Pricing exercise based on a collection of actuarial assumptions Assumptions generally divided into two sets

Transcription

1 Whole Life Pricing Pricing exercise based on a collection of actuarial assumptions Assumptions generally divided into two sets Company specific: Mortality, Lapsation, Expenses, Dividends, etc. Prescription / affected by regulation 4

2 Whole Life Pricing Assumptions based on regulation Liability Valuation Amount and timing of reserves Increases to reserves are a statutory expense Nonforfeiture Benefits Minimum amounts and emergence of cash surrender values Risk Based Capital Amount of surplus needed to support writing of liabilities State and Federal Income Taxes; State Premium Taxes 5

3 Assumptions based on insurance regulation Reserve Valuation Life insurance valuation driven mainly today by the Valuation of Life Insurance Policies Model Regulation (generally effective 1/1/2000) Changes in most current laws focus much more on Term and UL valuation Whole Life valuation generally unchanged since 1980 Amendments to Standard Valuation Law Main components: Prescribed valuation method Prescribed Mortality Table; Currently 2001 CSO Table Most importantly, prescription of maximum valuation interest rates that change with the interest rate environment Maximum valuation interest rate for any calendar year of issue is based upon recent monthly averages of Moody s Corporate Bond Portfolio Index 6

4 Assumptions based on insurance regulation Reserve Valuation Recent maximum valuation interest rates for life insurance» Pre 1995: 5.00%» : 4.50%» : 4.00%» 2013: 3.50% Impact from a 50 bp change in Valuation Interest Rate is approximately 2% profit margin for Level Pay Whole Life if no change in premiums Much larger for Short Pay or Single Premium Whole Life 7

5 Assumptions based on insurance regulation Reserve Valuation Interest Rate 5.00% 4.50% 4.00% 3.50% Reserve Expense Ratio 50.4% 52.5% 54.6% 56.9% Loss Ratio 73.0% 75.1% 77.2% 79.5% 8

6 Assumptions based on insurance regulation Nonforfeiture benefits Standard Nonforfeiture Law for Life Insurance from early 1980 s defines prescribed calculations for determining minimum benefits and emergence of cash values Companies can offer higher guaranteed benefits; law just specifies minimum amounts; IRS regulations may limit maximum values Cash value calculations take into account an acquisition expense allowance that suppresses early duration minimum cash values Similar to valuation law, interest rate is dynamic with market interest rate levels Nonforfeiture interest rate is 125% of valuation interest rate, rounded to nearest 0.25% Current nonforfeiture rate = 4.00% x 125% = 5.00%; 2013: 4.50%; One year deferral of implementing new rate is permitted by law 10

7 Assumptions based on insurance regulation Target Surplus Companies will price in an expense that mimics the effect of needing to hold capital amounts prescribed by Statutory Risk-Based Capital (RBC) rules to support the writing of the product Typically defined as percentages of reserves, premium and death benefit amount Taxes Mainly State Premium/Income Tax and Federal Income Tax Federal Taxation of Life Insurance Companies is a whole other white paper. 11

8 Assumptions based on company information Mortality: Actual Company experience, research and reinsurer input Lapsation: Actual company experience Expenses: Actual company experience and expected inflation Investment yield: Recent and future portfolio expected yields Company Dividend Formula: Create factors that allow for desired emergence of dividends, and are flexible as experience changes 12

9 Sample Whole Life Pricing Projection No Deaths and No Surrenders Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9 Year 10 Premium 2,581,000 2,581,000 2,581,000 2,581,000 2,581,000 2,581,000 2,581,000 2,581,000 2,581,000 2,581,000 Investment Income (15,934) 147, , , , , , ,892 1,102,535 1,250,506 Total Revenue 2,565,066 2,728,113 2,857,105 2,987,482 3,121,945 3,260,168 3,398,902 3,539,892 3,683,535 3,831,506 Death Benefits Full Surrenders Reserve Increase 0 1,840,216 1,882,599 1,922,547 1,954,659 1,983,985 2,015,418 2,052,803 2,094,635 2,131,883 Total Benefits 0 1,840,216 1,882,599 1,922,547 1,954,659 1,983,985 2,015,418 2,052,803 2,094,635 2,131,883 Commissions 1,664, , , , ,543 78,411 77,559 76,707 76,707 76,707 Expenses 2,583,818 38,950 39,924 40,922 41,945 42,994 44,068 45,170 46,299 47,457 Premium Tax 45,168 45,168 45,168 45,168 45,168 45,168 45,168 45,168 45,168 45,168 Total Expenses 4,293, , , , , , , , , ,332 Pre-Tax Net Gain from Operations (1,728,664) 606, , , ,630 1,109,611 1,216,689 1,320,044 1,420,725 1,530,292 Dividends 0 223, , , , , , , ,000 1,066,000 Federal Income Tax (538,952) 193, , , , , , , , ,980 Post-Tax Net Gain from Operations (1,189,712) 190, , , , , , , , ,312 Total Target Surplus Effect (210,837) (13,980) (13,475) (12,913) (12,227) (11,485) (10,754) (10,083) (9,449) (8,730) Distributable Earnings (1,400,549) 176, , , , , , , , ,582 Policies IF Beg of Year 1,000 1,000 1,000 1,000 1,000 1,000 1,000 1,000 1,000 1,000 Deaths Lapses Policies IF End of Year 1,000 1,000 1,000 1,000 1,000 1,000 1,000 1,000 1,000 1,000 Policyholder IRR: Cash Dividends and Cash Surrender Value Paid to Policyholder Premiums Paid by Policyholder Policy Year 10: -7.1% Policy Year 40: 3.4% Policy Year 20: 1.6% Policy Year 50: 3.5% Policy Year 30: 3.2% Policy Year 60: 3.5% 16

10 20 Year Internal Rate of Return = 14.72% 17

11 Sample Whole Life Pricing Projection Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9 Year 10 Premium 2,581,000 2,295,915 2,167,974 2,057,444 1,952,035 1,870,951 1,792,738 1,717,237 1,661,497 1,606,996 Investment Income (16,122) 130, , , , , , , , ,841 Total Revenue 2,564,878 2,426,494 2,399,489 2,380,937 2,360,469 2,362,429 2,359,812 2,353,993 2,369,780 2,383,838 Death Benefits 51,755 69,116 87, , , , , , , ,694 Full Surrenders , , , , , , , ,688 Reserve Increase 0 1,545,734 1,421,907 1,302,001 1,239,566 1,147,751 1,060,578 1,070,970 1,015, ,471 Total Benefits 51,755 1,614,851 1,577,706 1,538,731 1,514,978 1,483,355 1,455,171 1,450,892 1,443,247 1,434,853 Commissions 1,664, , , , ,622 56,839 53,872 51,036 49,380 47,760 Expenses 2,583,857 34,701 33,604 32,705 31,825 31,283 30,744 30,205 29,977 29,744 Premium Tax 45,168 40,179 37,940 36,005 34,161 32,742 31,373 30,052 29,076 28,122 Total Expenses 4,293, , , , , , , , , ,626 Pre-Tax Net Gain from Operations (1,780,647) 561, , , , , , , , ,358 Dividends 0 198, , , , , , , , ,509 Federal Income Tax (557,146) 179, , , , , ,625 91,430 76,547 56,019 Post-Tax Net Gain from Operations (1,223,500) 184, , , , , , , , ,829 Total Target Surplus Effect (186,581) (337) 206 1, ,189 3,463 1,948 2,968 4,016 Distributable Earnings (1,410,081) 184, , , , , , , , ,846 Policies IF Beg of Year 1, Deaths Lapses Policies IF End of Year Note ratios of Dividends to Pre-Tax Gains 20

12 20 Year Internal Rate of Return = 6.24% 21

13 Anatomy of a Dividend Three components: Mortality, Interest and Expense Uses an excess approach where expected experience is compared to conservative estimates Dividend = (QV - QE) NAR Excess Mortality + (IE - IV) MR Excess Interest + (A GP) + K Expense 26

14 Anatomy of a Dividend Mortality (QV - QE) NAR QV = Statutory valuation mortality rate QE = Expected mortality rate NAR = Net Amount of Mortality Risk, generally equal to the base policy Face Amount less the policy reserve Pricing mortality is typically well below valuation mortality, generating a positive mortality dividend 27

15 Anatomy of a Dividend Interest (IE - IV) MR IE = Credited interest rate (the Dividend Interest Rate ) IE determined as Earned Rate less spread Example: Earned Rate less 100 bps IV = Valuation interest rate MR = Mean Reserve, the average reserve being held in a policy year Interest is typically above valuation interest rates, generating a positive interest dividend 29

16 Anatomy of a Dividend Expense (A GP) + K GP = Policy Gross Premium A, K = Multiplicative and additive factors used to mimic maintenance expenses as a function of the gross premium In some cases, the expense factor is additionally expressed as a function of the policy Face Amount 31

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