By Cyril Tuohy
A move by New York’s top financial services regulator to pull out of principal-based reserving (PBR) regulations has life insurers irate at the prospect of having to increase their reserves by billions of dollars to pay claims on life insurance products.
This latest dust-up in the eternal battle between insurance companies and the 50 state regulators who oversee them pits the state of New York’s powerful superintendent of financial services, Benjamin M. Lawsky, against the American Council of Life Insurers (ACLI).
Lawsky maintains that the compromise between insurance companies and regulators to create a new framework to set aside more money in reserves has been shown to be completely inadequate, and that New York will no longer support the PBR approach agreed to by 49 other state insurance regulators.
“Unfortunately, the preliminary results of this ‘compromise’ show that companies have increased their reserves for in-force business by less than $1 billion in the aggregate — a far cry from the $10 billion projected,” Lawsky wrote in a letter earlier this month to the 49 other insurance commissioners in the U.S.
PBR puts policyholders at risk, he said, drawing parallels to a banking framework known as Basel II that allowed banks to use their internal capital models to guard against risk, but that also turned out to be no match for the ensuing financial crisis.
Because so many companies do business in New York, the nation’s financial center, Lawsky’s actions often have repercussions throughout the rest of the country.
Within hours of Lawsky’s remarks being made public in a New York Times article, life insurers hit back by firing off a letter to every state insurance commissioner about the industry’s “profound disappointment” with Lawsky’s “irresponsible” comments.
“Every state insurance regulator should be outraged at this direct assault on the system they have worked so diligently to ensure operates in the best ways possible to protect insurance consumers,” said Dirk Kempthorne, ACLI president and chief executive officer.
For two years, New York regulators have made the National Association of Insurance Commissioners (NAIC) aware of the fact that many life insurance companies had not set aside enough in reserves to pay for insurance products known as universal life with secondary guarantee (ULSG) in violation of actuarial guidelines.
A survey conducted by New York and Texas found companies to be underreserved for ULSG policies by as much as $20 billion, Lawsky said.
The resulting NAIC compromise was to come up with PBR, but when PBR was put to the test last year, only five of the top 16 ULSG underwriters had increased their reserves.
Correspondence between state insurance regulators and the industry is typically a civil and understated affair, even if insurance carriers occasionally grumble about the amount of regulation they face. But the PBR issue has put the industry on notice that Lawsky intends to be aggressive and unyielding in matters of insurance reserving.
Indeed, Lawsky continued with his no-holds-barred assault, and said the PBR compromise “will hardly quell the gamesmanship and abuses associated with the setting of reserves,” referring to a lightly regulated sector of the insurance industry known as captives. Captives serve as an insurance company’s in-house insurance or reinsurance company.
Sometimes called “shadow insurance,” captives allow insurance companies to cede or reinsure a risk through the in-house company, thereby removing exposures from the parent insurance company’s balance sheet.
Lighter balance sheets allow carriers to set aside fewer reserves, and instead return the capital to the shareholders in the form of dividends, or reinvest the money to fund future growth. But the danger is that an insurer may not have enough money to pay future claims.
The NAIC’s “reluctance to endorse a moratorium on such shadow insurance transactions, coupled with the move to implement PBR, represents a potent cocktail that could put policyholders and taxpayers at significant risk,” Lawsky wrote.
Kempthorne rejected the superintendent’s claims, saying the industry has “consistently maintained that reserves being held were appropriate,” and that reserve adequacy levels are reviewed annually by state regulators.
“PBR represents a change in how policyholder reserves will be established in the future,” Kempthorne wrote in a letter to the nation’s insurance commissioners. “That change is important and proper to measure the increasingly complex products that companies develop to meet the needs of consumers, and to compete in the global economy.”
Due to Lincoln Financial Group's strong capital base and because the company stopped selling universal life policies with secondary guarantees earlier this year, the proposed changes by the New York Department of Financial Services will be limited to Lincoln's New York subsidiary, the company said in a statement.
Cyril Tuohy is a writer based in Pennsylvania. He has covered the financial services industry for more than 15 years. He can be reached at [email protected].
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