For the past decade, the insurance industry and state regulators have been working on a new system for how life insurance companies determine whether they have enough money in reserve to pay out their claims. Known as principle-based reserving, the framework has been adopted by 46 states and was rolled out across the nation on Jan. 1, 2017. Insurance companies have three years to transition to the new system that uses simulation models to estimate the necessary reserves to cover future claims. Some experts in the industry expect life insurance premiums to drop as companies adjust to the new reserve requirements.

The move to modernize life insurance reserves. The use of principle-based reserves represents a major shift for the industry, and one that reflects the changing face of life insurance policies. “If we go back 50 years, most of the life insurance products were very similar,” says Nancy Bennett, senior life fellow with the American Academy of Actuaries. So it wasn’t too problematic that state regulators required insurers to use a standard formula to determine how much cash to keep in their reserves for claim payments.

However, the market has changed significantly, and companies now offer a variety of term, whole and universal policies. As a result, the old rigid system of calculating reserves no longer worked. In some cases, companies had accumulated large reserves, “far larger than what you would think would be needed,” Bennett says.

Since the formula didn’t allow for variations, companies were unable to adjust the size of their reserves on their own. “We and other companies went to the NAIC [National Association of Insurance Commissioners] and said we want to work with you to right-size the reserves,” says Shawn Loftus, senior vice president and chief actuary of USAA Life Insurance Company. The result of that work is the new principle-based reserving model, which offers companies more flexibility when determining how much capital to have on hand. The first wave of regulations affects two types of polices: term life and universal life with secondary guarantee.

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