Effective Jan 1, 2017, state insurance commissioners agreed to make two significant changes to the way carriers are required to price and reserve for life insurance products.
While these changes were technically effective in 2017, states provided insurance companies three years to comply, or until Jan. 1, 2020. As is often the case, insurance companies have delayed implementation to maximize the benefits of the current regulatory framework, but now the time to make changes is arriving.
For the remainder of 2019, there will be a flurry of product reprices as carriers scramble to comply with these new guidelines by the end of the year. Before we can understand what’s to come, let’s dive into what is changing and what it means to you.
As insurance products have evolved over the last several decades, the regulatory framework for proper reserving has often lagged. Universal life products and universal life with “secondary guarantees” have grown significantly in market share over the last few decades and this has challenged regulators to create a framework to ensure policy promises are sound and secure. Principle-based reserving (PBR) is the latest attempt to ensure that carriers are adequately capitalized on the insurance business they are putting in place. Specific to the rationale for PBR, the National Association of Insurance Commissioners (NAIC) stated the following:
PBR is a significant change in underlying laws and regulations to solve a problem created by our current regulatory framework. The issue lies with laws and guidance on how a life insurer is required to book its reserves. Insurers set aside funds, known as reserves, to pay insurance claims when they become due.
Prior to PBR, static formulas and assumptions were used to determine these reserves as prescribed by state laws and regulations. However, sometimes this rule-based approach leaves an insurer with excessive reserves for certain insurance products and inadequate reserves for others. The solution is to "right-size" reserve calculations by replacing a rule-based approach with a principle-based approach.
The overall pricing impact of PBR changes have appeared to be relatively minimal. The carriers that have already released pricing on 2020 compliant products have made relatively small tweaks to pricing, with modest cost reductions in some areas and increases in others. Technically speaking, the PBR changes are not requiring the carriers to reprice their products but will be a significant factor in how they price products today and beyond.
When carriers are pricing product and regulators are setting reserve requirements, mortality assumptions must be made based on a standard. These mortality tables are updated periodically. The last update was the adoption of the 2001 CSO. For policies effective in 2020 and beyond, the NAIC will require carriers to comply with the 2017 CSO. The 2017 CSO will reflect a more robust data set for mortality and will generally reflect overall increases in life expectancy. The new mortality tables will certainly play into the PBR discussion as it relates to the way in which companies reserve for policies. Furthermore, the major impact of the 2017 CSO adoption is that all products must be repriced to comply with the 2017 CSO rather than the current 2001 CSO.
As the 2017 CSO is adopted, it will have notable pricing and product performance impact on Modified Endowment Contract (MEC) limitations. Every insurance contract has a methodology to comply with Internal Revenue Code Sections 7702 and 7702A, which, among other things, determines how much premium can be paid into a contract without creating a MEC. The calculations for compliance with these tests are based on mortality assumptions. Shorter mortality assumptions allow for a higher non-MEC premium, while longer assumptions allow lower non-MEC premiums. When carriers adopt the 2017 CSO, life expectancy assumptions will be generally longer, which will lower the amount of premium that can be paid into a contract without creating a MEC.
To use an overly simplified example, a 50-year-old male acquiring $1,000,000 of coverage in a product on the old mortality tables could fund a policy with an annual premium of approximately $56,000 for a period of seven years. On the new mortality tables, that same client would be limited to funding his policy with only about $47,000 annually over seven years. Because the non-MEC funding level will be less, the net amount at risk in the contract will increase and cash accumulation products will likely be adversely affected. It remains to be seen if carriers will be able to offer lower cost of insurance charges or other value to offset this impact.
Because all non-compliant policies must be placed no later than Dec. 31, 2019, carriers will be rolling out new product pricing throughout the year. Many carriers are waiting as long as possible to make this transition and are not disclosing their pricing until the transition period. There could also be additional repricing in early 2020 for carriers to maintain their competitive positioning relative to peers.
Producers should be aware of product pricing changes, transition deadlines and new pricing impacts on any active cases. There will certainly be some clients that will significantly benefit from the old pricing, which may not last much longer. This is especially true for those considering a cash accumulation policy funded to the MEC limit.
© 2018 Ash Brokerage LLC.