Authority: N.J.S.A. 17:1-8, 17:1-15e and 17B:25-18.2 and 18.3.

Proposal Number: PRN 2001-435

Submit written comments by January 18, 2002 to:

Karen Garfing, Assistant Commissioner

Department of Banking and Insurance

Regulatory Affairs

20 West State Street

PO Box 325

Trenton, NJ 08625-0325

(FAX) (609) 292-0896

Email: legsregs@dobi.nj.gov

The agency proposal follows:

Summary

On August 3, 1998 the Department of Banking and Insurance (Department), in compliance with P.L. 1995, c. 73, the Life and Health Insurance and Health Maintenance Organization Form Approval Reform Act enacted April 10, 1995, proposed a new rule (N.J.A.C. 11:4-41.16) establishing standards by which a life insurer may reclassify an insured from a smoker to a nonsmoker based on changed smoking habits (see 30 N.J.R. 2814(a)). The Department received several critical comments on its proposal. The comments indicated that the industry's and the Department's views on reclassification differed, and that the industry considered some of the provisions contained within the Department's proposal neither administratively feasible nor equitable.

Based on the comments, the Department decided not to adopt the rule as originally proposed, but to repropose the rule instead. In this reproposal, the Department intends to address the concerns expressed by the commenters to the original proposed rule. It should be noted that references to reclassifications based upon a change in smoking status apply equally to reclassifications based upon tobacco use status.

This reproposal clarifies the types of policies and practices subject to this rule. The reproposed rule is intended to apply only to reclassification when classification depends explicitly on smoking habits. It is not intended to apply to reclassification when the classification system does not refer explicitly to smoking, policy values do not depend on smoker status, and smoking is not the only or primary underwriting factor used in reclassification.

The proposed standards regarding issue age and attained age reclassification have been revised. The provision requiring a refund of premium and/or excess cash value if reclassification takes place within two years of issue of the policy has been deleted. The reproposed new rule requires premium, cost or benefit factors to be adjusted to reflect reclassification, but makes no distinction between reclassification within or after two years of issue of the policy.

Additional revisions to the original proposed rule include references to account value policy and flexible premium account value policy to more clearly indicate different requirements for products with different features, along with a specific prohibition against insurers assigning insureds a less favorable classification upon evidence of insurability received in support of a reclassification.

It should also be noted that the original proposed new rule, if adopted, would have been codified at N.J.A.C. 11:4-41.16. However, during the time period since the Department's original proposal and this reproposal, other rule changes have been made to subchapter 41, necessitating that this reproposed rule be codified at N.J.A.C. 11:4-41.14. Accordingly, all references to N.J.A.C. 11:41-41.16 by the commenters will apply to N.J.A.C. 11:4-41.14 in this reproposal whether or not explicitly stated.

The Department received comments from the following seven commenters: State Farm Insurance Companies, Aid Association for Lutherans, The Midland Life Insurance Company, New York Life Insurance Company, The Prudential Insurance Company of America, The Guardian Life Insurance Company, and Northwestern Mutual Life Insurance Company. Following is the summary of comments and responses on the Department's original proposal:

COMMENT: Several commenters expressed concern with proposed N.J.A.C. 11:4-41.16(a). Three commenters objected to the requirement that the policy form itself contain a provision concerning notice of reclassification. One commenter stated that companies would have to refile existing policy forms either to include the required provision or to exclude policyowners from requesting this benefit on the basis that their policies do not include this provision. Additionally, including this provision could exclude all existing policyowners from exercising a privilege they may already have had under a method in place prior to this proposal. The commenter added that the Department already has sufficient regulations in place to assure that reclassification is carried out in an ethical and consistent manner.

A second commenter stated that the policy form is not the appropriate location to provide notice to the policyowner, and that it would be more appropriate for the notice to be provided in the annual renewal notice. The commenter also stated that a notice contained in the policy form itself cannot be changed for the lifetime of the policy, and will mostly go to the wrong people because nonsmoker rated policies account for 75 percent of the life policies issued by the commenter.

A third commenter stated that the same notice information required by the proposal to be placed in the policy form could be conveyed to policyowners by a disclosure form furnished at the time of issue of a policy.

A fourth commenter stated that the Department has no statutory authority under N.J.S.A. 17B:25-18, 18.1, 18.2 or 18.3 to require life insurance policy forms to contain what it believes is an underwriting and rating rule. According to the commenter, underwriting and rating rules have always been separate and distinct from policy forms. Where a statute treats rate filings and form filings the same, it does so by express language saying that one includes the other. The commenter stated that the reclassification of a smoker to a nonsmoker is simply an underwriting and rating rule not subject to regulation by the Department under the policy form statute. The commenter added that the Department could adopt rules pursuant to the Unfair Trade Practices Act at N.J.S.A. 17B:30-1 et seq. to prevent abuses in the reclassification of a smoker to a nonsmoker rate, but could not require insurers to include these rules in a policy form.

RESPONSE: The reproposed rule continues to set forth the requirements for disclosure by a provision in the contract. The Department continues to believe that reclassification is a contractual matter, and failure to include it in the contract may result in real or perceived discriminatory behavior by the insurer. The Department does not believe that disclosure would be more appropriate in a premium notice since such notices are not required by either statute or rule, and are provided at the option of the insurer. Further, such notices are administrative forms traditionally outside the scope of policy form review. The Department further does not believe that an informal notice provided at issuance of the contract would be appropriate. The Department has concluded that requiring a provision in the policy guarantees uniform disclosure and administration of the provision, and further prohibits the insurer from arbitrarily discontinuing this option to reclassify.

Regarding comments received that it is inappropriate to include this provision in the contract because it is inapplicable to all policyowners, the Department believes that many items already mentioned in the contract (for example, misstatement of age) are relevant to only a small percentage of policyowners.

Concerning the comment on the possible obsolescence of the information contained in the policy provision, the reproposed rule has been revised to require only a general discussion on the availability of the option (and any limits on that availability) and the underwriting standards. The reproposed rule does not require that specific underwriting standards be discussed, nor does it impose restrictions on changing underwriting procedures other than those already found at N.J.A.C. 11:4-41.14.

Concerning the comment on the refiling of previously approved forms, the reproposed rule has been revised to include a subsection requiring insurers electing not to endorse previously approved forms to provide insureds with all pertinent information concerning the option by way of a premium notice or other notice, and to comply with all requirements of the subchapter.

Concerning the comment dealing with the possible exclusion of all existing policyowners from exercising a privilege they may already have had in place prior to the proposal, the Department, by requiring a contract provision, is actually ensuring that policyowners are not excluded. Absent such a provision, owners may only have been made aware of this right as the result of an inquiry on their part or possibly by agent initiative. A contract provision ensures a more credible method of notice and consistency in insurer standards.

Regarding the comments that reclassification is simply an underwriting and rating rule not subject to regulation under the policy form statute, the Department believes that the administration of a reclassification and the subsequent impact on premiums and/or cash values affects the entire contract provision, contestability provision, and the requirements of the Standard Nonforfeiture Law, all policy provisions that are routinely regulated by policy form review. In addition, the Department already has in place comparable provisions for other types of post-issue reclassification, such as re-entry under term plans, which have routinely been enforced through the policy form review process.

COMMENT: One commenter stated that proposed N.J.A.C. 11:4-41.16(a)1 requires a separate provision in the policy form to state that reclassification is permitted, and that the Economic Impact statement states that insurers must provide written notice of the changes resulting from reclassification. The commenter is seeking clarification that these two references are to the same notice requirement, and that one endorsement that includes all the required standards will satisfy the requirement.

RESPONSE: The proposal requires that only one notice be provided, which shall include all the items set forth at proposed N.J.A.C. 11:4-41.14(c)1. These items include the reference in the original Economic Impact statement to notice of any potential negative impact of reclassification. It should be noted, however, that this notice requirement is separate from the requirement at proposed N.J.A.C. 11:4-41.14(g) that, following reclassification, insurers must provide either an endorsement or new policy specifying any changes to the original policy.

COMMENT: One commenter stated that proposed N.J.A.C. 11:4-41.16(a)1ii requires insurers to include their underwriting rules for evidence of insurability at a nonsmoker rate reclassification as a provision of the life policy form, which the commenter believed would lock into place for the life of the policy the insurer's underwriting procedures for evidence of insurability as a nonsmoker. The commenter suggested deleting the words "including any requirements for evidence of insurability" from the proposed provision. Another commenter requested the flexibility to use "smoking status" as defined by its underwriting rules because it does not have a classification based only on smoker/nonsmoker status. The commenter recommended that insurers be permitted to place "smoking status" definitions in the application rather than in the policy or schedule page and that they not be locked into the strict terms of smoker/nonsmoker, tobacco/nontobacco, nicotine/non-nicotine, which could require them perpetually to refile their portfolio to remain in compliance. The commenter added that not permitting alternative methods of compliance would place an undue administrative and systems burden on insurers when they change their underwriting rules. The commenter believed that underwriting rules in effect at the time of issue should apply at the time of change in status.

RESPONSE: The phrase "including any requirements for insurability" was intended only to alert the owner that reclassification would be subject to an underwriting process to determine insurability. The subsection in question has been revised extensively in response to commenters to allow flexibility in the degree to which underwriting may occur upon reclassification, and to allow either the current or original definition of smoker and nonsmoker for reclassification.

COMMENT: Three commenters objected to proposed N.J.A.C. 11:4-41.16(a)1iii, which requires that the policy form contain a provision stating that evidence of insurability shall be limited to information relating to smoker status only. The commenters stated that their reclassification review is not limited solely to smoking status. Rather, existence of health conditions related to smoking and/or tobacco use is also considered, and individuals whose health could already have been compromised because of a smoking-related illness should not be eligible for the preferred, non-smoking classification. The commenters thus believed that adoption of the rule as proposed would have adverse pricing consequences that would unfairly impact the nonsmoker class as a whole.

RESPONSE: At the time of proposal, the Department assumed that industry practice was to reclassify an in-force insured from a smoker to a nonsmoker, and to allow a lower premium, based solely on a verification that smoking habits had changed. In response to these comments, the reproposed rule permits the reclassification to involve criteria other than smoking status.

COMMENT: Two commenters expressed concern with proposed N.J.A.C. 11:4-41.16(a)2 and 3. One commenter stated that it uses issue age reclassification without any change in guaranteed values. Thus, any eligibility rule put in its policy form cannot be changed for the life of the policy. While the proposed rule allows for a change in eligibility rules by endorsement for insurers using attained age reclassification, the commenters stated that the courts may not allow such action. Contract law requires consideration to the policyowner for a change in contract, and there would be none in this case. The commenters thus suggested deleting the proposed provision entirely.

RESPONSE: As previously stated, the Department has revised the reproposed rule to allow more flexibility in the definition of smoker and nonsmoker used as a basis for reclassification. However, the Department does not fully understand the statement that contract law will not allow such a reclassification since there is no consideration to the policyowner. If this statement were true, there would be no basis for allowing any type of reclassification, such as the well-accepted practice of re-entry or the removal of substandard ratings. The Department does not agree that any standards in place for any type of reclassification are contrary to contract law.

COMMENT: Several commenters objected to proposed N.J.A.C. 11:4-41.16(b)1i, which requires insurers to return any excess premium to policyowners after reclassification from smoker to nonsmoker status if the reclassification takes place within the first two years of the policy issue. The commenters emphasized that the classification as a smoker for the first two years was not a mistake. Rather, the true smoking status was known at issue, compensation was paid to the agent based on the premium in effect at that time, and the insurer cannot capture commissions that have already been paid. One of the commenters stated that the Department has no authority to order a refund of premium or to otherwise regulate life insurance rates, but the insurer could choose to make a refund as a special dividend. Another commenter stated that adoption of this requirement would have a direct adverse economic impact on insurers. The commenter also stated there would be an additional negative economic impact on insureds if an insurer prohibits reclassification within the first two years because of the proposed refund requirement. The commenter thus recommended that the Department amend its proposal to permit a premium change to occur only from the documented date on which the status of the individual changes from smoker to nonsmoker.

RESPONSE: This reproposed new rule continues to include the "issue age" and "attained age" methods as permissible options for reclassification, but the provision requiring a premium refund if the reclassification occurs during the first two years under the issue age method has been deleted.

COMMENT: One commenter expressed concern with proposed N.J.A.C. 11:4-41.16(b)1ii, which states that if reclassification takes place after two years of the date of issue of the policy, the premium may be lowered but no change in current cash value or scale of guaranteed cash values is permitted. The commenter believed that the basic intent of this rule was to preserve the equity built up prior to the change in status. The commenter believed, however, that this could be accomplished by returning the difference in smoker and nonsmoker cash value to the premium payor at the time of the change in risk class. The commenter stated that the policy could then be handled as any nonsmoker policy in future durations. In addition to simplifying insurer operation with no loss of value to the owner, the owner is free to invest the excess values as they see fit. The commenter believed that this could result in a larger total value for the owner, which the commenter believed was apparently prohibited by the rule.

RESPONSE: The Department agrees with the commenter, and has revised the rule accordingly to allow for a refund of the difference in value.

COMMENT: One commenter expressed concern with proposed N.J.A.C. 11:4-41.16(b)2ii, which states that any guaranteed period premiums begin anew upon classification. The commenter indicated that a new no lapse guarantee period should not apply because of the expense factor involved.

RESPONSE: While the reproposal still requires that any guarantee period for premiums begin anew, it has been revised to provide that any original minimum guarantee premium period (no lapse guarantee period) for flexible premium account policies shall either be continued or begin anew.

COMMENT: One commenter requested a clarification concerning proposed N.J.A.C. 11:4-41.16(d). The commenter questioned whether this provision means that an insurer has the option to issue either an endorsement (that includes all the required information) or to reissue the policy forms (including schedule pages). If the endorsement option is elected, there would be no need for a reissued schedule page. The commenter stated that it does not reissue data (schedule) pages along with an endorsement, and any requirement to do so would be an unnecessary administrative and systems burden because the commenter does not believe that duplicate disclosure would provide any additional protection to consumers.

RESPONSE: The original proposal and reproposal offer insurers the option to either reissue the policy or endorse the existing policy. By either method, the effective date of reclassification must be displayed.

COMMENT: One commenter stated that N.J.A.C. 11:4-41.3(b)3ii(2) should be deleted because it is redundant with proposed N.J.A.C. 11:4-41.16(e) and confusing in light of insurability restrictions.

RESPONSE: The Department does not view this as a redundancy. Rather, the new subsection N.J.A.C. 11:4-41.16(e) expands on the practice of nonsmoker reclassification. Since there is no conflict between the provisions, the Department believes that a change is unnecessary.

It should be noted that the rule has been revised to emphasize that smoker/nonsmoker reclassification is a specific case of re-underwriting subject to N.J.A.C. 11:4-41.16. The Department believes the distinction between smoker status reclassification and all other types of reclassification is appropriate for the following reasons: (1) it is not as obvious that a smoking classification can be changed as it is that sub-standard rating can be removed or that re-entry can take place; (2) it should be made clear to insureds that terms such as smoker/nonsmoker do not mean that smoking status is the only basis for reclassification; and (3) smoking is the only changeable classification of the generally immutable classifications (age and gender are the others) used as a basis for guaranteed non-forfeiture values, and change of status can cause those values to decrease.

COMMENT: One commenter stated that contrary to the Department's Economic Impact statement, the proposed rule would have a significant adverse economic impact. Insurers that do not already have policy forms like those described in the proposal will have to create the forms, file them for approval, deal with the Department regarding approval and modify systems regarding policy form preparation. The commenter stated that given the lack of any clear need for the Department to regulate in this area and cause these expenses to be incurred, the rule should not be adopted.

RESPONSE: As previously stated, the reproposed rule reaffirms that the policy should disclose the option to reclassify. Through normal business practices, an insurer should be able to develop a provision or amendatory endorsement to describe the option. Insurers should view this as a pro-active measure to preserve business. This option should be equally communicated to all owners, and not be made available to only those owners sophisticated enough to approach the insurer on a case by case basis.

COMMENT: One commenter requested that the Department confirm that this new rule would apply prospectively, and not to previously approved forms. The commenter stated that being required to refile its entire portfolio would create a tremendous and untenable economic and administrative hardship that it believed would be difficult to justify. The commenter suggested that the Department provide alternatives, such as a mailing, for insurers to notify in-force policyowners about the procedure to change smoking status.

RESPONSE: The Department does not intend to require insurers to provide an endorsement to a previously-approved form if insurers provide insureds with the information concerning change in smoking status classification set forth at proposed N.J.A.C. 11:4-41.16(a)1 and 2 by way of a premium notice or other mailing, and additionally comply with the other administrative requirements of this rule. The Department is revising the language in the rule to reflect this intent.

COMMENT: One commenter stated that the Life and Health Insurance and Health Maintenance Organization Form Approval Act enacted April 10, 1995 requires that policies conform to the requirements of Title 17B of the New Jersey Statutes, and that any regulations adopted or guidelines published by the Commissioner of Banking and Insurance be consistent with the requirements of Title 17B. The commenter indicated that although the Department has not published guidelines, the insurer was required to comply with the requirements contained in this proposed new rule in recent policy form filings.

RESPONSE: For new forms not already on file with the Department, N.J.S.A. 17B:25-18.2 requires the Department to propose and adopt rules after a form has been approved. Accordingly, the Department may establish standards for a particular form and require compliance with those standards prior to the proposal or adoption of rules regarding reclassification from smoker to nonsmoker status.

A 60-day comment period is provided for this proposal; therefore, pursuant to N.J.A.C. 1:30-3.3(a)5, the proposal is not subject to the provisions of N.J.A.C. 1:30-3.1 and 3.2 governing rulemaking calendars.

The proposed new rule should have a favorable social impact on insureds, insurers and the Department. By setting forth specific standards for reclassification of an insured from a smoker to a nonsmoker status or from a tobacco to a nontobacco status, the policy forms review process will be more streamlined, thus benefiting insureds, insurers and the Department.

The Department does not anticipate that the proposed new rule will result in an adverse economic impact on insurers or the Department in that the rule merely contains standards for reclassification of insureds under individual life insurance policies. The Department will continue to incur costs for reviewing these forms.

As a result of reclassification from smoker to nonsmoker status, or from tobacco to nontobacco status, insureds will most likely experience direct positive economic effects in the form of a reduction in premiums and charges. On the other hand, some insureds may experience a negative impact as a result of such reclassification, such as a reduction in cash values. In either case, the proposed new rule requires that insurers provide insureds with written notice of any such changes.

A Federal standards analysis is not required because the proposed new rule sets forth standards for reclassification of insureds under individual life insurance policies from smoker to nonsmoker status, or from tobacco to nontobacco status, and are not subject to any Federal requirements or standards.

The Department does not anticipate that the proposed new rule will result in the generation or loss of jobs. The proposed new rule sets forth standards to be followed by insurers in reclassifying insureds under individual life insurance policies from smoker to nonsmoker status, or from tobacco to nontobacco status. The Department expects insurers to continue to use existing staff in complying with the requirements of the new rule. Likewise, the Department will continue to use existing staff in reviewing insurers’ forms submissions for such reclassifications.

Pursuant to P.L. 1998, c. 48, the Right to Farm Act, and N.J.S.A. 52:14B-4(a)(2), the Administrative Procedure Act, the Department does not expect any agriculture impact from this new rule.

The Department believes that the proposed new rule will apply to few, if any, "small businesses" as that term is defined in the Regulatory Flexibility Act at N.J.S.A. 52:14B-16 et seq. because the insurers subject to the rule do not employ fewer than 100 full-time employees. Insofar as the new rule may apply to small businesses, the Department does not believe that the rule independently imposes any undue additional costs or burdens on any insurers in that they merely establish certain standards pursuant to the requirements of N.J.S.A. 17B:25-18.2.

The proposed new rule establishes standards for insurer reclassification of insureds under an individual life insurance policy from smoker to nonsmoker status, or from tobacco to nontobacco status, and provides no different requirements based on insurer size. The Department does not believe that any such differentiation would be appropriate or feasible in that the standards included in the proposed new rules directly affect all insureds under individual life insurance policies seeking reclassification from smoker to nonsmoker status, or from tobacco to nontobacco status. Accordingly, the proposed new rule provides no differentiation in compliance requirements based on insurer size.

Full text of the proposal follows (additions indicated in boldface thus; deletions indicated in brackets [thus]):

bbsmoke/inoregs