BILL ANALYSIS Ó ----------------------------------------------------------------- |SENATE RULES COMMITTEE | SB 696| |Office of Senate Floor Analyses | | |(916) 651-1520 Fax: (916) | | |327-4478 | | ----------------------------------------------------------------- THIRD READING Bill No: SB 696 Author: Roth (D) Amended: 5/5/15 Vote: 27 SENATE INSURANCE COMMITTEE: 7-0, 4/22/15 AYES: Roth, Gaines, Berryhill, Hernandez, Liu, Mitchell, Wieckowski NO VOTE RECORDED: Hall SENATE JUDICIARY COMMITTEE: 6-0, 4/28/15 AYES: Jackson, Anderson, Hertzberg, Leno, Monning, Wieckowski NO VOTE RECORDED: Moorlach SENATE APPROPRIATIONS COMMITTEE: 6-0, 5/28/15 AYES: Lara, Beall, Hill, Leyva, Mendoza, Nielsen NO VOTE RECORDED: Bates SUBJECT: Insurance: principle-based valuation SOURCE: Association of California Life & Health Insurance Companies California Department of Insurance DIGEST: This bill replaces the current method of calculating reserves for some types of life insurance products, including whole and term life insurance policies, with a new method known as Principle-Based Reserving applicable to contracts issued on or after the effective date, as specified. SB 696 Page 2 ANALYSIS: Existing law: 1) 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. 2) Requires insurers to use a prescribed formula, specified mortality tables approved by the IC, and method for calculating the applicable interest rates for the purpose of determining reserves required by law for various types of life insurance contracts. 3) Sets minimum benefit values when policies are surrendered or lapsed (referred to as "nonforfeiture benefits"). This bill: 1) Requires the IC and life insurers to incorporate a new method known as Principle-Based Reserving (PBR) for calculating reserves that employs a specified manual of valuation instructions, known as the Valuation Manual (VM), as adopted by the National Association of Insurance Commissioners (NAIC). 2) 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). SB 696 Page 3 3) Requires insurers to calculate reserves using PBR for policies issued after the effective date of the VM. 4) Establishes a process for amending the VM and for determining the effective date of the VM. 5) 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. 6) Requires reserves subject to PBR to reflect potentially unfavorable condition and describes appropriate sources of data acceptable when establishing assumptions not otherwise prescribed in the VM. 7) 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. 8) Requires a company to establish reserves subject to PBR that meet specified conditions in the VM and requires the insurer to develop and file with the IC upon request, a principle-based valuation report that complies with standards prescribed in the VM. 9) Requires an insurer to submit mortality, morbidity, policyholder behavior, or expense experience, and other data as prescribed in the VM. SB 696 Page 4 10)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 opinion on compliance with reserving requirements. 11)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. 12)Authorizes the IC to take other disciplinary action as permitted by all other applicable laws. 13)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. 14)Authorizes the IC to hire and assign department staff, including one exempt position, and retain outside actuaries and other consultants, to assist in the implementation of PBR. 15)Establishes an annual assessment on each participating insurer, effective when this bill goes into effect, that is capped according to the insurer's volume of business. 16)Coordinates the assumptions used to determine nonforfeiture benefits with those used to determine reserves under PBR when applicable. 17)Makes numerous, clarifying, technical, and stylistic changes. SB 696 Page 5 Comments 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. It is not necessary to set aside funds equivalent to the entire life insurance benefit, but enough to ensure payment of future claims given the probabilities related to claims, investment income on the assets, future premium to be received, reinsurance agreements (where one insurer assumes risks from another insurer) and other factors. Existing law establishes methods required by law to calculate reserves that apply in a similar manner to all insurers and most products, and that operates on standardized assumptions, such as life expectancies established by mortality tables developed using industry-wide data and formulas used to anticipate investment income. The current method has worked well for many products, especially traditional whole life products with basic terms. However, life insurers offer a many types of 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 and regulators recognize that the current method does not accurately measure reserving needs of some products and results in excessive reserving for some products and under-reserving for others. This bill codifies the PBR, a new method defined in the Model Standard Valuation Law adopted by the NAIC, intended to determine more accurate reserving requirements. The language lays out a framework but the actual method is structured according to a detailed manual, the VM. The most current version of the VM was adopted by the NAIC in December of 2012. Under PBR, the insurer proposes a valuation method and reserve requirement based on its experience and other factors specific to the product and insurer. The insurer's proposal would include detailed modelling and data that has been run through SB 696 Page 6 numerous simulations reflecting a variety of economic conditions. The IC must review and approve the model, figures, data, and assumptions. Because PBR is much more labor intensive for the Department of Insurance (CDI), this bill establishes an assessment on each participating insurer (capped according to the insurer's volume of business) to offset the additional workload. SB 696 also empowers the IC to hire independent actuaries for additional analysis at the insurer's expense, require insurers to change assumptions or methods inconsistent with the VM or applicable law, and establish specific valuation requirements when needed. Two studies, one sponsored by the NAIC and one by the American Council of Life Insurers suggest 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 policyholder flexibility to adjust premium amount and frequency, as well as the death benefit, but also contain a lapse protection feature.) States would not implement PBR until at least 42 of the 55 NAIC jurisdictions (including Guam, Puerto Rico, etc.) representing 75% of total U.S. premium adopt the NAIC model. At least 26 jurisdictions have adopted the model act. FISCAL EFFECT: Appropriation: No Fiscal Com.:YesLocal: No According to the Senate Appropriations Committee: CDI estimates administrative costs of $389,000 in FY 2015-16; $1.6 million in FY 2016-17; and $1.0 million in FY 2017-18 and ongoing (Special Fund). The CDI estimates the above costs for promulgating regulations, and for the hiring of additional staff to review and approve all participating companies' detailed modeling. In addition, SB 696 authorizes the CDI to hire an expert in principle-based SB 696 Page 7 valuation and specifies that this individual will be exempt from the state civil service system, thereby authorizing the CDI to fix salary and compensation without approval of the Department of Human Resources. A preliminary estimate for total compensation is approximately $300,000. SB 696 authorizes the CDI to annually assess all insurers to defray costs incurred preparing to implement, and implementing, principle-based valuation including department salaries and overhead, and consultant fees and expenses. The assessment will be set by an aggregate assessment in tiers based on the insurers annual premiums, and will total at least $1 million annually. SUPPORT: (Verified 5/29/15) Association of California Life & Health Insurance Companies (co-source) California Department of Insurance (co-source) American Council of Life Insurers Pacific Life Insurance Company United Services Automobile Association OPPOSITION: (Verified5/29/15) None received ARGUMENTS IN 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. Prepared by:Hugh Slayden / INS. / (916) 651-4110 5/31/15 9:04:41 SB 696 Page 8 **** END ****