SOA 2010 Annual Meeting & Exhibit Oct , Session 92 PD, Hot Topics in the Principle-Based Approach to Reserves and Capital

Transcription

1 SOA 2010 Annual Meeting & Exhibit Oct , 2010 Session 92 PD, Hot Topics in the Principle-Based Approach to Reserves and Capital Moderator: John R. Roeger, FSA, MAAA Presenters: Stephen P. Blaske, FSA, MAAA William M. Sayre, FSA, MAAA Gregory L. Stephenson

2 AG 43 Pi Principles-Based i dc Considerations i Session 92 SOA Annual Meeting, New York October 19, 2010 Steve Blaske, FSA, MAAA VP & Appointed Actuary Ameriprise Financial, Inc. Agenda I. Introduction II. Understanding Sensitivities & Drivers III. Process/Analyses/Assumption Governance IV. Other Challenges 2 1

3 I. Introduction New dynamics of principles-based reserves Each company is unique Wide variety of benefit types Vintage and size of business Distribution Assumptions Lapse, Mortality, Expenses, Investment strategy, Fund mapping Company by company comparisons are very difficult No single right answer Greater Sensitivity often results in more volatile reserves Economic environment Changes in policyholder behavior assumptions (especially LBs) 3 II. Understanding Sensitivities & Drivers Standard Scenario vs. CTE Amount AG 43 introduced us to PBR and also a standard scenario reserve floor Requires analysis of which reserve dominates and why Benefit type differences A GMIB with an aggressive roll-up guarantee creates a high SSA Other benefit types may create a greater CTE Amount than SSA Dependent on utilization and dynamic lapse assumption to ITM Aggregate (CTE Amount) vs. Seriatim (SSA) Aggregate Hedging & Reinsurance Existing hedges will often increase CTE Amount and decrease SSA Dynamic hedging / CDHS impact Ceded reserve credit differences between CTE and SSA Will the relationship change in different market or interest rate environments? 4 2

4 Standard Scenario vs. CTE Amount Example: Change in Equity Market 9.0% % Excess over CSV 80% 8.0% 7.0% 6.0% 5.0% 4.0% 3.0% 2.0% 1.0% 0.0% -50% -45% -40% -35% -30% -25% -20% -15% -10% -5% 0% 5% 10% 15% 20% Change in Equity Performance CTE SSA Both CTE Amount and SSA increase relative to CSV in market shocks Dynamic policyholder assumptions for LB s under higher ITM drive the greater increase in CTE over SSA 5 Standard Scenario vs. CTE Amount Example: Change in Interest Rates 0.9% % Excess over CSV 0.8% 0.7% 0.6% 0.5% -1.0% 10% -0.5% 05% 00% 0.0% 05% 0.5% 10% 1.0% 15% 1.5% 20% 2.0% 25% 2.5% 30% 3.0% Change in Interest Rates (10 Yr Treasury) Change in CTE is materially impacted by change in discount rate Existing hedges impact both results, but by varying degrees Both results are impacted by bond fund gains/losses 6 3

5 Drivers Results by Benefit Type Although the CTE Amount is computed on an aggregate basis, looking at the computation under each benefit type can provide insight into the drivers of your result CTE Amount by Benefit Type Sum of Benefit GMDB GMAB GMIB GMWB Types Aggregation Benefit Reported Amount (1) CTE 70 5, ,519 10, ,064 (2) Cash Surrender Value 5, ,424 10, ,000 (3) (CTE Amount - CSV) (3)/(2) 0.4% 2.2% 6.4% 2.8% 1.6% 0.6% Std Scen Amt (SSA) 5, ,488 10, ,084 (SSA-CTE) (36) (13) 8 (31) (73) (93) 20 GMWB - Additional Details by Issue Year Vintage 2008 & 2009 & Later Sum of All Aggregation Prior Issues Issues Issues Benefit Total Benefit Amount (1) CTE 70 2, , ,519 (2) Cash Surrender Value 2, , ,424 (3) (CTE Amount - CSV) (3)/(2) 4.0% 1.5% 3.4% 2.8% Std Scen Amt (SSA) 2, , ,488 (SSA-CTE) (44) (8) (52) (21) (31) 7 Impact of Hedges / Reinsurance Hedges (CTE Amount) Existing hedges Equity hedges likely increase reserves Hedges are valued under risk neutral and brought into a real world scenario set Good scenarios are included in CTE 70 where hedges lose value with no payoff Interest rate hedges depend on interest rate scenarios included in CTE CDHS Diversity in approaches amongst companies Some may use stochastic on stochastic while many use simplified approaches E Factor reduces impact Reinsurance Individual vs Aggregate Reinsurance Each reinsurance arrangement has company specific considerations 8 4

6 Predictability By understanding dynamics and sensitivities of AG 43 to : Equity Markets Interest rates Benefit Types CTE Amount vs. SSA Other Items ( hedging, reinsurance) Can you develop a prediction of results? Understand volatility and drivers Necessary for capital planning Income vs. capital impact AG 43 interplay with C3 Phase II AG 43 reserve > TAR? Understand relationship of AG 43 and C3 P2 drivers and sensitivities 9 III. Process/Analyses/Assumption Governance Process Modeling system needs to support a reserve reporting routine Effective data capture (assets, liabilities, hedges) Controls Model Audit Rule effective 12/31/10 Model change management and governance Reporting Frequency Monthly, Quarterly Time frames by work day x ( 5?, 7?, 10?) Modeling efficiencies Compression techniques (Inforce & Scenarios) 10 5

7 Reporting Validation & Analyses Validation The SSA is a repeated formula/method while CTE Amount is not Validate model inputs Pull out analytical information from model results Duration of GPVADs, PVs of key cash flows in CTE scenarios Review reserve components BAR, ANR, Excess CTE Relationships to AV or CSV, SSA vs. CTE Amount Trends and Predictions Reserve Roll-forward AG 43 Reserve Rollforward CTE SSA Beginning Period (Reserve - CSV) (-) Change due to market (-) Change due to interest rates (-) Assumption Changes (-) Decrements / Other (1) (1) = Current Period (Reserve - CSV) Assumption Governance Experience Studies Use of Company vs. Industry experience Development of regular experience studies Surrenders Dynamic analyses Benefit Utilization Mortality Expenses Assumption Review How often are you reviewing assumptions? If you report under GAAP, you can consider coordination with the unlocking assumption review process 12 6

8 Assumption Governance Sensitivity Testing Have you developed d a standard d set of sensitivity tests? t Helpful aid for confirming margins Predictive Modeling Possibilities Often used in the P&C industry Consideration for companies with a material block of living benefits where policyholder behavior is a critical assumption See recent papers on SOA website (Research Projects Life Insurance) 13 IV. Other Challenges Forecasting AG 43 Reserves CTE Amount Stochastic Modeling Need Stochastic on Stochastic? Deterministic scenario modeling Nested stochastic may be performed with an annual time step Convert to formulaic calculation using regression techniques for short- term or baseline forecasting needs Standard Scenario Amount Full computation Nested calculation performed on annual time step Formulaic estimation Tax Reserves Guidance is given by Notice Substantial differences between tax and statutory methods create stat cap and deferred tax asset challenges 14 7

9 Tax Issues in the Transition to Principle- Based Reserves Society of Actuaries Annual Meeting LECG is a global litigation: economics; consulting and business advisory; and governance, assurance, and tax expert services firm. We provide independent expert testimony, original authoritative studies, strategic financial advisory services, and innovative business consulting solutions. Attest services provided through Smart and Associates, LLP, pursuant to an alternative practice structure. LECG is not a licensed CPA firm. 2 Tax Issues Associated With AG 43/PBR Background on basic tax reserve deduction rules. Summary of tax reserve deduction issues related to AG 43/PBR. IRS Notice IRS Notice

10 3 Basic Rules for Deduction for Life Insurance Reserves An insurer may deduct increases in its life insurance reserves. I.R.C. 807(d) prescribes how deductible life insurance reserves must be computed. The amount of life insurance reserves per contract equals the greater of (1) the contract s net surrender value, and (2) the federally prescribed reserve, but (3) not in excess of statutory reserves for the contract. 4 What are federally prescribed reserves? Federally prescribed reserves for a life insurance contract are the annual statement reserves for the contract recomputed using: The reserve method prescribed by the NAIC for that type of contract (CRVM or CARVM under current law). The greater of the federally prescribed interest rate or the prevailing state t assumed interest t rate (published by the IRS annually). The most recent prevailing commissioners standard mortality table (the table permitted by 26 states). 2

11 5 Other Tax Rules for Reserves Deduction Deductible life insurance reserves must be for future unaccrued claims. Life insurance company expenses and policyholder dividends deductible only on an accrual basis. No deduction for deficiency reserves. 6 Tax Issues Related to AG 43/PBR Is the Standard Scenario or Deterministic Reserve a CARVM or CRVM reserve for tax purposes? What about a stochastic reserve? Does it matter? Does a reserve computed using a gross premium valuation method qualify for a reserve deduction? Is any portion of the AG 43/PBR reserve a deficiency reserve or non-deductible because unaccrued expenses are reflected in the calculation? How does the introduction of non-guaranteed elements affect tax reserves? 3

12 7 Tax Issues Related to AG 43/PBR (cont d) How is the discount rate used under I.R.C. 807(d) determined if the stochastic reserve is deductible? Is there a prevailing State assumed rate? What are the mortality and morbidity tables used under I.R.C. 807(d)? How are contract-by-contract comparisons made to statutory reserves and net surrender values? Are explicit margins for conservatism permissible? 8 Tax Issues Related to AG 43/PBR (cont d) Will reserves on pre-existing business be computed under the new reserve rules? How are annual adjustments to reserve assumptions reflected? How will the IRS audit I.R.C. 807(d) compliance? 4

13 9 IRS Notice Identifies tax issues on VACARVM and PBR. Suggests tentative conclusions on several issues. Expresses concern about ability of VACARVM stochastic reserve and PBR to satisfy several tax issues. 10 IRS Notice (Positive Aspects) No desire for VACARVM/PBR to trigger disqualification as life insurance company. No desire for VACARVM/PBR to change standards for qualification as life insurance contracts for policyholders. Demonstrates flexibility on compliance with specified rules for interest rate and mortality tables. No concern about transition rules. 5

14 11 IRS Notice (Primary IRS Concerns) Deduction for reserves in excess of expected value. Use of company-specific expenses, lapse, and margin assumptions. Annual adjustments to assumptions. Gross premium method and inclusion of expenses in cash flow assumptions. Difficulty in auditing. 12 IRS Notice Provides interim guidance on VACARVM/AG 43. No discussion of Stochastic CTE Amount except not included in Federally Prescribed Reserves. Standard Scenario Amount included in life insurance reserves, Federally Prescribed Reserves, and Statutory Reserves Cap. AG 43 not retroactive for tax reserves for contracts issued prior to December 31, No inference for PBR. 6

15 13 Conclusions from Notice Establishes safe harbor for Standard d Scenario Amount. Recognizes interest and mortality assumptions. Silent on Stochastic Excess for total reserves, life reserves and statutory cap. Requires a 10-year spread of reserve differences under the statutory cap. 14 Implications for Life PBR Treasury and IRS appear willing to accommodate reserve changes to the extent t they can fit within tax reserve definitions. Allow assumptions that are in addition to basic interest and mortality. Concerns remain about margins, items other than mortality and expense, and company-specific assumptions. Difficulty reconciling stochastic processes under tax. 7

16 15 VM-20 Net Premium Reserves The inclusion of a net premium reserve component was intended to make PBR more tax friendly. Discussions with Treasury and IRS similar to AG 43 approach would be helpful to develop guidance. 8

17 Principle Based Reserves and Capital for Life Session 92 Presented by William Sayre, FSA, MAAA Principal (attribution to Karen Rudolph) October 19, 2010 Where are we? Timeline looking forward Legislative Package VM-20 specifics Scope Components Exclusion tests Valuation mortality/margins 2 Mortality 1

18 Where Are We? Fall 2009 SVL revisions completed Tentatively adopted pending completion of Valuation Manual Summer Meeting 2010 VM20 deemed final LHATF forms Regulatory Testing Subgroup APF reviewed and dealt with RFP issued to actuarial consulting community 3 Timeline looking forward Sept. 2010: Impact Study launches March 31, 2011: Impact Study Report deadline Q2-Q3, 2011: Regulators consider Impact Study results; Fine-tune VM Legislative sessions consider package 2013 Earliest Operative Date, assuming adoption criteria met by during 2012(state; premium volume) 4 2

19 Legislative Package Standard Valuation Law Allows for both formulaic and PB standards Provides req mts for VM, and its operative date (S11) Provides for corporate governance (S12) experience reporting (S13), confidentiality (S14), single state exemption (S15) Valuation Manual VM-00 VM-01 VM-## LOB specifics VM-30 AOMR VM-31 Reporting VM-50, 51 Experience Reporting VM-A, C, G 5 Legislative Package Line of Business included: VM-20 Life Insurance VM-21 Variable Annuities VM-25 Health Insurance VM-26 Credit Life and Disability 6 3

20 VM-20 Specifics Posted here Section 2 establishes the Minimum Reserve A. Except as provided in B, the minimum reserve equals the aggregate NPR 1 plus the excess if any of the greater of the aggregate deterministic reserve and the stochastic reserve over the aggregate NPR B. Company may elect to exclude one or more groups of policies from the stochastic reserve calculation and the deterministic reserve calculation if certain exclusion tests are passed. 1: Net Premium Reserve 7 VM-20 Specifics ULSG, Variable Life Other Than ULSG, Variable Life Actuarial Certification of No Material Tail Risk Perform Stochastic Exclusion Test or meet exclusion requirement PASS FAIL Min Resv = NPR + Max{(A, B) NPR; 0} Where A = Stochastic Reserve B= Deterministic Reserve Perform Deterministic Exclusion Test FAIL Min Resv = NPR + Max{B NPR; 0} Where B = Deterministic Reserve PASS Min Resv = Aggregate Net Premium Approach Reserve, if Term or ULSG Min Resv = SVL CRVM current minimum, otherwise 8 4

21 VM-20 Specifics If Term, or ULSG * NPR equals ACLI s proposed NPR method If other than Term or ULSG, NPR points to minimum requirements of VM-A and VM-C * A policy is not considered ULSG if 2ndary guarantee is 5 years or less. 9 VM-20 Specifics Stochastic Reserve Designed to capture tail risk Determined for groups of policies with similar risk characteristics An aggregate reserve Prudent estimate assumptions GPVAD calculation, over a robust scenario set (1,000 specified) Discount rate = 105% one year Treasury 70CTE of Scenario Reserves (average of highest 30% of Scenario Reserves) From a valuation perspective relatively easy to calculate From pricing perspective implies stochastic-on-stochastic Another complicating factor for pricing: effects of aggregation 10 5

22 VM-20 Specifics Deterministic Reserve Not designed to capture tail risk Includes all liability cash flows Prudent estimate assumptions One deterministic scenario specified by regulators GPV type reserve Determined in aggregate Discount rate = rate of return of assets backing policies From a valuation perspective relatively easy to calculate From pricing perspective relatively easy to incorporate 11 VM-20 Specifics Net Premium Reserve (ACLI) Intended as a tax-compliant minimum reserve Formulaic in nature: PVB PVNP Uses $2.50 per $1,000 expense allowance year 1 Net premiums are uniform % of modified GP, where modified GP is: Yr 1: $0 Yr 2-5: 90% of GP Yr 6+: 100% of GP Basis = 2001 CSO, including Preferred class structure (for pre-need, 1980 ULT): Discount rate = SVL interest rate algorithm Lapse rates allowed for non-fund based policies that do not offer NF Lapse rates allowed for fund based policies, dependent on R, funding ratio. The closer to fully funded SG, the lower the lapse 12 6

23 VM-20 Specifics Net Premium Reserve Non-Fund Based: P NET= Uniform % of Adj GP PVB + $2.50 = PVP NET Adj GP(1) = $0 Adj GP(2-5) =.9*GP Adj GP(6+) = GP Fund Based: Similar EA component During SG, Res=Max (A, B) After SG, Res=A A = ULMR-like for lifetime B = ULMR-like for SG Net Premium Reserve is floored at policy Cash Surrender Value or Cost of Insurance 13 VM-20 Specifics Terminal Reserves - 20 year level term 45 Male Preferred Policy Year CRVM (basic) NPA NPA w/out lapse 14 7

24 VM-20 Specifics 15 VM-20 Specifics Net Premium Reserve (for Fund-Based) During SG, Max (A, B); After SG, A A is an entire period of coverage calculation Determine a GMP-like gross premium at issue; base EA components on this premium Valuation nets are uniform pct of at issue gross premiums At any valuation date, Resv t = m x+t * r x+t m x+t = PVB PVNP Unamort EA r x+t = AV t / GMF t 16 8

25 VM-20 Specifics Net Premium Reserve (for Fund-Based) During SG, Max (A, B); After SG, A B is a longest 2ndary guarantee period calculation Determine a GMP-like gross premium at issue; base EA components on the maturity premium from item A Valuation nets are uniform pct of at issue gross premiums. This uniform pct is the Net Premium Ratio At any valuation date, Resv t = PVB PVP Unamort EA Where PVP uses net premium ratio times level funding premium For both A and B: i, q, lapse are specified 17 VM-20 Specifics Stochastic Exclusion Test Intent: To identify policy groups (including assets) which will need to comply with the stochastic ti modeling requirement Can meet criteria one of 3 ways: Demonstrate passing the safe harbor test each year Demonstrate policies meet alternate criteria (every 3 years) Provide actuarial certification of no material tail risk * * Certification not available for ULSG or VL 18 9

26 VM-20 Specifics Stochastic Exclusion Test Intent: To identify policy groups (including assets) which will need to comply with the stochastic ti modeling requirement Formula (a b) / c a = Seriatim Reserve, baseline scenario b = Largest Seriatim Reserve under other 15 scenarios c = PV (benefits and expenses) using baseline scenario Use anticipated experience, dynamically adjusted as appropriate Discount: Net asset earned rate for scenario May not group policies with different risk profiles May not be used if CDHS in place < 4.5% result implies the policies will not require stochastic analysis 19 VM-20 Specifics Stochastic Exclusion Test Alternate demonstrations include: Mod. Dterm or Net Premium reserve > Stochastic reserve on standalone basis Mod. Dterm or Net Premium reserve > Scenario reserve that results from each of a sufficient number of adverse deterministic scenarios Mod. Dterm or Net Premium reserve > Stand-alone Stochastic Reserve, but using a representative sample of policies Or, demonstrate that any risk characteristics that would cause the Stochastic Reserve to exceed the Mod. Dterm or Net Premium reserve are not present or have been eliminated through reinsurance, hedging, investment strategy or contract provisions 20 10

27 VM-20 Specifics Stochastic Exclusion Test Recent dialog about Reinsurance VM-20 subgroup dealing with Reinsurance issues Identified problems with (a-b)/c when reinsurance is in place For example, expense allowances often serve a dual purpose Anticipated outcomes/soa Research Participating whole life passed Term insurance of 20 Years or less passed; 30 years did not (asset considerations) ULSG: strong SG did not pass; weaker/expired SG passed. Both supported by high quality assets 21 VM-20 Specifics Deterministic Reserve Exclusion Test Designed like a premium deficiency test Compare the aggregate net premium to the aggregate gross (guaranteed) premium for the policy group Use the method required by Section 2. Minimum Reserve (i.e. if ULSG or term, ACLI method, otherwise current formulaic) May not group together policies with different risk profiles Expected outcomes cannot be predicted. Depends on competitive profile and product design

28 VM-20 Specifics Setting Valuation Mortality Assumption 1. Credibility Segments 2. Mortality Segments 3. Credibility Data Set = most recent 3 years experience for Credibility Segment 4. If number of deaths is < 30, use simplified approach, if > 30, cannot use simplified approach 23 VM-20 Specifics Setting Valuation Mortality Assumption Approach if No. deaths < 30 Use actuarially sound method or UCS procedure to find applicable industry basic table Determine the margin Valuation table = Industry basic table increased by margin 24 12

29 VM-20 Specifics Setting Valuation Mortality Assumption Approach if No. Deaths > 30 Select a credibility procedure (for combining rates) 1 Use actuarially sound method or UCS to find appropriate industry basic table Determine credibility-adjusted experience mortality Develop Credibility Factor (used in margin) Develop margin Prudent estimate mortality assumption = Credibility adj. experience rates increased by margin. 1 Based on a statistical method; accepted actuarial practice; as credibility increases, rates move toward experience rates. 25 VM-20 Specifics Margin for Mortality is somewhat prescribed Percentage Increase 2 components: Random Fluctuation Risk and Company Variation Risk Random Fluctuation between 1% and 10% Company Variation = 0% if company data fully credible, or set to cover 85% of contributing companies qx experience supporting the industry basic tables, if not fully credible. CFac * RF + (1- CFac) * CoVar, where CFac = credibility factor 26 13

30 VM-20 Specifics Link to VM exposure drafts: 27 Capital vs. Reserves Key Differences 90 CTE Applies to all inforce individual life insurance policies No dual-track calculation, as in the life PBR greater of stochastic or deterministic amount After-tax calculation Discounting Working Reserve Reinvestment Spreads Reinsurance Credit Stochastic Modeling Alternative (Alternative Amount) 28 14

31 Capital Timing and Other Issues Still in exposure stage Issues raised by ACLI and NY Operative Date December 31, 2011? C3 Phase III Practice Note on Academy website 29 15