At issue: shadow account secondary guarantees (AP)

The NAIC has been concerned for months about a universal life product with secondary guarantees — sold by life insurance companies such as The Principal Financial and Lincoln National Corp. — that creates a situation where these companies are holding less than the statutory minimum reserve required.

According to discussions on the matter by the NAIC’s life actuarial task force (LATF), the companies are “artificially” increasing premiums used in the reserve calculations above the minimum premiums needed to keep the policy in force. This would reduce reserves below the minimum statutory requirement, they said.

The issue is coming to a head at the NAIC Fall National Meeting outside of Washington this week, and a decision whether to move forward on a position is expected shortly.

“Policy designs which are created to simply disguise those guarantees or exploit a perceived loophole must be reserved in a manner similar to more typical designs with similar guarantees,” the task force recorded in its March minutes.

Regulators want reserves to be established for the guarantees, the death benefits, provided by a universal life policy.

One prominent state actuary noted that he had seen a product filing in which the actuarial memorandum indicated that the reserves would be held according to Actuarial Guideline XXXVIII, but that the chart at the end of the document showed an interpretation of the guideline with reserves lower than those indicated by the guideline.

Kansas Insurance Department actuary Mark Birdsall said the universal life product in question was clearly designed to exploit a loophole and asked if the task force should consider a regulatory guidance document.

The LATF issued a statement on Sept. 9 that held that “some companies are holding reserves for universal life insurance products with shadow account secondary guarantees that do not fully reflect the benefits of the secondary guarantees as required pursuant to the NAIC model laws, regulations and actuarial guidelines…These reserves do not properly reflect the full benefits of the secondary guarantee as required by the law, regulation and guideline.”

This is known as the Statement on Actuarial Guideline XXXVIII (AG 38), the Application of the Valuation of Life Insurance Policies Model Regulation, or the Exposure.

The American Council of Life Insurers (ACLI) took issue with the direction of the task force and told it so.

“These statements are likely to be interpreted by outside parties to imply that some companies are holding inadequate reserves for these products,” it said in a letter Oct. 19, preceding a Wall Street Journal article this week.

Despite the heavy headlines, there is some word that the concern is with technical compliance, not asset adequacy.

“This issue… relates to the details of how to calculate formulaic reserves for a complex product design, and, to the best of our knowledge, is unrelated to reserve adequacy. Therefore a broad statement by a standard setting body is inappropriate…The assertions in the Exposure are potentially very damaging and could have serious negative consequences with various audiences (including rating agencies, analysts, agents, policyholders, etc.),” the ACLI stated.

“Such assertions have no place in a public document issued by the NAIC,” the association admonished. The letter was written by ACLI actuary John Bruins and addressed to Leslie Jones, chair of the LATF and a South Carolina Department of Insurance’s deputy director and chief actuary.

Affected life insurers agreed, also noting that the LATF statement could override state insurance regulators and that retroactively applying the new standard, if adopted, would be simply unfair.

Also, because the LATF statement does not address all design types, insurers worried it could leave companies uncertain as to what designs and reserve situations are acceptable.

Genworth Financial, one of the companies issuing the policies, told the task force that rules-based reserve approaches like the AG38 guidance, as it is called, do not work well for products like universal life with secondary guarantees. Genworth said the principles-based reporting (PBR) approach under development will be much more effective in establishing reserve levels that are appropriate in view of the insurance risk assumed.

PBR would require insurers to use actuarial judgment and statistical forecasting to monitor and manage their finances, rather than relying on static formulas and cut-offs.

Lincoln Financial Group said the adoption would cause unnecessary harm to consumers if adopted, as well as harm to the reputation of domestic regulators.

It was state regulators who approved these products, after all.

The Principal Financial Group stated in its 6-plus page letter to the task force, which was cc’d to top NAIC executives, that the NAIC should find a way whereby insurance companies can rely upon their domestic regulators. “A regulatory environment which allows non-domestic regulators to revisit historical domestic regulator decisions, or insurance company reserving practices, years after the fact is inefficient and unfair,” it said.

The statement says “These reserves do not properly reflect the full benefits of the secondary guarantee as required by the law, regulation and guideline.”

Yet, in making this assertion, LATF provides no clear legal or regulatory support of its claim, The Principal’s actuary wrote, and it does not link to what the regulation and actuarial guidelines actually say.

Minimum premiums are defined explicitly in the NAIC’s Model Regulation as the premium that, when paid into a policy with a zero account value at the beginning of the year, produces a zero account value at the end of the policy year.

Neither the Model Regulation nor AG38 makes any reference to using the lowest schedule of premiums when determining the minimum gross premiums, the company pointed out.

“This is a new regulatory requirement that, if ultimately agreed upon by state regulators, should be applied to new business only on a prospective basis through a revision to AG38,” The Principal’s letter stated.

Birdsall had been alarmed, though, the March minutes reveal. He called the fact that the products under discussion were developed after the changes to the guideline “unconscionable” and discussed reporting actuaries that developed these products to the Actuarial Board for Counseling and Discipline (ABCD).

South Carolina’s Jones said that if members of the task force thought there was a clear violation of the spirit and intent of the guideline, the LATF should consider contacting the ABCD to determine whether counseling is in order.

After further discussion, the task force then adopted a motion to draft a referral to  the ABCD regarding the professional responsibility of an actuary in setting reserves on universal life products with secondary guarantees using the methodology in Actuarial Guideline.

However, in late summer conference calls, the LATF decided not to move forward on the ABCD referral. Two regulators seconded that the task force not take the action directed at the NAIC Spring National Meeting relative to a referral to the ABCD. The motion passed unanimously.

The issue is not expected to affect mutual insurance companies with huge reserves.