For the past decade, the insurance industry and state regulators have been working on a new system for how life insurance companies determine whether they have enough money in reserve to pay out their claims. Known as principle-based reserving, the framework has been adopted by 46 states and was rolled out across the nation on Jan. 1, 2017. Insurance companies have three years to transition to the new system that uses simulation models to estimate the necessary reserves to cover future claims. Some experts in the industry expect life insurance premiums to drop as companies adjust to the new reserve requirements.
The move to modernize life insurance reserves. The use of principle-based reserves represents a major shift for the industry, and one that reflects the changing face of life insurance policies. "If we go back 50 years, most of the life insurance products were very similar," says Nancy Bennett, senior life fellow with the American Academy of Actuaries. So it wasn't too problematic that state regulators required insurers to use a standard formula to determine how much cash to keep in their reserves for claim payments.
However, the market has changed significantly, and companies now offer a variety of term, whole and universal policies. As a result, the old rigid system of calculating reserves no longer worked. In some cases, companies had accumulated large reserves, "far larger than what you would think would be needed," Bennett says.
Since the formula didn't allow for variations, companies were unable to adjust the size of their reserves on their own. "We and other companies went to the NAIC [National Association of Insurance Commissioners] and said we want to work with you to right-size the reserves," says Shawn Loftus, senior vice president and chief actuary of USAA Life Insurance Company. The result of that work is the new principle-based reserving model, which offers companies more flexibility when determining how much capital to have on hand. The first wave of regulations affects two types of polices: term life and universal life with secondary guarantee.
Some premiums may go down. Bennett says it's hard to tell whether premiums will be affected as a result of the new principle-based reserves, but those in the industry are optimistic consumers will see savings. "The big picture from our end is this rule is going to make life insurance premiums cheaper," says Justin Halverson, founding partner at Great Waters Financial in Minneapolis.
Term life insurance, in particular, could benefit from the change. According to a 2012 Impact Study from NAIC, companies are projected to reduce their reserves anywhere from 38 percent to 64 percent as a result of principle-based reserving. Loftus says USAA Life expects to drop premiums by up to 15 percent on some policies, with the average savings being 2.6 percent. Reduced premiums only apply to new policies and will not affect current customers.
The situation for universal life with secondary guarantee is a little more complex. Joseph E. Roseman Jr., managing partner for O'Dell, Winkfield, Roseman and Shipp in Charlotte, North Carolina, says the structure of permanent policies shifted from whole life to universal life in the late 1970s and early 1980s. During the next two decades, business for universal life boomed, but reserves didn't always keep up. "They were minimally funding policies," he says.
Now, the new regulations may result in some of those universal life policies needing to beef up their reserves. The 2012 Impact Study found some reserves may drop as much as 44 percent while others may need to boost their coffers by up to 63 percent. However, better reserves mean consumers can feel confident their plan will remain solvent. And life expectancy tables have been recalculated so premiums will be spread over a longer period, a change that should keep premium increases to a minimum.
Lower your life insurance premiums. Consumers shouldn't expect to see their existing premiums drop as a result of principle-based reserves. The lower prices will only be for new policies, but that should still be welcome news for those living on a tight budget. "About 35 percent of our members are living paycheck to paycheck, so price is a big deal for them," Loftus says. To find out if they can take advantage of lower premiums, the company is recommending all its members conduct an annual insurance review.
Part of that review includes getting quotes for a new policy or additional coverage to supplement an existing policy. Halverson cautions anyone getting quotes to be sure the company in question is actually using principle-based reserves. While some firms, such as USAA Life, are implementing the change immediately, insurers have until Dec. 31, 2019 to comply. And a handful of states have not yet adopted the new framework.
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"[Another] big warning would be to not go dump your current coverage," Halverson says. Getting a quote at a lower cost doesn't mean the company will sell you a policy. The results of a health exam, for example, could result in an application being denied. "Make sure you've had a guaranteed offer," Halverson urges.
Principle-based reserving represents a major change for the insurance industry, and it could have benefits for your bottom line as well.
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