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Proposal Could Ease Variable Annuity Hedging Rules

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State insurance regulators may break away from the accounting rule crowd and adopt their own rules for life insurers that offer variable annuities with guaranteed benefits.

The change could affect what a life insurer has to say when the value of a derivative contract goes up or down.

An accounting rule team at the National Association of Insurance Commissioners will be talking about the proposed change Saturday, in Boston, at the NAIC’s summer national meeting.

(Related: State Regulators to Look at Variable Annuity Draft)

The American Council of Life Insurers (ACLI) is asking the NAIC to have the proposed change take effect Jan. 1, 2019.

State regulators say they want more time to work on the proposal.

The NAIC staffers working on the proposal are emphasizing that, if insurers end up using the proposed rules, those insurers will have to include explicit disclosures, to help regulators understand how the insurers’ financial reporting is different from what would normally be required by U.S. Generally Accepted Accounting Principles (GAAP), International Financial Report Standards (IFRS), or the NAIC’s Statutory Accounting Principles (SAP).

“The provisions proposed are significantly different from what is currently allowed under SAP, U.S. GAAP and IFRS,” the NAIC staffers write.

Derivative Accounting Basics

A derivative contract is a financial instrument designed to pay off when something, such as an interest rate benchmark, changes.

Life insurers often use derivatives contracts to meet VA benefits guarantees obligations.

If, for example, interest rates fall much more than a VA issuer expects, an interest-rate-based derivative contract could pay of. The insurer could use the cash to cover the cost of keeping withdrawal benefits at the minimum guaranteed level.

An arm of the NAIC, the Statutory Accounting Principles Working Group, has been working on an update of the accounting rules that apply when the value of an insurer’s VA hedging derivative goes up or down.

The Draft Guidance

U.S. and international accounting regulators have been pushing organizations to “mark prices to market” as much as possible.

Life insurers argue that taking that approach for the derivatives used in VA guarantee hedging often produces misleading results.

The Statutory Accounting Principles Working Group posted a draft of an “issue paper,” or batch of guidance, reflecting that view in March.

One provision, for example, could change the timing of hedge value change reporting. Instead of reporting value gains or value drops all at once, an insurer could “amortize,” or spread, the effects of the value change over a 10-year period.

An insurer would implement that provision by treating a fluctuation in the value of derivative contract as a “deferred asset” or as a “deferred liability.

NAIC staffers say in a note that the ACLI would like insurers to be able to spread the value of derivative contract value fluctuations over the entire duration of the VA guarantee being hedged, not just for 10 years.

The NAIC staffers say they prefer a 10-year amortization period for the VA hedge deferred assets and deferred liabilities.

The derivative value fluctuations could be big enough to affect how a regulator sees an insurer, and “these deferred assets/liabilities do not meet the definition of actual assets or liabilities,” the staffers write.

More information about the issue paper draft is available here, in the VA derivatives agenda packet.

Why This Is Important

Life insurers make heavy use of bonds, stock indexes, bond indexes and derivatives to back their annuity guarantees.

Any rule changes that affect the cost, complexity or ease of hedging could affect the cost of annuities, or how eager life insurers are to offer some types of annuities, annuity crediting options, or annuity benefits guarantees.

— Read New Derivatives Rules Raise Life Insurers’ Collateral Needson ThinkAdvisor.

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