A.M. Best Special Report: The Triple X Dilemma - Large Companies Have An Advantage.

OLDWICK, N.J. -- As A.M. Best Co. continues to monitor the growth in Regulation Triple X reserves and the potential impact to U.S. life insurers' balance sheets, it is clear that larger companies have the financial wherewithal and flexibility to address the Triple X dilemma with more certainty than small and medium-size term life writers.

Regulation Triple X, adopted by most U.S. states as of January 1, 2000, simply stated, requires direct writers to hold increasingly high levels of redundant reserves on level term products. This redundant reserve is the difference between economic reserves that companies establish under GAAP accounting (generally accepted accounting principles), based on their actuarial assumptions, and those reserves required under Regulation Triple X. Companies most impacted by Triple X are those with preferred underwriting classes on term life insurance policies with level premiums for long time periods, in some cases up to 20 or 30 years.

Term life writers argue that Triple X reserve requirements are very punitive since these reserves exceed what would be required under actuarial assumptions. While A.M. Best believes that Triple X reserves do have redundancies, the real question is how redundant are these reserves. A.M. Best cautions that the true redundancies may actually be somewhere in between GAAP reserves and statutory reserves.

The anticipated large statutory strains on earnings and capital that will emerge have forced term life writers to search for solutions, and reinsurance has offered a quick fix. Many companies are relying on reinsurers to secure statutory reserve credits, and much of this business has been placed offshore, where NAIC reserving regulations do not apply. To meet statutory requirements, offshore companies need to secure reinsurance reserve credits, typically with letters of credit, which have been getting more expensive. Additionally, as the demand grows for letters of credit, the capacity will shrink. These factors are potentially very troublesome, as increased pricing in the letters-of-credit market will ultimately translate into lower earnings. Moreover, since reserves on new business increase for approximately 10 to 11 years after issuance, companies will become increasingly dependent on letters of credit. As the need increases over time, and if prices continue to rise as expected or availability becomes scarce, A.M. Best believes company profits can be reduced or, in more extreme cases, result in a capital crunch.

Large companies have a better ability to manage risks by diversifying away from letter-of-credit dependence. A.M. Best will look favorably upon companies that execute a diversified strategy in managing Triple X reserves. Companies that remain dependent on letters of credit may encounter challenges due to letter-of-credit pricing/capacity issues that may emanate in the future as Triple X reserves continue to mount for the term life industry.

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A.M. Best Co., established in 1899, is the world's oldest and most authoritative insurance rating and information source. For more information, visit A.M. Best's Web site at http://www.ambest.com.