INVESTMENT RISK-BASED CAPITAL (E) WORKING GROUP Sunday, March 25, :00 a.m. 9:00 a.m. 102 A-E Wisconsin Convention Center 1 st Floor ROLL CALL

Transcription

1 Date: 2/28/ Spring National Meeting Milwaukee, Wisconsin INVESTMENT RISK-BASED CAPITAL (E) WORKING GROUP Sunday, March 25, :00 a.m. 9:00 a.m. 102 A-E Wisconsin Convention Center 1 st Floor ROLL CALL Kevin Fry, Chair Illinois Tish Becker Kansas Philip Barlow, Vice Chair District of Columbia Anna Taam New York Greg Lieber California Steven Drutz Washington Kathy Belfi Connecticut Richard Hinkel Wisconsin Shawn Steinly Florida NAIC Support Staff: Julie L. Garber AGENDA 1. Consider Adoption of its Feb. 27, 2018, and Oct. 23, 2017 Minutes Kevin Fry (IL) Attachment A 2. Receive an Update Related to Revisions to Bond Structure and Factors in the Risk-Based Capital (RBC) Formula Kevin Fry (IL) and Nancy Bennett (American Academy of Actuaries Academy) 3. Receive an Update from Academy s Joint P&C/Health Bond Factors Analysis Work Group Lauren Cavanaugh (Academy) 4. Discuss Treatment of Exchange-Traded Funds (ETFs) Related to the Bond Portfolio Adjustment Kevin Fry (IL) 5. Discuss Federal Tax Reform and Implications Related to Risk-Based Capital (RBC) for Investments Kevin Fry (IL) American Council of Life Insurers (ACLI) Letter Academy Letter Attachment B Attachment C 6. Any Other Matters Brought Before the Working Group Kevin Fry (IL) 7. Adjournment W:\National Meetings\2018\Spring\TF\CapAdequacy\IRBC\National Meeting\IRBC Agenda Spring NM.doc 2018 National Association of Insurance Commissioners 1

2

3 Attachment A Attachment Capital Adequacy (E) Task Force 3/--/18 Draft: 3/14/18 Investment Risk-Based Capital (E) Working Group Conference Call February 27, 2018 The Investment Risk-Based Capital (E) Working Group of the Capital Adequacy (E) Task Force met via conference call Feb. 27, The following Working Group members participated: Kevin Fry, Chair (IL); Philip Barlow, Vice Chair (DC); Greg Lieber (CA); Kathy Belfi (CT); Ray Spudeck and Shawn Steinly (FL); Tish Becker (KS); Anna Taam (NY); Steven Drutz (WA); and Randy Milquet (WI). 1. Discussed Comment Letters Received Related to the Academy s Revised Report Related to the Bond Factors in the RBC Formula Mr. Fry stated that the Working Group has been discussing the structure and the factors for use with bonds in the risk-based capital (RBC) formula for some time, and the Working Group hopes to complete this project in time for an implementation date of year-end The American Academy of Actuaries (Academy) original report on this topic was submitted to the Working Group in August Since that time, the Working Group has continued to discuss various aspects of the proposal and consider feedback from interested stakeholders. Mr. Fry stated that the Working Group has agreed that the granularity in all of the statement types for bonds should be increased from six to 20; however, the factors for each of the categories still need to be determined. The Academy has provided the Working Group with updated factors on two occasions, with the most recent report dated Oct. 10, On its Oct. 23, 2017, conference call, the Working Group agreed to expose this report for a public comment period of 90 days. Mr. Fry said that the bond model used to produce the bond factors has numerous assumptions embedded in it, and these assumptions have been discussed for several years. The Academy has provided responses to many of the comments received over the years related to these assumptions, and Mr. Fry said that this topic has been thoroughly considered and discussed. He said that is time to select just one of the key assumptions and consider further updates to it. The Academy could rerun the model with the updated assumption and provide results that would allow the Working Group to perform a sensitivity analysis. He suggested that this may be the most productive way to move forward, although the Working Group will need to select the one assumption to be updated. Ms. Belfi and Mr. Spudeck agreed with this approach. Steven Clayburn (American Council of Life Insurers ACLI) summarized ACLI s comment letter (Attachment XX), stating that it is concerned with the material increase in the C-1 bond charges and the slope of the bond charges, particularly for smaller companies. The comment letter specifically identifies two adjustments to the current model that the ACLI believes is reasonable. The first adjustment is a small amount of additional risk premium in the model, while the second adjustment is to expand the recovery experience to include other asset classes such as municipal bonds and private placement bonds. He said the ACLI is encouraged by the suggestion made by Mr. Fry to select one assumption for further revision, and although it is disappointed that both of its recommended adjustments cannot be reevaluated, the ACLI is supportive of a path forward in which one of the adjustments is reviewed. He also suggested that this review include consideration of the new corporate tax rate. Mr. Fry said that first the Working Group will need to update the bond factors based on the current scheme, and then it can consider changes to the bond factors related to tax reform. He said there is sufficient time to get this implemented for yearend 2019 reporting. Based on the ACLI s comments, Mr. Fry said that the Working Group should focus on updating the risk premium offset assumption, which is the amount of credit losses already included in statutory policy reserves. Nancy Bennett (Academy) said that they could work on this, noting that the risk premium offset is one of the more subjective assumptions. She said they could rerun the bond model with varying assumptions for the risk premium offset. Mr. Barlow said he is agreeable to looking at this assumption, although he said this should be the last iteration of updates as the Working Group has already spent a considerable amount of time discussing the model and assumptions. Mr. Fry agreed. Jonathan Rodgers (National Association of Mutual Insurance Companies NAMIC) summarized NAMIC s comment letter (Attachment XX), stating that NAMIC supports the work of the joint industry and actuarial group that is reviewing bond factors for the health and property/casualty (P/C) formulas. He said he understands that creating a new model would be a multiyear project and is not a feasible solution, although he said he thinks it is not appropriate to apply the life bond factors to the P/C formula. He said NAMIC is supportive of expanding the number of RBC bond categories from six to 20. In addition, 2018 National Association of Insurance Commissioners 1 1

4 Attachment A Attachment Capital Adequacy (E) Task Force 3/--/18 he said he agrees with reviewing the risk premium offset assumption as suggested by Mr. Fry, although he suggested that perhaps the holding period could also be reviewed, as such differs significantly between life companies and P/C companies. Mr. Fry noted that the joint industry and actuarial group is considering a number of different topics, including the holding period. Bill Weller (America s Health Insurance Plans AHIP) said that the most sensitive issues for health companies may not be the same as that for life companies and that he hopes that such will be considered by the joint industry and actuarial group. He said AHIP does not oppose moving forward with the expansion to the 20 bond categories. Mr. Fry said that at the Spring National Meeting, the Capital Adequacy (E) Task Force and the Financial Condition (E) Committee may be considering for adoption the expansion of the bond categories, so that the information technology (IT) work may begin on the project in anticipation of a year-end 2019 implementation date. 2. Discussed the Academy s Response to Regulator Questions Related to the Bond Factor Project Mr. Fry said the Working Group met Dec. 12, 2017, in regulator-to-regulator session pursuant to paragraph 6 (consultations with NAIC staff members related to technical guidance) of the NAIC Policy Statement on Open Meetings. No action was taken during the call. He said that as the bond project has unfolded, various questions have been raised by state insurance regulators regarding the Academy s modeling process and related recommendations. He said the purpose of the Dec. 12 call was to discuss these questions with NAIC staff and the Academy, and the Academy provided its written responses subsequent to the call (Attachment XX.) Mr. Fry said that most of these questions have been discussed by the Working Group in prior meetings, but it is helpful to have this information in one document. Having no further business, the Investment Risk-Based Capital (E) Working Group adjourned. W:\National Meetings\2018\Spring\TF\CapAdequacy\IRBC\02-27 CC\ IRBC Minutes.docx 2018 National Association of Insurance Commissioners 2 2

5 Attachment A Attachment Two Capital Adequacy (E) Task Force 11/14/17 Draft: 10/31/17 Investment Risk-Based Capital (E) Working Group Conference Call October 23, 2017 The Investment Risk-Based Capital (E) Working Group of the Capital Adequacy (E) Task Force met via conference call Oct. 23, The following Working Group members participated: Kevin Fry, Chair (IL); Philip Barlow, Vice Chair (DC); Kim Hudson and Perry Kupferman (CA); Wanchin Chou and Michael Colburn (CT); Lisa Parker and Ray Spudeck (FL); Nicole Boyd (KS); Jim Everett and Mark McLeod (NY); and Randy Milquet (WI). Also participating was: Steve Ostlund (AL). 1. Adopted its Summer National Meeting Minutes Mr. Barlow made a motion, seconded by Mr. Everett, to adopt the Working Group s Aug. 7 minutes (see NAIC Proceedings Summer 2017, Capital Adequacy (E) Task Force, Attachment Three). The motion passed unanimously. Mr. Fry said the Working Group also met Oct. 11 in regulator-to-regulator session pursuant to paragraph 3 (specific companies, entities or individuals) of the NAIC Policy Statement on Open Meetings. No action was taken during the call. 2. Exposed the Academy s Revised Report and Recommendations Mr. Fry stated that the Working Group had been talking about the structure and the factors for use with bonds in the life RBC formula for some time. He highlighted that because of the complex and technical topic, there were a great deal of differing opinions on the topic. He emphasized the importance of the Working Group performing its due diligence in this process and not rushing to come to a decision. Mr. Fry stated that, at one point, he had a goal for the Working Group to complete its work with a 2017 implementation date but, given the ongoing discussions, a 2019 implementation date is a more realistic goal. He discussed the need for system changes, both for the industry and the NAIC, and also how a 2019 date should put people at ease, because it should allow the Working Group sufficient time to work through its remaining issues. Mr. Fry indicated that the Academy s original report on this topic was submitted to the Working Group in August Since that time, the Working Group had continued to discuss various aspects of the proposal and consider feedback from interested stakeholders. He stated that the Working Group had agreed that the granularity in the life formula for bonds should be increased from six to 20; however, the factors for each of the categories still need to be determined. Mr. Fry noted that the Working Group has also agreed that the bond granularity should be increased to 20 in the P/C and health formulas. Mr. Fry stated that during the Working Group s June 13 conference call, it exposed a June 8 report from the Academy that was an update to its original August 2015 report. Mr. Fry noted that the Academy had provided the Working Group with an updated report dated Oct. 10 (Attachment Two-A), and it was included in the materials for discussion. He asked Nancy Bennett (Academy) to discuss the revised report, suggesting that a long exposure of up to 90 days may be appropriate. Ms. Bennett highlighted that the revised report includes changes for: 1) increasing the base factor up to the 96 percentile over 10 years; and 2) the portfolio adjustment to reflect diversification for an individual insurer s portfolio, as the Academy is no longer looking for the portfolio adjustment to bring the factors up to the 96 percentile. Ms. Bennett described the changes in more detail by noting that the original factors were developed in the early 1990s, and the recommendations made by the Academy in 2015 were calculated in two steps, with the first step being the base factors and the second step being a portfolio adjustment. Ms. Bennett stated that the original base factors were established based on a statistical safety level of a 92 percentile over a 10-year period. She explained that after this, the portfolio adjustment was applied to bring the total requirement up to the regulator-specified safety level of 96 percentile over a 10-year period. She noted that the 92 percentile has never been prescribed by anyone, including, most important, the regulators. One of the comments received in June 2017 noted that the representative portfolio should be adjusted to be more appropriate for the typical life insurer. She noted that there were some anomalies in the June 2017 data because of this National Association of Insurance Commissioners 1 3

6 Attachment A Attachment Two Capital Adequacy (E) Task Force 11/14/17 Ms. Bennett noted that while the Academy did not change the requirement for the industry, the Academy did believe it should shift how the calculation provided the regulators with the 96 percentile requirement, and this is reflected in the revised report. It was noted that the average portfolio adjustment factor will now be one, where one reflects an adjustment of zero after the factors are applied. Mr. Fry reiterated that there is no net adjustment to the proposed capital requirements for the industry as a whole, because any increase in the factors is offset by the change in the portfolio adjustment factor. Ralph Blanchard (Travelers) stated he did not really see any difference from the prior report and suggested the exposure only deal with the life factors, as Travelers would likely make the same comments as when the report was previously exposed. He stated that Travelers continues to be concerned about the length of time that a property/casualty (P/C) company is exposed to risk versus a life company. Ms. Bennett noted that the health factors currently do not have a portfolio adjustment and so that may need to be reconsidered by regulators, because this modifies the calculation of the two steps previously exposed. Jerry Holman (Academy) noted that the Academy revised report being exposed specifically indicates that the Academy is not making a recommendation related to P/C and health, noting that there is a different Academy group that is separately considering adjustments for those two formulas. Ms. Bennett noted that the information included in the Academy s report for P/C and health are not recommendations for P/C and health, but, rather, are only intended to be a starting point for such formulas and only because the Working Group requested such information. Mr. Fry noted that when the factors were developed in 1990, there was no adjustment by P/C and health, but someone could do such work and develop such adjustments. Mr. Ostlund asked if the Academy s P/C and health work groups will comment on these recommendations. Ms. Bennett said they commented in June, and, therefore, they could again, but the revised report does not include any recommendations for P/C and health. Mr. Spudeck asked about the process for exposure. He noted that questions have been raised about details of the inputs and wondered if 90 days was sufficient. Mr. Fry stated that he would try to obtain some information about these aspects, such as the recovery rate, the discount rate, the risk premium and how those impact the factors. Mr. Spudeck and Mr. Chou agreed that the accumulation and exposure of such information would be helpful, as it could be used by commenters as they consider development of their comments. The Working Group agreed to expose the revised report for a 90-day public comment period. 3. Discussed Treatment of ETFs Related to the Bond Portfolio Adjustment Mr. Fry stated that a few alternatives have been presented to him as options for addressing this issue. This includes: 1) leave things as-is, where an exchange-traded fund (ETF) counts as one issue to where little diversification benefit is provided; 2) develop a pro-rata percentage based on the size of the ETF to the entire portfolio (e.g., 2%), where that pro-rata percentage is applied to the number of issuers within this ETFs (e.g., 1,000 issuers) to add 20 issuers to the count for the total portfolio; and 3) carve out ETFs and apply a single factor to assume that every ETF is perfectly diversified. He asked anyone with ideas to contact him, as he has put some ideas in writing where they could be exposed in the future. 4. Continued Discussion of Real Estate in the Life RBC Formula Mr. Fry stated that the Working Group previously exposed a proposal from the American Council of Life Insurers (ACLI) at the Spring National Meeting and briefly discussed it at the Summer National Meeting, noting that the Working Group had received comments from the ACLI on some of the technical issues raised. Steve Clayburn (ACLI) stated that, with respect to the concern that the ACLI had not considered the most recent downturn, the ACLI had redone some of the work but still resulted in a proposed 10% factor, noting that the ACLI still believes the current 15% is too high. Mr. Clayburn also noted that, with joint ventures, a look-through approach is appropriate that would consider encumbrances. He stated that the ACLI included examples to demonstrate how this would be calculated. He stated that the ACLI s comment letter also addresses why the ACLI believes a market value adjustment is appropriate National Association of Insurance Commissioners 2 4

7 Attachment A Attachment Two Capital Adequacy (E) Task Force 11/14/17 Mr. Fry stated that there is probably a need to better understand how the Schedule A data had been updated to include the 2008 data. Mr. Clayburn stated the ACLI updated the data for both 2008 and the early 1960s, noting that the ACLI s response attempts to capture these suggestions and includes more information, but that a 10% factor is still being produced. He stated the industry is not fixated on this 10%, but rather the data and the belief is that the current factor is too high and the industry would like to work with the regulators to find the appropriate figure. Ms. Bennett stated the Academy had not yet had a chance to look at the ACLI response in detail, noting that it is still being evaluated. Mr. Fry suggested these discussions could be taken back up again in Mr. Fry questioned why the Schedule BA asset real estate should have the same charge as Schedule A real estate. Mr. Clayburn stated that through independent research, the joint venture real estate had no higher volatility than directly owned assets and actually tended to outperform the directly owned real estate. He stated the ACLI would include a leverage factor for those that do have encumbrances. Mr. Fry suggested the ACLI provide a summary of the industry exposure with a snapshot of those with leverage and those without, and other information that would help regulators develop a picture. Mr. Clayburn stated that he would be better prepared during future conference calls to better explain the ACLI s responses. Having no further business, the Investment Risk-Based Capital (E) Working Group adjourned. W:\National Meetings\2017\Fall\TF\CapAdequacy\IRBC\ InvRBC Minutes.docx 2017 National Association of Insurance Commissioners 3 5

8 6

9 Attachment B Paul Graham Senior Vice President, Insurance Regulation & Chief Actuary (202) t (866) f paulgraham@acli.com February 12, 2018 Commissioner David Altmaier, Chairman Financial Condition (E) Committee National Association of Insurance Commissioners 2301 McGee Street, Suite 800 Kansas City, MO RE: Impact of Recent Tax Reform Legislation on NAIC RBC, Reserve, and Accounting Requirements Dear Commissioner Altmaier: The American Council of Life Insurers (ACLI) 1 has spent the last month analyzing the impact of the recent federal tax reform legislation on NAIC RBC, reserve, and accounting requirements. In summary, here is what ACLI has determined and would recommend to the NAIC: 1. In many instances, the NAIC requirements are general enough that no changes due to tax reform are necessary. The new tax rate will simply flow through the calculations; 2. In some cases, a relatively simple fix is required; and 3. In other instances, a significant modeling effort is likely needed to reflect the new tax rates. Overall, the impact of tax reform on the RBC calculation is significant. There are factor changes that would increase RBC and factor changes that partially offset the increase. ACLI recommends that the impact of the increases and the offsets be implemented at the same time. Due to the complexity of some of the changes, we recommend a target date for completion of Please note that in this review, we did not include any necessary changes in SSAP 101, which is being handled in a separate workstream at the NAIC. Our analysis of each of the recommendations in items 1-3 above is detailed below. No Changes are Necessary ACLI has identified the following NAIC requirements that are based on after-tax calculations, but where no specific tax rate is expressed. Therefore, we do not believe that any changes to these requirements are necessary. 1 The American Council of Life Insurers (ACLI) is a Washington, D.C.-based trade association with approximately 290 member companies operating in the United States and abroad. ACLI advocates in state, federal, and international forums for public policy that supports the industry marketplace and the policyholders that rely on life insurers products for financial and retirement security. ACLI members offer life insurance, annuities, retirement plans, longterm care and disability income insurance, and reinsurance, representing 95 percent of industry assets, 93 percent of life insurance premiums, and 98 percent of annuity considerations in the United States. Learn more at American Council of Life Insurers 101 Constitution Avenue, NW, Washington, DC

10 Attachment B Page 2 of 7 1. Asset Adequacy Analysis required by VM Actuarial Guideline 38, Section 8.C. 3. Interest Maintenance Reserve (IMR) While the IMR is adjusted for taxes, the tax rate in the instructions is not specified. 4. NAIC Valuation Manual, Chapter VM-20 VM-20 s instructions for adjusting to a pretax IMR are generic and do not need to be changed. 5. Accounting for Deferred Gains on Reinsurance The NAIC Accounting Practices and Procedures Manual, A-791 Paragraph 3, states Any increase in surplus net of federal income tax resulting from reinsurance agreements entered into or amended after the effective date. The example uses a 34% tax rate that may be updated. Based on the guidance we do not believe any changes would be made to the amount of the deferral and that income shall be reflected on a net of tax basis as earnings emerge from the business reinsured in accordance with the guidance at the new tax rate. 6. Appendix 1a (Cash Flow Testing for C-3 RBC Methodology) - The C-3 Phase 1 Single Scenario Measurement Considerations state that tax treatment should be consistent with cash flow testing, and that enacted tax law changes can be anticipated (See item 7 entitled Tax Treatment ). 7. There are many references to the tax rate within C-3 Phase II. However, most do not include a reference to 35%. Those specific areas that will need to be changed are detailed below. Relatively Simple Fixes are Required ACLI has identified the following requirements that require changes to reflect the new tax rate that are rather straightforward to implement. 1. Tax adjustments on Page LR030 (Calculation of Tax Effect for Life Risk-based Capital) of the Life Riskbased Capital Instructions There are three categories of tax factors hard-coded on Page LR030; factors for no tax effect (some health C-2 factors), factors for 75% tax effect (C-1 asset factors for assets carried at book value), and factors for 100% tax effect (all others). a. For factors with no tax effect, no change is needed. b. For factors based on 75% tax effect, we recommend revising the assumption to at least 81.5% ( (.63) =.815) with consideration of a higher factor. The assumption for 75% effectiveness was based on the assumption that 50% of asset write-downs were realized in the calendar year in which they occurred and that 50% of the Deferred Tax Assets of the Life Insurance Industry were ultimately recognized ( (.50) =.75). Research done by the American Academy of Actuaries (AAA) while developing their C-1 Bond Factor proposal suggests that the original assumption on the recognition of DTAs was a bit low. The AAA requested the NAIC to compile data showing the portion of deferred taxes statutorily recognized as a proportion of the total deferred tax assets averaged over the past two years. This data showed 63% recognition of deferred tax assets rather than 50% for the life insurance industry. In reality, it s rare that a life insurance company loses a tax benefit on a capital loss, and the actual effectiveness is likely close to 100% when all the years to which tax losses can be carried are considered. Nevertheless, we will rely on the AAA research and recommend revising the assumption to at least 81.5% ( (.63) =.815) with consideration of a higher factor if facts warrant. Therefore, we recommend that all tax adjustment factors on Page LR030 that are 2

11 Attachment B Page 3 of 7 currently set equal to.2625 be updated to a minimum of (.815 x.21). You may want to round this to 4 decimal places as is done for other RBC factors. c. For factors based on 100% tax effect, change the factor from.35 to Factors on Page LR027 (Interest Rate Risk and Market Risk) of the Life Risk-based Capital Instructions The prescribed factors for the low-risk, medium-risk, and high-risk categories were all originally developed on an after-tax basis, with factors of.5%, 1%, and 2% respectively, following the rationale that a company producing an unqualified actuarial opinion would run a well-matched portfolio for low risk business. A well-matched portfolio was assumed to have a.125 duration year mismatch after tax considerations, with the event producing the capital level defined as a 4% rate shock, producing a.5% post-tax loss. The medium-risk and high-risk categories were simply multiples of the low-risk factors. 2 In 2001, when all factors were changed to pre-tax, those factors were simply divided by.65 so that when combined with the tax treatment prescribed by Page LR030, the result was the original after-tax factors. It would be inappropriate to assume that a company producing an unqualified actuarial opinion would necessarily manage a portfolio to a larger duration mismatch, after tax considerations, subsequent to tax reform. As a result, the same after-tax factors should be maintained, which requires dividing the prescribed post-tax factors for all three categories by.79. This results in the following factors: a. Low-Risk Category: Unqualified opinion =.0063, Otherwise =.0095 b. Medium-Risk Category: Unqualified opinion =.0127, Otherwise =.0190 c. High-Risk Category: Unqualified opinion =.0253, Otherwise =.0380 Similar changes are appropriate for the instructions for Page LR027 where the pre-tax factors are specified. These factors are not used for results obtained by C-3 Phase I and C-3 Phase II modeling. An example showing the impact of this change on the low-risk category is shown in Appendix I. 3. Factors on Page LR029 (Business Risk, C-4a) of the Life Risk-based Capital Instructions Similar to the methodology used for developing the before-tax prescribed factors on Page LR027, the after-tax factors for Business Risk were originally set at 2% of life premiums and annuity considerations, and 0.5% of health premiums. They were designed to mimic the maximum guarantee assessment for any one year and did not include any tax adjustments. They were recalibrated upon the insertion of Page LR030 by dividing by.65. Because the original factors were not developed with any tax adjustment, we believe that the NAIC should adjust the current pre-tax factors in such a way that we reproduce the original aftertax factors developed in the early 1990s. Therefore, the factors on Page LR029 should now be recalibrated using a 21% tax rate. This results in the following factors: a. Life insurance Premiums:.0253 b. Annuity Considerations:.0253 c. Accident and Health Premiums:.0063 d. Separate Account Liabilities:.0006 Similar changes are appropriate for the instructions for Page LR029 where the pre-tax factors are specified. No adjustments are necessary for factors used in the calculation of C-4b, as those are not tax effected on Page LR The factors for companies without an unqualified actuarial opinion are multiplied by 150% for each of the categories. 3

12 Attachment B Page 4 of 7 4. Instructions for Page LR027, Line (37), Overview, Step 8 of the Life Risk-based Capital Instructions - The instructions currently have a hard-coded 35% tax rate (shown as 65%, since the calculation uses 1 minus the tax rate). We recommend that Step 8 be amended to read Divide the results from step (7) by (1-enacted maximum federal corporate income tax rate) to arrive at a pre-tax amount.. 5. Instructions for Page LR027, Line (37), Paragraph B. of Calculation of Total Asset Requirement The instructions include the phrase including the effect of federal income taxes at a rate of 35 percent.. We recommend replacing the phrase at a rate of 35 percent with at the enacted maximum federal corporate income tax rate. 6. Instructions for Page LR027, Line (37), Paragraph III of Calculation of Standard Scenario Amount, Subsection D. (11) The instructions require all taxes to be based on a tax rate of 35%. We recommend that D (11) be amended to read Taxes: All taxes shall be based on the enacted maximum federal corporate income tax rate. 7. Instructions for Page LR049 (Exemption Test: Cash Flow Testing for C-3 RBC) Each line item in the instructions includes a tax adjustment of.65. We recommend that the.65 be replaced with (1- enacted maximum federal corporate income tax rate). The corresponding changes will also need to be made to Page LR049, Lines (5), (6), (16, (17), and (18). 8. Appendix 1 (Cash Flow Testing for C-3 RBC), Item (a) of four amounts The Appendix includes a tax adjustment of.65. We recommend that the.65 be replaced with (1-enacted maximum federal corporate income tax rate). 9. The C-3 Phase 2 report Recommended Approach for Setting Risk-Based Capital Requirements for Variable Annuities and Similar Products Presented by the American Academy of Actuaries Life Capital Adequacy Subcommittee to the National Association of Insurance Commissioners Capital Adequacy Task Force (June 2005)), which is referenced for the C-3 Phase 2 instructions states, The increase to TAR may be approximated as the corporate tax rate (i.e. 35%) on the top of page 15 (see Subsection 10 of Section entitled Modeling Methodology ). The same phrasing and parenthetical is used in the Calculation of Total Asset Requirement section of the instructions for LR027 in the subsection entitled Application of the Tax Adjustment. We suggest the easiest way to handle fixing this requirement is by simply removing the parentheticals in both places. Because the Report is an AAA document, the NAIC may need to request that the AAA make the change to the Report. 10. Alternate Method Contained in C-3 Phase II The tax rates are hard-coded into the Alternate Method of C-3 Phase II. Appendix 8 (Page 55) explains the alternate method. Paragraph 4 (Page 55) and Table 8-9 (Page 78) need to be changed to reflect the new tax rate of 21%. Rather than hard coding a rate, we recommend using the phrase The enacted maximum federal corporate income tax rate. 11. Instructions for LR037(XXX/AXXX Captive Reinsurance Consolidated Exhibit) Under the Section entitled For Captives that file RBC Reports, Paragraph 1.b. uses.65 to tax-affect the calculation. We recommend changing the parenthetical to read (times the enacted maximum federal corporate income tax rate to tax effect and then times the.5 ACL factor). The same edit needs to be made to the Section entitled For Captives that do not file RBC Reports in paragraph 1.c. and in the instructions for Columns 2 through 9, Line (7). 12. Asset Valuation Reserve (AVR) in the Life and Accident and Health Annual Statement The AVR Reserve Objective and Maximum Reserve are based upon the after-tax C-1 factors for the various asset classes. The factors should be updated to reflect any changes made to the C-1 factors and the changes made to LR030. 4

13 Attachment B Page 5 of 7 Significant Modeling Effort Necessary to Fully Reflect Tax Law Changes Most C-1 and C-2 RBC factors were calculated using models that included tax cash flows and discounted using after-tax discount rates. For small changes in tax rates, the difference in factors calculated in this fashion is likely immaterial. However, for large changes in tax rates, such as moving from 35% to 21%, the difference in factors calculated by the model can be material. For instance, ACLI did a quick calculation to determine the impact of a 21% tax rate on the C-1 bond factor proposal by the AAA currently exposed by the NAIC and found that the proposed factors would be approximately 3.2% lower using the new tax rates (the impact varies slightly by bond rating). It is likely that other C-1 and C-2 prescribed factors would have similar tax rate effects inherent in their original modeling. Therefore, ACLI recommends that the NAIC undertake a re-modeling effort on all C-1 and C-2 factors that have been calculated using tax cash flows in the original modeling. We would request that the NAIC ask the AAA to participate in this effort, both in identifying those factors calculated in such a fashion and in performing modeling, since they have most of the models that were originally used in the development of the currently prescribed RBC factors. ACLI developed the current C-1 commercial mortgage factors, and we will commit to determining the appropriate factor adjustments for the new tax rate. We also are currently working on the C-1 real estate factors, and will adjust our proposal for the new tax rate. Implementation ACLI recognizes that it is impractical to re-model every RBC factor using the new tax rate in time for use in However, given the large impact caused by the changes to Page LR030, it is difficult for us to ignore this partially offsetting impact that would occur if all the factors could be immediately re-developed using updated tax rates. Therefore, we recommend that the NAIC take advantage of some of the significant RBC projects currently underway (e.g., C-1 bond factors, C-1 real estate, C-2 mortality, and C-2 longevity) and determine the proper tax impact for the pre-tax factors while working on those new base factors. In some cases, the new base factors will be finalized in time for simultaneous implementation as the tax effect, while, in other cases, the tax impact will need to be incorporated into the existing base factors while work continues on the updated base factors. This will allow the tax effect on the most material factors for life insurance companies to be accurately calculated and implemented. Given the timeframes currently expected for these projects, following this path would necessitate a year-end 2019 implementation for all tax adjustments. Any pre-tax factors that cannot be re-modeled for the new tax rate by next year could be estimated based on the work completed on other factors, and a temporary adjustment could be made until such modeling is completed and new pre-tax factors implemented. ACLI doesn t believe that there should be any material factors that would require such estimation if this project is started immediately. One Last Recommended Item for Change One particular use of RBC that will need recalibrating is the minimum 450% RBC ratio requirement for the company exemption within the principle-based reserve (PBR) requirements. That ratio was set at a level that would allow exemption from PBR for almost all small companies without risky products, as long as they were not in danger of RBC regulatory action levels. Because these well-capitalized small companies are in no more danger of insolvency after tax reform than before, we recommend that the 450% RBC requirement be decreased to 360% (final number subject to review after other RBC changes are completed). Conclusion ACLI has endeavored to identify all the changes to NAIC RBC, reserve, and accounting requirements that should be considered as a result of tax reform. In certain cases, we have pointed out where the original methodology used to develop the current prescribed factors was dependent on the tax rate in effect at the time of the modeling or at the time that the NAIC first reflected tax adjustments through Page LR030. We have made suggestions as to how to treat that dependency. Because we do not believe that well-capitalized life insurance 5

14 Attachment B Page 6 of 7 companies are riskier after tax reform than they were before tax reform, we encourage the NAIC to take the time necessary to develop the material offsets to the C-1 and C-2 factors before implementing all the necessary RBC changes in unison for 2019 financial statements. These changes are going to have a significant impact on the RBC requirements for life insurance companies. RBC ratios should be expected to drop for all life insurers as capital requirements, which are measured against existing capital, are increasing (possibly by as much as 20%). The mindset concerning RBC matters also must now shift to consider the tax reform benefit to current earnings in addition to solely point-in-time capital. While negative events (e.g., a bond default) will truly be amplified as the tax offset will be less substantial under the new tax regime, these increased impacts from negative events should generally be offset by higher current after-tax earnings and do not need to be funded solely from existing capital. While tax reform has not generally changed the solvency position of the vast majority of companies, we urge regulators not to forget to review the Tax Sensitivity Test on LR033 when evaluating potentially weakly capitalized companies, as taxes can have a significantly different impact on companies without ongoing operating earnings. This has not changed with the implementation of the new tax law. The RBC ratio will continue to be a point-in-time metric with actual capital divided by risk-based capital requirements. However, given that even strongly capitalized companies will see a significant decline in RBC ratio (for example, 400% to 320%) without a commensurate decrease in real financial strength, the benefit of new tax rates to current earnings must be considered and expectations of appropriate capitalization levels must be recalibrated. By better understanding the long-term view of these new higher capital requirements, companies will be able to not only better monitor their capital position but ultimately continue to provide protection to consumers at competitive prices. Thank you for considering these recommendations. We look forward to discussing these with you as soon as possible. Sincerely, Paul S. Graham, III, FSA, MAAA cc: Dan Daveline, NAIC Staff Phillip Barlow, Chair, Life RBC Working Group Kevin Fry, Chair, Investment RBC Working Group Mike Boerner, Chair, Life Actuarial Task Force 6

15 Attachment B Page 7 of 7 Appendix I Impact of Recommended Changes to C-3 Prescribed Changes For Low Risk Category Old Law New Law Page LR027.1 Pretax factor Page LR030.4 Tax factor (35% rate) (21% rate) Page LR031.1 After-tax factor Life Insurance Reserves 10,000 10,000 Less policy loans (1,000) (1,000) Adjusted Life Reserves 9,000 9,000 C-3 Charge x C-3 RBC

16 8

17 Attachment C March 16, 2018 Mr. Philip Barlow Chair, National Association of Insurance Commissioners (NAIC) Life Risk-Based Capital (E) Working Group Dear Philip, The RBC Tax Reform Work Group (TRWG) of the American Academy of Actuaries (Academy) 1 Life Practice Council is pleased to submit comments on how the recent change in U.S. corporate tax law, 2 and in particular, the material change in the corporate tax rate from 35% to 21%, should affect the NAIC s Life Risk-Based Capital ( Life RBC ) calculation of Authorized Control Level (ACL) RBC. We also provide suggested modifications to certain tax-related aspects of the Life RBC formula. The tax law changes were adopted by the U.S. Congress and signed by the president in late December 2017, to be effective for tax years starting in Background Information The NAIC Life RBC calculation, which determines both Total Adjusted Capital (TAC) and ACL RBC, can be used by regulators as a tool to identify potentially weakly capitalized companies. Life RBC factors, originally determined on a post-tax basis, were derived and proposed by an industry group in 1991, with regulatory implementation in Since the implementation of Life RBC, the Academy has played a key role in advising the NAIC concerning refinements to the formula, including its technical aspects. In the early 2000s, as a part of the statutory codification effort, pre-tax factors and an explicit tax offset factor were added to the structure and calculation. The net effect of these two tax-related changes was that ACL RBC remained unchanged and regulators had additional information, both pre- and post-tax, about potentially weakly capitalized companies. The 2017 tax law changes include the first change to the corporate tax rate since the NAIC adopted the Life RBC calculation. While the codification changes to Life RBC in the early 2000s anticipated that there could be future corporate tax rate changes, until the enactment of the 2017 law, there had been no such changes. In this letter, we offer our comments and recommendations on the effect of the new tax law on TAC and ACL RBC. Following is some background information on Life RBC to put our comments into context: 1 The American Academy of Actuaries is a 19,000 member professional association whose mission is to serve the public and the U.S. actuarial profession. For more than 50 years, the Academy has assisted public policymakers on all levels by providing leadership, objective expertise, and actuarial advice on risk and financial security issues. The Academy also sets qualification, practice, and professionalism standards for actuaries in the United States. 2 Public Law No: M Street NW Suite 300 Washington, DC Telephone Facsimile

18 Attachment C 1. As noted above, the purpose of the Life RBC calculation is to function as a tool to identify potentially weakly capitalized companies. 2. The Life RBC formula identifies various risk factors which can negatively affect an insurer s TAC. RBC charges for those risk factors are based on the anticipated impact on a company s TAC arising from a specified stress condition. 3. Each Life RBC factor is defined to achieve a regulator-specified statistical safety level. 4. Life RBC factors were derived based on the post-tax losses under stressed conditions. The reason for reflecting taxes in the determination of minimum capital requirements is that life insurance companies are assumed to be payers of federal income taxes. Therefore, the financial loss due to the stressed condition would be partially offset by a reduction in federal income tax expense, because losses are deductible from an insurer s taxable income. The pre-tax results are provided to regulators to enable them to adjust the RBC results as appropriate for the tax situation of specific potentially weakly capitalized companies. 5. Regardless of the tax environment, the minimum capital requirements should continue to be defined at the targeted statistical safety level. 6. The original Life RBC formula was defined to accommodate different tax rates for capital gains and ordinary income. 7. As originally designed, any changes to the tax structure or tax rates were to be reflected in the RBC factors. Since the implementation of Life RBC in 1993, many of the Life RBC factors have been or are in the process of being updated. At the current time, the NAIC, with the Academy s assistance, is working on potential changes to several parts of Life RBC, including RBC factors for C-1 bonds, C-1 real estate and other C-1 assets, C-2 life insurance, C-3 Phase 2 capital, longevity risk, and operational risk. None of these potential changes was effective for 2017 RBC filings. An explicit operational risk charge may be included in Life RBC for 2018 filings, and the remainder of the potential changes could be effective in 2019 or later RBC filings. Impact on TAC Due to Tax Changes The 2017 tax law changes affect many items involved in the calculation of Life RBC. Both TAC and ACL RBC are impacted. While the primary focus of this letter is on the potential impact the tax law changes will have on ACL RBC, we thought that it would also be useful to identify potential impacts that the tax law may have on a company s TAC. Some provisions of the law potentially result in an increase to TAC while others potentially reduce it. Most provisions are fully effective for 2018 and later years, but the tax reserve and deferred acquisition cost tax effects do not reach equilibrium for a number of years. The effect of these items varies by company, depending on the company s mix of business and tax situation, so the collective impact of these items on either a particular life insurer or the industry as a whole is not known. The following provisions included in the tax law are expected to have a direct effect on a life insurer s taxable income and tax expense. To the extent that tax expense is lower, TAC is higher, or vice versa. 1. The tax rate is reduced from 35% to 21%, which will in general decrease tax expense. 2. The tax reserve is defined as the greater of 92.81% of statutory reserves and cash surrender value. In general, that will reduce tax reserves, and therefore increase taxable income and tax expense. 3. There is an eight-year phase-in of the difference between Dec. 31, 2017, tax reserves and the tax reserves defined in item (2) above. In general, that will increase taxable income and tax expense for tax years inclusive M Street NW Suite 300 Washington, DC Telephone Facsimile

19 Attachment C 4. The deferred acquisition cost tax provisions are changed, with capitalization percentages being increased and the amortization period being lengthened from 10 to 15 years, which generally increases taxable income and tax expense. 5. The dividends received deduction is revised, which generally increases taxable income and tax expense for affected companies. Following are additional potential indirect impacts to TAC that arise from the application of the tax law to life insurers: 1. The value of Deferred Tax Assets (DTA) and Liabilities (DTL) are recalculated using a 21% rate. Companies with a net DTA will generally see a reduction in TAC, while those with a net DTL will generally see the reverse. 2. The tax rate used in asset adequacy analysis reduces from 35% to 21%, which may impact the amount of asset adequacy reserves for affected companies. Given the number of items above and the differing impact for companies, we are not able to make a general comment about the aggregate impact of tax law changes on TAC for the life insurance industry. However, we expect that most, if not all, life insurers will see an increase in ACL RBC should the NAIC make the changes to Life RBC as suggested in this letter. Rationale for Changes to ACL RBC Due to Tax Changes The TRWG believes that there is solid logic and theoretical support for changes to the tax-related factors underlying ACL RBC (Life RBC factors) in light of the tax changes. As noted above, Life RBC factors were derived based on post-tax losses under stressed conditions, and any changes to the tax structure or tax rates were expected to be reflected in the Life RBC factors. Under the premise that the life insurer is paying taxes, a decrease in the federal tax rate increases required RBC, since the tax offset to a loss is reduced and the net post-tax financial loss is increased. Lowering the tax rate causes an increase to the post-tax Life RBC factors, which may seem counterintuitive at first impression. An example helps to illustrate this point: Assume that a certain stress event produces a post-tax loss of $65. At the time that the current Life RBC factors were derived, the tax rate was 35%. Therefore, the pre-tax loss when the factors were derived was ($65 / (1-0.35)), or $100. Under the new tax law, the same $100 pre-tax loss generates a $21 tax reduction, for a post-tax loss of $79. Because post-tax losses from the same risk event have increased from $65 to $79, post-tax RBC factors based on this type of event would need to be adjusted upward following the tax law change. The increase in Life RBC factors is offset, in part, for some factors, by an increase in the after-tax discount rate applied to the stressed losses. If the loss is assumed to happen n years in the future, the present value of the loss will be reduced due to the higher after-tax discount rate. This would temper the RBC impact of the factor change for those Life RBC factors that involve multiple-year discounting. The tax rate change from 35% to 21% is material. There may be significant changes to an insurer s ACL RBC at such time as Life RBC factors are changed. For example, for those Life RBC factors that currently use a tax factor of 35% and assume current (that is, not future) losses from a stress event, the Life RBC factors after-tax effect would increase by ([(1 tax factor NEW)/(1 tax factor OLD) 1]), or ([0.79/0.65] 1), which is 21.5%. Therefore, the maximum increase for any Life RBC factor due to tax law changes is 21.5%; however, many factors will have lower percentage increases, as outlined in this 1850 M Street NW Suite 300 Washington, DC Telephone Facsimile