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The Valuation of Life Insurance Policies model regulation, better known as Guideline Triple-X, has been a topic of discussion for more than five years. Initially we were uncertain about many things–its effect on reserves, price, short-term and long-term guarantees, and reinsurance programs, just to name a few.
Today we know a great deal more, but now we need to extend our learning to the implications of the reinsurance solutions–offshore for the most part–that have been put in place to manage Triple-X reserves.
Whether your company is just beginning to consider a more effective Triple-X reserve solution or already has one in place, it's important to understand how today's arrangements address reserves over the short term and whether they are sustainable over the long term.
This becomes more apparent if we look at the guideline's impact on level premium term products. Universal life products with lengthy secondary guarantees are also profoundly affected by Triple-X, but the insurance industry has not developed sufficient supportable solutions for the strain associated with these products.
Triple-X Effects
Triple-X requires pre-funding of future liabilities of term life over the level period of the product. This practice is actuarially sound and follows basic, generally agreed-upon principles of life insurance. However, outdated mortality assumptions required in the calculations do not reflect today's risk selection practices. This means term writers need to hold back significantly more of each premium dollar to cover conservative estimates of deaths later in the level period of a term product. Prior to Triple-X, this portion of the premium went right to earnings.
To prepare for the strain on earnings for the January 2000 effective date, many companies covered their bases by:
–Developing a term portfolio with guarantees shorter than the level premium period, for which Triple-X had little impact, so no pricing increases were necessary; and
–Increasing prices for their longer-term guaranteed term portfolio to offset new reserving expenses.
It took a few months to know which approach was more attractive to consumers, but when the dust settled, the choice was clear: Both consumers and agents prefer guarantees for the duration of the level premium period. Today, products with full level premium period guarantees continue to represent 75% of the market, or $900 billion in face amount.
To maintain profitability at a level comparable to pre-Triple-X, it originally appeared that life insurers would have to charge consumers an average of 20% to 25% more for a fully guaranteed 20-year level term product. In fact, life companies today, on average, are charging about the same for fully guaranteed 20-year level term products. What happened?
Reinsurance Cushions the Impact
Rather than increase prices, life insurance companies have found more economical ways to fund Triple-X reserves. Reinsurance has been the most common and effective way to manage capital and keep level premium term products viable.
The most popular reinsurance solution involves first-dollar quota share coinsurance–either with a direct or indirect connection to an offshore facility. While coinsurance has long been important for managing risk in the term market, it now has powerful capital management benefits.
Through these solutions, life insurers are realizing the economic benefit of holding economic reserves that reflect GAAP as compared with the Triple-X reserves required in U.S. jurisdictions.
Offshore: Direct or Indirect Approach
In today's market, a growing number of direct writers are ceding business directly to offshore reinsurers. Others are ceding to onshore reinsurers, who subsequently send the business offshore to an affiliated or unaffiliated retrocessionaire.
Interestingly, these latter arrangements are often called "transparent," when in fact they are opaque because the business practices of the offshore business partner are hidden from view. Life insurers that have never used offshore reinsurance and are unfamiliar with related concepts and terminology may be inclined to favor a 'transparent' offshore solution.
Despite the familiar facade, a transparent arrangement should not be treated as "business as usual." Whether a company cedes business offshore directly or indirectly, the risks are essentially the same–most importantly, future reserve management capacity for business written today. As always, the ceding company's due diligence process should uncover the full extent of the reinsurance program and all entities involved so the solution can be fully evaluated.
