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Two regulatory projects currently under way could have a major impact on annuities. The first would impact minimum crediting rates and product development for fixed annuities, while the second effort would affect reserving for variable annuities and variable products.

Work on changing the minimum interest guarantees in individual deferred annuities to reflect record low interest rates is considered a high priority item for life insurers selling these products.

Indeed, in a recent letter to regulators, William Schreiner, a life actuary with the American Council of Life Insurers, Washington, writes that without a change to minimum guarantees, a low interest rate environment will “negatively impact an insurers ability to offer deferred annuity products and meet contractual guarantees to customers.”

Regulators also want to get decisions made so they can offer guidance to legislators on how to approach the matter.

For instance, during a discussion on the issue, Mike Batte, a life actuary with the New Mexico insurance department, said that currently his states legislature is working on a bill, and it was his hope that consensus by regulators on changes could be quickly reached.

Indeed, a number of legislatures have bills pending that would provide guidelines that sunset while the National Association of Insurance Commissioners, Kansas City, Mo., develops a more enduring approach that uses an index as a benchmark to determine what interest rate crediting minimums should be used.

It is hoped that a draft of the amended Standard Nonforfeiture Law for Individual Deferred Annuities will be ready for the Life & Annuities “A” Committee during the spring NAIC meeting next month. From there it would need to jump over two more hurdles–executive committee and full plenary–before insurers could bring the approved revisions to existing law to legislators.

But a recent discussion on whether equity indexed annuities, a type of fixed annuity, should have an offset provision in the amended model to put them on a level playing field with other annuities, underscored the difference in opinions on the details of proposed changes. An offset provision would allow an equity guarantee in an EIA to offset the straight interest guarantee in the product.

Opinions among regulators themselves and between regulators and some industry representatives, differ on issues that include: what happens when interest rates make a U-turn and head back up again; whether EIAs should be discussed at all since they are “tangentially tied” to interest rates; and whether the minimum value calculation for nonforfeiture amounts should subtract a $50 annual contract charge and any premium tax paid by the company for the contract from the accumulation value in the contract.

Schreiner also says the interest rate employed to determine nonforfeiture values should use a three-year average constant maturity treasury rate minus 1.25% rather than a five-year CMT minus 1.25%. He says the three-year CMT better enables insurers to offer products and meet customer guarantees.

A constant maturity rate takes the average yield of U.S. Treasury securities and adjusts it for the period under examination. CMT indices move with the market.

In the last decade, the three-year CMT has with one exception been lower than the five-year CMT.

According to statistics culled from the Federal Reserve Board, between 1992 and 2002, the average for the spread between the five-year CMT and the three-year CMT over that period was 33 basis points or a third of a percent higher for five-year CMTs. So, using a three-year CMT during the past decade would have produced a lower minimum guarantee rate.

Separately, a draft document related to reserving for variable products with guarantees is being exposed for public comment through Feb. 15.

Regulators at the NAIC voted to expose the report of the American Academy of Actuaries, Washington, which is the second phase of an effort to identify and reflect asset/liability mismatch risk in risk-based capital requirements.

At least one interview raised concern that if the new approach is adopted at the NAIC, reserving requirements would increase substantially and make the product more costly for insurers to offer.

Robert Brown, vice chair of the Academys Life Capital Adequacy Subcommittee, says it is important that companies know this document is being exposed because “this is significant” since it affects capital requirements for variable products with guarantees.

While higher capital requirements could be the result of the approach recommended in the report, Brown notes that it also depends on product design, when the contract was written, and how hedging and reinsurance are used in the product as well as the product guarantees offered. He notes that such guarantees have a “wide range of aggressiveness” depending on which company is offering the product.

And, he also notes that when reviewing the report, it should be kept in mind that although a total amount to be set aside is recommended, that total would be less any reserves that a company already has. Consequently, the capital requirements are not as high as they might seem, Brown adds.

The second phase of the project seeks to identify both interest rate and equity risk associated with variable products with guarantees including living, death benefit and secondary guarantees.

The report excludes variable annuities sold as fixed annuities which would continue to be handled as products subject to interest rate risk. It also excludes equity indexed products.

But, variable life insurance with secondary guarantees would also be included if doing so increases the capital requirement, the report indicates. And, separate account products that guarantee an index are looked at in another recommendation also being considered by the NAIC.

According to the Academy report, the C-3 Phase II RBC determination process resembles the need to look at health and property-casualty reserves on a regular basis to reflect new liability information. It is not the same as assuming that reserves along with the accumulation of interest will be sufficient to pay future claims.


Reproduced from National Underwriter Edition, February 10, 2003. Copyright 2003 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.