Thursday, March 31, 2016

No. 153: Vermont's Frightening Accounting Rules and the Secrecy Surrounding Them

Primerica Life Insurance Company is domiciled for regulatory purposes in Massachusetts and headquartered in Georgia. It is a wholly owned operating subsidiary of Primerica, Inc. (NYSE:PRI). The Primerica organization is the successor to the A. L. Williams organization (ALW). My first article about ALW was in the April 1981 issue of The Insurance Forum, and later I wrote 50 other articles in the Forum about ALW.

Recently I reviewed the two most recent 10-K annual reports filed by Primerica, Inc. with the Securities and Exchange Commission (SEC). The reports illustrate the contrast between the strong disclosure requirements imposed by federal securities regulators and the weak disclosure requirements imposed by state insurance regulators. Here I describe information from various reports about the accounting practices of one of Primerica Life's captive reinsurance companies.

Peach Re
Peach Re, Inc., which is wholly owned by Primerica Life, is a special purpose captive reinsurance company domiciled in Vermont. Thus Peach Re is regulated by the Vermont Department of Financial Regulation. Primerica, Inc. refers to it in 10-K reports as the "Vermont DOI," but I refer to it as the "Vermont DFR."

When Primerica Life formed Peach Re in 2012, the Vermont DFR issued a "licensing order" that explicitly permits Peach Re to treat a letter of credit (LOC) as an admitted asset. Thus Peach Re accepts reserve liabilities transferred to it from its parent, Primerica Life, and the Vermont DFR permits Peach Re to offset those liabilities in large part with an LOC that Peach Re treats as an admitted asset on its balance sheet.

It is important to understand that accounting rules adopted by the National Association of Insurance Commissioners (NAIC) prohibit companies from treating LOCs as admitted assets. The Vermont DFR, however, deviates from those accounting rules by permitting captive reinsurance companies domiciled in Vermont to treat LOCs as admitted assets. Primerica says in its 10-K reports that this accounting practice permitted by the Vermont DFR "was critical to the organization and operational plans of Peach Re."

Primerica says in its 10-K reports that Peach Re's statutory financial statements "are prepared in accordance with statutory accounting practices prescribed or permitted by the NAIC and the Vermont DOI." The word "and" implies that the practices are permitted by both the NAIC and Vermont. That implication is false because the NAIC prohibits treating LOCs as admitted assets. The problem could be avoided by saying the practices are permitted by the NAIC "or" the Vermont DFR.

Peach Re's LOC
The 10-K reports provide information about Peach Re's LOC. Effective March 31, 2012, Peach Re entered into an agreement with Deutsche Bank. The purpose of the agreement was to support reserve liabilities associated with level premium term life insurance policies that Primerica Life ceded to Peach Re through reinsurance. Primerica Life has issued many such term life policies, which are subject to enhanced reserve liability requirements imposed by state insurance regulators.

Under the agreement, Deutsche issued an LOC in the initial amount of $450 million with a term of about 14 years. The LOC amount may be increased to a maximum of about $507 million. The LOC is for the benefit of Primerica Life. If Primerica Life should draw from the LOC, Peach Re would be obligated, with limitations, to reimburse Deutsche, with interest. Peach Re collateralized its obligations to Deutsche by granting Deutsche a security interest in all of Peach Re's assets, with exceptions.

Peach Re's LOC and Primerica's Risk-Based Capital
An insurance company's risk-based capital (RBC) ratio is total adjusted capital divided by company action level RBC, with the quotient expressed as a percentage. At the end of 2015, Primerica Life's total adjusted capital was $576.8 million, company action level RBC was $127.3 million, and the RBC ratio was 453 percent ($576.8 divided by $127.3).

Because Peach Re is a wholly owned subsidiary of Primerica Life, an admitted asset of Peach Re is reflected directly in the admitted assets and total adjusted capital of Primerica Life. The LOC amount at the end of 2015 was $455.7 million. Therefore, if Peach Re was not permitted to treat the LOC as an admitted asset, the total adjusted capital of Primerica Life would have been $121.1 million ($576.8 minus $455.7), and the RBC ratio would have been 95 percent ($121.1 divided by $127.3), or 358 percentage points below the RBC ratio including the LOC amount (453 minus 95).

The impact of the LOC on Primerica Life's RBC data was more severe in 2014, when the LOC amount was $507 million. Primerica Life's total adjusted capital was $515.4 million, company action level RBC was $127.6 million, and the RBC ratio was 404 percent ($515.4 divided by $127.6). Without the $507 million LOC amount, Primerica Life's total adjusted capital would have been only $8.4 million ($515.4 minus $507). Total adjusted capital of $8.4 million would have been far below all the RBC levels, including mandatory control level RBC.

Peach Re's LOC and Primerica's Financial Strength Ratings
Primerica Life has high financial strength ratings: A+ (superior) from A. M. Best, A2 (upper medium grade) from Moody's Investors Service, and AA– (very strong) from Standard & Poor's. All three ratings have a stable outlook. It is not clear to what extent the ratings take into account the questionable nature of the LOC as an admitted asset.

Regulatory Triggers
The 10-K reports mention "minimum statutory capital and surplus" that might "trigger a regulatory action event" at Primerica Life. For example, the 2014 10-K report mentions a trigger of $79.3 million. The 2015 10-K report alludes to the subject, but does not mention a number.

In an effort to understand precisely what "regulatory action event" is referred to in the 10-K reports, I calculated the RBC levels for 2014 from data shown in Primerica Life's statutory statement. For example, regulatory action level RBC was $95.7 million, and authorized control level RBC was $63.8 million. Thus the trigger of $79.3 million mentioned in the 2014 10-K report was about halfway between regulatory action level RBC and authorized control level RBC. When this blog item is posted, I will ask Primerica, Inc. how it calculates the triggers.

Consequences of the Triggers
In its 10-K reports, Primerica, Inc. mentions the significance of the regulatory triggers discussed above. Here are comments in the 2014 10-K report and the less informative comments in the 2015 10-K report:

  • [2014 10-K] As of December 31, 2014, if Peach Re had not been permitted to include the letter of credit as an admitted asset, Primerica Life would have been below the minimum statutory capital and surplus level of approximately $79.3 million that triggers a regulatory action event. However, if Peach Re had not been permitted to include the letter of credit as an admitted asset in its statutory capital and surplus, Primerica Life would not have paid the ordinary dividends to the Parent Company that were paid in 2014.
  • [2015 10-K] As of December 31, 2015, even if Peach Re had not been permitted to include the letter of credit as an admitted asset, Primerica Life would not have been below the minimum statutory capital and surplus level that triggers a regulatory action event. [Blogger's note: This assertion is questionable. As I mentioned earlier, Primerica Life's RBC ratio would have been 95 percent. That figure is between company action level RBC and regulatory action level RBC. The situation would have required the company to file an RBC report with its domiciliary regulator, and possibly take further action to deal with the low RBC ratio.]

The Capital Maintenance Agreement
The 10-K reports mention a "capital maintenance agreement" with Peach Re. It requires Primerica, Inc. to make capital contributions to Peach Re to assure that Peach Re's regulatory account as defined in the reinsurance with Primerica Life will not be less than $20 million. The regulatory account will only be used to satisfy obligations under the reinsurance with Primerica Life after all other assets have been used, including the LOC issued by Deutsche.

My Public Records Request to Vermont
On March 21, 2016, I sent a public records request to Commissioner Susan L. Donegan of the Vermont DFR. I quoted from the 2015 10-K report of Primerica, Inc. and requested copies of four items: the licensing order, the LOC, the capital maintenance agreement, and the 2015 statutory financial statement of Peach Re. I asked, if the request is denied in whole or in part, that DFR cite the statutes or regulations on which the denial is based. On March 22, a DFR staff person said:
By statute the information you have requested is confidential, however, we would be happy to pass along your request to the appropriate management company, who would be more likely to answer your questions. I won't take further action unless you authorize.
I responded by repeating my request for the relevant statutes or regulations. I also said I would prefer to contact the appropriate person at the management company directly, and requested contact information for that person. On March 24, David F. Provost, DFR's deputy commissioner for captive insurance, said:
The information you requested in your letter of March 21, 2016 contains information proprietary to the operations of Primerica and is held confidential pursuant to 8 V.S.A. §§ 6002 and 6007 and is exempt from public records request pursuant to 1 V.S.A. §317(c). Pursuant to 1 V.S.A. §318(a)(2), you have a right to appeal any determination regarding exemptions under 1 V.S.A. §317(c) to Commissioner Donegan.
Deputy Commissioner Provost also gave me contact information for the appropriate person at the management company: Edward F. Precourt, senior vice president of Marsh Management Services, Inc. in Burlington. I wrote to him but have not yet received a reply.

My Public Records Request to Massachusetts
On March 21, 2016, I sent a public records request to the Massachusetts Division of Insurance (MDOI), which is Primerica Life's domiciliary regulator. I mentioned the comment in the 2015 10-K report of Primerica Life's parent that Peach Re's statement is filed with Primerica Life's statement. On March 29, I received from the MDOI an 84-page PDF containing Peach Re's 2015 statutory financial statement. Some information as of December 31, 2015 is shown here. Dollar figures are to the nearest tenth of a million, except where billions are indicated.

The balance sheet shows that total net admitted assets were $582.6, of which the LOC amount was $455.7. Most of the remainder was $44.4 of bonds and $51.2 of funds held by or deposited with reinsured companies. Total liabilities were $506.7, of which $498.9 was aggregate reserve for life contracts. Surplus was $75.9.

The summary of operations shows total income was $107.3, of which $104.7 was premiums and annuity considerations for life and accident and health contracts. Total expenses were $50.9, of which $32.0 were death benefits. Net income was $55.6. Dividends to stockholders were minus $60.4. Surplus adjustment for letter of credit was minus $51.3.

The notes to the financial statements include a discussion of the LOC. Among other comments, the notes say:
The LOC is not included as a risk-based asset in our risk-based capital calculation. As of December 31, 2015, had we not been permitted to include the LOC as an admitted asset, our NAIC risk-based capital would have been below the NAIC mandatory control level.
The notes also indicate that the surplus on the Vermont basis was $75.9, and on the NAIC basis was minus $379.8 ($75.9 minus $455.7). In 2015 Peach Re paid a dividend of $60.4 to Primerica Life with the approval of the Vermont DFR.

The Atlanta office of KPMG LLP conducts the annual audit. Daniel B. Settle, FSA, MAAA, executive vice president and chief actuary of Primerica Life and Peach Re, provides the actuarial opinion.

From the statement I derived RBC data for the end of 2015. Total adjusted capital was $76.1, company action level RBC was $10.5, and the RBC ratio was 725 percent ($76.1 divided by $10.5). The exhibit of reinsurance assumed shows that Peach Re assumed $498.9 of reserve liabilities from Primerica Life on policies whose total amount in force was $11.8 billion.

General Observations
No justification exists for the secrecy surrounding admitted assets that captive reinsurance companies carry on their statutory balance sheets. I refer to LOCs, parental guarantees, contingent notes, variable funding notes, credit linked notes, note guarantees, and other questionable financial instruments. Nor is there justification for the secrecy surrounding licensing orders, capital maintenance agreements, statutory financial statements of captive reinsurance companies, valuation actuary reports, and independent auditor reports. The response by the MDOI to my request for Peach Re's 2015 statutory financial statement clearly demonstrates the lack of justification for secrecy surrounding such statements.

The fact that statutes and regulations shroud such documents in secrecy does not justify the secrecy. Statutes are drafted by those who want documents kept secret, and friendly state legislators enact the statutes without public input. Regulations are drafted by those who want documents kept secret, and friendly state insurance regulators adopt the regulations without public input. In short, at no time during the process of enacting the statutes and adopting the regulations are those desiring secrecy required to provide the public with justification for the secrecy.

I challenge those who favor secrecy in this area to explain why they favor secrecy. I plan to report on the responses to this challenge.

Available Material
I am making available a complimentary 19-page PDF containing selected excerpts from the 2014 and 2015 10-K reports filed with the SEC by Primerica, Inc., RBC data derived from the 2015 statutory financial statement filed with state insurance regulators by Primerica Life, and selected pages from the 2015 statutory financial statement filed with the MDOI by Peach Re. Email jmbelth@gmail.com and ask for the March 30, 2016 excerpts from Primerica filings.

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