U.S. Life Insurers Favor Principles-Based Regulation, But Have Concerns, According to Latest Tillinghast CFO Study

Few Have Made Significant Progress to Prepare, Despite Expectation of Major Impact

STAMFORD, CT., August 9, 2006 — More than 80% of life insurance CFOs favor the transition from formula-based to principles-based regulation for reserves and capital, according to the latest life insurance CFO survey by the Tillinghast business of Towers Perrin. However, only 37% of respondents favor the way the framework is currently being implemented. Key concerns include misinterpretation from external parties, possible non-standardization across companies and time-consuming calculations.

“As principles-based regulation gains momentum, we expect a dramatic change to the competitive landscape for life insurers,” said Jack Gibson, Managing Principal for the firm’s North American life insurance practice. “Experiences with similar Canadian regulation and the recent adoption of C-3 Phase II risk-based capital in the U.S. indicate that a number of challenges lie ahead, such as the need for more sophisticated modeling tools and capabilities, the need to adapt management monitoring/analysis and the development of products and features which are not overly penalized by the new rules. Companies should make preparing for the potential impact of the new regulations a major priority in 2007.”

The survey — the 14th in a Tillinghast series of periodic surveys among more than 70 North American life insurance CFOs — focused on overall implications of principles-based regulation for reserves and capital.

Dramatic Changes Anticipated

Survey respondents anticipate that the new regulations will lead to a greater need to develop hedging programs that respond to the changes (90%), the potential for manipulating the system due to some flexibility allowed in calculating reserves and capital (82%) and a lack of comparability of results across companies (81%).

“The implementation of the proposed principles-based framework will lead to further bifurcation in the U.S life insurance industry, since larger and more sophisticated companies will have greater resources for analyzing and capitalizing on the new rules,” said Hubert Mueller, Principal and survey leader. “Important changes will be required in a variety of areas, and those companies that react quickly and decisively will realize significant competitive gains. We already see some of this happening in the variable annuity sector, where the market share of the Top 10 companies continues to increase.”

Insurers believe new regulations will also impact companies’ existing risk management framework, an area that is already undergoing transformation as a result of increased rating agency scrutiny and recent marketplace events.

Respondents anticipate that the new regulations will drive the following needs:

  • Greater modeling resources and capacity (83%)

  • More education (61%)

  • Establishing or expanding the use of economic capital (57%) and enterprise risk management (ERM) (52%)

“With the new regulations, it will still be difficult to compare companies on a like-for-like basis because of the judgment involved in setting assumptions,” said Duncan Briggs, Region Manager for the Americas. “The biggest plus is that it should result in reserves that more appropriately reflect the full spectrum of risks that a particular company takes. New products and features will be better managed because this approach looks more holistically at the products and risks versus the current reserving regime, which is essentially reactive.”

Higher Demands

Respondents expect the new regulatory framework to increase demands on their company in several areas:

  • Amount of year-end work (100%)

  • Software and hardware requirements (100%)

  • Cost of financial reporting (100%)

  • Staffing requirements (95%)

  • Need for external advisors (81%)

“The status quo is not going to work any longer for companies as they adapt to principles-based regulations,” Gibson said. “Management reports and analyses, actuarial and accounting software, and internal processes and controls will all need significant changes to meet company needs.”

Next Steps for Companies

Careful planning and the commitment of significant resources will be critical to ensure successful implementation of the new principles-based framework, yet most insurers have been slow to make much progress in preparing for the proposed regulations, according to the study. Nearly half (46%) of the respondents have only just begun to analyze what the new regulations mean, while one-quarter are adopting a “wait and see” attitude.

“Many companies aren’t expecting implementation to occur before 2008; however, this attitude is dangerous from a competitive standpoint,” added Gibson. “Some leading companies have already seized the opportunity and begun to offer new innovative products with different risk profiles that make use of the new regulations. This leads to lower cost of capital and reserves and, ultimately, to more competitive pricing and lower cost for the consumers.”

Positive Outlook for Second Quarter

Nearly two-thirds (65%) of respondents predicted growth of at least 4% in new life and annuity premiums in the second quarter, compared with the same period last year, while 15% believed the increase would be more than 10%. Just over two-thirds of respondents (68%) expected GAAP net revenues to increase by at least 4% during the second quarter versus the same period last year. Nearly 70% expected second quarter GAAP net income to increase 4% or more compared to the same period last year. This represents an uptick in CFOs’ forecasts for year-over-year growth in all three measures.

“The current outlook reflects ongoing optimism by the CFOs about the economy and recent earnings results, which have generally exceeded expectations,” according to Mueller. “A slowdown of the economy in the second half of the year may lead to lower values for the third quarter.”

About Tillinghast’s Life Insurance CFO Survey

The Web-based survey was conducted in May and June 2006 and is the 14th in a series of Tillinghast pulse surveys, which explore issues important to the North American life insurance industry and its CFOs. This two-part survey focused on the implications of principles-based regulation for capital and reserves, and had a respondent base of 25. Respondents primarily included CFOs from large and midsize North American life insurance companies; 61% had assets of $5 billion or more and 68% had operations focused on the U.S. For more information on this survey program, please contact program leader Sarah Prevett at 212-309-3979 or [email protected].

About Towers Perrin and Tillinghast

Towers Perrin is a global professional services firm that helps organizations improve their performance through effective people, risk and financial management. Through its Tillinghast business, Towers Perrin provides consulting and software solutions to insurance and financial services companies and advises other organizations on risk financing and self-insurance. Tillinghast helps clients improve business performance in areas related to their financial, risk, product, distribution and capital issues. The firm’s other businesses are HR Services, which provides human resource consulting, and Reinsurance, which provides reinsurance intermediary services. Together, these businesses have offices and business partner locations in 25 countries. More information about Tillinghast is available at www.towersperrin.com/tillinghast