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Executive SummaryForwardInsurance regulation is a dynamic, ever-evolving exercise to achieve an appropriate balancebetween providing adequate consumer protection and allowing the free market to operateunconstrained. Since insurers and the products they offer change over time, it is imperative forthe regulatory framework to keep pace with industry dynamics. This study explores areaswhere the life insurance industry has changed over time through different product offerings,globalization, evolving technology, and changes in the economic environment. Additionally, thestudy examines the regulatory responses to the growing complexity brought about by thesechanges. The study provides a framework to assist regulators in assessing which changes havebeen successful, which need improvement, and what needs to be addressed in the future.Executive SummaryThe study begins with the Evolution of Life Insurance, an examination of how the life insuranceindustry in the United States has evolved over time. The rise of the mutual insurer model iscovered along with early efforts to regulate the industry, including the creation of the NationalAssociation of Insurance Commissioners (NAIC). In the late 19th century large insurersdominated the marketplace and controlled large amounts of money not backed by reserves.They used these funds to purchase controlling shares of banks and other businesses. Theseexcesses led to the 1905 Armstrong investigations in New York. The Armstrong investigationscaused the pendulum to swing toward heavy regulation, with life insurers prohibited fromowning common stock, underwriting securities and paying excessive commissions to agents.Deferred dividend plans also went by the wayside. The pendulum moved back slightly in theearly part of the 20th century, leading to a growth cycle for the life insurance industry. Groupannuities were introduced in the 1920s along with other product innovations. A majorcompetitor in the form of the federal government also found its way into life insurance marketswith the offering of War Risk Insurance to members of the armed forces. Life insurance salesgrew in the 1920s and as a result of the regulatory restrictions stemming from the Armstronginvestigations, life insurers did not suffer to the extent banks did during the stock market crashof 1929.Congress was interested in addressing the causes of the Great Depression. The result was theBanking Act of 1933 (commonly known as Glass-Steagall) that separated commercial banks andinvestment banks from each other and from insurance and investment firms. Insurance reformoccurred in the early 1940s when a U.S. Supreme Court case (U.S. v. Southeastern Underwriters)overturned the long-held opinion (Paul v. Virginia) insurance was not a form of interstatecommerce. Congress enacted the McCarran-Ferguson Act to allow states to continue toregulate and tax the business of insurance despite its new status as a form of interstate2

Executive Summarycommerce. The prosperity following World War II, along with the certainty of governmentprograms such as Social Security, led to a shift in insurance product demand toward productsoffering more long-term investment opportunities. The 1980s saw the introduction of universallife insurance and variable life insurance products. Consolidation and demutualization were thebuzzwords of the day and as a result of the Gramm-Leach-Bliley Act of 1999, banks, insurersand securities firms were once again allowed to affiliate and cross-sell products, and theconcept of functional regulation was introduced. The 1990s through the early 21st century werecharacterized by strong sales and profitability. The Commodities Futures Modernization Act of2000 was adopted. It deregulated over-the-counter-derivatives and allowed financial servicesfirms to invest in a wide variety of derivatives, some of which turned out to be very risky. Inparticular, the introduction of the credit default swap proved to be hazardous to the financialmarkets generally. When combined with the bursting of the housing bubble, the result was theglobal financial crisis of 2007-2008.The study looks at the impact of life insurance product trends in the Current and EmergingProduct Trends in Retirement and Long-Term Care Markets section. There are two key factorsdriving life insurance product development—mortality risk and longevity risk. Traditional lifeinsurance products like term and whole life were intended to address mortality risk—morespecifically, the risk one dies prematurely. Their primary purpose was to provide a safety net forfamilies when one of the primary breadwinners passed away. In recent years, the focus hasshifted to address longevity risk as the baby boomers reach retirement age in a time when thedefined benefit pension plan has become a relic of the past. As the general health of thepopulation improves over time, people are living longer. The blessing of a longer life isaccompanied by the need to generate sufficient income in retirement to be able to enjoy theextra years and pay for long-term care when health status declines. Life insurers areincreasingly targeting product development to meet this need.The Impact of Technology on the Life Insurance Industry section explores how technologicaladvances and consumer preferences are shaping product design and sales. The Internet wasinitially used by insurers to promote their brand and provide some general communications.Increasingly, it is used to recruit insurance producers and actually conduct the business ofinsurance. Access to the Internet using mobile devices is rapidly changing the environmentagain. Insurers are beginning to explore how to use social media such as Facebook and Twitter.Monitoring insurer activity in this emerging area is becoming a challenge for insuranceregulators. The individualization of the social media experience presents many complianceconundrums for insurers and regulators.3

Executive SummaryThe Life Insurer Balance Sheets section looks at the financial performance of the life insuranceindustry over the last decade. As a decade with significant upheaval and economic turmoil, it isa credit to the conservative nature of the life insurance industry and the diligence of insuranceregulators that the life insurance industry significantly outperformed the banking industryduring the decade. The conservative regulatory framework was a major contributing factor tothe success of the industry during the period. An in-depth look at the 2011 numbers is providedto give a snapshot of the industry’s sound financial position today.The Implications of Economic and Market Changes on Life Insurers section discusses how lifeinsurers have responded to the current economic and market volatility. The role life insurersplay with respect to the overall economy is discussed, as is the industry’s role as institutionalinvestors. The section also covers the impact of the recent global financial crisis on the industryand the impact of the low interest rate environment on life insurers.The Meeting the Risks of the New Environment section addresses risk management in the newenvironment. It covers the importance of Enterprise Risk Management (ERM) and the role ofthe new Own Risk Solvency Assessment (ORSA) tool required of many insurers starting in 2015.The influence of the international community is discussed with respect to group supervision.The section also covers market conduct activities of regulators, with an emphasis on newmarket analysis tools being used to target regulatory resources. Regulators use a number oftools to ensure capital adequacy for life insurers. The chapter evaluates the evolution from arules-based to a principle-based regulatory system. The appropriateness of both capital andreserves are covered. Reserving requirements are evaluated to determine whether the ruleslead insurers to establish appropriate reserves for the products being sold. Suggestions forimprovement are included along with a discussion of the role of regulators to improvetransparency through consumer disclosures.4

Historical Evolution of Life InsuranceHistorical Evolution of Life Insurance5

Historical Evolution of Life InsuranceHistorical Evolution of Life InsuranceBy NAIC StaffLife Insurance Industry in its InfancyThe life insurance industry has gone through several periods of transformation, instigated bykey historical events and changes in consumer needs. The Presbyterian Ministers’ Fund,established in 1759, was the first life insurance entity in the United States.1 Although itspurpose was to provide life insurance to the widows and orphans of deceased ministers,negative perceptions surrounding assigning a monetary value to one’s life during this timeperiod stifled growth.2Legal restrictions also presented a barrier to life insurance sales during this time. Many statesbarred women from entering contracts, including insurance policies, or legally inheriting anestate. As such, a wife would not be able to collect proceeds from her husband’s policy.Furthermore, spousal or dependent relationships alone did not meet the monetary insurabilityinterest requirements insurers of this time period required. In addition to limiting who couldtake out an insurance policy, insurers also placed stringent requirements on the activities ofpolicyholders. These requirements usually limited travel to healthier regions of the country,required regular health and character checks and prohibited the consumption of alcohol.3Economic Turbulence of the 19th CenturyComplicating things further was a five-year depression brought on by the Panic of 1837. Landspeculation (driven mostly by western territory sales) fueled by loose credit from state bankshad created a real estate bubble and high inflation.4 In response, President Andrew Jacksonissued the Specie Circular in 1836, limiting payment of land to gold and silver.5 The state bankshad overextended their lending abilities by printing money beyond their reserves, resulting inbank and business failures, real estate losses, and record high unemployment levels.6 These andsimilar sequences of events would play out several times throughout history, including threemore times in the latter part of the 19th century.1Murphy, Sharon. "Life Insurance in the United States through World War I". EH.Net Encyclopedia.[1798-1899], Presbyterian Ministers’ Fund records (Collection 3101), The Historical Society of Pennsylvania. Fromhttp://hsp.org/sites/default/files/legacy Murphy, Sharon. "Life Insurance in the United States through World War I". EH.Net Encyclopedia, edited byRobert Whaples. August 14, 2002. URL urance.us.4McNamara, R. (n.d.). Financial panics of the 19th century. Retrieved a/financialpanics.htm5“Panic of 1837," Ohio History Central, July 1, 2005, http://www.ohiohistorycentral.org/entry.php?rec 536.6Ibid.26

Historical Evolution of Life InsuranceState Regulation is BornInsurers, unable to raise sufficient capital to form as a stock company following the Panic of1837, mutualized instead.7 A mutual company is owned by its policyholders as opposed tostockholders. Mutual insurers have less stringent capital requirements and higher reliance onpremiums from policyholders (also owners) for cash flow. To increase premiums, mutualinsurers launched a very successful marketing campaign promoting ownership benefits,essentially policyholders as owners of the company would share in the company’s profitsthrough dividends or reduced premiums.8The ease of starting up a mutual insurance company, combined with the appeal of policyholderdividends, produced a plethora of new entrants into the marketplace. Eventually the marketbecame saturated and insurers began using fraudulent activities to increase market share. NewYork responded to this fraudulent activity by instituting capital stock (1849) and depository(1851) regulatory requirements.9 New Hampshire appointed an insurance commissioner in1850.10 Massachusetts implemented legal reserve principles, and formed a state insurancedepartment to oversee these new laws (1858).11 Soon other states were following suit, withmost states implementing regulatory oversight of insurers by the early 1870s.12In 1868, the Supreme Court decision in Paul v. Virginia securely placed insurance under thesupervision of states. Soon after, in 1871, the National Insurance Convention (later known asthe National Association of Insurance Commissioners (NAIC)) was formed to address the needto coordinate regulation of multistate insurers. Although the new state regulations slowedindustry growth for the next decade, they also restored consumer confidence. Additionally,legislative changes during this time allowed women access to insurance and institutedconsumer-friendly nonforfeiture laws.13 Stability returned the growth to the United Stateseconomy, which was growing more industrial and prosperous. The resulting rise in demand,coupled with the changes in legislation, insurer structure, and marketing practices, set the stagefor future industry expansion.7Murphy, Sharon. "Life Insurance in the United States through World War I". EH.Net Encyclopedia, edited byRobert Whaples. August 14, 2002. URL urance.us.8Ibid9Ibid10Ibid11Insurance & the U.S. Economy. Best Insurance Education Company. Retrieved L-IUS.pdf.12Poterba, James M., The History of Annuities in the Unit

life insurance and variable life insurance products. Consolidation and demutualization were the buzzwords of the day and as a result of the Gramm-Leach-Bliley Act of 1999, banks, insurers and securities firms were once again allowed to affiliate and cross-sell products, and the concept of functional regulation was introduced.