#229 | The Impacts of AG 49-A

At last, it appears as though the process to make edits to AG 49 is coming to an end and has coalesced around the proposal crafted by life insurers and put forth by their industry group, the ACLI, and now formally referred to as AG 49-A. Despite objections raised by numerous independent insurance analysts and consumer advocates, including yours truly, the industry has once again been able to come together to write its own regulations for its own products at the behest of regulators. But that doesn’t mean AG 49-A doesn’t have teeth – it does. Regulators successfully pushed for more conservatism and the industry complied. When AG 49-A is presumably adopted in a few weeks and implemented at the end of this year, it will fundamentally change the landscape of the Indexed UL market just like AG 49 did the last time around.

Virtually every clause of AG 49 was modified to create AG 49 A, but a lot of those modifications were required in order to make the clunky and complex language “work” and therefore aren’t worth discussing on their own. Other modifications were clarifications to the original language and, again, probably aren’t worth discussing. The remainder are the changes that producers and distributors will see clearly impacting their beloved (or hated) Indexed UL illustrations. They are:

1. Elimination of the illustrated benefits of indexed features that are funded through policy charges. The way I described it is a simplification of a lot of really complex language, but the basic upshot is charge-funded index credit multipliers and other indexed benefits are illustrated at the same rate as the charges used to support them. This fulfills the core goal set forth by the regulators for edits to AG 49, albeit in a complex and incomplete way, as we’ll see in a minute.
2. Prospective application only. All sellers of PacLife PDX and the products made in its likeness can breathe a sigh of relief. Charge-funded multipliers and bonuses will remain for in-force policies – at least until the class action lawyers start a feeding frenzy.
3. One Benchmark Index Account (BIA). The original AG 49 stated that a product could have multiple BIAs,each governing the maximum illustrated rates for any accounts with the same charge structure as that particular BIA. No longer. Now, the product only has one single BIA – but companies are still allowed to use a hypothetical BIA that is not actually offered in the product, a bizarre allowance considering that one of the definitions of a BIA is that “there are no limitations on the portion of the account value allocated to the account.” I’d call a 0% allocation allowance a restriction, wouldn’t you?
4. Charges of any kind cannot be used to increase the Benchmark Index Account cap. This one is a doozie for companies like Global Atlantic, Zurich and Transamerica, all of which have extremely high caps that are being propped up either directly or indirectly through policy charges. They will likely need to create a hypothetical BIA to set the maximum illustrated rate for the product, which will be much lower than it is right now. But there are a lot of companies that are also inflating their caps with charges to a lesser degree than the worst offenders and those companies may simply choose to lower their BIA caps rather than create a hypothetical account.
5. For non-BIA accounts, actuaries are told to set a maximum illustrated rate based on the lookback methodology used for the BIA. At first glance, this makes a lot of sense. We wouldn’t want actuaries going rogue on how they set illustrated rates for non-BIA accounts, even if the illustrated rate is still limited by the BIA. But it’s actually a nasty little clause because it doesn’t allow actuaries to take into account the fact that not all lookbacks are created equally. A lookback on the S&P 500, for example, is real historical performance data based on a simple weighted allocation between the stocks. A lookback on JP Morgan Mozaic II in Nationwide’s New Heights IUL, by contrast, is hypothetical performance using historical data from constituent parts depending on a complex and proprietary algorithm built with the benefit of hindsight overlaid with a volatility targeting mechanism. This little clause in AG 49-A is a free-pass for actuaries to play dumb when it comes to “actuarial discretion” for illustrating proprietary indices. And as we’ll discuss in a second, there’s a reason why they’re going to want to do that.
6. Specifies that actuaries can test all indexed accounts in aggregate for actuary testing. This is another innocuous little technical specification that can have profound impacts. Imagine a life insurer offers 5 indexed accounts. Four of them are immensely profitable but one of them is a money-loser and wouldn’t pass illustration actuary testing even if it had the answers taped to its thigh. Now let’s imagine that the Benchmark Index Account happens to be the Index Account that is the money loser. That’s not just any old index account – it sets the illustrated rate for the entire product. So what this little note is saying is that a life insurer can play games with their BIA rate so that it fails illustration actuary testing as long as the rest of the accounts pass sufficiently. What’s the easiest way to make this math work? By using proprietary indices. I think you’re probably starting to see a pattern.
7. Policy loan arbitrage reduced from 1% to 0.5% and cannot be increased by any non-Indexed Credit. I’m dead-certain about the first part, the reduction from 1% to 0.5%, because it’s explicitly stated in the guideline but the non-Indexed Credit piece is a bit trickier. The language says that the loan earns a Policy Loan Interest Credited Rate. What’s that? It’s the Annual Rate of Indexed Credits minus the Supplemental Hedge Budget. Ok, what’s that? It’s the “total annualized percentage of Indexed Credits expressed as a percentage of the account value.” Err, what’s an Indexed Credit? “Any interest credit, multiplier, factor, bonus, charge reduction or other enhancement to policy values that it linked to an index or indices.” Taken together, it looks like only Indexed Credits inform the illustrated rate on the loan, which means a fixed bonus doesn’t apply for the purposes of calculating the illustrated loan arbitrage for an Indexed Loan. We’ll see if this part stands and if I’m interpreting it correctly, but that’s how I’m reading it.

All of these changes are going to massively impact illustrated performance in Indexed UL. Let’s take PacLife PDX 2 as an example. Selecting the most aggressive allocation – High Cap (0.8% charge), Performance Plus EPF (7.5% charge) and the full indexed Persistency Credit – might yield an illustrated income of $92.5k and a long-term illustrated IRR of 8.21%. Under AG 49-A, all 3 of the indexed bonuses would be netted out against their charges and the illustrated arbitrage would drop from 1% to 0.5%. This produces an illustrated income of approximately $53k and a long-term IRR of about 5.7%, which is a whopping 2.5% less than it is right now. Like I said, AG 49-A ain’t perfect, but it has teeth.

Admittedly, PacLife will probably be one of the most heavily impacted companies out there. PacLife has a BIA cap of 9% and achieves its massive illustrated performance with massive leverage. But other products using leverage to fly will also have their wings clipped. John Hancock’s Accumulation IUL 19 showed similar maximum income as PDX 2 and a similar decline in the same scenario – and will show even worse if, in fact, its embedded fixed persistency credit isn’t allowed to be added to the 0.5% illustrated arbitrage. Even Allianz, which isn’t typically thought of as being particularly multiplier-dependent, shows a decline from $101k to $61k. There is absolutely no doubt that some of most dominant and/or fastest growing companies – PacLife, John Hancock, Lincoln, Nationwide, Global Atlantic, Allianz – are going to take a beating with AG 49-A.

But the same thing happened after the original AG 49 was implemented and it didn’t last. Companies created product features to maximize their illustrated performance while remaining in compliance with the guideline. It would be foolish to assume that companies will do anything different this time around. In fact, AG 49-A practically gives them a bold print, highlighted guide for how to do it. The simple answer is that life insurers are going to exploit proprietary indices just like they did for FIA products and just like Allianz, Nationwide and AIG are already doing in their IUL products. But that’s only the first step. In order to maximize the benefits of proprietary indices, companies will also take advantage of some of the ambiguities in the definitions of the guidelines, create timing differences, play games with quasi-indexed accounts and all sorts of other subterfuge to maximize illustrated performance. If I’m being optimistic, I’ll say that the net result is that illustrations will still be more conservative than they are today. Maybe that’s the case. But if I’m being pessimistic, I’ll say that they might be more conservative, but they’ll also be a lot more confusing. Comparing illustration to illustration is already bad practice, but it might become completely irrelevant under AG 49-A. That’s my fear. But we’ll see – maybe life insurers will actually do the right thing and stop competing on the basis of illustrated performance for use in hyper aggressive strategies like accrued interest premium financing.

Ah, sorry, I slipped up. That was the opening line to my upcoming stand-up comedy act for life insurance professionals. What I meant to say was that we all know exactly what life insurers are going to do and exactly how this is going to end. But for companies who are going to play the game, they’ll make hay like they did with multipliers and they’ll get away with not even a slap on the wrist. It’ll take a couple more years, but AG 49 will get reopened again and, as the regulators said, the third time they’re going to be a lot less friendly to the industry’s perspective.

But in the interim, buckle up. It’s going to be a wild ride. As soon as AG 49-A hits, the whole market is going to flip over and it’ll be a feverish rush to figure out how to carve out a spot in the new environment, come hell or high water. Or, of course, life insurers will just switch to doing what they used to do in Indexed UL but now they’ll do it inside of a Variable UL product, which is not subject to AG 49. Now that would make things interesting.