the NAIC meeting but had many top department staff there, warned that, "we should not ignore one of the clear lessons of the financial crisis -- that de-regulation and laissez-faire attitudes by regulators can have disastrous consequences for all parties involved."
Sterne Agee Group Inc. analysts said that the extent to which the implementation of PBR will actually result in higher levels of deployable capital -- lower reserve requirements--will be heavily influenced by whether the rating agencies incorporate the change into their ratings methodology. If the rating agency models don't adjust, then the move by the NAIC to PBR will have little, if any, impact since the rating agencies remain a/the key arbiter as it relates to measuring excess/deployable capital.
In short, coupled with the opposition of regulators representing a major chunk of the market, this possible “modest positive” for the life sector is too young too soon to incorporate into stock selection, according to Sterne Agee. Thus, for life insurance agents and producers, it is too soon to anticipate price and premium reductions on products.