NU Online News Service

The U.S. life insurance industry has been overcapitalized, andthat level of overcapitalization increased in 2006.

Douglas Meyer, a managing director in Fitch Ratings' Chicagooffice, gave that assessment today during a teleconference focusingon the firm's Prism capital model.

Fitch has incorporated the Prism model, which relies onstochastic forecasting techniques, into the rating process the firmuses both for life insurers and property-casualty insurers.

Stochastic modeling involves use of computer simulations todetermine how a product or company might perform under a wide rangeof randomly changing conditions.

The U.S. life industry ended 2006 with $253 billion in capital,or about $54 billion more capital than it needed to meet the Prismaggregate AAA rating standard, Meyer said.

At the end of 2005, the industry had $249 billion in capital, orabout $45 billion more capital than it needed to meet the AAAstandard, Meyer said.

The average Prism score for the U.S. life universe as a wholeheld steady in 2006 at AA plus.

For the life insurance sector and large mutuals, the overallPrism rating was AAA.

The overall Prism rating was AA plus for the annuity sector,large stock companies, foreign-owned companies, and life and healthcompanies.

The strong capitalization levels are not surprising, given thebenign credit environment and strong stock market performance thatprevailed in 2006, Meyer says.

"Prism indicates that whole life insurance requires very littlecapital, often as little as 2% of reserves at the AA capital levelthreshold," Fitch analysts write in a discussion of the results."This in part is based on recognition that much of the productperformance deviation can be passed to the policyholder via thedividend mechanism."

Fitch is finding that the Prism capital model requires morecapital for variable annuity products than required by the C3 PhaseII approach that most regulators and insurers now use, Meyersaid.

The Fitch model ends up requiring more capital for VA productsbecause of differences in the way the Fitch model handles hedgingand the weighting given to risk measurements, Meyer said.

During the call, Julie Burke, another Fitch managing director,said 2006 was a "banner year" for most insurance companies asmeasured by the Prism capital model.

Going forward, the stochastic model will be "an integral part ofthe ratings analysis, Burke said.

The development of the Prism model fits with European efforts todevelop the Solvency II framework and U.S. efforts to shift toprinciples-based reserving, Burke said.