The Superintendent of the New York State Department of Financial Services (DFS), Benjamin M. Lawsky, has informed his fellow state insurance regulators in the National Association of Insurance Commissioners (NAIC) that New York will no longer implement an arrangement developed by the NAIC for setting the amount of reserves that life insurance companies would be required to maintain for certain products. This decision is likely to lead to stricter regulation of reserve requirements in New York.

Mr. Lawsky's position is set forth in a letter sent on September 11, 2013, to the NAIC’s Commissioners. The letter notes that in 2011, New York informed the NAIC that many national life insurance companies had not maintained sufficient reserves for their universal life with secondary guarantee (ULSG) products as required by a specific actuarial guideline, Actuarial Guideline 38 (AG38). Consequently, the NAIC formed a working group that ultimately developed a modified "principles-based reserving" (PBR) approach for determining these reserves.

The PBR approach generally allows insurers to employ their own data and assumptions in calculating reserves, rather than being required to follow more formulaic statutory requirements, which insurers argued forced them to hold more reserves than necessary. Mr. Lawsky stated in his letter that this approach, which he characterized as a "compromise," had been expected to increase the reserves for ULSG products by about $10 billion.

Mr. Lawsky contended, however, that preliminary results of using PBR show that companies increased their reserves for in-force business in an amount far less than projected. A review of 16 prominent insurers on ULSG business indicated that only five companies reported an increase in their reserves for in-force business, totaling $668 million, according to Mr. Lawsky. Moreover, the 11 other companies failed to increase their reserves and, in fact, would have been able to reduce reserves by nearly $4 billion had other provisions of the agreement not prevented them from using the new calculations to do so.

Mr. Lawsky concluded that "[t]his cannot possibly be the 'compromise' that we as insurance regulators had in mind with regard to AG38." He stated that, as a result, New York will no longer implement the arrangement using the PBR approach, and will let the regulation intended to effectuate it expire on September 13, 2013.

Mr. Lawsky went on to warn his fellow Commissioners about adopting a PBR approach. First, he stated that with the preliminary results from using such an approach being so far off projections, "it is incumbent upon us as insurance regulators to fundamentally question the current embrace of PBR." Second, he opined that "PBR will hardly quell the gamesmanship and abuses associated with the setting of reserves," observing that "the NAIC has pointed to its work on PBR as the panacea for the kinds of 'shadow insurance' transactions" that DFS highlighted in a June 2013 report.

According to that report ("Shining a Light on Shadow Insurance – A Little-known Loophole That Puts Insurance Policyholders and Taxpayers at Greater Risk"), insurance companies use shadow insurance to shift blocks of insurance policy claims to special entities—often in states outside where the companies are based, or otherwise offshore—to take advantage of looser reserve and regulatory requirements. In his letter, Mr. Lawsky contended that "the NAIC's reluctance to endorse a moratorium on such shadow insurance transactions, coupled with the move to implement PBR, represents a potent cocktail that could put policyholders and taxpayers at significant risk."

Accordingly, Mr. Lawsky asserted that "PBR represents an unwise move away from reserve requirements that are established by formulas and diligently policed by insurance regulators in favor of internal models developed by insurance companies themselves. ... By outsourcing the setting of reserves to companies themselves, insurance regulators invite criticism about whether state-based regulation is truly effective." He urged his fellow state insurance regulators to "reconsider the course being charted with regard to PBR before it is too late."

In addition to raising the prospect of increased regulation in New York, DFS's rejection of PBR might also stir further debate nationally over the implementation of PBR and, more generally, about the proper approach for establishing insurance companies' reserve requirements.

Ballard Spahr’s nationally recognized Consumer Financial Services Group advises on regulatory matters, assists in the design and documentation of credit products, and represents clients in class actions, regulatory enforcement proceedings, and other lawsuits nationwide. The firm’s Insurance Group includes industry veterans who handle the full scope of business, regulatory, and litigation matters for domestic and international carriers, brokers, and other insurance-related businesses.

Our attorneys, including the attorneys who joined us from the New York City litigation firm Stillman & Friedman, P.C., to form Ballard Spahr Stillman & Friedman LLP, have substantial experience in handling litigation with New York state regulatory agencies.

For more information, please contact CFS Practice Leader Alan S. Kaplinsky at 215.864.8544 or

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