Proposed IASB Discount Rate Proposal Could Hurt Immediate Annuities, Long-term Care products, Insurers Say

State insurance regulators are monitoring efforts to modernize reserving and accounting systems that are currently underway.

Efforts to modernize reserving with a principles-based reserving system that more accurately reflects the risk of a life insurers is an internally driven effort that the National Association of Insurance Commissioners, Kansas City, Mo.; the American Academy of Actuaries, Washington; and the American Council of Life Insurers, Washington; have been working on for over five years.

"Our modernization efforts promise to improve the accuracy with which regulators and companies match reserves to risk. It will be vital that we implement these core consumer protections with the clearest possible view of their impacts," said Thomas R. Sullivan, Chair of the NAIC Life Insurance and Annuities Committee and Connecticut Insurance Commissioner.

The NAIC is currently doing a test run to see how the PBR approach will work. The work is being done by the actuarial consulting firm of Towers Watson to examine PBR provisions (VM-20) of the Draft Valuation Manual. The study will calculate the impact of these provisions on industry reserves and compare them to current methodologies.

"Measuring impacts is an important part of completing adoption of these modernization tools," said Adam Hamm, Chair of the NAIC Principles-Based Reserving Working Group and North Dakota Insurance Commissioner. "We will work with our partners to ensure that the entire process remains thorough and rigorous. Our goal is to improve the consumer protections gained through strong solvency standards."

Work on the PBR impact study will begin immediately and is expected to be completed by March 31, 2011. The NAIC plans to present the final report during its 2011 Summer National Meeting in Philadelphia.

Regulators are also responding to an externally driven project driven by a reexamination of international accounting standards by the International Accounting Standards Board, London, and the Financial Accounting Standards Board, Norwalk, Conn.

On Sept. 17, the FASB issued its discussion paper on insurance contracts with all comments to be received by Dec. 15. The draft follows a June 2010 release of an IASB exposure draft of a proposed international financial reporting standard that would apply to all insurance contracts written by both insurance companies and noninsurance companies.

The FASB Discussion Paper asks stakeholders to provide input about the following:

-- Whether the IASB's proposal would be a sufficient improvement to U.S. GAAP to justify the cost of change;
--Whether the project goals of improvement, convergence;
--Whether simplification would be more effectively achieved by making targeted improvements to existing U.S. GAAP (rather than issuing comprehensive new guidance); and,
--Whether certain critical accounting issues for which the preliminary views of the FASB differ from the IASB's exposure draft.

With that as a backdrop, a joint conference call was held by the International Accounting Standards (EX) working Group and the Statutory Accounting Principles “E” working group, led by Rob Esson, the NAIC’s senior international advisor.

During the call, the working groups tried to hammer out points so that a conversation of the insurance contracts subgroup in Kansas City, this coming week will be streamlined. The subgroup is trying to formulate comments to responses on the IASB draft by the International Association of Insurance Supervisors, Basel, Switzerland.

The discussion included a review of a series of 19 questions ranging from relevant information to users of insurers’ financial statements to the appropriate discount rate used by the insurer for non-participating contracts and whether it should reflect contract liability and not the assets backing the liability.

On the discount rate issue, Esson said that there is not absolute uniformity among regulators on the issue. The NAIC’s staff draft, according to Esson, is based on its understanding of the majority view of the NAIC’s Life & Health Actuarial Task Force that adjustments to any asset portfolio is limited to specific risk and default risk is removed from that portfolio and addressed through an economic default adjusted rate.

Esson went on to describe how the NAIC understood concerns that such an approach could impact contracts, particularly long-term contracts.

Doug Barnert, executive director with the Group of North American Insurance Enterprises, New York, said that he could not specifically comment on what companies would or would not do in response to such a requirement. However, he did say that there is the potential to create a situation that would be “extremely unprofitable,” and when businesses are not profitable, generally they exit the market.

Alan Close of Northwestern Mutual, Milwaukee, representing the ACLI, said that insurers are “very much concerned that a rate that creates an artificial restraint would produce a loss on a number of long-term contracts.” He cited the immediate annuity as one example. He argued that guidance should develop a principle for a discount rate for the time value of money.

A discussion of how to define the risk-free rate (RFR) ensued and the NAIC’s Esson said that the U.S. short-term government bill rate is the rate that should be used.

In response to a question from Bill Carmello, a New York regulator about whether the present value of earnings from an investment should be shown over time, GNAIE’s Barnert said that investors want to know management’s estimate of what they expect to earn and what they will pay out on portfolios.

Esson enumerated a number of potential responses to the discount issue:

--a straight U.S. risk-free rate;
--a RFR with a liquidity adjustment as recommended by the IASB in which the method of calculation is very open but corresponds with the minority view on LHATF on VM-20;
--the majority view of LHATF on VM-20;
--a benchmark rate; and,
--an economic rate that is not a default adjusted rate but a pure portfolio rate.

Esson cautioned, however, that “the chances of that passing the IASB and FASB are zero.” Carmello reminded regulators that VM-20 is still in the testing stage. Esson noted, however, that for those that are participating in the insurance contracts roundtable, the deadline is Nov. 30, so that there is no time to waste because 35 percent of the world insurance premium will be representing themselves before the IASB.

The discussion turned to how there are different approaches in different parts of the world. For instance, in Europe, the approach is basically the Solvency II approach of a RFR with a liquidity adjustment that is small except in very stressed markets. And, in Australia, it is the RFR.

Henry Siegel, a life actuary with New York Life, New York, noted that there are potentially serious implications for products including immediate annuities and long-term care products.

Marty Carus, representing American International Group, New York, said that consumers would have to pay for “capital being held hostage for considerable periods of time.”