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Credit Risk Hides In Level-Term Backing

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NU Online News Service, Jan. 16, 2004, 4:43 p.m. EST – Regulations for level-premium term products and universal life products may be creating hidden credit risks.[@@]

A new report from Moody’s Investors Service, New York, says ceding companies and reinsurers that use bank letters of credit to secure reinsurance reserve credit on their balance sheets face significant short-term liquidity and repricing risks

Those risks could lead to credit problems, according to the report, which was prepared by Moody’s analyst Joel Levine.

The potential problem is that the amount of reserves allotted because of Regulation XXX and Actuarial Guideline AXXX becomes more significant after the policy is issued, sometimes 5 years or more later, Moody’s says.

Regulation XXX, the Valuation of Life Insurance Policies model regulation, was developed so that regulators could make sure that companies properly reserved for level-premium products. Actuarial Guideline AXXX clarifies Regulation XXX as it applies to universal life policies with no-lapse guarantees.

The amount of collateral now in place for a level-premium product may become inadequate as reserve requirements increase, the report says.

If the need for collateral increases at a time when financing is more expensive or collateral is scarce, there could be “enormous pressure on the earnings and capital of ceding companies and their reinsurers,” the report says.

However, new funding structures are improving, Moody’s says, because funding agreements extend the current 1-year renewal risk that accompanies using a letter of credit. The new funding structures are also an improvement over reinsurance trusts because the cost of funding is locked into a specific, fixed term, Moody’s adds.

Among the possible remedies that Moody’s lists are:

- Redesigning products to reduce the level of the XXX/AXXX reserves, particularly with respect to UL no-lapse guarantees.

- Slowing new business growth.

- Lowering reserve requirements by adopting the 2001 CSO mortality table.

- Seeking LOC alternatives.

Reinsurance pricing is being pushed up for because of factors that include increased LOC costs, says Carl Friedrich, a consulting actuary in the Chicago office of Milliman USA.

Direct writers can expect to see a continued increase in prices, says David Rains, second vice president-life solutions at Transamerica Re, Charlotte, N.C., a unit of AEGON N.V., The Hague, Netherlands. Better capital management is becoming more necessary because of the need for letters of credit, Rains adds.

Jeff Burt, vice president-marketing with Hannover Life Reassurance Company of America, a unit of Hannover Re Group, Hannover, Germany, says he once heard a speaker at an industry meeting compare a direct writer’s growing dependence on reinsurance at any price to an addict’s dependence on a drug.