NAIC’s Draft Framework for Strengthening US Life Insurance Reserving Is Credit Positive

NAIC’s Draft Framework for Strengthening US Life Insurance Reserving Is Credit Positive

On 13 January, the joint working group of two committees of the National Association of Insurance Commissioners (NAIC) published a draft framework for establishing regulatory guidelines to evaluate reserves for secondary guarantee and term universal life products. If adopted, the framework will be credit positive for insurers because new business written will likely require higher reserves, which will be established by applying a formulaic reserving methodology.

Reserves for the existing blocks of secondary guarantee and term universal life products would be grandfathered, provided that asset adequacy tests (actuarial based cash flow projections) indicate that current reserves are sufficient.

The formulaic approach applied to new business complies with the Life Actuarial Task Force’s interpretation of Actuarial Guideline 38 (the requirement for setting reserves for universal life insurance) and would generally call for reserves at a substantially higher level than under the asset adequacy testing approach. For new business, the formulaic approach would also give rise to a more level playing field by enforcing more uniformity in setting universal life reserves, even if it results in companies seeking to finance or reinsure the additional “non-economic” reserves. The proposed framework would use the formulaic method until principles-based reserving goes into effect, an event that could be several years away.
The framework developed by the Joint Working Group of the Life Insurance and Annuities Committee and the Financial Condition Committee of the NAIC ensures appropriate reserves for existing business, which would become closed blocks, by employing asset adequacy testing by the companies’ actuaries, making use of moderately adverse scenarios. If the asset adequacy testing indicates a future shortfall, the insurer would need to increase reserves. The grandfathering approach would also allow insurers the time to adapt to the reserving requirements for new business. To remain profitable and competitive in these life insurance products, some insurers may need to adjust capital plans, product designs and marketing strategies, as well as secure financing solutions for any additional “non-economic” reserves.

A related prior proposal under consideration in November 2011 could have forced a number of companies to immediately add significant reserves for existing business by retroactively applying a formulaic reserve methodology. While we typically view higher reserves as a credit positive, putting up additional reserves for existing business that had been priced under a different reserving methodology would have been a credit negative because it would have constrained capital positions and disrupted business operations. In addition, it would not have meaningfully improved policyholder protection because we expected many companies would finance these “non-economic” reserves by reinsuring them to captive reinsurers rather than strengthening their capital position to build higher reserves.