State of the Life Insurance Industry - NAIC

CIPR Study

State of the Life Insurance Industry:

Implications of Industry Trends

by Anne Obersteadt

and Larry Bruning, Brenda Cude Kris DeFrain, Brian Fechtel Shanique Hall, Dimitris Karapiperis Andrew Melnyk, Reggie Mazyck Greg Niehaus, Eric Nordman Bruce Ramge, Guenther Ruch Karen Schutter, Daniel Schwarcz

Jeremy Wilkinson

August 2013

State of the Life Insurance Industry:

Implications of Industry Trends

Larry Bruning Brenda Cude Kris DeFrain Brian Fechtel Shanique Hall Dimitris Karapiperis Andrew Melnyk Reggie Mazyck

By Anne Obersteadt

And

Greg Niehaus Eric Nordman Bruce Ramge Guenther Ruch Karen Schutter Daniel Schwarcz Jeremy Wilkinson

This CIPR Study presents research whose purpose is to inform and disseminate ideas to regulators, academics and financial service professionals.

The mission for the CIPR is to serve federal and state lawmakers, federal and state regulatory agencies, international regulatory agencies, and insurance consumers, by enhancing intergovernmental cooperation and awareness, improving consumer protection and promoting appropriate marketplace competition.

Disclaimer: This study represents the opinions of the author(s), and is the product of professional research. It is not meant to represent the position or opinions of the NAIC or its members, nor is it the official position of any staff members. Any errors are the fault of the author(s).

CIPR StudyS 2013

Date: August

NOTE TO READERS This is the final release of the study in its entirety as one document. This study is organized in six sections, each of which consist of distinct essays by contributing authors, both internal and external to the NAIC (NAIC/CIPR staff, state regulators, academics, and industry representatives), covering a broad range of issues having profound and transformative implications for the life insurance industry. The sections explore how the industry has evolved over time, the nature of regulatory responses, the changes in product offerings and technology, and the challenges of the economic environment. The first section, the Evolution of Life Insurance, traces the history of life insurance from the 18th century to the present time. The second section, Current and Emerging Product Trends in Retirement and Long-Term Care Markets, discusses how insurers are meeting the increased need for retirement products. The third section, The Impact of Technology on the Life Insurance Industry, discusses the impact of emerging technologies on the life insurance industry. The fourth section, Life Insurer Balance Sheets, looks at financial performance of the life insurance industry over the last decade and provides an in-depth look at the 2011 numbers to give a snapshot of the industry's sound financial position today. The fifth section, Implications of Economic and Market Changes on Life Insurers, highlights the important role life insurers play in the economy and covers the impact of the recent global financial crisis on the industry with a special focus on the low interest rate environment. The sixth section, Meeting the Risks of the New Environment, explores risk management in the context of the changing and complex environment.

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Authors: Larry Bruning, International Life Actuary, Financial Regulatory Affairs--International, NAIC Brenda J. Cude, Professor of Housing and Consumer Economics, University of Georgia Kris DeFrain, Director, Research and Actuarial Services, NAIC Brian Fechtel, CFA, Agent and Founder, Breadwinners' Insurance Shanique Hall, Manager, CIPR, NAIC Dimitris Karapiperis, Researcher, CIPR, NAIC Andrew Melnyk, Vice President, American Council of Life Insurers Reggie Mazyck, Life Actuary, Research and Actuarial Services, NAIC Greg Niehaus, Professor of Finance and Insurance, University of South Carolina Eric Nordman, Director, Regulatory Services and CIPR, NAIC Anne Obersteadt, Senior Researcher, CIPR, NAIC Bruce Ramge, Director, Nebraska Department of Insurance Guenther Ruch, Principal, GHR Consulting, LLC. Karen Schutter, Executive Director, Interstate Insurance Product Regulation Commission Daniel Schwarcz, Associate Professor, University of Minnesota Law School Jeremy Wilkinson, Senior Manager, Communications, NAIC

Acknowledgements: The authors are grateful to those that reviewed and contributed to the study and helped improve it with their insightful comments. Special thanks to former NAIC CEO Terri Vaughan, from whom the concept of this study originated. Additional thanks goes to other NAIC staff, particularly NAIC COO and CLO Andy Beal; Jennifer Cook, Jolie Mathews, and Ethan Sonnichsen, Government Relations Office; Dan Daveline, Dave Fleming, Bruce Jensen, Jane Koeningsman, Robin Marcotte, and Todd Sells, NAIC Financial Regulatory Services Department; Randy Helder and Craig Leonard, NAIC Market Regulation Department; Dave Keleher, NAIC Research and Actuarial Services Department; Ed Toy, NAIC Capital Markets Bureau; and Pamela Simpson, NAIC Regulatory Services for her editorial help. The authors also thank NAIC Members Jim Mumford (IA) and Steve Caughill (WI), as well as James W. Schacht (The Schacht Group) for their invaluable comments on the draft released at the CIPR Life Insurance Symposium October 25, 2012.

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Contents

Executive Summary....................................................................................................................................... 1 Historical Evolution of Life Insurance ........................................................................................................... 5

Life Insurance Industry in its Infancy ....................................................................................................... 6 Economic Turbulence of the 19th Century .............................................................................................. 6 State Regulation is Born........................................................................................................................... 7 Life Insurers Dominate the Financial Markets ......................................................................................... 8 The Armstrong Investigations Restrict Insurers' Role as Financial Institutions ....................................... 8 Growth and Confidence Restored Through Regulation and Legislation.................................................. 9 Life Insurance Sales Soar with the Roaring 1920s.................................................................................. 10 The Great Depression Pressures Life Insurers ....................................................................................... 10 Commercial Banks Repeat Life Insurers' Mistakes ................................................................................ 11 Federal Regulatory Investigations.......................................................................................................... 12 Federal Regulations Reform the Economy............................................................................................. 12 Banking Reforms .................................................................................................................................... 13 Insurance Reforms ................................................................................................................................. 14 Consumer Demand Shifts to Long-Term Security in the Golden Age .................................................... 14 Consumer Protections............................................................................................................................ 16 Insurers Innovate into Investment-Oriented Products to Keep Pace with High Interest Rates ............ 16 Birth of Universal Insurance and Variable Insurance............................................................................. 17 Variable Annuities .................................................................................................................................. 18 High Insurance Lapse Rates Lead to Stronger Insurance Regulations ................................................... 21 High Interest Rates Spark Deregulation of Financial Institutions .......................................................... 22 The Financial Services Modernization Act ............................................................................................. 24 Consolidation of the Life Insurance Industry ......................................................................................... 25 Demutualization..................................................................................................................................... 26 Insurance Regulators Respond to the Financial Services Modernization Act........................................ 28 The Rise of Derivatives and the Commodity Futures Modernization Act (CFMA) of 2000 ................... 29 Insurers Enter the Twenty-First Century................................................................................................ 30 Recession of 2001 .................................................................................................................................. 31 Insurers Return to Growth and Core Competencies.............................................................................. 32 Insurers Turn to Alternative Funding Mechanisms for Statutory Relief ................................................ 32 Suitability and Disclosure of Annuities................................................................................................... 33 Contingent Commission Practices Investigation.................................................................................... 34 Global Financial Crisis............................................................................................................................. 35

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Systemic Risk Intervention..................................................................................................................... 36 Lessons Learned from the Financial Crisis ............................................................................................. 37 Dodd-Frank Wall Street Reform and Consumer Protection Act ............................................................ 38 Solvency Modernization Initiative ......................................................................................................... 39 Current and Emerging Product Trends in Retirement and Long-Term Care Markets ................................ 41 Introduction ........................................................................................................................................... 42 Longevity Risk and Insurance................................................................................................................. 44 The Growing Need for Retirement Products Provided by Life Insurers ................................................ 45 Annuities in Pensions ............................................................................................................................. 55 Pension Risk Transfer ............................................................................................................................. 58 Contingent Deferred Annuities .............................................................................................................. 61 Regulatory Implications of the Risks Inherent in Longevity Products and Transfer Mechanisms......... 62 The Growing Need for Long-Term Care Insurance ................................................................................ 67 Insurance Regulatory Perspectives on Long-Term Care Insurance........................................................ 76 The Impact of Technology on the Life Insurance Industry.......................................................................... 86 Internet and Mobile Technology and the Life Insurance Industry......................................................... 87 Barriers to Insurers' Use of the Internet for Product Distribution......................................................... 91 Implications of Emerging Technology on Insurance Regulation ............................................................ 94 Life Insurer Balance Sheets: Description and Issues of the Past Decade.................................................... 99 Introduction ......................................................................................................................................... 100 Framework, Terminology and Data ..................................................................................................... 102 The Life and Health Insurance Industry in 2011 .................................................................................. 104 Capital-to-Asset Ratios Vary with Company Size and Line of Business ............................................... 110 Medium Size Accident and Health Capital-to-Asset Ratios Trend Lower ............................................ 113 NAIC RBC Ratios: 2001-2011 ................................................................................................................ 116 Changes in Capital During and After the Financial Crisis ..................................................................... 118 Conclusions on Life Insurer Balance Sheets......................................................................................... 121 Implications of Economic and Market Changes on Life Insurers .............................................................. 125 Insurers' Place and Key Role in the Economy ...................................................................................... 126 Impact of Financial Crisis...................................................................................................................... 127 Current Economic and Market Environment ....................................................................................... 132 The Challenges of the Low Interest Rate Environment ....................................................................... 135 How Do Life Insurers Counter Low Interest Rates ............................................................................... 139 The Risk of a Spike in Interest Rates .................................................................................................... 141 NAIC Low Interest Rate Study and Methodology ................................................................................ 142

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Meeting the Risks of the New Environment ............................................................................................. 147 Introduction ......................................................................................................................................... 148 The Importance of Group Supervision................................................................................................. 150 The Need for Stronger Corporate Governance.................................................................................... 155 The Significance of Enterprise Risk Management................................................................................ 160 Ensuring Capital Adequacy in the New Environment .......................................................................... 163 Implications of the Interstate Insurance Product Regulation Commission ......................................... 172 Opportunities for Better Collaboration between State and Federal Regulators................................. 173 Market Conduct?Better Analytical Tools............................................................................................. 175 The Legal Entity Identifier (LEI) Improves Financial Transparency ...................................................... 181 Enhancing Transparency ...................................................................................................................... 182

Conclusion................................................................................................................................................. 195 References ................................................................................................................................................ 199 Appendices................................................................................................................................................ 205

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