BILL ANALYSIS Ó SB 696 Page 1 Date of Hearing: July 14, 2014 ASSEMBLY COMMITTEE ON JUDICIARY Mark Stone, Chair SB 696 (Roth) - As Amended July 2, 2015 As Proposed to be Amended SENATE VOTE: 38-1 SUBJECT: INSURANCE: PRINCIPAL-BASED VALUATION KEY ISSUE: SHOULD INFORMATION DISCLOSED TO THE INSURANCE COMMISSIONER IN AN INSURANCE COMPANY'S PRINCIPLE-BASED VALUATION REPORT BE SHIELDED FROM DISCOVERY OR ADMISSIBILITY IN A PRIVATE CIVIL ACTION AND FROM DISCLOSURE UNDER THE PUBLIC RECORDS ACT? SYNOPSIS This bill, as proposed to be amended, seeks to permit life insurers and the Insurance Commissioner (the Commissioner) to use a new methodology, known as principle-based reserving (PBR), for determining the amount of reserves required for some types of life insurance policies. This method is based on a model law developed by the National Association of Insurance Commissioners (NAIC). Currently the calculation method for life insurance reserves is located in the Standard Valuation Law, a standard SB 696 Page 2 that was originally designed for whole life insurance policies. However, there are other forms of life insurance policies that involve various forms of complexities and risks that differ from those contained in whole life policies. For example, term life policies expire after a certain term of years instead of an entire lifetime and have been found to be an appealing alternative to consumers who do not want the terms offered by a whole life policy. According to the sponsors, PBR allows for a more accurate and precise determination of the required reserves based on the characteristics of the individual life insurance policy. In order for PBR to take effect, at least 42 states (representing at least 75% of total U. S. premiums) must adopt it. Currently, 29 states have adopted PBR, but New York has rejected the PBR methodology in favor of a modified version of the current statutory formula. This means that, size-wise, California's adoption of the method is required in order for the method to become effective in other states, and that is what this bill does. Specifically, the bill authorizes the Commissioner to assess life insurers for the cost of implementing PBR and requires insurers to submit detailed modeling, data, and analysis to justify their proposed reserves specific to a particular insurance product to the Commissioner for review and approval. The information in the report to the Commissioner must include factors such as future economic conditions, mortality, policyholder behavior and other financial variables. This bill adds provisions to hold a qualified actuary liable for negligent and tortious acts with regards to PBR and allows the Commissioner to provide for disciplinary actions against an insurance company or a qualified actuary in regulations that the bill allows the Commissioner to develop as emergency regulations. This bill also excludes a PBR report from public disclosure or discovery in any private civil action if obtained from the Commissioner, unless the information is used in an action against an actuary, in a public hearing, or is released by the insurer to the media. The amendments clarify that the bill's provisions would not affect the ability of the SB 696 Page 3 public to obtain the information that is contained in the report to the Commissioner from the insurer through the normal discovery process, which is consistent with how similar reports are available today. This bill is co-sponsored by the California Department of Insurance (CDI) and the Association of California Life and Health Insurance Companies. This bill has no known opposition. SUMMARY: Authorizes life insurers and the Insurance Commissioner to use a new methodology, known as principle-based reserving to calculate the reserves required for life insurance policies and increases confidentiality of newly required reports. Specifically, this bill: 1)Provides that PBR only applies to policies issued on or after PBR's effective date. Provides that PBR only applies to non-forfeiture benefits on policies issued on or after PBR's effective date. 2)Requires all life insurers to annually submit an actuarial analysis of the company's reserves based on the Valuation Manual (VM) adopted by the NAIC. 3)Provides that future changes to the VM shall become effective on January 1 of the year following its adoption by NAIC and the issuance of an order adopting the changes by the Commissioner. 4)Permits the Commissioner to conduct an independent actuarial analysis of a life insurance company's reserves if the company fails to submit one or if the Commissioner finds the submitted analysis to be unacceptable. Permits the Commissioner to conduct the actuarial examination, at the insurer's expense, of a life insurer's reserves, reserve assumptions, and reserve SB 696 Page 4 methodology. 5)Permits the Commissioner to adopt regulations establishing the PBR valuation method, including a process to discipline actuaries and insurers for misconduct related to the insurer's actuarial opinion supporting the insurer's reserving under PBR, as emergency regulations for a period of 180 days. 6)Provides that documents and information provided to the Commissioner as part of the actuarial analysis of reserves, assets supporting reserves and the opinion of the actuary of whether the reserves are sufficient to support the companies' policies and contracts are confidential and not subject to disclosure under the California Public Records Act, subpoena, or discovery from the Commissioner, unless the information is to be used in a private civil action against the actuary, the company cites the information in a public hearing, in marketing materials, or to the media. 7)Provides the Commissioner with access to the confidential materials in the actuarial memorandum and supporting documents as necessary to perform his or her official duties. Permits the Commissioner to share documents and information related to the actuarial analysis with other regulators, the American Academy of Actuaries, and the NAIC if the recipient agrees to maintain confidentiality. 8)Provides that if the VM does not address a specific product or does so in a manner in conflict with California law, the insurer must comply with the minimum reserve requirements established by the Insurance Code or by regulations and bulletins issued by the Commissioner. 9)Permits the Commissioner to require a life insurer to change SB 696 Page 5 any reserve assumption or methodology that, in the Commissioner's opinion, is necessary to comply with California law or the VM. Requires a life insurer to subsequently adjust reserves as required by the Commissioner. 10)Permits a life insurer using PBR to consider the particular experience of its insureds, if that experience is substantiated by credible statistical evidence, when determining the level of reserves it is required to maintain. 11)Requires a life insurer to share mortality, morbidity, policy holder behavior, or expense experience data with the Commissioner as specified in the VM. 12)Permits the Commissioner to hire one subject matter expert, exempt from the civil service, to lead the implementation of PBR and permits the Commissioner to set the salary for that position without approval of the Department of Human Resources. 13)Permits the Commissioner to assess life insurers for the cost of implementing PBR, based on the dollar value of life insurance premiums collect by each insurer. 14)Requires that actuaries engaged by the Commissioner maintain confidentiality, be free of any conflicts of interest, and disclose potential conflicts of interest. 15)Provides that an actuary providing an opinion under PBR is liable for his or her negligence or any other tortious act. 16)Provides that PBR takes effect on January 1 of the year SB 696 Page 6 following the first July 1 after PBR is adopted by at least 42 of the 55 jurisdictions within the National Association of Insurance Commissioners (NAIC) representing 75% of the premiums for life, health, and accident insurance policies collected in all states and U.S. territories, provided that in order for PBR to become effective in California, the Commissioner must first provide a letter to the Insurance Committees of the Legislature certifying that adequate funding has been appropriated by the Legislature and that all other resources are available and sufficient to implement PBR. The certification letter must be posted to the CDI Internet Web site immediately after being submitted to the Legislature. 17)Makes numerous technical and clarifying changes to the Insurance Code. EXISTING LAW: 1)Authorizes the Commissioner to regulate the insurers of life and disability insurance. (Insurance Code Section 10110 et seq. Unless stated otherwise, all further references are to that code.) 2)Provides that the Standard Valuation Law requires life and disability insurers to calculate the minimum standard for the valuation of policies and contracts using specified mortality tables approved by the Commissioner, sets forth the applicable interest rates, and establishes the reserve requirements for various types of life and disability policies and contracts. (Section 10489.1 et seq.) 3)Requires every life and disability insurer doing business in this state to annually submit the opinion of a qualified actuary as to whether the reserves and related actuarial items held in support of the policies and contracts specified by the Commissioner are computed appropriately, are based on SB 696 Page 7 assumptions that satisfy contractual provisions, are consistent with prior reported amounts, and comply with applicable state law. (Section 10489.15.) 4)Authorizes the Commissioner to issue a bulletin to provide tables of select mortality factors and rules for their use, rules concerning a minimum standard for the valuation of plans with non-level premiums of benefits, and rules concerning a minimum standard for the valuation of plans with secondary guarantees. That bulletin has the same force and effect, and may be enforced by the Commissioner to the same extent and degree, as regulations issued by the Commissioner. (Section 10489.94(a).) 5)Authorizes the procedure for the adoption, amendment, or repeal of regulations by state agencies and for the review of those regulatory actions by the Office of Administrative Law. (Government Code Section 11340 et seq.) 6)Provides that the people have a right of access to information concerning the conduct of the people's business and the right of access to public records, which must be open to public scrutiny. Any limits on the people's right of access must be adopted with findings demonstrating the interest protected by the limitation and the need for protecting that interest. (Cal. Const., art. I, Section 3.) 7)Requires, generally, that records maintained by public agencies are to be accessible to the public. (Government Code Section 6250 et seq.) 8)Authorizes an exemption from public disclosure for applications filed with the state agency responsible for regulation or supervision of insurance companies. (Government SB 696 Page 8 Code Section 6254(d)(1).) FISCAL EFFECT: As currently in print this bill is keyed fiscal. COMMENTS: National Association of Insurance Commissioners and its Model Laws. The NAIC is the regulatory support organization created by and composed of the chief insurance regulators from the 50 states, the District of Columbia and five U.S. territories (in California, the chief insurance regulator is the Commissioner). The NAIC establishes standards and best practices, conducts peer reviews, and coordinates regulatory oversight by insurance commissioners in the U.S. NAIC is a key part of the national system of state-based insurance regulation. NAIC's primary mission is to promote uniform practices amongst states in regulating multi-state insurers. To support this effort, NAIC maintains an insurance regulator accreditation program and develops uniform standards known as Model Laws. The Model Laws are intended to provide inter-jurisdictional uniformity and cooperation among regulators in a manner that builds in quality control and allows one jurisdiction to comfortably rely on another NAIC-accredited jurisdiction because, by statute, the regulatory processes and standards applied are substantially similar. Additionally, NAIC performs an on-site accreditation review of each insurance regulator at least every 5 years. An insurance regulator's accreditation status is dependent on its adoption of statutes and regulations that align with NAIC Model Laws. Existing Method of Calculating Reserves for Life Insurance Policies in California. Existing law requires life and disability insurers to set aside reserves for their existing insurance policies and contracts. In calculating the minimum standard for the valuation of policies and contracts, the SB 696 Page 9 insurer must use specified mortality tables that have been approved by the Commissioner. (Section 10489.94(a).) The Standard Valuation Law sets forth the applicable interest rates, and establishes the reserve requirements for various types of life and disability policies and contracts. (Section 10489.1 et seq.) Insurers calculate the required reserves for their existing policies and then submit to the Commissioner an annual report with the opinion of a qualified actuary as to whether the reserves held to support the policies and contracts are: calculated accurately, based on assumptions that meet contractual provisions, consistent with prior reported amounts, and comply with state law. (Section 10489.15.) This bill seeks to authorize a new method of calculating reserves for life insurers and the Commissioner. According to the author: In order to make sure that life insurers will be able to fulfill their contractual obligations, they are required to set aside assets or "reserves" dedicated to payment of anticipated claims. It is not necessary to set aside funds dollar-for-dollar, but enough to ensure payment of future claims according to the probability of losses, anticipated premium and investment income, reinsurance agreements (where one insurer assumes risks from another insurer) and other factors. For life insurers, the formula used to determine the value of those reserves is set forth in the Standard Valuation Law (SVL) which reflects an approach originally designed for whole life insurance policies and utilizes market-wide standards and statutorily established assumptions. But life insurance products have evolved far beyond whole life products and involve varying degrees of complexity and risk. Actuarially, an insurance product that poses less risk to the insurer should require lower reserve levels, SB 696 Page 10 but the existing formulaic approach does not always take that into account. For some products, existing law requires life insurers to set aside higher reserves than necessary for some products and too little for others. Applying inappropriate reserving requirements may cause higher premium for some types of products and discourage or eliminate the development of new products. New Method of Calculating Reserves. This bill, co-sponsored by the CDI and the Association of California Life and Health Insurance Companies, authorizes life insurers and the Commissioner to use a new methodology, known as principle-based reserving (PBR), for determining the amount of reserves required for some types of life insurance policies. This method is based on a model law developed by NAIC. According to the NAIC, the adoption of the SVL in 2009 introduced a new method for calculating life insurance policy reserves. The Valuation Manual (the manual of valuation instructions adopted by NAIC) was adopted by a supermajority of NAIC members in December 2012, paving the way for states to begin adopting revisions to the SVL in their legislative sessions. The Valuation Manual begins the process of revising reserving requirements to meet the need of the various insurance products that are available in today's marketplace, by establishing calculation methods for reserves required to be held on different types of life insurance policies. This bill replaces the current "one size fits all" approach to determining policy reserves for life insurance policies with the PBR approach that, according to the sponsors, more closely reflects the risks of highly complex life insurance products. For example, term life policies expire after a certain term of years instead of the entire lifetime of the insured, and have, according to the sponsors, been found to be an appealing alternative to consumers who do not want the terms offered by a whole life policy. The reserves required for whole life and term life, argue the sponsors, should be different because the life term of the policy is calculated differently by insurers due to several factors such as risk, life span, and anticipated payouts. However, under the existing valuation SB 696 Page 11 methods, they are calculated in the same manner. According to the NAIC, PBR calculations are expected to be more exacting, and will reduce the chance of reserves being too high for some products or too low for others. Once at least 42 states (a supermajority) representing 75% of total U.S. premiums adopt the revisions to the SVL, PBR will be implemented over approximately three years and only for new policies issued. As of June 1, 2015, 29 states, representing 45% of premium, have adopted the revised model laws. ( http://www.naic.org/cipr_topics/principle_based_reserving_pbr.ht m ) This bill would require that PBR take effect on January 1 of the year following the first July 1 after PBR is adopted by at least 42 of the 55 jurisdictions within the NAIC, representing 75% of the premiums for life, health, and accident insurance policies collected in all 55 jurisdictions. However, PBR will not be effective in California until the Commissioner provides a letter to the Insurance Committees of the Legislature certifying that adequate funding has been appropriated by the Legislature and that all other resources are available and sufficient to implement PBR. The certification letter must be posted to the CDI Internet Web site immediately after being submitted to the Legislature. PBR will only apply to policies and non-forfeiture benefits (a refund of all or part of the premiums paid by an insured, if the insured decides to cancel his or her policy after a specified date) issued on or after its effective date. Does the California Department of Insurance Have the Necessary Professional Workforce to Implement PBR Effectively and, Given New York's Reasons for not Participating, Does PBR Make Sense for California Consumers? When this bill was heard by the Assembly Insurance Committee, that Committee was concerned about whether the California Department of Insurance will have sufficient resources and staff to implement PBR. The Committee's concerns were based on reports regarding the ability of states to effectively implement PBR. One such report was published in December 2013 by the Federal Insurance Office of SB 696 Page 12 the U.S. Department of the Treasury entitled, How to Modernize and Improve the System of Insurance Regulation in the United States, in the report the Federal Office of Insurance cautions: The U.S. life insurance sector's reserving requirements should properly reflect current mortality rates, the life insurer's business model, and its particular risk profile, but substantial concerns arise with the prospect of a wholesale adoption of PBR. In addition to consistency issues, state regulators will also face the challenge of maintaining a sufficiently high level of expertise for understanding the "black box" of the models on which reserve levels would be established. Specifically, the need for many more sufficiently trained and expert actuaries and examiners than are currently available to regulators raises necessary questions with respect to states' ability to verify insurers' implementation of PBR in a uniform manner that is consistent with the [Valuation] Manual. To obtain necessary expertise, states likely would have to contract with consulting actuaries and other professionals, many of whom may have clients in the life insurance industry and, thus, state regulators will need to sort through and manage potential conflicts of interest. This report also provides that while New York, California, Florida and North Dakota moved forward in establishing a working group through the NAIC to recognize challenges of implementing PBR, the New York Department of Financial Services identified flaws and raised serious questions about the efficiency of the working group process. New York eventually opted not to implement PBR because, according to a November 2012 letter from the New York State Superintendent of the Department of Financial Services, Benjamin Lawsky, "There are numerous factors that should give regulators pause [with an untested PBR model]: (1) Principles-based reserving in the banking sector proved disastrous; (2) Under PBR, reserves will decrease, and the risk of insurer insolvency will increase; (3) It is not clear that a SB 696 Page 13 PBR regime will benefit consumers; (4) Regulators are ill-equipped at present to implement and oversee PBR; and (5) Even if the rules-based approach has its shortcomings, it does not necessarily follow that PBR is the answer." Thus, as California looks to implement the PBR, it is critical that the Commissioner does so in a way that benefits consumers and does not risk insurer insolvency. The PBR Report and Supporting Documents Submitted to the Commissioner Are Exempt From the Public Records Act. Documents that are provided to the Commissioner qualify as public records to which the public has access unless there are legislative findings or exceptions that impose limitations on the public's right of access to those records. Any limitation to public access is always of great concern because the public has a right to information that becomes part of a public agency's records. The bill seeks to exclude all information in a PBR report annually filed with the Commissioner from disclosure and from discovery or admissibility into evidence in any private civil action if the information is obtained from the Commissioner in any manner. This bill requires that documents and information provided to the Commissioner as part of the actuarial analysis of an insured's reserves using PBR be confidential and not subject to disclosure under the California Public Records Act, subpoena, or discovery and are not admissible in any private civil action unless the documents and information are cited to in an action against an actuary, in a public hearing, or are released by the insurer to the media. The basis of the exemption is that the report and supporting documentation, according to the insurers, contain confidential data, trade secrets, and proprietary information that the insurers have developed through extensive research and development. Existing law holds that the confidential memorandum and supporting information is subject to subpoena with the SB 696 Page 14 Commissioner's consent, or after notice to the Commissioner and all other interested parties and a hearing, the superior court can release the information if it determines that the need for the subpoena outweighs the interest of the insurer or actuary in protecting the confidential information, and the public interest and ongoing investigation of the Commissioner will not be unnecessarily jeopardized by compliance with the subpoena. (Section 10489.15(B).) The provisions of this bill, by contrast, do not include an exception to disclose the contents of the PBR report that is filed with the Commissioner, either by consent of the Commissioner or by a subpoena and a court order. However, the proposed amendments clarify that the public may still obtain the information that is contained in reports to the Commissioner from the insurer through the normal discovery process. This bill also permits the Commissioner to share documents and information related to the actuarial analysis with other regulators, the American Academy of Actuaries, and the NAIC if the recipient agrees to maintain confidentiality. The additional disclosure to third parties helps to ensure the critical cooperation and full disclosure of insurers and affiliates who otherwise may be forced to seek disclosure of this information under other laws. Civil Liability for Actuaries. Under existing law, an actuary is liable to persons for damages caused by his or her negligence or other tortious conduct with respect to any act, error, omission, decision, or conduct with respect to the actuary's opinion. This bill provides that a qualified actuary (an individual who is qualified to sign the applicable statement of actuarial opinion in accordance with the American Academy of Actuaries qualification standards and who meets the requirements specified in the VM is liable for his or her negligence or other tortious conduct regarding PBR. Existing law gives the Commissioner the authority to suspend or revoke a license, but due to the apparent severity of that penalty, that option SB 696 Page 15 apparently is rarely invoked. This bill allows the Commissioner to define "disciplinary action" in the emergency regulations (for the initial 180 days of the regulations) for implementing the PBR law against a company or the qualified actuary. Creating a new form of discipline for a negligent actuary should help serve as a deterrent for actuarial misconduct in calculating PBR reporting information and providing false or misleading information in reports regarding a company's available reserves. ARGUMENTS IN SUPPORT: In support of this bill, the Association of California Life and Health Insurance Companies writes: PBR is a modern method of calculating these mandatory reserves required to pay claims of policyholders for certain insurance products sold to individuals. It accomplishes this goal by prescribing a dynamic approach to calculating a company's reserve requirements that expressly factors in an individual company's inherent risk associated with a particular product. Compared with today's industrywide, static, formulaic approach, in which reserve requirements are locked in and inflexible regardless of future experience, economic conditions, or other risk, reserves that are calculated utilizing PBR are judged as the company's risk changes. This calibration of reserves to risk ensures greater transparency on the company's balance sheet and more frequent regulatory review, thereby strengthening consumer protections. Importantly, reserves will not experience swings from high to low which have been experienced in the past. Even more importantly, consumers will experience the pricing benefits of proper reserving. Prior Legislation: AB 2384 (Nakano, Chap. 601, Stats. 2004) requires that all life and annuity contract forms be filed with SB 696 Page 16 the CDI prior to being issued. REGISTERED SUPPORT / OPPOSITION: Support Association of California Life and Health Insurance Companies (co-sponsor) California Department of Insurance (co-sponsor) Affordable Life Insurance Alliance USAA Pacific Life Insurance Company Opposition None on file Analysis Prepared by:Khadijah Hargett / JUD. / (916) 319-2334 SB 696 Page 17