Benjamin Lawsky, Superintendent of the New York Department of Financial Services (the “Department”), sent a letter [PDF] to the National Association of Insurance Commissioners (“NAIC”) last week criticizing the NAIC’s plan to move forward with implementing the principles based reserving approach (“PBR Approach”) for life insurers. Specifically, Superintendent Lawsky stated that the NAIC’s implementation of the PBR Approach “represents a potent cocktail that could put policyholders and taxpayers at significant risk.” Superintendent Lawsky indicated that New York will allow the regulation setting forth the PBR Approach to expire on September 13, 2013. New York will revert to using a formula-based approach for the calculation of life insurance reserves. Since many insurers have separate New York life insurers, Superintendent Lawsky’s decision may not impact life insurers not licensed in New York.

The PBR Approach was developed by the NAIC after states discovered that many life insurers had not maintained sufficient reserves for their universal life with secondary guarantee products (“ULSG Products”). Insurance regulators expected that the PBR Approach would raise reserves for ULSG Products by $10 billion. Under the NAIC rule adopted in June of 2013, life insurers will use internal models to set reserves instead of following more formulaic statutory requirements. Current supporters of the PBR Approach believe the method reduces redundant reserves required to be held under the formulaic approach, leading to lower life insurance product prices and increased flexibility for life insurers. Capital Market participants, including hedge funds, investment and commercial banks, as well as pension funds, are also keenly interested in this continuing debate as they have historically been investors and solution providers of securities linked to life insurance reserves.

Superintendent Lawsky has been a critic of the PBR Approach stating that it allows insurers excessive leeway. In June, Superintendent Lawsky called on the NAIC to pass a national moratorium on the PBR Approach after an investigation conducted by the New York Department of Financial Services uncovered $48 billion in allegedly dubious transactions where life insurers used the PBR Approach to reduce its reserve requirements. In the letter, Superintendent Lawsky states that the implementation will water down reserve and capital standards putting the insurance industry and consumers at risk.

Following receipt of Superintendent Lawsky’s letter, Jim Donelon, president of the NAIC and Louisiana's insurance commissioner, did not indicate delaying plans for the implementation of the PBR Approach, but stated that New York’s input would be considered. Commissioner Donelon stated, “Preliminary results of this process have not identified any improper reserve activity . . . State insurance regulators will continue their diligent work in developing the critical building blocks that will support an effective [PBR] system for the life insurance industry.”