#148 | The Compact
One of the most frequent questions I get when I do a presentation on the proliferation of Index Credit Multipliers (ICMs) is some variation of – “why are state regulators approving these products?” The short answer is that they are approving them because, regardless of how opaque, complex, leveraged and aggressive they might be, they’re still in compliance with the law. The longer answer, however, is a little bit more complicated. The reality is that most states aren’t approving these products at all. Instead, states are relying on an independent body called the Interstate Insurance Product Regulation Commission (referred to as the Compact) to review and approve the products to be sold in their state. Virtually every state uses the Compact these days, with only a few exceptions – the major markets of New York, California and Florida, but also the fiercely independent Dakotas and the District of Columbia. Unless you live in one of those places, your friendly state regulator likely doesn’t even see the filings for the products approved for sale in their state.
If this is somewhat surprising or disconcerting to you, let me take a step back and explain why the Compact exists and why it is generally a very good thing. The reality is that the insurance regulatory and legal frameworks are not identical in all 50 states. Some states have extensive life insurance and annuity legislation and others have traditionally had very little. The Compact’s primary goal is to write and implement uniform standards that effectively become the state law for its member states unless the state specifically opts out of the Compact for a particular product line. These uniform standards raise the minimum level of consumer protection across all of the states to what is generally reflective of the more conservative laws of the member states and allows for a more consistent legal framework for product regulation and supervision. This uniformity and adherence to a generally conservative standard is a clear benefit to the average consumer, even if some states and observers believe that the uniform standards could be even more conservative.
From the standpoint of insurance companies, the Compact dramatically simplifies and centralizes the product approval process so that a single filing effort at the Compact results in state approvals for the vast majority of states. It’s almost an unmitigated benefit to insurers unless, of course, the Compact uniform standard has something unsavory in it. If so, then life insurers still have the option of filing directly with the states, although fewer carriers take that approach these days.
But there are tradeoffs to the states’ reliance on the Compact, chief of which is that state regulators lose the ability to keep tabs on what products are being approved in their states and deny specific product offerings. Many of the features in modern Indexed UL products unquestionably conform to the letter of the Compact uniform standards and are rightly approved for sale based on those standards. But if a state has an issue with a product that falls outside of the Compact standard and wants to take action, the state commissioner has to appeal the Compact and petition for the Compact to take action against the insurer. That seems like a somewhat remote possibility given the fact that the Compact is largely funded by the fees paid by insurers to file their products.
The chief recourse left to state regulators to manage what is sold in their state is the creation of NAIC guidelines. In the case of Indexed UL, AG49 was a way to dictate the content of the illustration but had no impact on what product features would or would not be available to consumers because product standards are the domain of the Compact for most states. To get back to the original question that sparked this article, the only way to practically deal with ICMs is to write a new restriction for illustrated ICM interest under AG49. The alternative, which would be to attempt to get the Compact to change its standards, is untenable. ICMs are not necessarily bad for consumers. They are only bad insofar as they throw gas on the illustration war already raging in Indexed UL. That’s why this is an illustration issue, not a product feature issue and must be dealt with using an illustration guideline, not a product restriction. Hence, the reason regulators have reopened inquiry into AG49.
More specifically, the only real way I see to deal with ICMs is to drop the 145% option profit allowance in AG49 to 100%. Any other option would involve creating artificial boundaries around certain designs that would simply incentivize life insurers to come up with new ways to circumvent the boundaries and continue to put more money in the illustration to work at 145% profits in order to generate ever-better illustrated performance.