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Regulations for level premium term products and universal life products are creating hidden credit risks for reinsurance, according to a report from Moodys Investors Service, New York.

The report, “Hidden Credit Risks of Regulation XXX/Guideline AXXX Reinsurance Programs,” prepared by analyst Joel Levine, says ceding companies and reinsurers that use bank letter of credits to secure reinsurance reserve credit on their balance sheets are exposed to significant short-term liquidity and repricing risks that can pose significant negative credit consequences.

Both LOC and funded reinsurance trusts are used to collateralize reserve credit.

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

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

Consequently, the amount of collateral now in place may become inadequate as reserve requirements increase, Moodys says.

Thus, if the need increases when there is a rising cost of financing or a scarcity of collateral, 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, Moodys says, because they extend the current 1-year renewal risk that accompanies using a LOC. They are also an improvement over reinsurance trusts because the cost of funding is locked into a specific fixed term, Moodys adds.

Among the remedies in the Moodys report are: A redesign of products to reduce the level of the XXX/AXXX reserves, particularly with respect to UL no-lapse guarantees; slower new business growth; lower reserves through the adoption of the 2001 CSO Table; and, seeking LOC alternatives.


Reproduced from National Underwriter Life & Health/Financial Services Edition, January 23, 2004. Copyright 2004 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.