New York secedes from Principles Based Reserving
New York is letting the Joint Working Groups principles-based reserving (PBR) expire as of today and will revert to its previous way of calculating reserves for triple X insurance.
Benjamin Lawsky, New York State's superintendent of financial services, announced his intention to fellow state insurance regulators in a letter earlier this week.
Lawsky’s decision means that life companies will have to add an estimated $4bn to the reserves they hold backing triple X life insurance. The total amount could ultimately be higher if regulators in other states decide to join Lawsky’s lead.
Also called universal life with secondary guarantees (ULSG), triple X offers both death benefits and a cash value to policyholders. Due to the highly flexible of its design, for many years it has been subject to questions about the amount of reserves that insurers should be required to hold to back it.
In a bid to address the issues the National Association of Insurance Commissioners (NAIC) passed Regulation 30 in 2000 which was adopted by 40 states. Known as Triple X, the rule required life insurers to increase the reserves on their term life insurance policies beyond the economic reserves.
The unexpected result was that life insurers were saddled with redundant reserves which escalated year by year.
In a bid to avoid tying up their own capital, life insurers turned to captives, which allowed them to securitise the reserves in the capital markets or negotiate a letter of credit with a bank i.e. to use outside money to capitalize the reserve obligation.
In acknowledgement of this on 2 December 2012 the NAIC voted to approve a new Valuation Manual containing details of a “principles-based” rather than a “formula-based” approach to life insurance company reserves.
The vote passed with 43 to 8 – one vote more than the 42-vote supermajority required for adoption. Significantly, among the “no” votes were the insurance commissioners from two the commercially important states of California and New York.
Recognizing the need for further study, the NAIC formed a Joint Working Group of the Life Insurance and Annuities (A) Committee and Financial Condition (E) Committee to oversee the study process and address critics’ concerns.
New York's decision to secede is important because the Valuation Manual (and the PBR approach it contains) will not become effective unless it is enacted into law by legislatures in at least 42 states representing more than 75% of US direct premiums written for life, annuities and health insurance. California and New York oversee the largest segment of life premiums written in the U.S.
Proponents of PBR, including the NAIC, contend that it tailors the reserving process to specific products, rather than using a “one size fits all” approach that can lead to over- or under-reserving, a stifling of innovation and artificial inflation of rates.
However critics, such as Lawsky, claim PBR has resulted in an overall reduction of reserves that will ultimately diminish the security of policyholders and lead to an increase in insurer insolvencies.
Lawksy was particularly scathing about the use of captive facilitated securitisation by triple X insurers to manage reserves, terming it ‘financial alchemy’.