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Life Health > Life Insurance

New York issues heavy-duty warning against PBR

By Elizabeth D. Festa

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UPDATE: California weighs in as well, comment from Tennessee’s Department of Commerce and Insurance spokesman for Life (A) Committee Chair Julie Mix McPeak (p. 2). 

New York Department of Financial Services (DFS) Superintendent Benjamin Lawsky launched a warning to his insurance commissioners about principles-based reserving (PBR) in a November 26 letter near the eve of the NAIC national meeting where the state-based organization is gathering to adopt as an organization the pivotal Valuation Manual that helps set PBR in motion.

Lawsky said they all should be able to say with a straight face that PBR is the right move, or there could be major solvency issues in the future.

In addition, California Insurance Commissioner Dave Jones also sent a letter to fellow commissioners November 26 expressing concern that regulators may not be effectively prepared to evaluate the reserving models developed by individual companies or have the resources to perform effective oversight, leaving the industry pretty much on tis own to develop its own reserves. Jones wants a study on additional costs and resources needed for departments to ensure that the new PBR computer models can be understood and evaluated by state regulators. 

The more deeply skeptical New York letter is a shot across the bow at the NAIC as the timing is critical—if the Valuation Manual does not gain adoption this year or very early next year, it will be hard to get the many states needed to enact it to do so—legislative sessions are starting up in January and in some states, the legislature won’t be back in 2014. The adoption has been a moving target all year, with revisions and edits powering through to the understood finish line of year-end 2012.

Forty-two state bodies need to pass it so that it can become the defacto model of reserving by 2015. California is not voting yes on the Valuation Manual, Jones says, until its resources issues to actually do its job with PBR as regulators have been addressed by the NAIC/Life Insurance and Annuity Committee.

NAIC staff and key state regulators shepherding the process through were unavailable for comment. The item is on the agenda for the Sunday, December 2, Executive/Plenary meeting, but it is unclear if it has the necessary votes. No one wanted to go on the record to discuss its chances.

Under PBR, reserves will decrease, and the risk of insurer insolvency in the life insurance industry will increase, warned Lawsky, who has expressed in the past heightened concern about solvency amid various reserving issues now at play in the life insurance industry.

But before moving away from a proven regulatory regime, insurance regulators ought to understand exactly “(1) how PBR works; (2) how to administer it; (3) what PBR means for the companies they regulate and the industry at large; and (4) be able to say with a straight face that it is at least as good, if not better, than the rules-based system that currently is in place,” Lawsky told his fellow state regulators.

Lawsky arrived to one of his first NAIC national meetings (if not his first) last November, also at National Harbor, with concern about Actuarial Guideline 38 and how some companies were reserving for universal life with secondary guarantees, for instance. Heads of life insurance trade associations and key industry people approached him after general sessions to chat up the AG 38 issue, which was ready to blow up before being taken under the wing of a joint committee of executive-level regulators and industry consultants.

Lawsky, whose department actuaries have long expressed caution about various current or planned practices of life insurance reserving said that PBR does not adequately support product risk, on issues from AG 38 to captive insurance use to offload reserves and free-up capital, they offered reasons why regulators should not “plow forward” with PBR. He even raised the specter of the 2008 financial crisis.

PBR in the banking sector proved “disastrous,” he wrote, noting that while banking is different from insurance the appeal is the same to the industry. Lawsky is also top state regulator for New York banks.

PBR, with its less formulaic approach and its company driven models may seem attractive, but when the industry transitioned under the Basel 2 regime in the early 2000s to a framework also of  ”principles based reserving,” failure ensued, Lawsky told commissioners.

Indeed, banks like Lehman Brothers that reduced their reserves under the Basel II regime were hit hardest by the financial crisis, he said.

Moreover, he wrote, state regulators are ill equipped at present to implement and oversee PBR.

“There is universal agreement-among state regulators, the insurance industry, and even the American Academy of Actuaries-that the administration of a PBR reserving regime will create significant challenges for state insurance regulators,” Lawsky wrote, and many departments lack actuaries or experts to police or administer the PBR framework (New York’s DFS is richer in actuaries than most).

Lawsky noted that many states, on both ends of the political spectrum, have expressed apprehension about moving forward with PBR unless and until state insurance regulators across the board have a concrete understanding of the resource drain and cost that administration of PBR will inevitably require.

Christopher Garrett, a spokesman for Life Committee Chair and Tennessee Insurance Commissioner Julie Mix McPeak responded by stating that, “PBR is the product of a deliberative process lasting more than six years and bolstered by input from regulators, legislators, actuarial associations, and consumer and industry organizations and associations. 

“Conservative, long-term safeguards in PBR are designed to ensure that reserves are appropriate. In fact, some actuaries have argued that PBR might verge on being too conservative,” he argued.

McPeak, who also is commissioner of Tennessee’s Department of Commerce and Insurance, has said that the Valuation Manual is not intransigent but that it can be modified as situations warrant.

“Continuing to delay PBR neither helps consumers who, under its implementation, might see more affordable and more innovative products, nor benefits an industry that is required to keep artificially high reserves for certain product lines. Instead, under PBR, companies could direct formerly excess reserves toward innovation, research and reduced premiums for customers,” Garrett said.

Lawsky did offer a compromise approach, but it is unclear how it will be taken and whether his letter is enough to shake adoption of the Valuation Manual at this meeting or this year, effectively delaying PBR.

If, Lawsky said, a supermajority of state regulators are at this time resolved to plow forward with PBR, then at least we as commissioners ought to do the following: run the PBR and rules-based approaches in parallel for at least a three-year period, while still booking the numbers from the current system, before making a final, irrevocable commitment to PBR.”

“Given the importance of the solvency and soundness of the life insurance industry to ordinary Americans, state insurance regulators need to be careful about removing the current regulatory scaffolding and replacing it with a structure whose ramifications are not clearly and fully understood,” Lawsky wrote.

McPeak had indeed noted earlier this month that the Valuation Manual is still a work in progress while speaking during the most recent teleconference meeting this month. She pointed to the continuing work of the Life Actuarial Task Force (LATF) to address issues through the amendment process.

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