State insurance regulators are questioning whether it is proper for life insurance companies to sell or to guarantee synthetic guaranteed investment products.
New York and Illinois insurance officials openly questioned whether it is appropriate for life insurance carriers to issue synthetic GICs or to underwrite the book value wrapper that forms the backbone of synthetic guaranteed investment contracts.
The New York insurance commission, which sets the standard for many other states, has initiated a formal inquiry before developing a position on whether to allow state-licensed life carriers to write book-value wrap agreements. In addition, the National Association of Insurance Commissioners, the national organization made up of representatives of state and local regulators, has formed a working group to study insurance company synthetic products and to recommend guidelines on where such products fall in the regulatory scheme.
Industry sources are not concerned about the future of the booming synthetic GIC business, because insurance carriers now write only a small percentage of the book-value wrappers. But, they fear an adverse reaction by regulators could stifle competition in the future.
Insurance companies now only write about 10% to 15% of book-value wraps, while Bankers Trust Co., New York, continues to dominate the industry it helped create with well over 75% of the wrap business.
Synthetic GICs provide similar characteristics as traditional insurance company general account GICs, but are backed by a segregated pool of assets. The book-value wrapper usually is purchased from a third-party provider.
The biggest insurance company providers of book-value wrappers are Capital Holding Corp., Louisville, Ky., and Pacific Mutual Life Insurance Co., Newport Beach, Calif.
Book-value wrappers provide synthetic contract participants the right to make benefit with- 29
Continued from page 2drawals at book value regardless of where the portfolio stands with respect to its market value. The wrap guarantees against a negative return, and ensures that participants will receive the initial crediting rate for the period of the contract.
"We are looking at the whole issue of synthetic GICs by New York-licensed companies," said a spokesman for the New York State Insurance Commission. He said the "main concern" is insurers may be incurring financial liabilities without control over the offsetting investment assets.
Another New York insurance official said the concern is with book-value wrappers, and not separate account GICs issued by insurance companies, a form of alternative GICs backed by a pool of assets that are not general account assets. He said the commission will issue a policy statement on whether to allow life companies to write book-value wrappers later this year.
Larry Gorsky, chief life actuary of the Illinois insurance department in Springfield, said life insurance companies may not legally provide financial guarantees, which is how some interpret book-value wrappers. He said property casualty carriers may provide such guarantees.
"We are exploring this whole issue. And the issue, to me, is whether an insurance company is insuring a risk and whether a life insurance company can legally offer a financial guarantee," he said.
A secondary issue, he said, is whether a financial liability may be incurred without access to or possession of the underlying assets.
Mr. Gorsky said he represents Illinois on the NAIC task force that is in the early stages of reviewing the synthetic GIC issue.
Most GIC specialists do not expect a negative finding by the New York commission would severely damage the synthetic GIC business, which has exploded during the past five years.
Rich Cowan, principal at Brentwood Asset Advisors, Santa Monica, Calif., said the New York commissioner "is asking if it is correct for a New York-licensed life insurance carrier to offer a book-value wrapper on a portfolio of securities the company doesn't have title to." Brentwood is a GIC consulting firm.
Mr. Cowan said the inquiry "definitely raises some eyebrows" in the industry, but he believes the action is directed more toward those considering entering the book-value wrap business than toward existing companies. He said if an adverse decision is rendered, it could halt the growth of competition among wrapper providers, who have grown in numbers in recent months.
"The danger is that if New York decides life carriers cannot write wrappers, it wouldn't really affect the existing set-up immediately. But it might set a trend for the future for other state insurance departments to keep companies from writing wrap business. We hope there will be no domino effect," Mr. Cowan said.
"The question is: 'Are insurance carriers sticking their necks out by wrapping something they don't own?' We don't think so. If the pricing and underwriting are done correctly, the plan has enough buffers, and if the investment manager is investing correctly, the risk is almost nil."
Mr. Cowan acknowledged that if the investment manager "drastically underperforms," there could be "some exposure" for the wrap provider.
But, he added, wrap contracts usually are written "so tightly" and the portfolio is of the usual high quality, the risk is minimal.
Michael Odlum, director-investment contract management group at the Vanguard Group of Cos., Valley Forge, Pa., said an adverse decision by New York would not be fatal to the synthetic GIC business but "would put a dent" in the business of insurance companies involved in writing wrap agreements.
"Frankly, it would be an unfortunate decision if there is a ruling against wrapper providers by insurance carriers," said C. Jason Psome, director of synthetic GICs at Sanford C. Bernstein & Co., New York. "We don't see any big liabilities to the industry from writing wrappers, the exposure is minimal. We would certainly hate to see competition in the wrapper industry decline. We believe more competition would be healthy."
Larry Mylnechuk, executive director of the GIC Association, Lake Osewgo, Ore., said the association has been working with New York officials and the NAIC task force.
He said the association's position is that the insurance industry should be allowed to continue writing book value wrappers because "what they are doing is not that much different than in pricing a traditional GIC. Insurance companies are as knowledgeable, or even more so, than banks in underwriting this type of risk," he said.
Alfred A. Turco, an attorney and partner in the firm of Turco & Mercier, Manchester, Conn., a law firm staffed by former insurance company executives, said the growth of synthetic products "caught regulators by surprise." He said "the market overtook the regulators," resulting in the current inquiries by state insurance officials.
Mr. Turco said he is not yet certain what the impact of the inquiries will be yet, but "plan sponsors should continue to monitor the situation."