Report of the Nonforfeiture Improvement Work Group

Transcription

1 A PUBLIC POLICY PAPER Reprt f the Nnfrfeiture Imprvement Wrk Grup August 2011 Nnfrfeiture Imprvement Wrk Grup

2 REPORT OF THE NONFORFEITURE IMPROVEMENT WORK GROUP August 2011 Develped by the Nnfrfeiture Imprvement Wrk Grup f the The is a 17,000-member prfessinal assciatin whse missin is t serve the public and the U.S. actuarial prfessin. The Academy assists public plicymakers n all levels by prviding leadership, bjective expertise, and actuarial advice n risk and financial security issues. The Academy als sets qualificatin, practice, and prfessinalism standards fr actuaries in the United States.

3 2011 Nnfrfeiture Imprvement Wrk Grup Jhn MacBain, FSA, MAAA Nel Abkemeier, FSA MAAA Mary Bahna-Nlan, CERA, FSA, MAAA Duglas Bennett, FSA, MAAA Tm Berry, FSA, MAAA Calvin Birkey, FSA, MAAA Eric Carlsn, FSA, MAAA Armand De Pal, FSA, MAAA Anthny Ferrar, FSA, MAAA Alice Fntaine, FCIA, FSA, MAAA Barbara Gld, FSA, MAAA Andrew Grdn, FSA, MAAA David Hippen, FSA, MAAA Jeff Hlzbauer, FSA, MAAA Barbara Lautzenheiser, FCA, FSA, MAAA Brian Lessing, FSA, MAAA Dnna Megregian, FSA, MAAA Cande Olsen, FSA, MAAA Arthur Panighetti, FSA, MAAA Nichlas Pasyans, FSA, MAAA Sandra Ptasky, FSA, MAAA Tmasz Serbinwski, FSA, MAAA Mark Shickler, FSA, MAAA Randall Stevensn, ASA, FCA, MAAA Eugene Strum, FSA, MAAA Wayne Stuenkel, FSA, MAAA Andrew Ware, FSA, MAAA Graham Ireland, FCIA, FSA, MAAA 1850 M Street N.W., Suite 300 Washingtn, D.C All rights reserved.

4 TABLE OF CONTENTS PAGE NO. Executive Summary and Recmmendatins 1 Overview and Charge... 3 Terminlgy and Cnventins Used in this Reprt. 3 Sectin I: Impetus fr Nnfrfeiture Refrm... 5 Histrical Perspective n Nnfrfeiture Mandates. 5 Changed Business and Prduct Envirnment... 5 Cnstraints f Current Standard Nnfrfeiture Laws... 6 Sectin II: Benefits f Nnfrfeiture Refrm. 9 Pssible Prduct Innvatins Under a Revised Nnfrfeiture Apprach Sectin III: Challenges t Achieving Nnfrfeiture Refrm.. 14 Varying Views as t the Objectives f Nnfrfeiture Refrm 14 Resistance t Change frm Segments f Regulatry and Industry Sectrs 14 Challenges t Nnfrfeiture Refrm Presented by Multiple Line Cmbinatin Prducts. 15 IRS Guidelines d nt Address the Prducts being Cnsidered. 15 Sectin IV: Basic Framewrk Guiding Prpsals fr Nnfrfeiture Refrm 17 Objectives f Nnfrfeiture Refrm Criteria. 17 Sectin V: Recmmended Apprach t Nnfrfeiture Mandate Refrm.. 19 General Overview 19 Appraches t Determining a Plicy s Nnfrfeitable Amunt 19 Prefunding Cncept 20 Basic Cmpnents f the GPNM.. 21 Threshld Level f RPNA.. 22 Establishment f NFB Assumptins 23 Additinal GPNM Cmpnents GPNM Examples General Observatins n the GPNM 27 Regulatry Framewrk fr the Operatin f the GPNM Sectin VI: Issues Related t Mandating Cash Surrender Values in Life and Annuity Prducts General Cmments On Cash Surrender Values, If Prvided, and Their Relatinship t the RPNA Actuarial Relatinship f Cash Surrender Values t RPNA 31 Prs and Cns f Mandating Cash Surrender Values 32

5 Sectin VII: The Rad Ahead Next Steps and Deliverables. 35 APPENDIX A: An Histrical Perspective 37 Insurer Practices. 37 Regulatry Respnses 38 APPENDIX B: Other Appraches T Determining Nnfrfeitable Values Cnsidered By the WG.. 39 APPENDIX C: Treatment f Nn-Par and Par Fixed Level Premium WL Under the GPNM. 41 APPENDIX D: Treatment f Accelerated Death Benefits Under the GPNM. 43 APPENDIX E: Public Plicy Issues Raised by the GPNM 44 Requirement fr Mandatry Cash Surrender Values when a Threshld Prefunding Level is Present. 44 Threshld RPNA Level where Nnfrtfeiture Benefits Must be Prvided.. 44 Qualificatin f Life Insurance Prducts as Life Insurance Under IRC 7702 and 7702A and Other Tax-Related Issues 45

6 Executive Summary and Recmmendatins This reprt is prepared in respnse t the charge assigned t the Academy Nnfrfeiture Imprvement Wrk Grup (WG): Study the feasibility f a new nnfrfeiture law fr life insurance and annuities t replace the existing nnfrfeiture standards. Prvide quarterly status reprts n this prject. Tw terms used in this Executive Summary and the reprt that fllws need further cmmentary: Nnfrfeiture benefit The benefits in kind available t a plicywner when required premium payments are n lnger being made and the plicy remains in frce. Cash surrender value the term used t define the amunt, if any, payable in cash t a plicywner at the time the plicy is discntinued. Current minimum nnfrfeiture mandates treat any plicy cash surrender value as a nnfrfeiture benefit. The recmmendatins fr nnfrfeiture refrm presented in this reprt cnsider any plicy cash surrender value as a separate and distinct ptin under the plicy rather than as a nnfrfeiture benefit under the plicy. All references t nnfrfeiture benefits in this reprt shuld be cnstrued t exclude any plicy cash surrender value. In this reprt, the WG makes certain recmmendatins with respect t life insurance and annuity nnfrfeiture mandates and sets frth certain items fr further discussin. The recmmendatins in the reprt are based n the cnclusins f the WG: 1) existing minimum nnfrfeiture value mandates are inadequate t meet the needs f regulatrs, cnsumers and industry in tday s dynamic life insurance and annuity market, and 2) cnsumers wuld benefit frm nnfrfeiture mandates that are mre transparent and adaptable t the ever-changing prduct envirnment. The WG s specific recmmendatins are: Current life insurance and annuity minimum nnfrfeiture mandates shuld be replaced with a revised methdlgy fr determining required plicy nnfrfeiture values. Required nnfrfeiture values shuld be determined using a retrspective methdlgy utilizing actual plicy grss premiums and reflecting the funded prtin f the risks assumed by the cmpany under a plicy. 1

7 The required nnfrfeiture value methdlgy shuld be cnsistent fr life insurance and annuity plicies. Required nnfrfeiture values shuld include amunts fr nn-guaranteed elements in excess f the plicy guarantees, including, fr purpses f this reprt, dividends that have been declared by the cmpany and included in plicy values. Enhanced methds f cnsumer infrmatin (relative t that prvided tday) shuld be develped fr cnsumers as part f the prpsed required nnfrfeiture value methdlgy. Apprpriate, timely and relevant nnfrfeiture basis infrmatin shuld be prvided t regulatrs t facilitate versight f the applicatin f the prpsed required nnfrfeiture value methdlgy. The WG recmmends the fllwing issues fr discussin and/r reslutin as part f implementing a revised apprach t life insurance and annuity nnfrfeiture mandates: Whether cash surrender values shuld be mandated fr life insurance and annuity plicies when prefunding is present. What, if any, guardrails shuld be placed n the nnfrfeiture basis assumptins used in determining required nnfrfeiture values. Hw any tax issues assciated with the prpsed nnfrfeiture methdlgy shuld be reslved. 2

8 Overview and Charge In 2007, the NAIC Life and Health Actuarial Task Frce (LHATF) included in its annual list f charges: Study the feasibility f a new nnfrfeiture law fr life insurance and annuities t replace the existing nnfrfeiture standards. Prvide quarterly status reprts n this prject. LHATF requested the (Academy) t prceed with the effrt t assist it in cmpleting this charge. It is wrth nting that similar charges have been undertaken by LHATF a number f times in the past, ver a perid dating back almst 20 years. As with any effrt f the magnitude envisined by the language f the charge, the ability t accmplish the charge was subject t many influences nt directly assciated with the actuarial effrt invlved such as ther mre pressing LHATF pririties, regulatry and industry indifference t revising nnfrfeiture mandates, and the slwness f prduct innvatins in the marketplace that cnsequently lessened the pressure fr revisin. The currently cnstituted Academy Nnfrfeiture Imprvement Wrk Grup (WG) believes that nw is the pprtune time t revisit life and annuity minimum nnfrfeiture mandates. This reprt utlines the histrical rts f the current nnfrfeiture mandates, sets frth the reasns that these are n lnger the mst ptimal mandates fr the current insurance and annuity marketplace, and prpses a framewrk and apprach t refrm. The effrt t implement refrm is significant, but the WG feels it is essential. The WG believes that regulatrs and cnsumers wuld benefit frm a nnfrfeiture apprach having an emphasis n principle-based standards rather than n rule-based standards. Prperly implemented, a principle-based apprach t the determinatin f required nnfrfeiture values shuld prvide values mre apprpriate t the cnsumer s needs. Terminlgy and Cnventins Used in this Reprt In preparing this reprt, the WG has incrprated the use f certain terminlgy and abbreviatins in cmmunicating its ideas and recmmendatins with respect t nnfrfeiture mandate refrm. Where first utilized in this reprt, abbreviatins are defined but, in additin, these are summarized belw tgether with the terminlgy t define certain terms in a cnsistent fashin. Cash surrender value the amunt, if any, payable in cash t a plicywner at the time the plicy is discntinued. GPNM The Grss Premium Nnfrfeiture Methd fr determining the RPNA as set frth in this reprt. 3

9 NFB The Nnfrfeiture Basis fr the plicy as articulated in the plicy. These include the guaranteed mrtality, interest, and expense assumptins, as well as any ther risk charge assumptins, used in determining the amunt f plicy prefunding and excludes the values f any NGEs, including dividends, declared by the cmpany, in excess f the guarantees fr the plicy. NGE Nn-guaranteed Elements such as interest, COI rates, expense charges, and, fr purpses f this reprt, dividends, the values f which may be in excess f the NFB guarantees. Such excess values are included in determining a plicy s RPNA nce declared by the cmpany and credited r charged accrding t the declaratin. Nnfrfeiture benefit The benefits in kind available t a plicywner when required premium payments are n lnger being made and the plicy remains in frce. The nnfrfeiture benefit at any time is equal t the RPNA using the NFB specified in the plicy. Plicy the cntract entered int between the plicywner and the insurer t prvide life insurance r annuity benefits; includes infrmatin specific t the particular plicywner and insured r annuitant under the cntract as well as the mre general cntract prvisins. Plicywner - the wner f a life r annuity plicy and the premium payr. RPNA The Required Plicy Nnfrfeiture Accunt fr a plicy; the prefunding value f the plicy based n the actual nnfrfeiture assumptins (NFB) articulated in the plicy and reflecting the value f any NGEs in excess f the NFB guarantees. Threshld A limitatin n an amunt intended t represent a level deemed apprpriate fr the particular purpse, as chsen by all parties discussing the issue. This level is nt t be necessarily deemed a de minimis level which is mre apprpriately described as smething s small, miniscule, r tiny as t be f n cnsequence financially. 4

10 Sectin I Impetus fr Nnfrfeiture Refrm Histrical Perspective n Nnfrfeiture Mandates 1 The NAIC Mdel Standard Nnfrfeiture Law fr Life Insurance (SNFL) was adpted in 1942 and the NAIC Mdel Standard Nnfrfeiture Law fr Individual Deferred Annuities (SNFLIDA) was adpted in Bth Mdel Laws have been ccasinally amended t react t emerging changes t histrical prduct types and their prvisins have been extended t apply t new prducts (e.g., variable annuities, variable life, universal life, mdified guaranteed annuities, etc.) thrugh varius regulatry mechanisms. The Mdel Laws remain in their riginal basic frm and nt nly have nt been applied cnsistently acrss plans but als have nt been applied cnsistently acrss all jurisdictins (a case in pint here has been the incnsistent applicatin f the prspective test in the SNFLIDA). The latter is ften the result f regulatrs attempting t adapt the laws t changes in the marketplace. Since the intrductin f these Mdel Laws, the business envirnment fr insurance cmpanies and their prducts has changed dramatically in terms f cnsumer needs and preferences, the lwering f cmpetitive barriers between insurers and ther financial services cmpanies, the intrductin and use f new financial instruments, and increased administrative capabilities thrugh technlgical develpments. This suggests the need t revisit the existing nnfrfeiture requirements in a way that will allw insurers t address cnditins f the 21 st century. The thrust f the needed changes is t facilitate innvatin in prduct design that benefit the cnsumer while als prviding adequate prtectin f the insurer s ability t perate prfitably. The changes needed cnsist f a reductin in unnecessary design cnstraints and the eliminatin f requirements fr values that d nt reflect the true ecnmics f the plicy (e.g., mandatry ne-size-fits-all acquisitin expense allwance). Since the purpse f nnfrfeiture laws is cnsumer prtectin, any revisin t the Mdel Laws must cntinue t assure that apprpriate prtectins are in place. T mve beynd the current rule-based laws, it will be necessary t establish a sund set f principles that will serve as the fundatin fr any revisin. Changed Business and Prduct Envirnment The business and prduct envirnment has changed fr insurance cmpanies since the existing nnfrfeiture laws were put in place. Cnsumer awareness and lifestyles, 1 This sectin f the reprt prvides nly a passing reference t the histrical cntext f nnfrfeiture mandates. Fr additinal reference, Appendix A, An Histrical Perspective prvides extensive detail n the rigin f and ratinale fr the nnfrfeiture mandates in place tday. 5

11 cmpetitive pressures, prduct designs, and technlgy have prgressed in ways that were unanticipated when nnfrfeiture laws were frmulated. Cnsumers value flexibility in the prducts they buy and cnvenience in dealing with prviders f financial services. Custmized and persnalized slutins fr all types f cnsumer needs are far mre cmmn tday than they have been histrically, and the trend is certain t cntinue. Cnsumers are als mre interested in learning abut the prducts and services they are buying, in rder t make mre infrmed chices. All f this is magnified by the imprtance placed n individual retirement planning by the mbility f the jb market, increased lngevity and demgraphic changes, and the transitin frm defined benefit pensin plans t defined cntributin structures. The existence f a secndary market fr life insurance cntracts, althugh nt a substitute fr required nnfrfeiture values, has prvided additinal ptins t cnsumers that did nt exist even a decade ag. New life insurance and annuity prducts that satisfy cnsumers changing needs and desires have emerged since the enactment f the Mdel Laws. Fr example, universal life and variable universal life have been available fr several decades, and frms f these prducts with premium guarantees have been very ppular fr a decade r mre. Als, level premium term insurance prducts, sme with premium guarantees as lng as 30 years, have had significant market acceptance since the 1980 s. Als, many deferred annuity prducts nw incrprate Guaranteed Living Benefit features. Cmpetitin frm ther financial services prviders has increased due t deregulatin in thse sectrs, allwing these prviders t develp and successfully market nn-insurance prducts with characteristics similar t thse ffered by insurers but nt subject t nnfrfeiture r crrespnding requirements (e.g., bank CD s). Technlgical changes have made it pssible t value and administer increasingly cmplex prducts. They als facilitate imprved cmmunicatin with cnsumers, a requirement fr sme f the flexible prducts encuntered tday. Principle-based reserves are bringing a cnceptual shift t hw the risks t which life insurers are expsed are measured. A parallel shift in the methdlgy fr determining required nnfrfeiture values is cnsistent with this enhanced apprach t risk management. Cnstraints f Current Standard Nnfrfeiture Laws The NAIC Mdel Standard Nnfrfeiture Law Fr Life Insurance and NAIC Mdel Standard Nnfrfeiture Law Fr Individual Deferred Annuities (bth subsequently referenced as SNFL in this reprt) were develped when fixed premium plicies with bk value benefits were the nrm and asset/liability management was nly indirectly addressed within the insurance and annuity industry. The prducts that characterize the market tday have mre flexible premium payment ptins and requirements, ften with 6

12 market value r equity value based designs that emphasize cnsumer chice in funding and/r investment decisin making, but with additinal risks retained r assumed by the cmpany. Certain characteristics f the current nnfrfeiture requirements represent cnstraints that may serve t be impediments t the develpment f certain prducts and als may impse barriers t mre effective asset/liability management ptins. Sme f these impediments are: 1. Current prescriptive apprach t nnfrfeiture minimums: Life insurance nnfrfeiture requirements are prspective in nature and assume a fixed pattern f future premiums. Many prducts tday are flexible premium and, in part and t varying degrees, retrspective in their peratin. This makes demnstrating the equivalence between retrspective and prspective minimum nnfrfeiture values dependent n arbitrary assumptins. Current laws d nt recgnize any relatinship between the value f the prefunded benefits and a prduct s grss premiums Premium payment patterns and cntractual benefit structures may dictate a cash surrender value be made available, despite the fact that this may nt be cnsistent with the cnsumer s preferences r needs. Nnfrfeiture mandates include a smthness test f cash surrender values that may nt be easily applied t current prducts and is inapprpriate fr thers. Life insurance nnfrfeiture mandates require a nnfrfeiture interest rate fr the life f the cntract, which may nt be representative f desirable benefit guarantees nr the investment strategy backing the benefit guarantee. The incnsistency between the nnfrfeiture rate and the investments backing the cntract has the ptential t impse slvency strains in lw interest rate envirnments. Life nnfrfeiture mandates incrprate frmulaic expense levels as ppsed t the specific recgnitin f actual cmpany csts. Mandated cash surrender values d nt recgnize disintermediatin risk. Bth life and annuity nnfrfeiture laws limit surrender charge patterns in a fashin that represents an expense amrtizatin algrithm that is inflexible and des nt address specific prduct and/r cmpany. 2. Existing nnfrfeiture mandate framewrk induces cmpanies t use cmplex and difficult t understand prduct designs, such as the fllwing, t address cnsumer needs: The use f unusual premium scale patterns in cncert with the unitary apprach t reduce annually renewable term cash surrender values. 7

13 The use f secndary guarantees in universal life plicies t reduce r eliminate cash surrender values that wuld therwise be required in whle life insurance plicies incrprating similar guarantees. The Prspective Test fr deferred annuities encurages the use f fixed maturity dates. This creates the appearance f a lack f flexibility fr the cnsumer when that flexibility actually exists. The use f Return f Premium term prducts essentially similar t partial endwment prducts but incrprating n interim cash values. This cntrasts with the nnfrfeiture benefits that wuld be required fr similar stand alne endwment prducts under current nnfrfeiture mandates. 3. Current laws and varying interpretatins result in incnsistent regulatry treatment f prducts with similar benefit guarantees but different cntractual structures: Mdel nnfrfeiture laws are nt enacted in all jurisdictins and mdel laws are mdified befre adptin in thers. This will be mitigated but nt reslved with the implementatin f the Interstate Cmpact. A revised nnfrfeiture mandate apprach wuld reduce the need fr varying versins f nnfrfeiture mandates amng the states. The cnsumer prtectin value f existing nnfrfeiture requirements is interpreted differently in varius jurisdictins, resulting in incnsistent treatment and additinal unnecessary cmpliance csts. Insurer interpretatins vary and this is nt addressed cnsistently in the regulatry framewrk fr current nnfrfeiture mandates. 8

14 Sectin II Benefits f Nnfrfeiture Refrm Revising the nnfrfeiture laws t better apply t the current and prspective marketplace wuld bring a brad array f benefits t cnsumers. Revised laws culd facilitate innvatin. Insurance cmpanies culd prvide prducts that are better tailred t purchasers needs. Cnsumer csts fr insurance prducts culd be reduced cmmensurate with the ability t eliminate certain risks and their csts. This culd result frm either the eliminatin f unwanted ancillary benefits that are currently required r mre efficient cmbinatins f benefits in a single prduct. Cst reductins are als pssible due t the eliminatin f multiple filings currently required due t varius state interpretatins. Certain current prduct designs are smewhat cmplex t deal with under the cnstraints in the nnfrfeiture laws. Updated nnfrfeiture mandates culd allw fr prducts that are mre easily understd by the cnsumer. A new nnfrfeiture apprach, designed apprpriately, wuld prvide increased transparency t cnsumers with respect t plicy values and hw they are determined, prviding cnsistency in this regard with ther prducts in the financial services marketplace. If cnstructed apprpriately, a revised apprach t nnfrfeiture mandates will reduce the ptential fr cmplex prduct design features cnstructed primarily t cmply with r avid nnfrfeiture mandates. Insurer enterprise risk management can be aided by allwing the design f prducts that are less vulnerable t ecnmic changes. Sme f the ptential benefits f a revisin in nnfrfeiture mandates can be identified by nting several types f prducts that wuld bring added cnsumer benefits, but currently are unavailable due t cnstraints impsed by current nnfrfeiture mandates. An array f pssible such prducts are described belw. Fr mst f these prduct innvatins, the value t the cnsumer is either a mre flexible plicy that allws multiple needs t be addressed thrugh ne purchase decisin r the eliminatin f undesired mandated benefits. This prvides the ptential fr imprved efficiency fr cnsumers and insurers, and the increased efficiency may translate int cst savings. 9

15 Pssible Prduct Innvatins Under a Revised Nnfrfeiture Apprach The prduct innvatins described belw are examples f prducts that culd be made available in the marketplace with apprpriate mdificatins t current nnfrfeiture mandates. The WG is nt endrsing any f these prducts, but is presenting this list t fster discussin f whether r nt changes t current nnfrfeiture mandates are apprpriate. The prducts indicated suggest the breadth f pssibilities under the mst sweeping revisin t these laws; hwever, nly sme are pssible under the apprach recmmended in this reprt. Thus, they help put in perspective the changes being prpsed. It is wrth nting here that nnfrfeiture mandates are primarily a cnsumer prtectin device and, under any revised nnfrfeiture mandate apprach, the prduct innvatins nted belw wuld be successful in prviding apprpriate cnsumer benefits nly if cupled with enhanced disclsures t the cnsumer and actuarial infrmatin t regulatrs. 1. N cash surrender value permanent life insurance This prduct is nt allwed under current US nnfrfeiture laws. It is allwed in Canada. This type f prduct is currently being apprximated in the US thrugh the use f universal life with secndary guarantees. It can als be apprximated thrugh a decreasing term t 100 with a nn-guaranteed element equal t the decreased amunt. The cnsumer value in this prduct is that it culd prvide permanent guaranteed death benefit cverage at a lwer premium. The savings result frm the eliminatin f cash payments upn surrender (althugh ther nnfrfeiture benefits wuld still be prvided), imprved plicy persistency due t the reduced attractiveness f terminatin, better investment returns due t lengthened liability duratin and a resultant ability t invest lnger, and the ability f the insurer t reduce csts with less cmplex administrative systems. Als, the sale is simplified and cnsumer understanding is increased because f the simplicity f the prduct (althugh the need fr adequate disclsure f n cash surrender ptin cannt be verstated). 2. Straightfrward n cash surrender value term insurance Many term insurance plicies currently utilize high guaranteed renewal premiums and high maturity ages in rder t achieve zer cash surrender values under a unitary cash surrender value calculatin. Nevertheless the apprach is incapable f achieving zer cash surrender values at high issue ages with the result that term insurance ften is nt ffered abve issue age 65. Withut frmulaic cash surrender value requirements, term insurance withut cash surrender values culd be ffered at all ages. Als, guaranteed renewal premiums culd be set at lwer levels. 3. Life insurance plicies with nn-smth cash surrender values 10

16 The wrding f the smthness test in the current SNFL prhibits this type f prduct. The cnsumer benefit fr this prduct is that cash surrender values can be generated t fit a plan designed at issue. An example is a prduct used t help fund cllege expenses. There culd be n cash surrender value fr years, and then relatively large cash surrender values s that a parent can pay cllege tuitin fr a child. T the extent that cash surrender values are reduced frm what wuld therwise be required, there are the same kinds f savings as with n cash surrender value life insurance, althugh the degree f savings is reduced. 4. Life insurance with nnfrfeiture interest rate peridically reset The mst recent revisin t the Mdel Standard Nnfrfeiture Law fr Individual Deferred Annuities intrduced indexing f the nnfrfeiture interest rate and the capability t reset the rate using the same index at specified times during the plicy lifetime. Lw interest envirnments als affect the ability t supprt interest guarantees in life insurance prducts; cnsequently, there may be value in allwing annuity-type indexing f the nnfrfeiture interest rate in life insurance plicies. The advantage wuld be a strengthening f insurers ability t address r respnd t lw interest rate envirnments. 5. Cash surrender value plan life insurance This prduct is nt allwed under current law, althugh it was given heavy cnsideratin by LHATF as the basis fr a pssible revisin t the SNFL in The cncept is that the cash surrender values are nt declared in advance, but rather the methd fr calculating the cash surrender values is stated in a plan that is filed with regulatrs and cmmitted t by the insurer. The insurer then certifies cmpliance with the plan annually. The cash surrender values that are prduced by the plan reflect mrtality, interest, lapse, r ther specified experience that develps. A variatin f the apprach might specify a guaranteed minimum interest rate, while experience n the ther factrs is reflected in the cash surrender values. Anther variatin might guarantee a cash surrender value flr (perhaps a nn-smth pattern as discussed abve) and prvide experience-based benefits in additin t that n the basis f a plan. The value t the cnsumer is that a prduct can be structured with cmplete flexibility t meet cnsumer preferences at the time f sale. The chice f a plan with lwer cash surrender values can ptentially lead t lwer premiums. As the plan reduces guarantees, the insurer can reduce risk-based capital and create savings that can be passed n t the cnsumer. 6. Universal insurance funding multiple benefit types 11

17 Universal insurance culd be prvided in the frm f a plicy with a single accunt value frm which csts f insurance culd be drawn fr full levels f cverage t meet the cnsumer s needs in many lines f insurance (e.g., life insurance, annuity funding, annuity payuts, lng-term care, r ther types f insurance). It may be pssible t structure the plicy n a mre traditinal chassis while prviding the multiple-line benefits. Multiple benefit plicies currently are ppular in Eurpe. In the US it is pssible t receive apprval fr life insurance r annuity plicies with ancillary benefits frm ther lines f insurance; hwever, many kinds f cverage in the secndary lines are nt pssible because f cnflicts in laws and regulatins amng the varius lines f insurance. Additinally, even with the limited cverages, the apprach by regulatrs varies by jurisdictin. Examples f currently ffered cverages are critical illness cverage n life insurance plicies and lng-term care cverages in bth life insurance and annuity plicies. Cnsumer benefits frm this type f plicy culd be numerus. One stp shpping is a cnvenience fr the purchaser bth at the time f purchase and when subsequently paying premiums r requiring custmer service. The packaging f multiple cverages can encurage cnsumers t purchase needed cverages that they are reluctant t purchase separately. Integrated designs can make it pssible t reduce csts due t the eliminatin f benefit verlaps. Cmbining cverages can reduce issue expense and administrative expense, with a resulting reductin in premium cst. Fr cverages that require medical underwriting, sme prtins f the underwriting can be shared efficiently. Fr lines that nrmally d nt utilize underwriting, it may be pssible t use underwriting infrmatin frm ther lines t justify discunts. Sme benefits culd be mutually exclusive and thereby reduce csts belw what might ccur with separate purchases. Varius benefits may have negatively crrelated risk prfiles and thus wuld create a reduced aggregate risk prfile that impses less risk n the insurer and require less capital, again reducing benefit csts. 7. Multi-generatinal family plicy This prduct wuld make available all the cverages f a universal insurance plicy, but als have the ability t transfer frm ne generatin r family member t anther. Fr example, it culd be a deferred annuity fr a parent, then change t a life plicy n a child, and then back t a payut annuity fr the parent. Cncurrent multi-line benefits culd als be ffered. The ptential cnsumer and insurer benefits f such a plicy are similar t thse mentined fr universal insurance. Additinally, there culd be the pprtunity t reduce aggregate csts and premiums because new sales wuld be replaced by intensive service, which culd allw reduced sales cmmissins and issue expenses. 8. Life cycle insurance This type f plicy culd prvide a sequence f cverages that track the differing needs that emerge at varius pints in a persn s life cycle. The clearest example wuld be a life insurance plicy that changed t a deferred annuity and later changed 12

18 again t an incme annuity with lng-term care benefits. Currently this is pssible nly thrugh the sequential purchase f separate plicies because f the incmpatibility f life insurance and annuity nnfrfeiture requirements. This type f prduct wuld be ecnmically efficient and wuld prvide great cnvenience t the purchaser. It culd make sense t cnsumers and culd be ppular in the market. It culd be even mre beneficial if there is the ability t partially cnvert the cash surrender value int an incme stream and cntinue all r a prtin f the life cntract simultaneusly (i.e., single-benefit changing t multibenefit). 9. Market value adjusted life insurance There is a mdel regulatin (the NAIC Mdel Guaranteed Life Insurance Regulatin) that allws fr mdified guaranteed life insurance that is similar t the NAIC Mdified Guaranteed Annuities (MGA) mdel, but this regulatin has nt been widely adpted. Allwing a cmpany t prvide cash surrender values that reflect market value changes wuld enable lnger duratin investments and lwer liquidity needs which in turn wuld imprve plicy wner value. As with ther prducts, ther nn-cash surrender ptins wuld be available withut market value adjustments s that the plicywner des nt need t liquidate the plicy if premiums are terminated. This type f prvisin might entail a change t the plicy lan laws and regulatins s that the market value adjustment is applied cnsistently when a plicy lan is taken. 13

19 Sectin III Challenges t Achieving Nnfrfeiture Refrm While the WG believes that there are cnsiderable cnsumer, regulatry and insurer benefits that can be realized if prducts can be designed withut the cnstraints impsed by the current nnfrfeiture mandates, it als recgnizes that there are ther laws, regulatins, and practices that may present impediments t develping sme f the prducts described previusly. A strategy fr dealing with these issues will have t be develped in rder fr nnfrfeiture refrm t be effectively implemented withut having cunterprductive results. Sme f the issues that can create impediments are discussed belw. Varying Views as t the Objectives f Nnfrfeiture Refrm There are varius views cncerning the need fr and requirements f nnfrfeiture mandate refrm as nted belw: Revisin is needed t make nnfrfeiture requirements mre flexible and hence cnsistent with a principle-based apprach t meeting cnsumer needs. Changes are needed t ensure the equal treatment f a variety f prduct design appraches that prduce the same benefits fr cnsumers but have different nnfrfeiture requirements. Changing prduct designs will require that disclsure requirements be addressed t assure that the cnsumer prtectin aspects f nnfrfeiture mandates are mre directly addressed thrugh disclsure requirements than by mandating minimum benefits. Nnfrfeiture laws that were written between 30 and 65 years ag need t be updated t be mre reflective f the realities f tday s marketplace, a marketplace which is far mre cmplex than envisined when the laws were written. Resistance t Change frm Segments f Regulatry and Industry Sectrs The insurance industry is nt unanimus in calling fr nnfrfeiture revisin. While there is general agreement that the nnfrfeiture laws are nt apprpriately designed fr the current marketplace envirnment r the evlving future marketplace, insurers have fund ways t wrk within the cnstraints f the laws. While this generally requires mre cmplex prducts, these insurers have fund that they can cntinue t cmpete successfully. With SNFL changes, sme f these prducts may n lnger be ffered. Als, any advantages f change, sme feel, culd be utweighed by the ptential risks f adverse incme tax cnsequences. Regulatrs generally recgnize that the nnfrfeiture laws need t be updated, and varius effrts t this end have taken place ver many years; hwever, these effrts have nt cme t fruitin. It is recgnized that the changes wuld be 14

20 significant; cnsequently, the breadth f the change is an issue fr sme. The arrival f principle-based reserving has brught a heightened fcus n the need t adapt nnfrfeiture requirements. This is viewed as an additinal catalyst fr bringing nnfrfeiture refrm effrts t a cnclusin. Challenges T Nnfrfeiture Refrm Presented By Multiple Line Cmbinatin Prducts The current regulatry framewrk in many states differs by line f business. If changes t the SNFL were made t accmmdate multi-line cmbinatin prducts, methds t blend, integrate, r islate the differing requirements may need t be fund. Health insurance and prperty/casualty insurance are regulated in sme states via lss ratis and are nt subject t nnfrfeiture requirements while life insurance and annuities each have their wn SNFL. Questins arise as t what cnstitutes the highest cmmn regulatry denminatr fr multi-line cmbinatin prducts. Life insurance and annuities typically have cash surrender values while ther cverages generating prefunding may nt (e.g., LTC). Statutry reserve requirements wuld need t be develped. At first glance, it may make sense t use current principle-based reserve appraches, but it wuld be necessary t take a clser lk t assure the current prpsals are apprpriate. Premium taxe issues with respect t a multi-line cmbinatin prduct wuld need t be addressed, since these vary amng lines f insurance. Crdinatin f agent licensing may need t be addressed fr multi-line cmbinatin prducts. Disclsure requirements vary by line f business and wuld need t be crdinated. Rate flexibility varies by line f business. Risk-Based Capital (RBC) requirements vary amng lines f insurance fr similar risks. These wuld need t be integrated. Guarantee fund assessments vary by line f insurance and wuld need t be integrated. IRS Guidelines D Nt Address the Prducts being Cnsidered In a manner similar t state regulatin, the federal tax treatment f prducts has been prduct line-specific. Cmpany and plicywner taxatin issues in relatin t cmbinatin prducts and prducts with reduced r flexible cash surrender values include the determinatin f what is cnsidered t be life insurance, hw the deferral f taxatin n cash surrender value grwth wuld be applied, and what patterns f cash surrender value develpment are allwable. These and ther tax issues must be addressed in rder 15

21 fr nnfrfeiture refrm t mve frward. It s nt clear what the NAIC s rle wuld be in addressing sme f these issues, but if the issues are nt addressed they may becme impediments t gaining universal supprt fr change. 16

22 Sectin IV Basic Framewrk Guiding Prpsals fr Nnfrfeiture Refrm In its deliberatins regarding the histrical cntext fr nnfrfeiture mandate refrm and cnsidering the current prduct marketplace, heightened cnsumer awareness and access t infrmatin, and current regulatry practices and peratinal prcesses with respect t minimum nnfrfeiture cmpliance, the WG felt it apprpriate t establish a basic framewrk fr refrm. This framewrk cnsists f a set f criteria t guide effrts t develp an apprach t refrm. The criteria belw cnstitute the WG s framewrk fr refrm and have been develped withut any attempt t impse real wrld restrictins (e.g., taxes, public plicy issues, etc.) n the subject f nnfrfeiture mandate refrm. These criteria shuld apply t any prpsal t change life and annuity nnfrfeiture requirements. Nnfrfeiture values shuld be based n prefunding resulting frm premium payments and credited r charged amunts Nnfrfeiture regulatry requirements shuld prvide specific guidance with respect t required nnfrfeiture value methdlgies and general guidance with respect t the establishment f nnfrfeiture value assumptins. Nnfrfeiture requirements shuld incrprate a well defined and purpseful apprach t any statistical agency cllectin f the assumptins needed t supprt revised nnfrfeiture standards. Required nnfrfeiture values at any time shuld nt be representative f the ecnmic value f the plicy at that pint in time but rather be a retrspectively determined measure f the prefunding f benefits accrued t that pint in time. In determining required nnfrfeiture values, there shuld be n recgnitin f a change in insurability status since the date f plicy purchase, ther than thse that may ccur as a result f the exercise f a specific plicy prvisin. Nnfrfeiture value methdlgy requirements shuld be the same fr life and annuity prducts. The determinatin f nn-guaranteed elements (including dividends) shuld nt be regulated by required nnfrfeiture value mandates. Hwever, nce credited r charged such amunts must be cnsidered in the determinatin f any required nnfrfeiture values. Objectives f Nnfrfeiture Refrm Criteria The bjectives f nnfrfeiture refrm are t: 17

23 A. Prvide prduct design flexibility and transparency fr cnsumers B. Prvide a fair and equitable value t the cnsumer C. Achieve hmgeneus treatment f prducts D. Prvide lng-term strategic nimbleness fr the insurance industry in its prduct develpment activities E. Remedy shrtcmings in current nnfrfeiture mandates fr prducts It is imprtant t nte that the scpe f the framewrk fr refrm nted abve has been limited t life and annuity prducts since that is the nature f LHATF s charge t the WG. The WG understands that its charge is limited t the review f current nnfrfeiture mandates as they relate t life and annuity prducts nly, but wishes t pint ut that the framewrk fr refrm abve culd be applied t ther lines f business as well. In additin, the WG recgnizes that current life and annuity nnfrfeiture laws apply t individual prducts nly. Hwever, the WG believes that the criteria embdied in the framewrk fr refrm abve apply equally t grup life insurance and annuity prducts where individual certificates, by whatever name, are issued. The criterin f prefunding applies based n the guarantees applicable in the cntract and nt n the particular chassis in which thse guarantees are presented. The apprach t nnfrfeiture refrm presented in this reprt makes n distinctin as t the whether the plicy chassis is individual r grup. 18

24 General Overview Sectin V Recmmended Apprach t Nnfrfeiture Mandate Refrm Histrically, nnfrfeiture mandates fr individual life insurance and annuity prducts have established minimum nnfrfeiture values fr such plicies. These values have, as their basis, the prvisin f a minimum nnfrfeiture value predicated n certain regulated experience factrs rather than the specific guarantees prvided in the plicy itself (althugh in many cases, fr practical reasns, these are made the same) r the premiums paid fr thse guarantees. In effect, the current prspectively based minimum nnfrfeiture mandates can be viewed as a retrspectively determined amunt f prefunding based n the plicy type and the regulated experience factrs. Fr nnuniversal life insurance plicies, the actual plicy grss premium is nt a cnsideratin in the determinatin f the minimum nnfrfeiture value. Als, the values f any NGEs assciated with the plicy (dividends, excess interest, etc.) that are in excess f the plicy guarantees are generally ignred in the determinatin f the minimum nnfrfeiture values under current mandates and s further cause a separatin f the minimum values required frm the actual amunt f benefit prefunding accruing under the plicy. Appraches t Determining a Plicy s Nnfrfeitable Amunt The WG recgnizes that there are varius appraches t determining the apprpriate nnfrfeiture amunt available t a plicywner shuld the plicy terminate prir t its guarantees maturing. An verview f the ther pssible appraches cnsidered, but rejected by the WG because f their incnsistency with the criteria in the framewrk fr refrm, is prvided in Appendix B f this reprt. The WG decided that the apprach that best satisfies the criteria articulated in its framewrk fr refrm is ne that is retrspectively-based. The nnfrfeiture apprach prpsed in this reprt, defined as the Grss Premium Nnfrfeiture Methd r GPNM, assumes that the value in a plicy that is nt frfeitable is any prefunding by the plicywner f benefits thrugh premiums paid and interest credited in excess f amunts required t pay benefit and expense charges t date. The value f any NGEs that are in excess f the plicy guarantees cntributes t this amunt. The threshld amunt f prefunding abve which nnfrfeiture benefits must be ffered is nt defined in this reprt, and shuld be determined based n input frm varius parties. It shuld be nted that any decisin regarding this threshld level f prefunding is independent f any decisin regarding whether r nt cash surrender values shuld be mandated when prefunding is present. In rder t better cnvey the cncept f a nnfrfeiture value based n the amunt f actual prefunding accruing t the benefit f the plicywner thrugh the payment f premiums, the WG has, as part f defining the GPNM, utilized the term required plicy nnfrfeiture accunt (RPNA) t clearly indicate that this prefunding value is based n 19

25 the NFB articulated in the plicy and declared NGE values in excess f thse guarantees as ppsed t a general flr r minimum guarantee based n the plicy type, prescribed factrs, and excluding the value f any NGEs in excess f the guarantees. Under the GPNM, the risk charge, interest rate and expense charge structures are nt regulated, beynd perhaps a brad regulatry framewrk. Rather this methd relies upn disclsure, regulatry versight, cmpetitive pressures, and ther market disciplines t ensure fair cnsumer treatment. This prpsal des nt cnsider market value changes (i.e., changes in ecnmic cnditins) r changes in health cnditins (unless these are specifically prvided fr in the plicy) as cntributing t RPNA values. Prefunding Cncept The cncept f prefunding invlves accumulating funds twards cmpletely paying up the benefits prmised under the plicy. Once the benefits prmised have been fully paid fr, the nnfrfeiture benefit prvided becmes the benefits prmised and fully funded. Examples f this prcess as it relates t traditinal fixed premium life insurance are clear and straightfrward. A 20-pay nn-participating whle life plicy is fully paid after 20 years, the RPNA (see belw) is the amunt that, with interest, will fund all future risk (mrtality) charges and expense lads (based n the plicy s nnfrfeiture mrtality, expense and interest guarantees), and the nnfrfeiture benefit is the full face amunt, i.e., the full cntractual benefit. 2 Fr flexible premium universal life, the cncept is smewhat mre cmplex but still valid. If a universal life plicywner desires, at issue, $100,000 f insurance, the RPNA is the plicy accunt value based n the plicy NFB assumptins and the values f any NGEs in excess f thse guarantees. If the RPNA reaches an amunt that, with interest, will fund all future risk (mrtality) charges fr the $100,000 benefit and expense lads, the plicy is in effect paid up fr the $100,000 death benefit. Thereafter, the RPNA is the accunt value and the nnfrfeiture benefit is based n that amunt. Fr varius types f deferred annuities n the market tday, the guarantee is that, whatever the accumulated fund is when an incme ptin is elected, a certain minimum incme level per $1 f that fund will be prvided. It is the purchase rates that are guaranteed, nt a fixed incme amunt. Each premium cannt be lked n as prviding funding fr a specific guaranteed incme. The incme prvided depends n hw much fund has accumulated at the time incme payments are t cmmence. Accrdingly, there is n prefunding in the sense f premiums being used t fund a specific guaranteed incme level. Hence, there is n nnfrfeiture benefit in the sense f any prmised future benefit being fully r partially funded at any time, and hence n RPNA. The prtin f the fund value available t the plicywner as the cash surrender value at any time is determined by the language f the deferred annuity plicy. 2 In rder t clarify the applicatin f the GPNM t fixed level premium nn-par and par WL and t demnstrate that values equivalent t minimums under current nnfrfeiture mandates can be reprduced using current nnfrfeiture assumptins, Appendix C f this reprt prvides a detailed discussin f the cnditins necessary fr that equivalence. Appendix C demnstrates that fixed level premium WL minimum values can be reprduced as a special case f the GPNM. 20

26 Lngevity annuities are the exceptin t this general rule regarding deferred annuities. These prducts, in their typical frm, guarantee a certain incme cmmencing n a certain (deferred) date. If this guarantee is paid fr in ne premium, the prmised benefit is fully paid fr and the nnfrfeiture benefit is that guaranteed incme. If, n the ther hand, the guaranteed incme is t be paid fr ver a perid f years (typically less than the deferral perid), then shuld the cntract be terminated prir t all premiums being paid, there is a nnfrfeiture benefit based n the prefunding t that date. There may r may nt be a cash surrender value under the plicy, but a nnfrfeiture benefit and a RPNA exist. Once all premiums have been paid, the plicy is fully funded with the full incme payable n the cntractual incme cmmencement date. Basic Cmpnents f the GPNM Nnfrfeiture Basis (NFB) The actuarial basis used in determining the RPNA befre the value f any NGEs in excess f the NFB guarantees. If there are n NGEs under the plicy, the NFB is the actuarial basis used in determining the RPNA. If a cmpany has chsen t prvide benefit guarantees in the frm f factrs (interest, COI charges, and lads) then these frm the NFB. If the cmpany has chsen t prvide benefit guarantees based n the payment f a specified premium then they must declare in the plicy a NFB that is cnsistent with the specified premium and the benefit guarantees. Required Plicy Nnfrfeiture Accunt (RPNA) The value that represents the actual level f plicywner prefunding. The RPNA is calculated as the premiums paid, less risk charges and lads (expense and prfit) plus interest, all n the NFB, adjusted fr the value f any NGEs in excess f the NFB guarantees. The NFB assumptins may (t sme degree) r may nt be regulated, but are disclsed t enhance market discipline and transparency t the cnsumer. The NFB and any NGEs must be disclsed at issue f the cntract and NGE values in excess f the NFB guarantees must be declared in advance f their being credited r charged t the RPNA. The mechanics f the RPNA are similar t the fund mechanics in a universal life plicy where the amunts charged r credited must always satisfy the guarantees f the cntract. Nnfrfeiture Benefits The benefits in kind available t a plicywner when required premium payments are n lnger being made and the plicy remains in frce. These culd include reduced paid up, extended term, etc. A nnfrfeiture benefit will be required fr all individual life and deferred annuity prducts that have greater than a certain threshld (yet t be defined) level f RPNA. See Threshld Level f RPNA later in this sectin f this reprt fr additinal cmmentary. 21

27 The amunt f the nnfrfeiture benefit will vary with, and be actuarially equivalent t, the value f the RPNA. The assumptins underlying this relatinship must be cnsistent with the NFB as indicated in the plicy fr the nnfrfeiture benefit chsen. Threshld Level f RPNA Frm a pragmatic pint f view, there may be levels f RPNA prefunding belw which n nnfrfeiture benefits need be prvided; the WG believes that the cncept f what cnstitutes a threshld level f prefunding insfar as the RPNA is cncerned is beynd the scpe f this reprt. The materiality f the RPNA may be guided by mre than just numerical cnsideratins; it might cnsider elements such as perceptins f cnsumer fairness, plitical expediency, and prduct prfitability. All f these elements may need t be cnsidered in develping an acceptable definitin f a threshld level f prefunding. The WG recgnizes that the issue f frfeiture f any prefunding amunt, especially if n cash surrender value is available, has public plicy implicatins. The WG als recgnizes that certain prduct designs currently ffered invlve the frfeiture f sme amunt f prefunding upn terminatin (fr example, level premium term withut nnfrfeiture values). Ntwithstanding the abve discussin, the determinatin f any materiality threshld with respect t prefunding amunts shuld be guided by certain basic criteria. The WG recmmends the fllwing be used t guide any definitin f a materiality threshld level with respect t a plicy s RPNA: The apprach shuld nt vary depending n whether the prduct invlved prvides r des nt prvide cash surrender values The apprach shuld nt favr either fixed premium prducts r flexible premium prducts The apprach shuld be cnsistent fr life insurance and annuities The apprach shuld recgnize the primary benefit risk(s) assumed under the cntract (e.g., mrtality risk, lngevity risk, etc.) The apprach shuld be perceived by regulatrs and the public as being equitable The apprach shuld recgnize the ptential, under the GPNM t nnfrfeiture mandates, fr a plicy RPNA t be abve r belw the established threshld level during the perid the plicy is in frce and the implicatins, administratively, cntractually, and frm the plicywner s perspective, f that ccurrence There are a number f pssible appraches that satisfy these basic criteria gverning a threshld level f RPNA. Sme pssible appraches that are cnsistent with the abve criteria are shwn belw in n particular rder: 22