Dear Alliance Member Society CEOs:

I wanted to alert you to an important development related to the Small Company Exemption (SCE) language that is a key component of the NAIC's implementation of Principles-Based Reserving (PBR). This development will have a significant - and hopefully positive - impact on many small life insurers, including most fraternals.

As you know, enough states have enacted PBR-enabling legislation (42 states representing 75% of the total U.S. insurance market) to permit PBR to become effective nationally on January 1, 2017. There is a three-year phase-in period for the new law, so PBR can be deferred by any company until January 1, 2020.

The adoption of PBR-enabling legislation has been in the works for almost a decade. The PBR methodology for determining reserves has been supported by most large life insurers and their trade groups for a variety of reasons, not least being that under PBR rules these insurers would likely have to allocate fewer assets to their reserves to meet regulatory standards.

The SCE language attempted to address the needs of smaller insurers after the three-year phase-in period, for whom PBR regulations would be burdensome, expensive, and ineffective, by providing an exemption from PBR rules for insurers with less than $300 million in annual life insurance premium AND with a Risk-Based Capital (RBC) ratio of 450%.

The SCE language, including the 450% RBC threshold has been incorporated into the NAIC's Valuation Manual (VM). Since the PBR-enabling legislation that has been enacted in virtually every state defers to the NAIC's VM to address the SCE, the 450% RBC requirement would become a national threshold unless the VM was amended.

The American Fraternal Alliance analyzed the impact of the PBR SCE on fraternal life insurers. Our primary concern was the effect that the 450% RBC requirement would have on fraternals and other small insurers. Many companies and fraternals have informal minimum expectations of maintaining an RBC ratio of 300%. The 450% RBC threshold contained in the current SCE language would, in effect, raise the minimum RBC ratio expectations by 150%. While almost all Alliance member societies fell below the $300 million annual life insurance premium threshold, as many as 20 societies were well above the minimum RBC ratio expectations but near or below the 450% RBC ratio threshold. This would result in many of these societies having to comply with PBR regulations for which they are not suited; or, in an even more ominous scenario, having to comply with PBR regulations when their society was below the 450% threshold and being exempt from such regulations when it exceeded the 450% threshold. Note that all RBC percentages mentioned in this bulletin are percentages of the Authorized Control Level.

Moreover, the Alliance's analysis of the impact of the NAIC's proposed revisions to insurer investments - so-called Risk-based Factors - indicated that life insurers' RBC ratios may be reduced by up to 25% once these regulations, which could be as soon as January 2018. This means that an insurer with a current RBC ratio of 600% could see it drop to 450% with the stroke of a regulator's pen, further exacerbating the impact of PBR regulations for all small insurers - commercial and fraternal.

After thorough debate on the issue, the Alliance Board adopted a policy position that opposed the current PBR SCE language and encouraged regulators to consider amending it to address the needs of all small insurers, not just fraternals. (See policy position here.) This was a significant development for the Alliance because it expanded our advocacy "footprint" beyond exclusively "fraternal" issues, such as our tax exempt status, our guaranty fund exemption, and other structural and operational issues unique to our business model. The Alliance took the lead on bringing this issue to the attention of regulators and earned the support of members of other trade groups representing small insurers, including the National Alliance of Life Companies (NALC) and the Life Insurance Council (LIC).

Over the past two years, the Alliance staff and Board have met with and worked closely with regulators from those states in which a majority of fraternals are domiciled (Texas, Minnesota, Wisconsin, Pennsylvania, Ohio, and Illinois) to express our concerns about the unintended consequences of the current version of the PBR SCE. With the help of associate member Miller & Newberg, the Alliance outlined the reasons and rationale for our policy position (see this White Paper prepared by Miller & Newberg) and encouraged regulators to consider an amendment to the NAIC's Standard Valuation Manual that would address this issue on a national basis.

I am pleased to report that last week the Alliance was contacted by a leading member of the NAIC's Life Actuarial (A) Task Force who informed me that regulators from the group of states with domiciled societies have drafted an amendment to the SCE provisions that would exempt all insurers with less than $50 million in annual life insurance premium from the 450% RBC requirement in seeking a SCE from PBR. These insurers, which include a majority of fraternals, would submit a request to the commissioner under the requirements of the SCE but without the 450% RBC requirement. This amended version of the SCE will be considered in the NAIC's SVM, which would make this revision effective nationally upon adoption.

Due to the number of Valuation Manual amendments that the NAIC must adopt in 2016, consideration for approval of this SCE amendment will likely take place in 2017. The amendment to the SCE provision will be introduced for discussion and exposure this fall. This route would provide for this amendment to be considered for the Valuation Manual in 2017 and, if adopted, would become effective on January 1, 2018, well in advance of when the three-year phase end period expires on January 1, 2020.  

Please contact me if you have any questions or need more information on this issue.

Sincerely,