BILL ANALYSIS                                                                                                                                                                                                    Ó






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          |SENATE RULES COMMITTEE            |                        SB 696|
          |Office of Senate Floor Analyses   |                              |
          |(916) 651-1520    Fax: (916)      |                              |
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                                   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.










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          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).







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           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. 









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           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.
          








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          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  







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          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  







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          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








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