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INSURERS: BULLETIN 92-9

STATE OF CALIFORNIA
DEPARTMENT OF INSURANCE

45 Fremont Street
San Francisco, CA 94105

NOTICE: THIS BULLETIN (92-9) HAS BEEN SUPERSEDED BY BULLETIN 97-5

Date: November 20, 1992

To: All Insurers Authorized to Write Life and/or Disability Business in California and Other Interested Persons

Subject: Bulletin 92-9, Life and Health Reinsurance Contracts

With the adoption of the NAIC Model Regulation, Life and Health Reinsurance Agreements, California Bulletin No. 91-10 has been revised and issued as Bulletin No. 92-9. The revisions are made primarily to incorporate certain provisions found in the Model Regulation.

The following is an outline of the major changes and remaining differences:

  1. The Subject. It was "Surplus Relief Reinsurance Contract" for Bulletin No. 91-10. It is now "Life and Health Reinsurance Contracts."
  2. The 3rd paragraph of page 1. Companies which are subject to similar laws or regulations in their state of domicile may now be exempted from this Bulletin.
  3. The 4th paragraph of page 1. "Situations involving" is deleted from the first line. "Yearly renewable term reinsurance" is added to the list of excluded contracts.
  4. Requirement A.(1). Renewal expense allowances should be sufficient for any accounting periods. The expenses are based on those "expected by the company at the time the business is reinsured."
  5. Requirement A.(2). The reinsurer may terminate the reinsurance contract for non-payment of "other amounts due, such as modified coinsurance reserve adjustments, interest and adjustments on funds withheld, and tax reimbursement."
  6. Requirement A.(4). Treaties cannot be terminated "at the reinsurer's option".
  7. Requirement A.(5). "Other fees or charges" are included in the comparison to the direct premiums.
  8. Requirement A.(6). The description of the Lapse risk has been changed to voluntary termination prior to the recoupment of any surplus drain experienced at issue of the policy.
  9. Requirement A.(7). In addition to trust account, Escrow account and certain other mechanisms are acceptable.
  10. Requirement A.(7). Universal Life Fixed Premium plan is on the Model Regulation "exemption list" but not on California's list.
  11. Requirement A.(8). Settlements must be made in cash "within ninety (90) days of the settlement date."
  12. Requirement A.(11). This provision is added for situations not specifically covered by Accounting Requirements A.(1). through A.(10).
  13. The old Accounting Requirements Provision B. is deleted and merged into the 4th paragraph. See item 3. above.
  14. The old Accounting Requirements Provision C. is now Provision B.
  15. New Requirement B.(1). The reference to filing by a senior officer has been modified. The ceding company's valuation actuary is responsible for the documentation and demonstration of compliance.
  16. Written Agreements. An "entire contract" type of provision is added as Provision C.
  17. Existing Agreements. The last three lines are added to conform with the Model Regulation.

Reinsurance agreements not in compliance with Bulletin No. 92-9 will not be allowed to take any reserve credits for the December 31, 1992 Annual Statement.

John Garamendi
Insurance Commissioner


STATE OF CALIFORNIA
DEPARTMENT OF INSURANCE

45 Fremont Street
San Francisco, CA 94105

Bulletin No.92-9

Date: November 20,1992

To: All Insurers Authorized to Write Life and/or Disability Business in California and Other Interested Persons

Subject: Life and Health Reinsurance Contracts

This bulletin supersedes California Bulletin 91-10, issued November 27, 1991, California Bulletin 89-3, issued August 2, 1989, California Bulletin 89-3A, issued November 20, 1989, and the California notice issued April 15, 1991.

The reporting of corresponding assets or reserve credits by a ceding insurer who enters into a reinsurance agreement which is not in conformity with the provisions of this Bulletin violates:

  1. Sections 10489.1, et. seq. of the California Insurance Code, the Standard Valuation Law; and
  2. Sections 915, 916, and 917 of the California Insurance Code relating to the financial statements of insurers, thus, resulting in distorted financial statements which do not properly reflect the financial condition of the ceding insurer; and
  3. Sections 922.15 and 922.3 of the California Insurance Code relating to reinsurance reserve credits, thus resulting in a ceding insurer properly reducing liabilities or establishing assets for reinsurance ceded.

This Bulletin shall apply to all licensed life and disability insurers and to all licensed property and casualty insurers with respect to their disability business. However, this Bulletin will not apply to such insurers who are subject to laws or regulations in their state of domicile substantially similar to this Bulletin or the NAIC Model Regulation on Life and Health Reinsurance Agreements (adopted by the NAIC in September, 1992) provided that such insurers do not recognize any assets or reserve credits resulting from treaties which are not in compliance with such laws or regulations as of December 31, 1992 or, if later, the date of execution of the treaties.

This Bulletin shall not apply to assumption reinsurance, yearly renewable term reinsurance, or non-proportional reinsurance such as stop loss or catastrophe reinsurance.

Accounting Requirements

A. No insurer subject to this Bulletin shall, for reinsurance ceded, reduce any liability or establish any asset in any financial statement filed with the Department if, by the terms of the reinsurance agreement, in substance or effect, any of the following conditions exist:

(1) Renewal expense allowances provided or to be provided to the ceding insurer by the reinsurer in any accounting period, are not sufficient to cover anticipated allocable renewal expenses of the ceding insurer on the portion of the business reinsured. Those expenses include commissions, premium taxes, and direct expenses including but not limited to billing, valuation, claims, and maintenance expected by the company at the time the business is reinsured;

(2) The ceding insurer can be deprived of surplus or assets at the reinsurer's option or automatically upon the occurrence of some event, such as the insolvency of the ceding insurer, except that termination of the reinsurance agreement by the reinsurer for non-payment of reinsurance premiums or other amounts due, such as modified coinsurance reserve adjustments, interest and adjustments on funds withheld, and tax reimbursements, shall not be considered to be such a deprivation of surplus or assets where such termination is made prior to an Order of Liquidation of the ceding insurer;

(3) The ceding insurer is required to reimburse the reinsurer for negative experience under the reinsurance agreement, except that neither offsetting experience refunds against current and prior years' losses under the agreement nor payment by the ceding insurer of an amount equal to the current and prior years' losses under the agreement upon voluntary termination of in force reinsurance by that ceding insurer shall be considered such a reimbursement to the reinsurer for negative experience;

(Voluntary termination does not include situations where termination occurs because of unreasonable provisions which allow the reinsurer to protect its interest. An example of a situation which is not to be considered as voluntary termination on the part of the ceding company is its decision to credit to fixed premium universal life policyholders an interest rate higher than guaranteed in the policy if such rate is not excessive when compared either to the return on the underlying assets or to current market rates offered on similar products by other insurers.)

In the event the ceding company is placed under an Order of Liquidation, the ceding company shall not be required to reimburse the reinsurer for any unrecovered surplus relief or for any past or current losses.

(4) The ceding insurer must, at specific points in time scheduled in the agreement or at the reinsurer's option, terminate or automatically recapture all or part of the reinsurance ceded;

(5) The reinsurance agreement involves the possible payment by the ceding insurer to the reinsurer of amounts other than from income realized from the reinsured policies. For example, it is improper for a ceding company to pay reinsurance premiums, or other fees or charges to a reinsurer which are greater than the direct premiums collected by the ceding company;

(6) The treaty is not of a form which transfers all of the significant risks inherent in the business being reinsured. The following table identifies, for a representative sampling of products or types of business, the risks which are considered to be significant. For products not specifically included, the risks determined to be significant will be consistent with this table.

RISK CATEGORIES:
1 = Morbidity  
2 = Mortality  
3 = Lapse The risk that a policy will voluntarily terminate prior to the recoupment of any surplus drain experienced at issue of the policy.
4 = Credit Quality (C1) This is the risk that invested assets supporting the reinsured business will decrease in value. The main hazards are that assets will default or that there will be a decrease in earning power. It excludes market value declines due to changes in interest rate.
5 = Reinvestment (C3) This is the risk that interest rates will fall and funds reinvested will therefore earn less than expected. If asset durations are less than liability durations, the mismatch will increase.
6 = Disintermediation (C3) This is the risk that interest rates rise and policy loans and surrenders increase or maturing contracts do not renew at anticipated rates of renewal. If asset durations are greater than the liability durations, the mismatch will increase. Policyholders will move their funds into new products offering higher rates. The company may have to sell assets at a loss to provide for these withdrawals.

+ = significant 0 = insignificant

TYPE RISK CATEGORY 1 2 3 4 5 6
Health Insurance - other than LTC/LTD* + 0 + 0 0 0
Health Insurance - LTC/LTD* + 0 + + + 0
Immediate Annuities 0 + 0 + + 0
Single Premium Deferred Annuities 0 0 + + + +
Flexible Premium Deferred Annuities 0 0 + + + +
Guaranteed Interest Contracts 0 0 0 + + +
Other Annuity Deposit Business 0 0 + + + +
Single Premium Whole Life 0 + + + + +
Traditional Non-Par Permanent 0 + + + + +
Traditional Non-Par Term 0 + + 0 0 0
Traditional Par Permanent 0 + + + + +
Traditional Par Term 0 + + 0 0 0
Adjustable Premium Permanent 0 + + + + +
Indeterminate Premium Permanent 0 + + + + +
Universal Life Flexible Premium 0 + + + + +
Universal Life Fixed Premium 0 + + + + +
Universal Life Fixed Premium 0 + + + + +

dump-in premiums allowed

*LTC = Long Term Care Insurance

LTD = Long Term Disability Insurance

(7) The credit quality, reinvestment, or disintermediation risk is significant for the business reinsured and the ceding company does not (other than for the classes of business excepted) either transfer the underlying assets to the reinsurer or legally segregate such assets in a trust or escrow account with the ceding company as the beneficiary or otherwise establish a mechanism satisfactory to the Commissioner which legally segregates, by contract or contract provision, the underlying assets.

Notwithstanding the requirements of this paragraph A(7), the assets supporting the reserves for the following classes of business, and any classes of business which do not have a significant credit quality, reinvestment, or disintermediation risk, may be held by the ceding company without segregation of such assets:

  • Health Insurance - LTC/LTD
  • Traditional Non-Par Permanent
  • Traditional Par Permanent
  • Adjustable Premium Permanent
  • Indeterminate Premium Permanent

The associated formula for determining the reserve interest rate adjustment must use a formula which reflects the ceding company's investment earnings and incorporates all realized and unrealized gains and losses reflected in the statutory statement.

The following is an acceptable formula:

RATE = 2 * (I + CG) X + Y - I - CG

Where: I is the net investment income (Exhibit 2, Line 16, Column 7)

CG is capital gains less capital losses (Exhibit 4, Line 10, Column 6)

X is the current year cash and invested assets (Page 2, Line 10A, Column 1) plus investment income due and accrued (Page 2, Line 16, Column 1) less borrowed money (Page 3, Line 22, Column 1)

Y is the same as X but for the prior year

Note: Line and column references are for the 1992 Annual Statement.

(8) Settlements are made less frequently than quarterly or payments due from the reinsurer are not made in cash within ninety (90) days of the settlement date.

(9) The ceding insurer is required to make representations or warranties not reasonably related to the business being reinsured.

(10) The ceding insurer is required to make representations or warranties about the future performance of the business being reinsured.

(11) The reinsurance agreement is entered into for the principal purpose of producing significant surplus aid for the ceding insurer, typically on a temporary basis, while not transferring all of the significant risks inherent in the business reinsured and, in substance or effect,the expected potential liability to the ceding insurer remains basically unchanged.

B. (1) Agreements entered into after the effective date of this Bulletin which involve the reinsurance of business issued prior to the effective date of the agreement, along with any subsequent amendments thereto, shall be filed by the ceding company with the Commissioner within 30 days from its date of execution. Each such filing shall include data detailing the financial impact of the transaction. The ceding insurer's actuary who signs the financial statement actuarial opinion with respect to valuation of reserves shall consider this Bulletin and any applicable Actuarial Standards of Practice when determining the proper credit in financial statements filed with this Department. The actuary should maintain adequate documentation and be prepared upon request to describe the actuarial work performed for inclusion in the financial statement and to demonstrate that such work conforms to this Bulletin.

(2) Any increase in surplus net of federal income taxes resulting from arrangements described in C(1) shall be identified separately on the insurer's statutory financial statement as a surplus item (Aggregate write-ins for gains and losses in surplus in the Capital and Surplus Account, page 4 of the Annual Statement) and recognition of the surplus increase as income shall be reflected on a net of tax basis in the Summary of Operations (Commissions and expense allowances on reinsurance ceded line, page 4 of the Annual Statement) as earnings emerge from the business reinsured. [For example, on the last day of calendar year N, company XYZ pays a $20 million initial commission and expense allowance to company ABC for reinsuring an existing block of business. Assuming a 34% tax rate, the net increase in surplus at inception is $13.2 million ($20 million - $6.8 million) which is reported on the "Aggregate write-ins for gains and losses in surplus" line in the Capital and Surplus account. $6.8 million (34% of $20 million) is reported as income on the "Commissions and expense allowances on reinsurance ceded" line of the Summary of Operations. At the end of year N+1 the business has earned $4 million. ABC has paid $.5 million in profit and risk charges in arrears for the year and has received a $1 million experience refund. Company ABC's annual statement would report $1.65 million (66% of ($4 million - $1 million - $.5 million) up to a maximum of $13.2 million) on the "Commissions and expense allowance on reinsurance ceded" line of the Summary of Operations, and -$1.65 million on the "Aggregate write-ins for gains and losses in surplus" line of the Capital and Surplus account. The experience refund would be reported separately as a Miscellaneous income item in the Summary of Operations.]

Written Agreements

A. No reinsurance agreement or amendment to any agreement may be used to reduce any liability or to establish any asset in any statutory financial statement filed with this Department, unless the agreement, amendment or a binding letter of intent has been duly executed by both parties no later than the "as of date" of the financial statement.

B. In the case of a letter of intent, a reinsurance agreement or an amendment to a reinsurance agreement must be executed within a reasonable period of time, not exceeding ninety(90)days from the execution date of the letter of intent, in order for credit to be granted for the reinsurance ceded.

C. The reinsurance agreement shall contain provisions which provide that:

(1) The agreement shall constitute the entire agreement between the parties with respect to the business being reinsured thereunder and that there are no understandings between the parties other than as expressed in the agreement; and

(2) Any change or modification to the agreement shall be null and void unless made by amendment to the agreement and signed by both parties.

Existing Agreements

Insurers subject to this Bulletin shall reduce to zero (0) by December 31, 1992 any reserve credits or assets established with respect to reinsurance agreements which were in effect prior to the effective date of this Bulletin and which, under the provisions of this Bulletin, would not be entitled to recognition of such reserve credits or established assets, provided, however, that such reinsurance agreements shall have been in compliance with laws or regulations in existence immediately preceding the effective date of this Bulletin.

Any questions regarding this Bulletin should be addressed to:

Hsien-Ming Keh, FSA, CMA, ARM, CLU, ChFC
Life Actuary, Actuarial Division

California Department of Insurance
3450 Wilshire Boulevard
Los Angeles, CA 90010

Telephone: (213) 736-2786

FAX: (213) 736-4800

John Garamendi
Insurance Commissioner

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