A.M. Best Remains Concerned Over Potential Emergence of ULSG Tail Risk

The debate over how Actuarial Guideline 38 should apply to certain universal life with secondary guarantee and term universal life products is heating up again ahead of the National Association of Insurance Commissioners spring meeting in New Orleans, which begins on March 3.

The NAIC took the first step toward resolving the AG 38 issue on Feb. 21 when a joint working group approved taking a bifurcated approach in setting up different evaluation standards for "closed blocks of business" policies that were written before a specified date and for policies deemed to be new business, or those that were written after the decided-upon date.

Bob Adams, senior financial analyst at A.M. Best Co., said although A.M. Best views the NAIC's initial approach positively, it remains concerned over potential tail risk that may emerge; given the prolonged and significant decline in interest rates amidst aggressive pricing by some ULSG carriers over the past decade. The precipitous drop in interest rates since August 2011 has further pressured embedded guarantees, and the Federal Reserve's recent announcement of its intent to keep interest rates low through 2014 further exacerbates these dynamics.

Members of the group also approved a proposal to bring in an outside actuary to aid in their fact-finding mission. The joint working group, which was formed after a heated debate among regulators about how reserve levels for certain universal life products were being set, did not approve the full contents of a framework for applying AG 38, instead limiting the vote to two issues.

The proposal will be sent to members of the full Life Insurance and Annuities Committee and the Financial Condition committees for further consideration. Texas Insurance Commissioner Eleanor Kitzman said on Feb. 21 she hopes to have the NAIC's Executive Committee and plenary consider the proposal during the organization's upcoming spring meeting (Best's News Service, Feb. 21, 2011).

Adams said as the debate moves forward, the role of outside actuaries includes establishing asset adequacy guidelines. One of the key aspects of adequacy analysis will be how tail risk is captured. Current principles-based reserving proposals have tests that companies use to see if they have to calculate reserves using a stochastic basis, a deterministic basis, or hold the traditional net premium reserve. While there is some degree of tail risk in the deterministic test, A.M. Best believes the stochastic approach is much more robust in determining how resilient reserve levels are.

Also at the heart of the AG 38 debate are term/universal life products, which have been described as a hybrid product that is marketed as a term product but is constructed on a universal life chassis. Last year, some NAIC regulators alleged that some universal life product designs exploit loopholes, resulting in companies holding reserves at levels less than statutory minimums (Best's News Service, May 26, 2011). The industry has been pushing back against those accusations aggressively, issuing a series of comment letters and public statements on AG 38 and the NAIC's move toward a statement on how it should be interpreted.

The AG 38 debate has made financial analysts that rate insurance companies wary of the uncertain environment. In a recent special report released by A.M. Best, the company said it has historically considered individual life insurance to be the most creditworthy of the various product lines life and health insurance carriers sell. But the report noted "the evolving dynamics of the UL market, which increasingly is exposed to rational policyholder behavior, have somewhat diminished the creditworthiness of certain life products." That trend is likely to continue, given there is continued exposure to policyholder rationality and as the low interest rate landscape enhances the value of a secondary guarantee for policyholders, the report said.

The debate over AG 38 comes at a time when the NAIC appears to be making progress toward principles-based reserving after years of discussion on whether that system would be preferable to the one currently in place. Affordable Life Insurance Alliance executive director Scott Harrison has said PBR would make the debate over AG 38 largely irrelevant because the PBR system would sidestep many of the questions that the existing framework has (Best's News Service, Jan 16, 2012).

NAIC President Kevin McCarty, who serves as Florida's insurance commissioner, told Best's News Service on Feb. 22 he expects the NAIC to present a draft of PBR guidelines by the end of 2012. "It's critically important that we get the AG 38 issue resolved," McCarty said. "We have seen a number of collateral issues crop around the discussion as we move forward on AG 38. It's time we really got our arms around the AG 38 issue."

(By Jeff Jeffrey, Washington Correspondent: [email protected])