By James Kavanagh | September 30, 2020 at 01:49 AM
The author wants advisors to work with him to develop an
advisor-driven contract valuation method.
Some time ago, I got a call from a relative who had bought a
variable deferred annuity, with a guaranteed income rider. His accumulation
fund had dropped from around $100,00 to $60,000, due to a precipitous decline
in the value of the investment subaccounts.
What should he do? Did he just lose $40,000? Was his contract
now worth $60,000? His contract could be worth a lot less than $60,000, or a
lot more. The actual value would depend on many factors, and a surrender might
mistakenly turn an emotional loss into an actual loss.
As recent market volatility has demonstrated, financial advisors
had better be prepared to answer these kinds of questions.
Adding Insult to Injury: New Requirements for
Advisors and Brokers
It seems somewhat unfair to require compliance of an advisor but
provide no real guidelines or tools to help the advisor. Yet, that’s what’s
happening.
Recent changes to the regulatory landscape, by the CFP Board (Code
of Ethics and Standards of Conduct), the U.S. Securities and Exchange
Commission (Reg BI) and the state of New York (Reg 187), address
updates to current best interest standards. The updates will bring deferred
annuities more into line with other financial products, and the updates will
require that deferred annuities be offered under a fiduciary standard.
As a result, many financial advisors will now need to
significantly improve their due diligence, to meet these best interest
requirements, for their clients’ deferred annuity purchases and replacements,
and for ongoing account management. This should include advice for 1) the
estimated evaluation of the clients’ contracts, and 2) the contracts’ need for
on-going monitoring and management.
This presents several challenges:
·
There are currently no
rules or methods for evaluating a deferred annuity contract.
·
There are no rules for
ongoing management and monitoring of a deferred annuity contract after its
purchase.
·
Evaluating and
monitoring a deferred annuity contract would require very sophisticated
software.
·
Although insurance
companies have very effective rules for evaluating deferred annuity contracts,
some rules could not be used “as is” and would have to be adapted for this
purpose.
·
Even if accepted rules
did exist, there’s no current resource to champion and shepherd these rules.
Insurance Companies and their Regulators: A
Relationship That Works
Insurance companies are required, by law, to hold reserves to
meet the future obligations for each and every deferred annuity contract on
their books. For statutory reserves, they are regulated by the states, and are
guided by their national body, the National Association of Insurance
Commissioners (NAIC), with significant participation from the American Academy
of Actuaries (AAA).
Insurance companies spend a lot of money and resources to value
their deferred annuity contracts, but from their point of view. They use
valuation methods such as “CARVM” and “PBR” that are the result of long-term
analyses and vetting by the various valuation committees of the American
Academy of Actuaries and the NAIC.
As a result, insurance companies are guided by a substantial and
well-vetted set of complicated rules detailing how they must value their
deferred annuity contracts. in addition, these rules require constant on-going
re-calculation of insurance companies’ reserves.
This provides an ideal setup because:
·
Well-vetted valuation
rules do exist.
·
A single body, the
NAIC, guides and shepherds the valuation regulations.
·
There is strong
support from the AAA, a group of highly qualified insurance experts.
·
A strong, mutually
beneficial cooperation exists between the companies and the NAIC.
Advisors and Best Interest Compliance: Too
Many Regulatory Cooks
Due to a lack of coordination, no recognized method exists for
financial advisors to determine the current value of a client’s deferred
annuity. Financial advisors also have no guidelines for deferred annuity risk
management.
A policyholder approach is needed — one that not only accounts
for a policyholder’s age and sex, but also for a policyholder’s goals and
targets, future actions, legacy considerations, longevity expectations, risk
appetite, tax bracket and benefit preferences.
All of those factors could materially affect the value of the
contract.
Future company actions could also have an impact.
Supporting the Community: Goals
I want to advocate a similar relationship for the financial
advisor/broker community. Not one that exactly parallels the relationship that
exists between insurance companies and the NAIC, but an open participation
among the parties. This can be achieved by establishing:
·
An online hub to guide
and shepherd these rules.
·
Online cooperation
between the hub and the financial advisor/broker community.
·
An online forum for
open debate about “the Method.”
·
A set of rules, the
Method, for evaluating and managing deferred annuity contracts.
·
An online manual for
the Method.
·
Detailed
implementation specs for software developers.
·
Numerous use case
examples of the Method.
·
Encouragement to
software developers to implement the Method for use by the financial
advisor/broker community.
·
Ongoing updates to the
Method related activities and software availability.
Currently, a strong candidate to play this role is a general
method called Best Interest — Simulated Evaluation Method
(BI-SEM). It addresses the evaluation and risk-management of deferred annuity
contracts. It was developed by a team of actuaries and actuarial valuation
software developers, myself included.
It’s Stochastic (and That’s a Good Thing)
BI-SEM is a stochastic multi-economic scenario solution. It’s
derived from sound accounting and actuarial-first principles, using relevant
and reliable figures only, and very similar to the time-tested insurance
company reserving methods required by both CARVM and PBR, but from the
policyholder’s point of view. In addition, it’s freely available for review and
implementation.
For those who are interested in looking at the BI-SEM
whitepaper, detailing the Method’s technical specs, visit https://www.bi-sem.org/post/introducing-bi-sem.
BI-SEM looks like a solid candidate, however, a debate here
should encourage thoughtful criticism. I fully expect this to lead to a better
BI-SEM, or other acceptable methods. Hopefully, this will lead to a method that
will gain wide acceptance and adoption by the advisor-broker community and
those who regulate them.
James Kavanagh is the organizer of BI-SEM,
a nonprofit group that’s trying to develop a method that advisors can use to
update deferred annuity valuations.
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