Comments at NAIC Meeting Spur Review of Secondary-Guarantee Life Insurance

Regulators and representatives of the life insurance industry have been working to resolve their differences after a report on secondary-guarantee life insurance by the New York State Insurance Department incited some heated discussion during the Spring National Association of Insurance Commissioners meeting in March.

In a written report, the New York Insurance Department presented a summary of universal life product designs that allegedly exploit loopholes in Actuarial Guideline 38, resulting in companies holding reserves at levels less than statutory minimums, according to accounts of the meeting by both Deloitte and PriceWaterhouseCoopers. AG 38's purpose is to provide guidelines for the calculation of reserves for UL products with secondary guarantees. The summary took place before the Life Actuarial Task Force.

"If there is a finding that AG 38 needs to be changed in some fashion, and that change causes significantly higher reserves, then... future product designs will be less generous or more costly," said Paul Graham, senior vice president and chief actuary at the American Council of Life Insurers. "The money has to come from someplace."

Ron Klug, a spokesman for the New York Insurance Department, said the report is not currently the position of the New York department. "The only purpose of the document was to start a discussion with the industry and the NAIC," he said.

Graham said the debate that came out of the meeting "was very misplaced. We objected behind the scenes to the process and suggested that before they make any kind of determination about what their next steps are, that they do some due diligence on the product design and reserves being held so there could be an informed decision."

The ACLI believes the process broke down in a big way. "LATF is not a regulator," he said.

Some LATF members said at the meeting that the task force should consider referral of the actuaries who developed the product designs to the Actuarial Board of Counseling and Discipline -- something George Hansen, managing senior financial analyst and actuary at A.M. Best Co., said goes too far. "When LATF starts talking about disciplinary action against those who created these products, that's going over the top," said Hansen. "In New York's opinion, there's manipulation of the product design to reduce the reserves. The industry is saying no, we've had this design in place for several years, and this isn't anything new."

The LATF is now collecting data in a survey of insurers under supervision of the Texas Insurance Department. Graham said LATF will have some closed-door meetings to review the results, which are confidential because the data is being collected under examination authority.

Consumers buy universal life policies with secondary guarantees to obtain permanent insurance that cannot lapse if they pay a stipulated premium determined at the time of purchase. They are much less expensive than whole life policies. Insurers are required to maintain a "shadow account" to kick in if policyholder cash values fall below zero. The shadow account is based on a different set of charges, expenses and interest credits than the real account value, said the New York report. It maintained that several companies artificially increase premiums used in the reserve calculations above the minimum premiums needed to keep the policy in force so that they can hold less than the statutory minimum reserve in the shadow account.

Graham said those who sell these products don't think they have done anything wrong. "The products have been around for eight years," he said. "For the NAIC or for particular regulators to call foul eight years into the game is sort of like changing the rules of the road after the course has been set." Most of these companies have undergone financial examination and have received no notice of problems, he added. These exams are performed by state regulators. "So it is concerning that somebody would suggest at this point that the actuaries have done anything capricious," said Graham.

Hansen said the position taken by New York is unusual in that actuarial guidelines are written by the NAIC and are intended to supersede state interpretations. "To me, this is clearly an interpretation of AG 38 by New York that is different than what the industry had agreed upon," he said.

Graham said no one from the New York Department of Insurance was present at the meeting. "After the fact, we found that many regulators might have jumped to conclusions that might not have been as well founded as they thought they were." He added there is now more cooperation between the LATF and industry. "Everybody recognizes that cooler heads should prevail and that we do a good job on all accounts," he said.

Normally, state legislatures adopt actuarial guidelines as law. "In many cases, the laws don't have enough detail to them to be applied, so they leave to the commissioner the ability to develop regulations that fit within the law and give application requirements of the law much more specifically than the law does," said Graham. New York does not adopt actuarial guidelines as law, he said. Instead, it adopts them as regulation; AG 38 was adopted in New York as Regulation 147. "But Regulation 147 is not identical to AG 38," said Graham. "So this whole concept of uniform interpretation sort of gets broken when New York gets pulled in."

Florida is the other state that does not adopt actuarial guidelines into law, but it generally will adopt them by regulation in a uniform fashion, said Graham.

But Graham added it's very difficult to come up with a rule that develops reserves for every single kind of product design with a secondary guarantee. "That's why the principles-based reserving project was started. And we would suggest that the best course of action is to get PBR finished so we don't have to keep trying to fit a square peg into a round hole."

(By Ron Panko, senior associate editor, Best's Review: Ronald.Panko@ambest.com)