BILL ANALYSIS Ó
SENATE COMMITTEE ON INSURANCE
Senator Richard Roth, Chair
2015 - 2016 Regular
Bill No: SB 696 Hearing Date: April 22,
2015
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|Author: |Roth |
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|Version: |April 14, 2015 |
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|Urgency: |No |Fiscal: |Yes |
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|Consultant:|Hugh Slayden |
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Subject: Insurance: principle-based valuation
SUMMARY Replaces the current method of calculating contract reserves
for life insurance products with a new method, Principle-Based
Reserving (PBR), for some types of life insurance policies
issued on or after the effective date, as specified.
DIGEST
Existing law
1. Sets minimum benefit values when policies are surrendered or
lapsed (referred to as "nonforfeiture benefits").
2. Requires every life insurer doing business in California to
annually submit to the Insurance Commissioner (IC) the opinion
of a qualified actuary as to whether the "reserves" (assets set
aside to pay future claims) are calculated appropriately, based
on assumptions that satisfy contractual provisions, consistent
with prior reported amounts, and in compliance with applicable
state law.
3. Requires insurers to calculate reserves according to a
statutory method, known as the "Net Premium Reserve Method,"
using a formula, specified mortality tables approved by the IC,
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and method for calculating the applicable interest rates, for
the purpose of determining reserves required by law for various
types of life insurance contracts.
This bill
1. Requires the IC and life insurers to incorporate a new
methodology known as Principle-Based Reserving that employs
a specified manual of valuation instructions, known as the
Valuation Manual (VM), adopted by the National Association
of Insurance Commissioners (NAIC) in making determinations
relating to reserve requirements and the minimum standard of
valuation for policies and contracts, as specified.
2. Requires insurers to calculate reserves using PBR for
policies issued after the effective date of the VM.
3. Requires an insurer to annually submit to the IC the
opinion of a qualified actuary as to whether the reserves
are calculated appropriately and that the opinion be
governed by the VM and other applicable standards.
4. Requires a company to establish reserves subject to PBR
that meet specified conditions in the VM, including
quantifying the benefits, guarantees, and funding associated
with the contracts, and requires the company to develop and
file with the IC upon request, a principle-based valuation
report.
5. Requires an insurer to submit mortality, morbidity,
policyholder behavior, or expense experience, and other data
as prescribed in the VM.
6. Grants the IC the authority to adopt tables of select
mortality factors and rules for use by issuing a bulletin or
through the adoption of regulations, and declares the
Legislature's intent that those rules be consistent with the
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NAIC's Valuation of Life Insurance Model Regulation 830.
7. Provides that the VM goes into effect January 1 the year
after it has been adopted by the NAIC by an affirmative vote
of at least 42 members, or three-fourths of the members
voting, whichever is greater, so long as it was adopted by
July 1 of the preceding year.
8. Provides that the PBR goes into effect when enacted by
states representing greater than 75 percent of the direct
premiums written and at least 42 of the 55 jurisdictions
(including U.S. states and some territories).
9. Establishes a process for amending the VM.
10. Requires that the VM include minimum valuation standards;
establishes criteria for which method applies to particular
policies or contracts and specifically which ones are
subject to PBR; establishes rules on how to treat
assumptions of risk for which the company has little to no
control; imposes procedures for corporate governance and
oversight of the actuarial functions; and sets standards for
products not subject to PBR.
11. Requires reserves subject to PBR to incorporate:
a. A level of conservatism that reflects conditions that
include unfavorable events that have a reasonable
probability of occurring; assumptions, risk analysis
methods, and financial models and management techniques
consistent with those utilized within the company's
overall risk assessment process.
b. Assumptions prescribed in the VM, and if not
prescribed, assumptions established utilizing the
insurers' available experience, to the extent it is
relevant and statistically credible, or data established
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utilizing other relevant, statistically credible
experience that provide margins for uncertainty including
adverse deviation and estimation error.
12. Requires insurers to establish procedures for corporate
governance and oversight of the actuarial valuation function
consistent with those described in the VM.
13. Requires the insurer to develop, and file with the IC upon
request, a PBR report that complies with standards
prescribed in the valuation manual.
14. Authorizes the IC to engage a qualified actuary, at the
expense of the insurer, to perform an actuarial examination
of the insurer and provide an opinion on the appropriateness
of any reserve assumption or method used, or to review and
provide an insurer's opinion on compliance with reserving
requirements.
15. Authorizes the IC to require an insurer to change any
assumption or method necessary to comply with the VM or
applicable law, and adjust the reserves as required. Also
authorizes the IC to take other disciplinary action as
permitted by all other applicable laws.
16. Exempts specified documents and information, with some
exceptions, that are submitted under the PBR process from
subpoena, disclosure under the Public Records Act, civil
discovery as applied to the IC, and prohibits documents and
information from being admitted into evidence in a civil
proceeding.
17. Authorizes the IC to hire and assign department staff,
including one exempt position, and retain nondepartmental
actuaries and other consultants, to assist in the
implementation of PBR.
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18. Establishes an annual assessment on each participating
insurer, effective when the bill (not PBR) goes into effect,
that is capped according to the insurer's volume of
business, to pay for additional staffing and resources to
implement PBR.
19. Coordinates the assumptions used to determine nonforfeiture
benefits with those used to determine reserves under PBR
when applicable.
20. Makes numerous, clarifying, technical, and stylistic
changes.
21. Makes legislative findings regarding the need to protect an
insurer's proprietary information and keep information
received by IC confidential.
COMMENTS
1. Purpose of the bill SB 696 would allow life insurers to
utilize Principle-Based Reserving to calculate the funds set
aside to pay future claims. Stakeholders agree that the
current method does not provide reserves that meet the risks
for some types of life insurance products. PBR is intended
to "right-size" reserves for those products.
2. Background In order to make sure that life insurers have
sufficient funds to pay future claims, they are required by
law to set aside sufficient assets, "reserves," to pay
anticipated liabilities. Since only a portion of
outstanding policies will pay benefits, it is not necessary
to set aside funds to pay the entire benefit, but enough to
ensure payment of future claims given the probabilities
related to claims, probable investment income on the assets,
future premium to be received, reinsurance agreements (where
one insurer assumes risks from another insurer) and other
factors. The Standard Valuation Law (SVL) establishes
methods required by law to calculate reserves. Currently,
most life insurance products are subject to the method
within the SVL known as the Net Premium Reserve Method
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(NPRM). The NPRM applies in a similar manner to all
insurers and most products. SB 696 would add a new method
to the Standard Valuation Law, known as Principle-Based
Reserving (PBR), that would consider the actual experience
of the insurer and incorporates many factors not considered
by NPRM.
Net Premium Reserve Method (NPRM). The current formula
reflects an almost 150-year-old method originally designed
for whole life insurance policies. Whole life policies have
no termination date and are intended to remain in effect
until the death of the insured and payment of the death
benefit. The Net Premium Reserve Method (NPRM) is
prescribed by law utilizing an inflexible formula and
operates on standardized assumptions, such as life
expectancies established by mortality tables and anticipated
investment income determined by interest rates established
in statute. Any factual input is based on data collected
across the life insurance industry and may not reflect the
actual experience of the insurer. The NPRM does not account
for random fluctuations. NPRM has worked well for
traditional life products intended to be held for the
insured's entire life and have relatively simple terms.
However, life insurers offer a variety of life insurance
products that involve a variety of complexity and different
risks. For example, term life insurance policies expire
after a specified period and appeal to consumers who are
more likely to give up the policy as they get older; they
also cost less for the same death benefit because they pose
less risk of loss to the insurer. Insurers argue that the
NPRM does not adequately account for specific liabilities of
different products resulting in excessive reserving for some
and under-reserving for others.
NPRM may limit insurer's options for designing more complex
products. Additionally, the potential for over-reserving
caused by the NPRM encourages some insurers to engage in
creative accounting practices that take advantage of
weaknesses in the interstate insurance regulatory system.
The NAIC white paper, titled Captives and Special Purpose
Vehicles, describes how some life insurers use captive
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reinsurers domiciled in other states or countries to avoid
"perceived reserving redundancies." This technique is a
form of creative accounting permitting an insurer to set
aside fewer reserves by shifting some risk to a wholly-owned
subsidiary subject to weaker regulatory standards. The
white paper suggests that PBR will make the use of a
captive, which is an additional operating expenses, less
attractive for policies issued once PBR is implemented.
Principle-Based Reserving. Under PBR, the insurer proposes
a valuation method based on its experience with that product
and other factors specific to the product and insurer. PBR
requires insurers to submit to regulators detailed modelling
and analysis specific to that product; the insurer proposes
its own reserve requirements for evaluation by the
regulator. Unlike the current NPRM, PBR incorporates
"stochastic" modeling for many types of policies that
incorporates random variations observed in historical data.
To develop this model, insurers must run a large number of
simulations (in contrast to NPRM that involves plugging in
standard assumptions into a formula). PBR allows the
insurer to use its own data on mortality and policyholder
behavior if it can prove that the data is credible.
The PBR method is structured according to a detailed manual,
called the Valuation Manual (VM). The VM contains the
details, rules and standards that the insurer must follow.
The VM incorporates a review and updating process to ensure
ongoing evaluation of the effectiveness of the PBR
methodology.
Once the modeling is complete, insurers would be required to
hold the higher of (1) a baseline reserve similar to the
current NPRM that applies to a product or type of product
prescribed by the VM or (2) the reserve calculated according
to insurer's model.
By incorporating variables that NPRM misses, PBR is supposed
to provide greater flexibility to design less conventional
products. According to the NAIC, PBR is a critical element
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to paving the way for new multi-benefit products that can be
more flexible and valuable to consumers, including life
insurance policies that can convert to annuities upon
retirement, products that could cover an entire family for
life insurance, or that could provide life insurance
protection for one person while simultaneously providing
retirement income to a parent or to pay for home or nursing
home care.
The IC must review these figures, models, data, and
assumptions for approval. The individualistic PBR approach
is much more labor intensive for the regulator. This bill
provides for an assessment (capped according to the
insurer's volume of business) on each participating insurer
to offset CDI's costs related to the workload resulting from
the transition to PBR. The assessment begins immediately,
even though full implementation of PBR will not occur for
several years, in order to give CDI the resources to build
the staff and infrastructure needed to conduct thorough
examinations. SB 696 also empowers the IC to hire
independent actuaries for additional analysis (at the
insurer's expense), requires insurers to change assumptions
or methods not consistent with the VM or the Standard
Valuation Law, and establishes specific valuation
requirements when needed.
Two studies examined the potential impacts of PBR on variety
of products and both suggest similar results. Both studies
are based on a prior version of the VM; according to the
Association of California Life and Health Insurance
Companies, while some additional edits have been made to
refine and clarify the requirements, it is doubtful those
changes had a material impact on the testing conclusions.
The studies, Presentation and Analysis of Results of VM - 20
Impact Study on Principle - Based Reserves for Life
Insurance Products (March 15, 2012) sponsored by the NAIC
and VM-20 Impact Study Compendium (February 2012) sponsored
by the American Council of Life Insurers, generally indicate
that PBR would lower reserves for term life insurance, have
mixed results for universal life insurance with secondary
guarantees (ULSG), and would not affect many other types of
products. (ULSG are sophisticated policies that provide the
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policyholder flexibility to adjust premium amount and
frequency, as well as the death benefit, but also contain a
lapse protection feature.) According to the NAIC's Impact
Study, PBR would result in an initial decrease of total life
insurance reserves of less than 5% because it would only
apply to new business, but that reduction would grow as more
policies become subject to the new reserving method.
States would not implement PBR until at least 42 of the 55
jurisdictions of the U.S. (including Guam, U.S. Virgin
Islands, etc.) representing 75% of total U.S. premium adopt
the NAIC model. According to Pacific Life Insurance
Company, 25 states have already adopted the model act. Once
PBR reaches the threshold, the changes will be implemented
over approximately three years and only for new business.
New York will not implement PBR, but it has significantly
lowered reserve requirements on some policies. Because of
its market share, California's participation is essential
for implementation of PBR nationally.
PBR would require insurers to provide the IC with very
sensitive and confidential information not required under
the NPRM. With some exceptions, documents and information
submitted under the PBR process would not be subject to
subpoena, disclosure under the Public Records Act, the civil
discovery process, and could not be admitted into evidence
in a civil proceeding. However, these protections only
apply to materials obtained by the IC and would not affect
the ability of a litigant to obtain information or documents
through other means. The bill has been double-referred to
the Committee on Judiciary that will further consider these
provisions.
PBR significantly increases the expense to calculate
reserves for insurers and CDI. Smaller insurers might not
have the up-front resources to implement PBR as effectively
as larger insurer potentially providing larger insurers a
market advantage. The NAIC is currently considering
exemptions for smaller companies to be incorporated into the
VM, but recommends against incorporating exemptions into
statute.
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3. Support The Association of California Life and Health
Insurance Companies and the American Council of Life
Insurers state that PBR would provide a uniform approach to
reserve calculations that more realistically reflects the
risks, variables, and changes in consumer behavior that
affect the value of cash reserve calculations. This in turn
leads to more flexible product designs, greater consumer
choice, and could improve pricing.
4. Opposition None received.
POSITIONS
Support
Association of California Life & Health Insurance Companies
(co-sponsor)
California Department of Insurance (co-sponsor)
American Council of Life Insurers
Pacific Life Insurance Company
United Services Automobile Association (USAA)
Oppose
None received.
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