Thermometer (Image: Thinkstock)

State insurance regulators may change the way they take the temperature of indexed annuity issuers.

Members of the Life Risk-Based Capital Working Group — an arm of the National Association of Insurance Commissioners (NAIC) — are talking about the idea of easing up on their current approach to calculating risk-based capital (RBC) ratios for indexed annuities that are regulated as fixed-rate insurance products, rather than as variable-rate securities.

(Related: Regulators Consider Young Annuity Index Rules)

Working group members talked about RBC treatment of indexed annuities Sunday, during a session in Orlando, Florida, at the NAIC’s spring national meeting.

NAIC Basics

The NAIC is a group for state insurance regulators.

State regulators are in charge of setting most rules for the business of insurance, but they often use NAIC models when developing their own insurance laws and regulations.

Regulators have developed RBC ratios to serve as a simple-to-use, standardized indicator of insurer health.

An RBC ratio is supposed to show whether an insurer looks as if it should have enough capital to meet its insurance and annuity obligations, after taking the apparent riskiness of its investments and other factors into account.

Indexed Annuities and RBC Ratios

The NAIC created the current formula for calculating RBC levels for fixed annuities and single-premium life insurance in C-3 Phase I, which was adopted in 2000. Regulators thought about applying the C-3 Phase I formula to indexed annuities but ended up keeping indexed annuities out of that formula.

Regulators and insurers have been using a different approach for calculating RBC ratios for indexed annuities.

Great American has now asked the working group to apply the C-3 Phase I RBC calculation strategy to indexed annuities, according to a conference call meeting summary included in the working group’s spring meeting document packet.

Yan Fridman, an actuary with Great American, has told members of the working group that regulators originally kept indexed annuities out of the C-3 Phase I rules because of a belief that the big problem with indexed annuities would be the volatility of investment indexes linked to the performance of the stock market.

Today, Fridman said, life insurers have shown that they can do a good job of managing stock market-related risk by using instruments such as derivatives to hedge their risk.

The real challenge the issuers have is risk related to the performance of bonds and other fixed-income holdings, which is the same risk they have when issuing traditional fixed annuities, Fridman said.

“Therefore, the C-3 Phase I scope should include indexed annuities without riders that are well-hedged without riders because this would recognize the benefit of well-matched assets and liabilities and result in the product being treated in a manner consistent with other fixed annuities,” according to the working group meeting summary.

Living benefits riders should still be excluded from the C-3 Phase I RBC calculation framework, because living benefits riders do involve exposure to equity risk, Fridman said, according to the meeting summary.

A Third Risk

Birny Birnbaum, director of the Center for Economic Justice, said he has concerns about applying the same RBC rules to indexed annuities as to traditional fixed annuities.

Traditional fixed annuities involve exposure to interest rate risk and mortality risk, Birnbaum said, according to the meeting summary.

Indexed annuities involve exposure to interest rate risk, mortality risk and hedging risk, Birnbaum said.

The costs of hedging are not fixed, and those costs may vary along with changes in economic conditions, Birnbaum said.

Resources

Links to Life Risk-Based Capital Working Group documents are available here, in the Meeting Materials section.

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