#169 | The AG49 Menu

After a rather contentious IUL Illustrations Subcommittee call where regulators sparred with a lawyer representing a coalition of life insurers who are using charge-funded multipliers over a menu of possible changes to AG49, Chair Fred Andersen made the motion to expose four of the options to begin the discussion. It will certainly be interesting to see the various arguments put forth in favor of and against each option, so I thought I’d put mine down on paper before things get messy.

Option #13 – Clarify whether charges can impact assumed earned interest underlying the DCS

This one strikes right at the heart of the multiplier debate. The 145% factor that AG49 allows IUL writers to apply to net investment earnings is essentially the mechanism that allows the assumption of 145% option profits to fuel illustrated performance in Indexed UL. In the case of multipliers, carriers are (apparently) assuming that they can add policy charge earnings to their net investment income and therefore augment their illustrated performance. Restricting their ability to do that would theoretically eliminate the illustrated benefit of using charge-funded multipliers. An illustration with a multiplier would look no different than one without.

However, this option isn’t workable for at least three reasons. First, restricting the ability to illustrate persistency bonuses and multipliers was discussed during the original AG49 debate and shelved because it would have put IUL at an unfair disadvantage relative to traditional UL. Second, AG49 already allows explicit charges to be added to the net investment income courtesy of Section 3(B)(vi), which allows for Benchmark Index Accounts that include asset-based policy charges to increase the cap and the illustrated rate, effectively allowing the full option budget (earnings plus charges) to earn the 145%. Allowing higher illustrated rates for charge-funded higher caps but not allowing higher illustrated rates for charge-funded Index Credit Multipliers (ICMs) would be inconsistent treatment. Finally, the original intent of using net investment income in AG49 was that it would be a proxy for the option budget, which is not a declared non-guaranteed element, and the option budget naturally includes any fees that explicitly go to fund options. It’s hard to argue that charge-funded high caps and multipliers don’t fit with the spirit of the regulation to apply the 145% to the option budget.

Option #14 – Include all policy credits in the 1% arbitrage limit OR disallow illustration of variable loans

This one is probably the easiest and most likely to be enacted, but it will also have the smallest impact. Clarifying that 1% means 1% for the purposes of illustrated loan arbitrage will reduce illustrated income streams in the most aggressive products by 20% or less. That might sound like a lot, but it’s not. Consider the fact that a competitive Indexed UL product showing Standard Loans, with 0% arbitrage, can still show 2.7 times the income of the most competitive Whole Life offering. Switching to 1% illustrated arbitrage or even forcing 0% arbitrage courtesy of Standard Loans might seem like it will hurt IUL writers, but it won’t – although IUL writers are undoubtedly well aware of the advantageous optics of being willing to make a trade first. But with illustrated loan arbitrage, they’ll be trying to trade glass beads for emeralds.

Option #15 – Consistent treatment of various IUL product types in terms of illustrations and DCS testing

This option is attempting to remedy the fact that bonuses and multipliers are not discussed in AG49 and proposes to bring those additions to the crediting rate back into the AG49 calculation. Sounds reasonable, doesn’t it? Unfortunately, it’s not as easy as it sounds. For example, does it make sense to include a bonus that starts in year 2 rather than year 1? And, if so, how do you value a future, non-guaranteed bonus in the illustration for the purposes of setting a level rate? Are bonuses and ICMs the same for determining what should be included? See, it gets really tricky. And, more importantly, whatever language would be crafted to expand AG49’s scope into bonuses and multipliers would be easily gamed. The reasons why bonuses and multipliers were not a part of AG49’s original scope are still valid.

Option #16 – Application of AG49 constraints to cash value IRR

This one is my favorite – for sporting purposes, that is. The basic idea behind it is well-intentioned. If cash value IRR was constrained by the BIA max AG49 rate, then carriers could only apply so much leverage before the CSV IRR exceeds the BIA AG49 rate. It certainly works for that purpose but it has two insurmountable problems. First, it allows life insurers to basically show “free” policies courtesy of multiplier interest. Think about it – if this regulation is enacted, then every life insurer will introduce just enough of a bonus to show a CSV IRR in almost every year equal to the Max AG49 rate. Free insurance. Is that really what was intended? If an illustration is supposed to show how a product works, then this would undermine the entire intent of the illustration because the client wouldn’t even be able to see the policy charges.

But let’s say that, somehow, the regulators don’t buy that argument. The second problem is just as bad. The BIA rate can be easily manipulated with more leverage. Imagine that a life insurer created a policy with a charge that floats every year and purchases 100% exposure in the S&P 500 with no cap. That would create a new BIA account, according to AG49, with a maximum illustrated rate of 11.85%. I’m actually kind of amazed that no company has done this yet, but that’s a conversation for another day. It would fly under the current AG49. Now, if this option were to be adopted, the new CSV IRR under AG49 would be a whopping 11.85%. Call me crazy, but that’s probably not what the regulators had in mind with this one.

What now?

Everyone knows that AG49 laid the groundwork perfectly for all of the designs being employed to increase illustrated performance in modern Indexed UL products, but here’s the controversial part – AG49, as written, also protects those designs. You can’t attack charge-funded multipliers without attacking AG49’s treatment of charge-funded high cap accounts. You can’t attack index return multipliers and illustrated loan arbitrage without attacking the entire idea of setting BIA rates based on hypothetical historical lookbacks. And all of these policy provisions trade on the core concept of 145% allowable option profits. As long as that stands, companies will have an enormous incentive to maximize the exposure of the product to options and, therefore, to illustrated 145% profits.

Trying to find a middle-ground solution is like dumping a bucket of water directly on the Continental Divide – you might think it’s going to stay on the mountain, but eventually it’s going to end up in either the Atlantic or the Pacific. Regulators can either do nothing and watch the industry take a headlong dive into ever more aggressive product designs or they can reopen AG49 to deal with the real issues of illustrating a fixed insurance product with 145% option profits. Anything else will only prolong the inevitable.