The National Association of Insurance Commissioners (“NAIC”) voted on 2 December 2012 to approve a new Valuation Manual containing details of a “principles-based” rather than a “formula-based” approach to life insurance company reserves. The vote was 43 to 8 – one vote more than the 42-vote supermajority that was required for adoption. Among the “no” votes were the insurance commissioners from the two commercially important states of California and New York.
The stated goal of “principles-based reserving” (“PBR”) is to make greater use of assumptions and judgment to produce a reserve calculation that is more aligned with the risks in today’s complex life and annuity products. Proponents of PBR contend that it will tailor the reserving process to specific products, rather than using a “one size fits all” approach that can lead to over- or under-reserving. They say that PBR will reduce redundant reserves for some products and increase inadequate reserves in other cases where significant product risks may not be adequately reflected under the current formula-based approach. They further suggest that reductions in redundant reserves will not only benefit insurers but will also make life insurance products more affordable for consumers. Critics point out that PBR will be more complicated to apply and more difficult for insurance department staff to oversee. Many critics further contend that there will be an overall reduction of reserves under PBR that will diminish the security of policyholders and lead to an increase in insurer insolvencies.
The NAIC vote on 2 December 2012 was just a milestone in a process that began in 2004 when the Life Practice Council of the American Academy of Actuaries first recommended the use of PBR to the NAIC’s Life and Health Actuarial (A) Task Force. The reason the NAIC vote is just a milestone is that the new Valuation Manual (and the PBR approach it contains) will not become effective unless it is enacted into law by legislatures in at least 42 states representing more than 75% of US direct premiums written for life, annuities and health insurance. That process could take years – and might not be successful at all. The insurance commissioners of California and New York have expressed strong opposition to PBR in its present form, and a number of other state insurance commissioners – including in the important state of Texas – have indicated that while they voted for the Valuation Manual at the NAIC level in order to move the process forward, they are not prepared to support its legislative enactment in their states without further study of the impact of PBR and how the transition to PBR would be handled.
Recognizing the need for further study, the NAIC voted to form a Joint Working Group of the Life Insurance and Annuities (A) Committee and Financial Condition (E) Committee to oversee the study process and address critics’ concerns. The membership of the Working Group is expected to be appointed in January 2013 and will include consumer representatives. It is likely that the insurance commissioners in many states will wait for the results of the Joint Working Group study before seeking approval of the Valuation Manual from their respective legislatures.