Subchapter L: Tax Hedge Accounting For Equity-Indexed Universal Life Insurance
Equity-indexed universal life insurance (EIUL) contracts typically allow the policyholder to allocate all or a portion of premiums to either a fixed account which provides for interest credited to the contract measured at a minimum fixed rate or to one or more indexed accounts which provide for interest credited at a rate determined by an equity index. This contract feature effectively provides the policyholder with an embedded equity option. Life insurance companies purchase derivatives (generally equity call options) to hedge the risks related to the policyholder’s embedded option.
Actuarial Guideline 36 (AG 36) provides several optional methods to comply with CRVM in computing statutory reserves for EIUL contracts, but many companies use the Updated Market Value (UMV) method. The UMV method applies the general approach of the Universal Life Insurance Model Regulation, but modifies the regulation to take into account the present value of the policyholder’s embedded equity option. The present value of future guaranteed policy benefits is calculated at the valuation date by projecting a fund equal to the greater of the Guaranteed Maturity Fund (GMF) or the policy value (policy accumulated value). In addition, under the UMV method, a current “option cost” at the valuation date is accumulated and added into the projected fund at the end of the current indexed segment term. The option cost for each indexed segment may be calculated using the same formula and assumptions (risk-free rate, volatility, strike price, current equity index value, time to maturity) as used to value the hedging instrument for statutory purposes. Thus, the amount taken into account for the option cost for a policy’s indexed segments under the UMV method is the indexed segment’s accumulated value at the valuation date. As a result, the option cost used in the AG 36 reserve calculation is valued consistently with, and moves with, the market value of the hedging asset. For this reason, the hedge accounting method used by many companies for statutory purposes is to mark the hedging instruments to market (MTM).
Taxing Times, Vol. 10, Issue 3 (October 2014)