VA Reserving Choices Could Have Big Impact On Bottom Line
A dilemma over the letter versus spirit of the law and how it applies to reserving for variable annuities with guaranteed death benefits, could tip the scales of profitability downward for some VA writers, according to concerns expressed during a recent discussion of the issue.
In some cases, the reduction could be by hundreds of millions of dollars to the point of statutory insolvency, some insurance representatives contended.
Other possible effects, according to interviews with National Underwriter, include a reevaluation of acquisition prices for companies selling these contracts or blocks of this business as well as potential liability for accounting firms and actuaries that do not properly account for reserves needed for these contracts.
At issue, are VA s with cash values that have dropped because of stock market losses but which guarantee death benefits that now exceed those values. The concern is both how and whether to reserve for the possibility that large numbers of contract holders will withdraw most of the value of their contracts and maintain a small amount of that value strictly in order to retain the insurance death benefit.
The issue as discussed by regulators of the National Association of Insurance Commissioners, Kansas City, Mo., and insurers broke out into several parts: the likelihood that all contract holders would take such action; the requirement that such a scenario be used in establishing reserves; and the actions regulators should take, and legally are required to take.
During the course of discussion, it was argued that experience was showing that only a small number of policyholders were actually keeping very small portions of the cash value in their contracts in order to retain a death benefit. The ranges mentioned included “less than 1%” to “virtually no one” to 5% for one company.
There is disagreement over how likely it is that producers would recommend such action.
Producers could make such a recommendation, but there could be tax consequences that would offset the benefit, says John Morris, a senior consultant with PriceWaterhouseCoopers, Philadelphia. And, in some cases, companies will not permit partial 1035 exchanges, he says.
But producers could have the incentive to move money out of existing contracts and earn a commission if there are no tax barriers, says Donna Claire, a life actuary with Claire Thinking, Port Salonga, Long Island, New York.
Claire argued that even if reserving for a 100% likelihood may be overreserving, it is still the letter of the law.
Some companies have designed their products to comply with the law and “it is not fair to those companies if you make some companies follow it and others do not,” she said.
For those companies that have designed their products to account for the law, she explained, reserves still have to be set aside, but it is a reduced proportional reserve reflecting the reduction in the account value.
A dollar for dollar contract, the focus of the discussion, would pay the death benefit on the original total rather than on the current pro rata value of the policy.
But Actuarial Guideline 33, a guideline to interpret the Standard Valuation Law developed by regulators, indicates that requiring a 100% likelihood that contract holders would take such action goes beyond the intent of the SVL, argued Link Richardson, a second vice president and appointed actuary, during the discussion.
For their part, regulators are deferring a decision in order to study the situation further.
At this point the issue is simply being discussed, says Mike Batte, a life actuary and regulator with the New Mexico department of insurance. But, he noted, “the laws the law. If thats the law, then we will enforce it.”
Regulators noted that a “draconian” and “nonrealistic” approach may result in unintended consequences that go beyond the conservative intent of statutory reserving.
States, including California and New York, are weighing what should be done on this issue. New York is seeking input from regulators and companies, says Joanna Rose, a department spokesperson.
And, in California, the department will see how companies are reserving for this kind of contract and then decide on what action, if any, to pursue, says Sheldon Summers, chief actuary. But, if Guideline 33 is applied, he says, it would seem that the greatest present value approach would have to be used.
That approach would look at the possibility that all contract holders would take such action.
The reserving discussion also noted that a new approach could eliminate future reserving dilemmas.
The American Academy of Actuaries, Washington, is examining a “prudent best estimate” model approach to reserving rather than a formulaic approach, says Tom Campbell, co-chair of the Academys Variable Annuity Reserve Working Group.
Steve Preston, executive vice president and chief actuary with ING US Financial Services, West Chester, Pa., noted that “we are trying to fit a complex product into an existing law. Even if this issue gets resolved, there will be a discussion on another product that is not currently available.
“It is clearly a complicated area. The only way to get to a solution is to look at the economic reality, rather than to fit it into an outdated law.”
Reproduced from National Underwriter Edition, April 28, 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.