Changes in Valuation and Nonforfeiture Rates Will Impact Life Insurance Forms
Current low interest conditions are having a double impact on life insurance. Investment yield have fallen, potentially below assumptions made in the pricing of the product. Changes in the maximum interest used for valuation and nonforfeiture calculations, required starting January 1, 2013, will impact insurer profits.
Valuation interest rates for life insurance policies and annuity contract are set by the Standard Valuation and Standard Nonforfeiture Laws. Maximum nonforfeiture interest rates are tied to the maximum valuation rate. Changes to these rates may require the revision of certain life insurance policy forms and therefore trigger a need for new regulatory approvals.
Interest rates are calculated according to the 1980 amendments to the Standard Valuation Law from the monthly average of Moody’s Composite Yield on Seasoned Corporate Bonds. The current low interest rate environment has resulted in a decrease in the maximum valuation for 2013 issuance of life insurance policies with interest rate guarantee periods of twenty or more years. That rate changes from the current 4.00% to 3.50% on January 1, 2013. This means that new reserve factors are needed for all products currently using 4.00%. While more newly developed life insurance policies may already be based upon 3.50% reserves, all insurers need to take action for those that do not.
As noted, the maximum nonforfeiture interest rate is tied to the maximum reserve interest rate. The maximum nonforfeiture rate is 125% of the maximum valuation interest rate rounded to the nearest 0.25 %. The current 5.00% therefore changes to 4.50%. Because there is a one year grace, the new 4.50% nonforfeiture interest rate is optional in 2013 and not required until January 1, 2014.
The new lower valuation and nonforfeiture interest rates will result in larger basic reserves and cash values. That in turn will increase surplus strain, reduce profit and impact existing or future deficiency reserves.
For life insurance policy forms changes, and therefore new regulatory filings, may or may not be required.
Some companies may elect simply to hold higher reserves in 2013 and postpone any changes to premiums, dividends and/or cash values until 2014. Alternatively, an insurer might decide to change reserves plus gross premiums and/or dividends, but make no change in the nonforfeiture values during 2013. Finally, insurers may elect to make reserve and nonforfeiture changes with the necessary changes to premiums, nonforfeiture values and, if applicable, dividends. While this last option results in only a single regulatory filing for each product, it requires the most effort. If the actuarial work is not yet completed, regulatory approval by the end of 2012 in all jurisdictions may now be very questionable.
The valuation rate may be stated in a policy, but neither the model law nor Interstate Compact Standards require such. However, many states do require a demonstration or statement of the reserve method. Changes to these should be filed with most state insurance departments, at least, on an informational basis.
Nonforfeiture benefits must be stated in the policy under the model law. The model requires that a policy contain “a paid-up nonforfeiture benefit on a plan stipulated in the policy”, in other words,a specific set of numbers. Under Interstate Compact Standards the nonforfeiture interest rate must be shown and cannot be changed without a filing.
While different life insurers have elected, or will elect, different action in response to the changes in the maximum valuation and nonforfeiture interest rates, the changes will clearly impact all.
John B. Palmer, III, J.D., CLU, FLMI, ChFC, AIRC, ACS
Vice President & Senior Consultant
First Consulting & Administration, Inc.