Michael Mingolelli, Jr. Shares Insights at 14th Annual PPLI/PPVA Forum

At the 14th Annual Private Placement Life Insurance & Variable Annuities (PPLI/PPVA) Forum, Michael Mingolelli, Jr. shared insights on implementing tax-efficient investments inside of private placement life insurance and annuities.  As part of his comments, Michael shared his perspectives on implementation best practices. The PPLI/PPVA Forum is a gathering of industry’s leaders, including investors, hedge funds and other alternative investors, insurance consultants and lawyers.

For more information, please contact us.

Dividend Interest Rates for 2015 Announced by Carriers for Participating Whole Life Policies

Mutual Insurance companies declared their dividend interest rates on participating whole life insurance policies for 2015. Below are the declared 2015 interest rates for the four largest issuers of participating Whole Life (WL) policies.

  • Guardian Life Insurance Co. of America: 6.05
  • Massachusetts Mutual Life Insurance Co. 7.10%
  • New York Life Insurance Co. 6.20%
  • Northwestern Mutual Life Insurance Co. 5.60%

This Advisor Alert provides insights on the elements that drive changes in Dividend Interest Rates (DIRs) which include insurance company asset allocations and investment returns.

Whole Life Dividend Interest Rates for 2015

New IUL Illustration Recommendations

Index Universal Life (IUL) is a relatively new type of universal life policy that has gained significant popularity in the last several years.  IUL already represents 39% of all universal life sales.

IUL credits interest based on the performance of an equity market index (e.g., S&P 500, DJIA), a participation rate, a growth cap, and a floor.  Having earnings credited based on a market index has made IUL more appealing than fixed universal life (UL) in this low interest rate environment as UL policy earnings are largely dictated by fixed income securities.  With a floor on its crediting rate, IUL insulates policyholders from negative stock market returns, unlike in a variable universal life (VUL) insurance policy.  Thus, at the expense of varying degrees of upside performance (by virtue of a cap on earnings), IUL offers collared equity market exposure with more limited downside risk.

Currently, there is no uniformity in how carriers illustrate the potential performance of their IUL policies nor in how hypothetical historical index returns are calculated.  In an effort to increase transparency and clarity for consumers, the National Association of Insurance Commissioners (NAIC) is seeking to establish IUL Illustration Guidelines (Guidelines) consistent with the rules for general account products covered by the NAIC Model Illustration Regulation.  The NAIC asked the American Council of Life Insurers (ACLI) to provide industry input for the development of the Guidelines.  In response, ACLI established a task force to develop an industry supported recommendation.  After extensive deliberations, and a vote by ACLI Member Companies, ACLI delivered a recommendation for IUL Illustration Guidelines to the NAIC that was supported by a super-majority of the ACLI Life Committee, the CEO Steering Committee, and the ACLI Board of Directors.

A minority group of Member Companies objected to the ACLI recommendation, claiming it does not go far enough to protect consumers because the use of a historical look back method for setting the maximum crediting rate is not consistent with illustration guidelines for other general account products (Whole Life (WL) and UL, which are based on current returns).  This minority group—comprised of Member Companies that do not offer IUL (including New York Life, MetLife, and Northwestern Mutual)—delivered an Alternative Proposal to the NAIC that would place significant limitations on the maximum allowable crediting rate for IUL illustrations.

Pinnacle has reviewed the input and recommendations.  We agree that there is a need for IUL illustration guidelines to provide consistency from carrier to carrier.  IUL products have a wide range of maximum illustrated crediting rates that vary between 7% and 18%. While some of this variation is due to different index terms and time periods, each company takes a different approach to establishing rates.  We acknowledge there is risk in the variability of sales illustrations and believe these risks should be communicated to clients.

Pinnacle supports ACLI’s efforts to develop a proposal that provides reasonable limits and disclosures and preserves a client’s access to illustrations that meet their specific situation.  Pinnacle believes the ACLI recommendation achieves this objective with meaningful limits on the illustration crediting rate and additional disclosures designed to help consumers better understand the mechanics of IUL and its increased variability relative to UL.  We also believe consumers should have access to the appropriate tools that allow them to make informed decisions based on their respective risk return profiles.

The ACLI recommendation seeks to provide:

  • consistency in illustrated crediting rates between carriers when using the same index and index parameters (e.g. cap and floor),
  • uniform guidance to companies and illustration actuaries on how to determine the maximum IUL illustrated credited rates,
  • additional disclosure of interest crediting rate variability to consumers, and
  • flexibility, so guidelines can be adaptable to future product differentiation, product development, and economic conditions.

To achieve these goals, the following rules were recommended:

The Maximum Illustration Crediting Rate is the lessor of (1) and (2):

  1. The 25-Year Historical Look Back rate calculated using a standardized methodology. The proposal standardizes both the look back time period of 25 years and the calculation for the look back rate.  This recommendation is consistent with the method the NAIC has adopted for other indexed product types (e.g., Annuity Disclosure Model Regulation).  Consumer understanding is enhanced with products having the same index parameters and crediting method illustrating the same maximum crediting rate across all carriers; and helping consumers compare different index choices within the same product.
  2. The Regulatory Cap of 10%, which is similar to the 12% maximum applicable to Variable Universal Life (VUL) illustrations.  This Regulatory Cap was established to provide an effective and meaningful limitation for current and future IUL designs, including various indexing time periods (e.g., 2 year, 5 year), while creating flexibility should economic environments change (thus avoiding the challenge of requiring all States to revise the Guideline again in the future).

Requirement for Additional Disclosures Unique for IUL

  • A reduced return “midpoint” illustration using current non-guaranteed charges and a crediting rate that is halfway between the maximum illustration crediting rate and the minimum crediting rate floor.
  • A table of annual year-by-year historical look back returns that highlights the annual volatility in the index return.
  • A table showing the 25-year Historical Look Back rate at current and reduced index parameter levels (e.g., cap rates between the current and guaranteed level).

The ACLI recommendation is supported by the principle that a regulatory structure should not disadvantage one product type in favor of another. Regulations without this critical balance ultimately impair the ability of consumers to choose the best product that meets their needs.

The Alternative Proposal
The minority group of Member Companies has delivered an alternative recommendation for the illustration guideline.  The minority group states the following objections to the ACLI recommendation:

  • IUL is a general account product; illustration rates should be tied to general account yields.
  • The look back methodology is flawed as it does not reflect, and overstates, current market expectations of future option returns.
  • Their stochastic analysis suggests historical look back returns have a low probability to occur based on current market conditions.
  • The alternative recommendation sets the maximum illustrated crediting rate based on the general account yield for the portfolio of general assets backing a carrier’s IUL product.  The rate would vary from carrier to carrier, and could vary between products from the same carrier if different portfolios support different products.

For a 0% floor:
Maximum Illustration Crediting Rate = General Account Yield x 112%
(the 112% would be adjusted down if the guaranteed floor is greater than 0%)
For a company with a 5% General Account Yield, the maximum illustrated crediting rate would be limited to 5.6%.


Based on the input and research, Pinnacle is supportive of the majority industry position and does not support the alternative proposal because:

  • It does not enhance consumer understanding of IUL mechanics.
  • It could either result in inconsistent and confusing illustration crediting rates when comparing carriers with the same index and parameters, or (the inverse) two carriers could use the same crediting rate when the index parameters are different.
  • It sets an overly conservative limit on the illustrated crediting rate.  IUL, by its nature, is more volatile than UL, and thus has a broader range of outcomes.  Consumers should have the opportunity to review illustrations that show the broad range of outcomes.
  • In-force IUL policyholders have been receiving returns higher than the alternative maximum.  This proposal would limit the usefulness of in-force illustrations that can provide valuable guidance to consumers.
  • The analysis supporting the alternative proposal’s theoretical argument for derivative returns and stochastic analysis is based on subjective assumptions.
  • Other general account products (UL and WL) are not required to disclose the General Account Yield supporting the crediting rate.

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Update on U.S. Life Insurance Financial Strength Rating Changes in 2013

The U.S. life insurance industry ended 2013 on an upward trajectory with regard to financial strength metrics and ratings. Relative to 2012, all four major rating agencies reported improvement in various aspects of their financial strength ratings. This could be seen in higher aggregate ratings and a higher number of upgrades than downgrades during 2013.

In addition, according to A.M. Best, no U.S. life and health insurance companies were impaired in 2013.1 Since A.M. Best started tracking life insurer impairments, this is the first year no companies required regulatory intervention.

During 2013, financial strength rating upgrades by the four major rating agencies outnumbered downgrades by a margin of 27 to 19.  See Figure 1.

Figure 1.  Summary of 2013 Financial Strength Rating Upgrades and Downgrades2

At the end of 2013, of all rated U.S. life insurers, 90% (S&P and Moody’s) and 78% (A.M. Best) had investment grade (i.e., ‘A’ or better) financial strength ratings.  See Figure 2.

Figure 2.  2013 Financial Strength Ratings Distribution3

Below is a summary of recent commentary issued by each rating agency with respect to industry financial strength.

Standard & Poor’s
S&P said in its most recent U.S. life insurance industry outlook that the credit quality of the industry remains stable, with headwinds subsiding and the economy continually improving. Companies with investment grade insurer financial strength ratings exhibit strong capital and liquidity, and stable investment portfolios. For the first time since 2007, S&P issued more upgrades (eight) on life insurers than downgrades (four). See Figure 3.

Figure 3.  S&P U.S. Life Insurance Upgrades and Downgrades

As of November 30, 2013, S&P had an ‘A3’ (Strong) rating or better on 90% of their 82 rated life insurance groups and more than 91% had a stable or positive outlook.

Moody’s recently upgraded its outlook for the U.S. life insurance industry to stable from negative, which was the outlook since September 2012. Moody’s stated its view that the downside risks to the industry have diminished and should allow revenues and earnings to stabilize over the next 12-18 months.

Moody’s provides financial strength ratings for 52 U.S. life insurance groups. As of December 4, 2013, Moody’s rated 90% of these groups at ‘A3’ (Good) or better; 88% of ratings had a stable or positive outlook.

A.M. Best
A.M. Best said the U.S. life and annuity sector has maintained strong risk-adjusted capital, steady operating earnings, and improved balance sheet fundamentals and continues to have a stable rating outlook for the industry.

At the end of 2013, A.M. Best had an ‘A-’ issuer credit rating (Excellent) or better on more than 78% of its rated companies. Ninety percent of the ratings have a stable outlook; the remaining 10% is split evenly between positive and negative outlook. A.M. Best also issued more rating upgrades (14) than downgrades (nine) during the year, which continued a trend observed over the past three years.

Fitch Ratings
Fitch continues to maintain a stable outlook for the U.S. life insurance industry, which it says reflects the industry’s very strong balance sheet fundamentals, solid liquidity profile, and improved operating performance. Fitch also said it believes the industry is well positioned to withstand macroeconomic challenges over the coming year.

Nearly all of Fitch’s 2013 rating actions through the third quarter were affirmations, with just two upgrades and two downgrades. As of December 18, 2013, 83% of their ratings had a stable or positive outlook.

Looking ahead to the remainder of 2014 and beyond, there are several areas of focus for rating agencies.

Interest Rates
The risk posed by low interest rates is declining as conditions improve and rates are expected to continue to rise gradually. A gradual increase in interest rates will relieve pressure on life insurers’ profits. However, rates remain very low from a historical perspective and continue to put downward pressure on spreads and operating fundamentals.  While the risk is viewed as manageable, concern remains about strategies some life insurers may use to generate incremental yield.

Macroeconomic Stability and Improvement
The economy has showed signs of improvement, albeit slow by historical standards. The economy is still viewed as being in a recovery mode, but economists see that recovery as vulnerable due to a number of risks, including, but not limited to, disruption caused by the end of monetary stimulus (i.e., quantitative easing); legislative gridlock related to budget battles in the U.S. Congress; and a flare-up of the euro region debt crisis.

Equity Markets

Rising equity markets will continue to improve the performance of variable annuity portfolios and other assets under management-fee driven businesses. While equity market performance has been very good overall since 2009, rating agencies remain concerned about potential volatility in equity prices and the resulting impact on insurers’ financial performance.

U.S. Life Insurance Industry Asset Portfolio Credit Quality

The concerns about the previous three items weigh heavily on the industry’s asset portfolio credit quality. Credit-related impairments since the financial crisis have continually been below expectations and historical averages. Rating agencies expect credit-related investment losses to remain below pricing assumptions and historical averages even if the economic recovery stalls. But they will be watchful to see if insurers increase the risk profile in their investment portfolios should interest rates remain near historical lows.


Since the financial crisis of 2008-2009, investors and policyholders have experienced a heightened sense of anxiety about the financial strength of life insurance companies. However, the failure rate of life insurance companies remains low in the wake of the financial crisis, with no impairments occurring in 2013. While financial strength ratings for life insurers understandably were lowered during the financial crisis, the industry generally remained resilient and has emerged with ratings that are on par with levels seen pre-financial crisis. While risks remain, life insurers are successfully managing their assets and liabilities to address these risks as exhibited by the current stable outlook provided by the rating agencies.

If you should have any questions about this advisor alert or specific carrier ratings, please contact us at pinnacle@e-pfg.com.



1  A.M. Best designates an insurer as a financially impaired company as of the first official regulatory action taken by a state insurance department. State actions include supervision, rehabilitation, liquidation, receivership, conservatorship, cease-and- desist orders, suspension, license revocation, and certain administrative orders.

2  Data for A.M. Best as of October 22, 2013. Data for S&P as of November 30, 2013. Data for Fitch as of December 18, 2013.  Data for Moody’s as of December 4, 2013.

3  Data for S&P as of November 30, 2013.  Data for Moody’s as of December 4, 2013.  Data for A.M. Best as of October 22, 2013.

Federal Regulation and Financial Accounting Update

Over the last few years, many people have called for regulatory changes and prognosticators have predicted as much. The two areas of expected change would be federal regulation and U.S. accounting standards conforming to international standards. We are now beginning to get clarity on both of these initiatives.

Federal Regulation of Life Insurance Industry

The Federal Insurance Office (FIO) finally released in December 2013 its long awaited report for modernizing and improving insurance regulation.  The report, mandated by the Frank-Dodd Wall Street Reform and Consumer Protection Act, was released 11 months after the initial deadline.

The report contained 18 state-directed recommendations and 9 areas for direct federal involvement in regulation spanning life insurance, property and casualty insurance, health insurance, and administrative insurance compliance.  Since the FIO has no actual regulatory authority, its comments within the report are non-binding, but they predominantly support current work by the National Association of Insurance Commissioners (NAIC) or previously ratified NAIC model regulations.

The two major takeaways from the FIO’s report are (1) a tacit endorsement of the current state-based regulatory system, and (2) the cautious endorsement of principles-based reserving (PBR). The potential future application of PBR could reduce or eliminate the need for captive reinsurance, which was pushed to the forefront by the NY State Superintendent of Financial Services’ June 2013 report. The FIO report concludes that states should develop a uniform and transparent regime for such transactions, which the NAIC has already formed a special taskforce to examine. In implementation of PBR, the FIO report stated that states should condition it upon:

  1. establishment of consistent, binding guidelines to govern regulatory practices whether a domestic insurer complies with accounting and solvency requirements; and
  2. attracting and retaining supervisory resources and developing uniform guidelines to monitor supervisory review of PBR reserving.

The other key takeaway was that after much delay and political posturing, the final impact of the FIO’s report remains uncertain and could ultimately become no more than a footnote in the 140 year history of the current state-based regulatory framework; this newly created federal office does not appear to be usurping regulatory power from the states.

To that end, while the FIO report discusses the recent history of the optional federal charter, it did not call for its implementation.

Accounting Standards Applicable to Life Insurers

In late February, the U.S. Financial Accounting Standards Board (FASB) announced it was abandoning plans to achieve a convergence of accounting standards for insurance contracts with the model proposed by the International Accounting Standards Board (IASB).  The goal of uniformity was sought so as to allow investors to compare domestic and international insurers using more uniform financial statements. The FASB said it will instead focus its efforts on making targeted improvements to the existing U.S. GAAP model. According to the FASB, the decision was based on the likelihood that the FASB and the IASB would be unable to agree on a unified accounting model as well as the cost of implementation for insurance companies.

Fitch Ratings said the development was a positive for most U.S. insurers as it reduces uncertainty and potential volatility in financial statements.  The methods of international standards of accounting make life insurance and annuity products, particularly those with guarantees, much more volatile on an insurer’s profit and loss statement, and adoption of the model proposed by the IASB could have impacted the product landscape (whether in terms of design or pricing) available to clients.

Moody’s Investors Service said the decision was a negative for global investors because of the difficulty of comparing insurers across borders with differing accounting regimes.  Moody’s also noted that the decision removes the downside risk for U.S. insurers of diminished investor interest because of the significant opposition to the proposal previously expressed by investors of U.S. insurers.

For more information about federal regulation or financial accounting relating to life insurers or their products, please contact Pinnacle at pinnacle@e-pfg.com.

The Use of Captive Reinsurance Transactions in the Life Insurance Industry

On Tuesday, June 11, 2013, the New York State Department of Financial Services (NY DFS) issued a report highlighting captives. Some media have used this report as basis for a discussion characterizing captives as complex tools companies use as a means to present a more robust financial portrait than may be the case. In the wake of the NY DFS report and related media coverage, Pinnacle, in partnership with M Financial, has compiled this white paper to provide background information on the uses and mechanics of captives, and detailed perspective from other interested parties.

What is a Captive?

Captive insurance companies, as the name implies, insure or reinsure the risk exposure of their parent companies and affiliates. Captives are formed under specific laws that prohibit them from issuing policies directly to consumers.

Why Captives Are Used and How Captives Work

Captive insurance companies provide for the efficient aggregation and management of certain insurance risks by insurance companies when third party commercial reinsurance may not be reasonably available. Captive structures can be especially helpful in managing term life insurance and no-lapse guarantee UL risks. These products are subject to statutory reserve requirements that are widely regarded within the insurance industry as conservative, resulting in reserves that are commonly referred to as redundant; “XXX” reserves for term life insurance products and “AXXX” for no-lapse guarantee UL products.

Captive reinsurance transactions work very much like other commercial reinsurance transactions in that they must meet the same regulatory requirements for the insurance company to receive credit for reinsurance. Unlike commercial reinsurance transactions, each captive transaction is reviewed by regulators—both the insurance company’s state of domicile and the captive’s state of domicile review and analyze these transactions to ensure they meet regulatory requirements.

The life insurance company cedes risks and reserves to the captive entity. For the insurance company to receive credit for the reinsurance, the captive must either be an authorized reinsurer in the insurance company’s state of domicile or post collateral that meets the regulatory requirements of the insurance company’s state of domicile. Collateral can take the form of assets held in trust, a letter of credit (LOC), funds withheld, or, in some states, a parental guarantee. In the context of “XXX” and “AXXX” captive transactions, the insurance company will determine the economic reserves (or actual expected losses) associated with the obligations through actuarial analysis. The formula used to determine the economic reserves is reviewed by an independent third party actuary at inception and may be subject to an annual independent third party actuarial review.

The difference between the statutory reserves and economic reserves is the redundant reserves. In a captive reinsurance transaction, the ceding company will generally create a funds withheld account to hold assets backing the economic reserves or require the captive to establish a trust account to hold assets in that amount. The redundant reserve will often be backed by an LOC, issued by a bank for the benefit of the ceding company, and held by the captive. In states where the law allows, and subject to certain requirements, guarantees from the ceding company’s parent may also serve to back the redundant reserve.

Captives are beneficial in that they allow for efficient use of capital. By segregating the risk in a captive, companies are able to obtain third-party financing at a lower cost, which results in more consumer friendly pricing (i.e., more affordable insurance coverage). In addition, risk is spread as third-party financing partners are liable for the risks represented by the redundant reserve.

Potential Captive Abuses

The NY DFS report focused primarily on transactions where an appropriate third-party LOC is not secured. In these transactions:

  • The LOC is contingent and may not provide the funds when needed by the insurance company, or
  • The LOC is a wrap-around arrangement where the LOC cedes the risk back to the original ceding company — there are reduced reserves but no risk transfer.

Industry Response to NY DFS Report

M Financial requested and received commentary regarding captive transactions from the following M Carriers: ING, John Hancock, Lincoln Financial, Pacific Life, Prudential, and TIAA-CREF Life Insurance Company.  According to their responses, all M Carrier captive transactions provide full risk transfer supported by high-quality assets or financing arrangements (such as banking institution LOCs), which provide reimbursement when needed.

Moreover, a number of interested parties have responded to the NY DFS report to bring context and balance to the issue. Their responses follow:

State Regulator Responses

While the NY DFS report has called for a national moratorium on captive reinsurance transactions, the National Association of Insurance Commissioners (NAIC)—the U.S. standard-setting and regulatory support organization created and governed by the chief insurance regulators from the 50 states, the District of Columbia, and five U.S. territories—has been studying the use of captive reinsurers for more than a year and is taking a more balanced approach by advocating enhanced disclosure of the transactions.

  • NAIC President Jim Donelon stated that there appears to be no need to call for a moratorium on captives as requested by the NY DFS. In addition, Donelon commented that state insurance regulators are continuing to monitor the risks posed by captives and special purpose vehicles while working to implement principles-based reserving (PBR) for life insurers. The overwhelming majority of state insurance regulators believe the successful implementation of PBR will address the perceived reserving redundancies that have precipitated the use of captives for reserving purposes.
  • The NAIC’s Captive and Special Purpose Vehicle (SPV) Use Subgroup met after the release of the NY DFS report and agreed to submit a white paper—Captives and Special Purpose Vehicles—to the Financial Condition (E) Committee for their consideration. The white paper lists the following regulatory recommendations:
    • Disclosure and Transparency—enhanced disclosure in ceding company statements regarding the impact of the transactions on the financial position of the ceding insurers.
    • Uniform Standards—development of guidance in the Financial Analysis Handbook for the states’ review and ongoing analysis of transactions involving captives and SPVs, including specific considerations of such transactions when performing holding company analysis.
  • On July 1, 2013, North Carolina joined 31 other states and the District of Columbia as a captive domicile.

All captive transactions already require approval from the ceding insurer regulator and the captive regulator.

Rating Agency Responses

The NY DFS report implies that rating agencies do not consider captives as part of their assessment of insurance company financial strength. In comments issued following the release of the NY DFS (excerpts of which are provided below), this implication was incorrect. Rating agencies are aware of—and assess—captive arrangements, including the ultimate collateral backing the redundant reserves, with such analysis impacting insurance company financial strength ratings.

A.M. Best

  • A.M. Best views as positive the continued industry discussions related to increased regulatory scrutiny and transparency surrounding life captive reinsurers.
  • A.M. Best stated “it will continue to look through these transactions, and analyze groups on a consolidated basis using its capital model regardless of which affiliated entity assumes the risk.”
  • Furthermore, “A.M. Best will continue to monitor life insurers’ reinsurance programs with respect to potential decreasing LOC capacity and/or increasing LOC costs in the marketplace.”
  • Moreover, A.M. Best believes there are notable differences in the quality of collateral involved in these funding solutions (e.g., reinsurance trusts, long-term LOCs, short-term LOCs, and contingent LOCs). These differences are incorporated in A.M. Best’s overall evaluation of an organization’s balance sheet strength.


  • Moody’s believes a greater focus on captives by regulators is credit positive for the industry.
  • Life insurers use captives to manage regulatory capital strain associated with life and health insurance products subject to what they perceive to be conservative reserve and/or capital requirements. They also use captives to manage the volatility of reserve and capital requirements associated with variable annuity guarantees. Both practices undermine the conservatism regulators have embedded in the reserving and capital regimes.
  • Moody’s analysis of life insurance companies’ creditworthiness on an enterprise basis has determined that many companies’ captives are capitalized at levels lower than standard operating companies, which tends to weaken overall capital adequacy. Moreover, transactions such as those identified by the NY DFS can lead to complex corporate structures and reduced investor transparency, both credit negatives.
  • The attention placed on captives, not only by New York, but also by the NAIC, will likely be a positive development that will lead to more disclosure of transactions with captives.

ACLI Response

The American Council of Life Insurers (ACLI), which represents the interest of life insurance companies, continues to examine captives and their impact on carriers, policyholders, and the life insurance industry as a whole. Following the release of the NY DFS report, the ACLI issued the following statement:

“For more than one year, the 56-members of the National Association of Insurance Commissioners (NAIC) have been reviewing the issue of captive reinsurance transactions discussed in the report issued by the New York Department of Financial Services.

Captive reinsurance transactions provide life insurers a means to spread the risks they assume. They also enable life insurers to deploy capital efficiently and, in turn, help them set prices as competitively as possible. Captive reinsurance transactions represent an important and positive element of a competitive life insurance marketplace and are, without exception, reviewed and approved by regulators.

To help improve transparency and regulation, ACLI is working with the NAIC to enhance disclosures that will provide regulators with more access to information about the captive reinsurer transactions. With greater transparency, concerns about this vital risk- management tool will be addressed.

ACLI fully supports national adoption of proposals to enhance disclosure involving these transactions.”

Pinnacle Perspective

Because of our commitment to client advocacy, Pinnacle and M Financial are focused on the scrutiny of captives and the impact captives may have on policyholders. Based on our understanding, which is supported by conversations with carriers and analysis of statements from rating agencies and regulators, captives can provide an appropriate and efficient vehicle for segregating and spreading risk, lowering the cost of reserve financing, and ultimately providing better pricing for consumers. Captive transactions that support redundant reserves backed by high-quality assets or financing arrangements (e.g., bank LOCs that provide reimbursement when needed) — with full transparency and disclosure, as well as review and approval by state regulators — would reasonably appear to provide the consumer protection intended by state regulators and provide the benefits of lower cost insurance products to consumers.

The use of captives is a direct result of current reserving requirements. Are required statutory reserves backing guaranteed products truly redundant or overly conservative? The adoption of PBR by the NAIC may implicitly suggest reserves backing guarantees are indeed redundant. If they are truly redundant, and PBR is implemented (as anticipated in 2015), there may no longer be a need for captives (and the issue may become moot). However, if required reserves are not redundant, then the discussion may focus more specifically on the ultimate party or collateral backing the redundant reserve, not the use of captives themselves. It is important to remember that the economic portion of the total reserve is retained by the insurance company, or is fully collateralized with assets meeting regulatory requirements.

Pinnacle and M Financial support regulatory changes that provide more disclosure and transparency, uniform regulator review standards, and uniform standards for permitted assets and LOCs backing reserves. The NAIC is moving forward with regulatory changes via the Captives and SPV white paper.

With potential regulatory changes, it is possible that some insurance companies may be negatively impacted. However, based on the responses from M Carriers, it is anticipated there will be little or no impact to M Carriers.

Finally, alarmist tactics that seek to scare consumers are of little benefit. For example, to suggest that ratings agencies are not aware of the issues with captives, and are not reflected appropriately in their financial strength ratings, is irresponsible. As an alternative, we support an open dialogue, supported by disclosure and transparency that facilitates informed consumer decisions.

Additional information and analysis on this topic will be provided as relevant news and facts evolve over time. In the meantime, if you have any questions or comments, please contact us.

A link to the NY DFS report—“Shining a Light on Shadow Insurance: A Little-known Loophole That Puts Insurance Policyholders and Taxpayers at Greater Risk”— is below.



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The Changing Life Insurance Product Landscape

For roughly the last ten years, universal life insurance with a secondary guarantee or no lapse guarantee insurance (NLG) has been widely used by affluent families for wealth transfer planning. It has provided guaranteed death benefits for estate liquidity at death and has also been utilized for its non-correlated investment characteristics. Of course, life insurance is a financial instrument, and as such, responds to the same financial pressures as bonds, equities and other financial assets.

What has happened?

In response to the prolonged and record low interest rate environment as well as increased statutory reserving requirements for NLG products, insurance carriers are taking some or all of the following measures:

  • Increasing premiums (especially for single premium or short-funded premium designs)
  • Restricting premium structure flexibility (especially for large up-front payments)
  • Exiting the NLG product marketplace (either temporarily or permanently)

The impact for clients and advisors is clear. While we do not expect NLG products to entirely disappear from the marketplace, we do anticipate costs and premium funding constraints to escalate even further. Meanwhile, NLG products will be offered by fewer carriers. Simply put, if a client is currently considering the acquisition of a NLG policy, now is the time to implement, as pricing, flexibility and options will become less attractive as we approach year end.

Reasons for these changes

Effective January 1, 2013, the National Association of Insurance Commissioners (NAIC) has released new, higher reserving requirements that will impact many, but not all, NLG products. All insurers are required to hold certain statutory reserves for their obligations, and NLG products are particularly reserve-intensive. While the full effect of these new requirements is not yet completely known, we do know that many carriers must increase their reserve requirements for new policies. Interestingly, the new reserve guidelines impact both existing and prospective policies, albeit to different degrees. Enhanced reserve requirements for existing or in-force policies (defined as policies effective between July 1, 2005 and December 31, 2012) should have a nominal impact on most carriers.

New policies will experience a greater impact since the NAIC effectively eliminated a loophole allowing carriers to reduce their reserve requirements. The NAIC has been concerned with certain carriers’ use of “triple shadow account” pricing designs, and the NAIC maintains that the spirit of the reserving regulations was not being followed. The net effect for NLG policies going forward will require carriers to either:

  1. Increase pricing to maintain acceptable profitability levels
  2. Seek reserve relief through the use of captive reinsurance arrangements
  3. Utilize reinsurance or letters of credit (LOCs) for reserve relief
  4. Securitize reserve obligations in the equity markets

Due to contraction in the reinsurance marketplace, there is limited capacity for additional reinsurance arrangements. Carriers that have not previously established these relationships will be even more constrained in their access to capacity. A similar scenario applies to LOCs, given the current contraction in the credit markets, and carriers would incur additional required fees to secure such LOCs. Securitizing reserve obligations is equally unlikely given the current state of the equity markets and the markets’ perception of asset-backed securities. Thus, we would expect carriers that have previously used triple shadow account pricing to be the most impacted; the most likely option for these carriers will be to increase pricing or exit the NLG product marketplace.

Looking ahead

We expect there to be continued contraction in the NLG product market. We recommend that any client contemplating the acquisition of NLG insurance as part of their portfolio to complete that process prior to the end of this year. Although almost all carriers have already re-priced their NLG products at least once already, we expect this trend to continue in light of the new reserve requirements. Even for insurance companies not directly impacted by the new reserve requirements, continued low interest rates will force many companies to place additional restrictions on premium funding designs.

The changing NLG value proposition should serve as a reminder and impetus to advisors and clients to consult with their life insurance advisor and reassess the balance of costs and benefits of all available permanent life insurance products. This includes NLG, whole life, traditional universal life, indexed universal life and variable universal life products.

If you would like to discuss the dynamic and changing life insurance product landscape, please contact us.

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Institutional Life Insurance: Not Just for Banks and Credit Unions

In today’s tumultuous economy, more attention is being given to ascertaining “safe” investments.  Investors, including high net worth individuals and companies alike, are struggling to earn acceptable returns on their safe money.  Many of our so-called safe cash havens, such as Treasuries and high grade bonds, currently offer only modest returns.  For example, earlier this month, the Barclays U.S. Investment-Grade Bond Index hit a record low of 3.25% – a rate not seen since 1973.  Treasuries are faring no better.  As of May 25, 2012, treasury rates were:  .76% for 5-year, 1.75% for 10-year, 2.44% for 20-year and 2.85% for 30-year treasury notes.

Exploring an option such as institutional whole life insurance, that can be advantageous in a low-interest environment, is a valuable component of helping families and businesses look to their future with optimism and security.

Institutional Insurance Offers Safe Returns and Tax Advantages

For years, banks have used bank-owned life insurance (“BOLI”) to finance their executive benefit liabilities by shifting some of their safe capital to BOLI contracts, which in turn offered an increased yield over other safe capital alternatives while not increasing volatility.  By the same token, perhaps the current interest rate environment presents an opportunity for high net worth families or companies to use institutionally priced insurance for both its yield during an insured’s lifetime and the returns upon death via a death benefit.

These unique financial instruments are single premium (1 payment only) whole life insurance contracts issued by highly-rated mutual insurers.  Since they are structured as single payment deposits, the life insurance contracts enjoy most, but not all, of the tax advantages of traditional life insurance.  In short, gains during the accumulation phase of the account value are not taxed, but if a policy owner accesses account value during the life of the insured, it is taxed as ordinary income (plus an additional 10% penalty if withdrawal is pre-59 ½ years of age).  The policy owner receives the death benefit free of income and capital gains taxes (and possibly even estate and Generation-Skipping Transfer tax-free if owned in an appropriately designed trust).

Whole life insurance contracts have both a guaranteed return and a projected return based on its current dividend crediting rate, and the current dividend crediting rate is only declared once per year.  An example may help us understand.  Let’s assume someone is investing $1 million into an institutional whole life policy issued by a sample carrier on a 45 year-old male rated a “preferred non-smoker.”

Table 1 shows both the guaranteed and projected returns for years 1, 5, 10, 20, 30 and 40 on the account value.  These projected returns are based on the carrier’s current dividend crediting rate of 6.85% (fees and expenses are deducted from this crediting rate).

Table 2 shows the tax-free returns on the $1 million invested on the death benefit.  If a policy owner does not withdraw funds during the insured’s life, the death benefit is received with a healthy return.  If funds are withdrawn from the policy during lifetime, these withdrawals would commensurately reduce the death benefit payable.

Dividend Crediting Rate Considerations

Current dividend crediting rates are based off of an insurer’s general account investments, which have a significant component of corporate bonds.  Because life insurers are hold-to-maturity investors, there typically is not a market-value adjustment for policy account values unlike other fixed income payments especially when facing a potentially rising interest rate environment.  The general account portfolio still has sensitivity to the general interest rate environment and has reinvestment risk.  This creates a lag on declared dividend interest rates versus the macro interest rate trends.  Since 1980, the dividend crediting rate on this product has ranged from 6.50% to 13.25%.

Given the unique tax characteristics and the strong risk-adjusted returns, institutional whole life can be a useful tool.   Businesses sitting on cash with key-person protection needs could benefit.  Similarly, for affluent families looking for tax-advantaged allocation of their assets, institutional whole life may prove worthy for an allocation.

For more information about institutional life insurance as an investment option please contact us, and please visit our Private Client Alerts & Insights page for additional resources and updates from Pinnacle.

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Assessing the Impact of Low Interest Rates on Life Insurance Products

While indicators of an economic recovery are showing some faint signs of life, and will hopefully gain momentum, interest rates are expected to remain near their current 30 year historic lows, in part due to a recent announcement by the Federal Reserve to keep short-term rates at their current level through 2014.  These low rates will continue to put pressure on financial services companies and the interest sensitive financial products they issue, including life insurance.  Advisors can provide added value and security to their clients by helping them to understand what the current interest rate climate means to their life insurance portfolio’s performance and what to explore in order to prudently maintain their insurance investment.


Insurers invest net policy premiums into their general account to support the interest crediting obligations of their interest sensitive/non-variable products.  Products such as universal life (UL) and whole life (WL) insurance are typically priced with an assumed spread, which is the general account yield less the policy crediting rate.  Target spreads vary by product but typically are around 50-150 basis points.  Moody’s Investors Service (Moody’s) and Standard & Poor’s (S&P) concur that if interest rates remain low for several more years, life insurers will be strained by both spread compression and the minimum rate guarantees common in fixed account insurance products.

Moody’s Interest Rate Benchmarks for UL and WL

The Moody’s Aaa Long-Term Corporate Bond Yield Average represents a long-term, high-quality, fixed income investment.  This index offers the best correlation to UL crediting rates and WL dividend rates, and it is therefore useful for gauging trends in product crediting rates over time.  The five-year rolling average of the Moody’s Corporate Bond Yield Average has the best correlation with UL crediting rates and the seven-year rolling average has the best correlation with WL dividend interest rates.  Using observations and predictions of the Moody’s Corporate Bond Yield Average from Moody’s, S&P and other financial analysts can be helpful in stress testing and projecting future UL and WL performance.

Summary Commentary

New Insurance Portfolios:  For interest sensitive products, such as UL and WL, we recommend funding new policies conservatively to anticipate lower future crediting rates while concurrently employing downside scenario testing (i.e., lower crediting rates) to test funding level adequacy.

Existing Portfolios:  We advise conducting annual policy reviews with in-force illustrations that demonstrate the impact of reductions in crediting rates on policy performance.  Again, we recommend using downside testing to determine appropriate funding levels going forward.

Considerations in Product Selection for New Insurance Portfolios

  • UL – Clients should expect potential crediting rate reductions of up to 50 basis points (bps) over the next three years and model funding scenarios with that expectation in mind.
  • No-Lapse Guarantee Universal Life (NLG UL) – While NLG UL can be a good product option for older clients, prices will likely continue to increase.  Premiums have risen on average more than five percent in the last three years.  Low interest rates, evolving reserving requirements and changes to accounting standards affecting U.S.-based insurers will likely cause guaranteed premium prices to continue to increase.  Consideration should be given to the lack of cash values and lack of upside performance potential with NLG UL.  In many instances, a UL product can provide lower premium, with significant downside performance cushion relative to an NLG UL product while hedging against long-term rising interest rates.
  • Indexed UL (IUL) – Low interest rates could result in lower caps on index crediting rates found in IUL products.  However, if equity markets have a sustained period of good returns, IUL could provide better returns than fixed account UL crediting rates.  One should bear in mind that the floor on IUL policies crediting rates is usually below the guaranteed crediting rates offered on UL policies so policyowners should be comfortable with the higher volatility of IUL returns.  Moreover, with IUL products’ higher overall charge structure, clients and/or their advisors should be aware of volatility’s impact on IUL products.
  • Variable UL (VUL) – Following a decade-long period of stagnant market returns, equity markets could offer better return potential relative to the low current yields found in fixed income.  If they can clearly understand and accept the accompanying volatility in VUL product returns, clients searching for higher returns may find better potential in VUL than in UL.  Traditionally, we have not utilized VUL policies in the estate planning context given the risk/reward analysis.  In short, without careful monitoring of these policies, market volatility can significantly and negatively impact a VUL policy’s performance or duration.


With the uncertainties of the markets and interest rates, coupled with the complexities of insurance products, product selection and management has never been more important and challenging.  Understanding the benefits, risks and volatility of insurance products is critical to sound decision-making.  Fortunately, quality consulting and its accompanying analysis will drive the sustainability of life insurance portfolios designed to meet client goals and objectives.

For more information regarding the impact of low interest rates on life insurance or any other life insurance-related questions, please contact us.

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