Debate Continues On Regulations

For VAs With Guarantees

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Proposed reserving and capital requirements for variable insurance products with guarantees continue to generate discussion over how to make sure that companies selling these products are financially strong without creating excessive capital hurdles.

The C-3, Phase II project moving through the National Association of Insurance Commissioners is raising issues such as how much capital is needed to back VA guarantees and how the new requirements may affect volatility as market fluctuations change the value of a guarantee for a consumer.

The American Academy of Actuaries, Washington, is working to develop reserving and capital actuarial projections that are part of the NAIC project, dubbed C-3, Phase II.

The NAIC defines C-3 risk as the risk of underestimating liabilities from business already written or inadequately pricing business to be written during the year that risk-based capital is being measured. Phase I of the project addresses interest rate risk. Phase II encompasses equity risk.

Under the proposal, companies would develop models to create different scenarios for the impact of equity markets on guarantees.

An alternative method using new actuarial tables could be used for VAs with minimum death benefits but not for those with living benefits. But once modeling was chosen by a company, it could not decide to use the alternative method for C-3 purposes.

New York regulators also are offering a standard scenario as part of requirements to ensure the financial strength of companies offering these products. Among the rationales offered are: reasonableness of results; reasonable constraints to actuarial judgment when models are used; and ensuring that requirements are not unreasonably low.

The New York proposal is being looked at for both RBC and reserving purposes. One part of that proposal is a 0.5% floor for RBC that would be applied to a formula using reserves. If regulators adopt the RBC guidelines, and a new reserving proposal, those reserving requirements would be used as part of the RBC formula. If the reserving proposal is not adopted and the RBC proposal is enacted, then the floor would be based on current reserving requirements.

But New York regulators said they are receiving feedback that refinement is needed to apply a lower percent to contracts with only a return of premium. Their next draft will probably reflect these comments, they added.

Indeed, Robert Meilander, vice president-corporate actuary with Northwestern Mutual Life Insurance Company, Milwaukee, said that although the scope of the proposal is to encompass all VAs, the floor was too high for products in which there was little risk such as return of premium contracts.

During the discussion, one company also stated it is projecting that its RBC requirements for GMDBs and GMIBs would increase tenfold, creating what it termed “excessive” capital requirements. The company, which was not named during the discussion, raised the issue of how rating agencies would treat this change.

Larry Gorski, a consulting actuary in the New Berlin, Ill., office of Claire Thinking and chair of the American Academy of Actuaries capital adequacy subcommittee, said the Academy was reaching out to rating agencies such as Standard & Poors Corp., New York.

The Academy is trying to get them to understand the proposal and components of the approach such as credit that would be given for hedging, he explained.

Gorski said concern that RBC requirements will increase dramatically needs to be taken in context. Currently RBC for guaranteed death benefits is zero, so any large increase is starting off a small base. While there are requirements in place for guaranteed minimum income benefits, the current formula does not recognize hedging, he continued.

The proposal, he added, really gives companies the opportunity to determine RBC because the amount of risk-based capital is determined by how sound and effective its hedging strategies are.

How final calculations are apportioned between capital and reserves is important to insurers, says Bill Schreiner, a life actuary with the American Council of Life Insurers, Washington. Reserves are important for reasons of federal income tax requirements while total capital helps determine the soundness of a company, he added.

Schreiner says that if the standard scenario is done correctly, then ACLI could support it. But, he continued, modeling work done by a company that involves testing of numerous scenarios should receive sufficient consideration.

Making capital requirements effective this year would not be appropriate, he said. The Academy still needs to produce information such as the treatment of hedging, Schreiner added.

Dave Sandberg, second vice president and corporate actuary with Allianz Life Insurance Company of North America, Minneapolis, offered a suggestion that capital requirements could be balanced with market disclosure.

And, according to those participating in the discussion, how the proposed changes could affect the volatility of capital is a consideration.

However, Bob Brown, a life actuary who is vice chair of the Academys capital adequacy subcommittee, says that some of these guarantees are similar to options reflecting changes in the market. Consequently, he explained, they need to be properly reserved.

Sheldon Summers, a life actuary with the California insurance department, asked whether there was a way to update factors in the alternative method to reflect changes in the marketplace. For instance, he said, viatical companies are buying contracts for more than the cash value because they are interested in the death benefit. It offers contract holders who are unhappy with a contracts performance a way to separate from the contract, Summers continued.

Doug Barnert of Barnert International, New York, said companies may choose to use the alternative approach because if they choose a modeling approach, they will not be able to switch to the alternative approach. Additionally, he said that small and medium-sized companies might decide to contract with larger companies to run models for them to reduce costs.

But, Gorski noted that if a company decided to use a service provider, then it would need to realize that because it could not change course, it would be a long-term arrangement.


Reproduced from National Underwriter Edition, May 14, 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.