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Fundamental concepts of statutory accounting



Advantages of formulaic reserves

- Adheres to fundamental concepts of conservatism, consistency and recognition
- Reserves were audit-able since all companies used the same assumptions


Disadvantages of formulaic reserves

- Reserve methods did not keep up with product changes (Term and ULSG)
- Bandaid approach to fixing the SVL causes too much complication
- Company specific characteristics are not reflected in reserves
- Ignore modern computing power


Requirements of Principles based approach

- Level of conservatism that has reasonable probability of happening during life of contract
- Assumptions, methods, models that are consistent with the company's risk management process
- Margins such that the greater the uncertainty, the greater the reserve
- Establish corporate governance (internal controls) for actuarial valuation function
- Assumptions based on company's available experience, other credible experience or prescribed by law
- File, with the commissioner upon request, a principle based valuation report that complies with standards prescribed in the VM


Standard Valuation Law: Critical provisions for PB system

1. insurance department/commission has ultimate authority
2. minimum standards for PBR impacted policies
3. actuarial opinion and memo required
4. required content of the VM
5. must follow the "principles" of a principle based approach
6. company must file experience data to help develop industry experience and trends
7. SVL sets minimum standards for annuities and A&H contracts


VM Objectives

1. Promote uniformity among state valuation requirements

2. Provide an efficient, consistent and timely process to update valuation requirements

3. One document for minimum reserve requirements

4. Enhance industry compliance with the revisions to the SVL, as adopted in various states

5. Mandate specific reporting requirements of experience data


VM Table of Contents

1. Introduction
2. Reserve requirements
3. Reporting requirements
4. Experience reporting requirements
5. VM minimum standards


Factors which should be considered when setting margin for lapse

1. existence and level of surrender charges
2. company crediting rates versus market interest rates
3. free partial withdrawal features
4. options and guarantees
5. utilization of policy loans


Factors which should be considered when setting margin for premium payment pattern

1. marketing factors
2. past funding levels
3. interest rate movements
4. equity market performance


PBR Risk Margin Overview

1. should be co specific, held for non-stochastically modeled (non-ehdgeable) risks
2. two view points on margin
a) regulator/PBR perspective: margin is a buffer for risk
b) investor perspective: margin is compensation for bearing risk
3. margin is a part of the liability (not capital or surplus)
4. margin is intended to cover routine losses (RC is intended to cover more severe losses)
5. test overall level to avoid holding excessive margin


VM-20 expense assumptions

Deterministic and stochastic expense assumptions are the same.

Use fully allocated expense assumption

Include inflation (inflation assumption may be different between stochastic and deterministic)

Assume "going concern" basis


VM-20 deterministic and stochastic reserve

Use asset liability projection models

Use prudent estimate assumptions for assumptions not prescribed

Aggregation allowed

DR: Single economic scenario.
Could use direct interaction approach
Floor each policy at the CSV



VM-20 Assumptions

Prudent estimates except:
Spreads over treasuries on reinvestment assets
Portion of mortality (tables, blending method)
Interest rate movement
Certain aspects of ULSG lapse
Equity performance


Examples of VM-20 Assumptions

1. PHB
2. expenses: inlaced direct costs plus an appropriate share of overhead
3. reinsurance (no mirroring)
4. asset modeling: develop assumptions related to options
5. derivatives: future derivative transactions can be included if they are a part of a clearly defined hedging strategy
6. economic assumptions: deterministic or stochastic


VM-20 NP Reserve

PV(Ben) - PV(NPs) >
a) CV
b) cx = amount needed to cover insurance until next paid to date

Same as CRVM in that it uses prescribed mortality/interest and guaranteed GPs

Different from CRVM:
1. different EA
2. Term and certain ULSG products may use prescribed lapses (Based on level of funding of guar for ULSG)


VM-20 Overview

Grouping: assets supporting policy should share common investment strategies

Projection period: long enough so that a greater reserve would not result from using a longer projection period

Initial asset: use portfolio actually backing the block: should be within 2% of final reserve


PBR implementation plan

1. Actuarial resource
goal is to maintain consistency
would respond to both companies and regulators' questions
group includes staff actuaries and outside consultants

2. Actuarial analysis working group
goal is to continually improve PBR by working with state insurance departments


PB Environment Corporate Governance

Board of Directors:
1. reviews infrastructure, valuation results, other reports/certifications
2. appoints peer review independent actuary

Senior management:
1. carry out items subject to review by the board
2. adopt appropriate internal controls
3. ensure that valuations are done in accordance with the VM

Appointed Actuary
1. develop standards for process, controls and documentation
2. ensure models and assumptions comply with laws and regulations
3. communicate results to senior management and the board


Bottom up approach for margin

apply margin to each assumption

assess margin by assumption
easy to monitor and review
consistent with historical regulatory frameworks and emerging PBR in US

need to account for diversification between risks
may result in excess margin in total


Top down approach for margin

apply one margin on an aggregate basis (Across all risk types)

Adv: implicitly accounts for diversification

no clear link between margin and individual risks
need a complex model (run multiple risks concurrently)


Criteria for selecting a good mortality model

1. Force of mortality should be positive
2. consist with historical data
3. should capture mortality trend over time and the age-specific changes
4. varying one parameter should not create drastically different results

Short term mortality deviations: mortality jump process

Long term deviations in mortality improvement: should NOT be mean reverting


Risk margin methods

1. discount related
2. factor based
3. judgement based on experience studies
4. stress testing/sensitivity testing
5. stochastic modeling
6. COC method
7. quantile distribution methods


PBR mortality margins - other considerations

underwriting practices
number of substandard lives
joint life vs single life policies
exposure to anti selection
riders or other features
sales and marketing practices


uncertainties covered by margin

random fluctuations
errors in assumed relationships between risk factors