nsura nce june 2007, issue no. 28 smalltalk newsletter of the … · 2012-01-19 · small talk...

Smaller companies have had concerns over the com-plexity of the Principles-Based Approach for reserves.To incorporate their concerns, a subgroup of theAmerican Academy of Actuaries Valuation Law andManual Team was created in January 2007. Thissubgroup gave the following report to the NAIC inMarch this year. It is reprinted here in its entirety.

The American Academy of Actuaries is anational organization formed in 1965 tobring together, in a single entity, actuaries

of all specializations within the United States. Amajor purpose of the Academy is to act as a publicinformation organization for the profession.Academy committees, task forces and work groupsregularly prepare testimony and provide informa-tion to Congress and senior federal policy-makers,comment on proposed federal and state regula-tions, and work closely with the NationalAssociation of Insurance Commissioners and stateofficials on issues related to insurance, pensionsand other forms of risk financing. The Academyestablishes qualification standards for the actuarialprofession in the United States and supports twoindependent boards. The Actuarial StandardsBoard promulgates standards of practice for theprofession, and the Actuarial Board forCounseling and Discipline helps to ensure highstandards of professional conduct are met. TheAcademy also supports the Joint Committee forthe Code of Professional Conduct, which

develops standards of conduct for the U.S. actuar-ial profession.

Continuing Requirements/Transition Subgroup

Pam Hutchins, F.S.A., M.A.A.A., ChairStewart Ashkenazy, F.S.A., M.A.A.A.Mark Birdsall, F.S.A., M.A.A.A.Mike Boerner, A.S.A., M.A.A.A.Steve Clayburn, F.S.A., M.A.A.A.Arnold Dicke, F.S.A., F.C.A., E.A., M.A.A.A.Alice Fontaine, F.S.A., F.C.I.A., M.A.A.A.Mark France, F.S.A., M.A.A.A.Dale Hall, F.S.A., M.A.A.A.Norm Hill, F.S.A., M.A.A.A.Leslie Jones, A.S.A., M.A.A.A.John Miller, F.S.A., M.A.A.A.Eddie Mire, F.S.A., M.A.A.A.Jonathan Pollio, F.S.A., M.A.A.A.Bill Schwegler, F.S.A., M.A.A.A.Jo Beth Stephenson, A.S.A., M.A.A.A.Jim Thompson, F.S.A., M.A.A.A.Mike Villa, A.S.A., M.A.A.A.

The Principles-Based Approach (PBA) beganwith the work on variable annuities with secondaryguarantees for Risk-Based Capital and was ex-panded to include reserves for universal life and

S M A L L E R I N S U R A N C E C O M PA N Y S E C T I O N“A KNOWLEDGE COMMUNITY FOR THE SOCIETY OF ACTUARIES”

Report of The ContinuingRequirements/Transition Subgroup ofthe Valuation Law and Manual Team........................................................ 1

Editorialby James R. Thompson ...................... 2

Update for Principles-Based Reserves atNAIC/LHATF Spring Meeting, New York,March 9-10, 2007by Norman E. Hill.................................. 6

Investment Management for a SmallerInsurance Companyby Arthur Aaronson .............................. 8

Pre-Need Mortality Studyby Mark Birdsall.................................. 10

The Pension Protection Act and ItsImplicationsby Cary Lakenbach ............................ 12

Smaller Insurance Company Section to Sponsor Four Sessions at AnnualMeetingby Leon L. Langlitz ............................ 16

Actuarial Value Ladder: Insurance MarketModelby Meg Weber .................................... 17

Highlights of the March, 2007 NAIC Lifeand Health Actuarial Task Force Meetingand Other NAIC Topicsby Ted Schlude, Jr. ............................ 18

What’s New In Research?by Ronora Stryker .............................. 27

June 2007, Issue No. 28

Newsletter of the SmallerInsurance Company Section

Published in Schaumburg, ILby the Society of Actuaries

This issue includes:

Report of The Continuing Requirements/Transition Subgroup of the Valuation Law and Manual Team

SmallTalk

continued on page 4

2 • Small Talk • June 2007

Smaller Insurance Company Section Newsletter

As you know, we have been following the fastdevelopments with the Principles-BasedApproach (PBA) to reserves and capital. We

have seen this evolve from an approach to UL to allproducts, however conventional. The November issueof Small Talk was devoted to this. In the March 2007issue of the Financial Reporter, the newsletter of theFinancial Reporting section, Norm Hill and I wrote anarticle on the update of PBA as of December. Duringlate 2006, various smaller company actuaries and con-sultants raised concerns at many professional meet-ings. During the December NAIC meeting, not onlytheir concerns, but also those of some regulators,reached the committees developing the PBA.

Mike Boerner, a Texas state actuary, proposed in theValuation Law and Manual Team that a subgroup beformed to study this. In January 2007, subgroup 4 wasformed and quickly named the ContinuingRequirements and Transition Subgroup. Their job wasto come up with practical ways of implementing PBA.Norm Hill and I, along with other actuaries, have beenmembers of the subgroup and have been involved andquite busy for the past three months.

The proposal seemed onerous for the smaller com-panies; however, various industry people are pushing italong. Thus, could we come up with some way to makeit acceptable to the larger and smaller companies?Could we use exemptions by product? By asset size(like the older asset adequacy analysis regulation)? Findreason for people to opt-in (no one had to use it unlessthey opted to use it)? Simplify it? There were many directions to go in, but we had to come up with someapproach to make the PBA acceptable.

After weekly conference calls we agreed on a reportthat was presented to the LHATF on March 9. NormHill attended the meeting and made a PowerPointpresentation when the report was accepted. The reportwas short enough that we used it as the lead article. Inhis article Hill describes his experience at the Marchmeeting.

Federal Tax IssuesThe following Tuesday, March 13, I made a presenta-tion regarding this report as part of a panel discussionat the Chicago Actuarial Association (CAA). In Marchthe CAA puts on a mini-actuarial convention withthree one–hour sessions. Registrants can sign up eachhour for any of over half a dozen choices. In the hourimmediately preceding the PBA panel, two prominenttax actuaries, Art Panighetti of Northwestern Mutualand Bud Friedstat of KPMG, were discussing tax issues

Small TalkIssue Number 28 • June 2007

Published by the Smaller Insurance CompanySection of the Society of Actuaries

475 N. Martingale Road, Suite 600Schaumburg, IL 60173-2226

phone: 847.706.3500 fax: 847.706.3599

www.soa.org

This newsletter is free to section members. Current-year issues are available from the

communications department. Back issues of section newsletters have been placed in the

SOA library and on the SOA Web site: (www.soa.org). Photocopies of back issues

may be requested for a nominal fee.

2007 Section LeadershipW. Howell Pugh, Chairperson

William M. Sayre, Vice-ChairpersonChristopher H. Hause, Secretary/Treasurer

Paul Carmody, Council MemberWade Harrison, Council MemberJeffrey D. Miller, Council Member

Richard B. Lassow, Council MemberJeffrey S. Morris, Council Member

James R. Thompson, Newsletter EditorCentral Actuarial Associates

866 Northhampton DriveP.O. Box 1361

Crystal Lake, IL 60039-1361phone: 815. 459.2083

fax: 815. 459.2092jimthompson@ ameritech.net

Angie Godlewska, DTP [email protected]

Sofi Garcia, Project Support [email protected]

Meg Weber, Director, Section [email protected]

Facts and opinions contained herein are the soleresponsibility of the persons expressing them and

should not be attributed to the Society of Actuaries, its committees, the Smaller Insurance CompanySection or the employers of the authors. We will

promptly correct errors brought to our attention.

Copyright © 2007 Society of Actuaries.All rights reserved.

Printed in the United States of America.

EditorialBy Jim Thompson

James R. Thompson,

FSA, MAAA, is the

newsletter editor and is

employed with Central

Actuarial Associates.

He can be reached at

815.459.2083 or at

jimthompson@

ameritech.net.

June 2007 • Small Talk • 3

Issue 28

and the possible impact of PBA figured promi-nently in their session.

Tax issues are intricate. One overall impres-sion I had was that the IRS will want one tax re-serve methodology for all sized companies.Current tax law uses a prescribed interest rate andmortality table and excludes deferred premiums,excess interest and deficiency reserves. It alsospecifies that companies must use a prescribedvaluation method (the current interpretation ofCRVM or CARVM as appropriate at the date thecontract was issued). If a PBA reserve is testedwith current credited interest or dividends (orother non-guaranteed elements), will this createproblems? Whatever the NAIC passes for a PBA,the hope is that it will fit into the current tax lawwithout requiring a complete change in the law.This would include the current three-prongedcomparison of a maximum of the net surrendervalue and the federally prescribed reserve, butnot exceeding the statutory reserve.

Another reference for possible IRS views ofPBA is an article by SOA President Ed Robbinsand Peter Winslow in Taxing Times, the newslet-ter of the Taxation Section of the SOA. They clas-sify the predicted possible outcomes of thepresentation of a PBA approach involving sto-chastic reserves to the IRS into three scenarios.One is that the PBA is so different from the cur-rent CRVM that the stochastic approach will notbe accepted at all. A second thought is that, be-cause congress allowed the NAIC to determinethe official reserve method, if the NAIC acceptsPBA, congress will accept that if theCommissioners do. A third school of thought isthat congress did not delegate unlimited powerto the NAIC. Thus, the deterministic reserve inthe PBA might qualify, but not any excess of thestochastic portion over the deterministic reserve.

My observation is that matters are movingquickly. I encourage everyone to tune into the discussion and not be shy about providingsuggestions.

Rest of the IssueThe rest of this issue covers other matters. Onechronic issue smaller companies have faced ishow to value pre-need insurance (and other sim-plified and guaranteed issue products). This issueconcerns smaller companies more so than largerones because some specialized in such products.The SOA has been working on a mortality studynarrowed to the pre-need market. A member ofthe Project Oversight Group (POG), MarkBirdsall, has written an article on their progress as reported to LHATF.

The Pension Protection Act of 2006(PPA2006) will affect product design in variousways. Will your company be able to handle the favored product ideas? See Cary Lakenbach’sarticle.

Ted Schlude attended the NAIC meeting andhas been kind enough to give us a summary of ac-tivities of interest to us. His summary is compre-hensive. The meeting itself covered a lot of issues.You will appreciate the complexity of the PBAproject by the number of groups reporting ontheir work. Note also the progress on the CapitalAdequacy Task Force (CADTF).

Art Aaronson has written a general articleabout investment management for the smallerinsurance company. This is useful when one con-siders the importance of the investment functionin insurance companies.

See Ronora Stryker’s article, “What’s New InResearch” (printed earlier in the Product Sectionnewsletter) and Meg Weber’s article on the actu-arial value ladder.

What sessions will appear at this year’s annualmeeting? See Leon Langlitz’ article.

There is a lot going on in our profession andthe pace of change is getting quicker. We hopethis newsletter reaches you before the next NAICmeeting, but that is early this year, June 1 - 4.Thus you might have to check for updates onwhat we are writing about. n

If a PBA reserve is tested with current creditedinterest or dividends (or other non-guaranteed elements), will this create problems?

continued from page 2



term insurance. As it was developed, the PBA approach wasfurther expanded to include reserves for all life insuranceproducts, with exemptions for a small number of products.Regulators and industry groups have expressed concernsover product exemptions and conversely about the com-plexity and expense of the PBA process as it applies to allproducts, even though many of those products will haveminimal tail risk. It is the concern of this group that a non-discriminating application of a PBA approach may be moreexpensive and complicated than is necessary or practical tocompute reserves for some types of life insurance products.The cost and use of resources to perform a full, stochastic-based PBA analysis may not be necessary for products thatdo not have a significant tail risk.

The following are the major areas of concern:

1. The process to justify the exclusion from stochasticmodeling is perceived to be too complex. The resourcesrequired for this process will put a strain on many companies where it may not be needed given theirproduct mix.

2. The cost of an extensive and independent PBA reviewof a complex PBA process.

3. The experience reporting required for a myriad of assumptions, including mortality, lapse and policy-holder behavior may be unnecessary (or at least not necessary annually) for companies that do not have material experience.

4. The cost of the PBA approach may put smaller compa-nies at a disadvantage in a way that may lead to an unlevel playing field.

Since it is a concern of some that the cumulative costs ofthe current PBA proposal may exceed the benefits of the approach from both a company and regulator standpoint,especially when applied to all products, we recommend thatinitial consideration be given to defining the various impor-tant tradeoffs of cost and benefits in a way that allows a productive estimate of their meaning to both the current oralternative options that may be developed.

This group has considered several possible approachesto simplify or modify the PBA approach for valuation.These approaches do not address all of the concerns listedabove because we would like further direction and input onwhat approaches would be considered by LHATF and theLRWG. We have considered several approaches and haveclassified them into three types:

1. Suggestion to phase in the LRWG requirements

A phase-in approach would be to consider initial adop-tion of PBA for more complex products only (e.g.,Variable, UL with long term secondary guarantees) anddelayed adoption or temporary exemption from all orparts of the PBA process for other products with less tailrisk. A phased-in approach would allow actuaries andregulators to gain experience and a familiarity with thenew PBA process based on a limited set of products andthen a decision can be made through the valuationmanual on whether an extension to products with lesstail risk is necessary or desirable or whether simplifiedmethods should be considered. Definitions of theseproducts based on the risks of the product would be re-quired. Extensive use of certain types of investments(e.g., equities, options) may also require stochastic testing. This may require a better definition of signifi-cant tail risk. It may be desirable to require an actuarial opinion to specify that no embedded options have beenincluded in the product design that would classify theproduct as one of the types requiring testing.

2. Changes suggested to the proposed LRWG require-ments to satisfy the concerns listed above.

a. Start with the presumption that reserves ought tobe deterministic and computed policy by policy.Develop a test to determine if stochastic work is re-quired. If the product fails the test, reserves arecomputed using the LRWG requirements. If itpasses, the deterministic method is used. The re-statement to put deterministic first may meet twopurposes: A contract by contract methodology mayfit better in the current tax law (while also raisingother issues) because there is one underlying basisfor the reserve and the reordering more clearlymakes the point that the PBA requirements are notmandating stochastic testing for all products.

b. PBA as currently designed with the followingchanges: A simplified exclusion test which, if satis-fied, would allow the use of a Deterministic Reserveand a simplified approach to setting Prudent BestEstimate assumptions. For companies with prod-ucts that qualify, this would simplify the cost ofmodeling and the cost of any independent PBR re-view required. We are currently working with theLRWG to identify areas that can be simplified andstill retain the PBA principles.



Issue 28

3. Development of simplified methods that areoutside of the current LRWG approach forsome or all products:

a. One idea is to require an initial actuarialopinion that would cover all products.The actuary would classify the reserveapproach needed for a product as either(1) current formulaic approach (net pre-mium reserves), (2) deterministic grosspremium reserves, or (3) the currentLRWG draft proposal. This opinionwould be fixed and would require justifi-cation for the classification, based on sce-nario testing and risk profiles present inthe products. Future valuations wouldcorrespond to the classifications above.A change of method would require ap-proval by the commissioner. The ration-ale supporting the initial opinion wouldbe monitored on a periodic basis, andany material changes may require the re-determination of the appropriate reservemethodology.

b. Another approach would calculate agross premium reserve under anticipatedexperience assumptions using a seriatim,deterministic approach. A provision forrisk is added, which would need to be determined before this approach couldbe adopted, agreed to by regulators andspecified in the valuation manual. Forcontracts with non-guaranteed ele-ments, the approach is simplified furtherby use of a “valuation basis underlyingguarantees.” This is a set of gross premi-um valuation assumptions under which,at issue, the present value of premiumsequals the present value of guaranteedbenefits and expenses. Normally, the assumptions in this valuation basis willbe conservative. This valuation basis islocked and used to value future guaran-tees (excluding non-guaranteed elements) on each future valuation date,subject to a simple adequacy test of valu-ing the guarantees under current assumptions. Secondary guaranteeswould be included as guarantees underthis approach

c. Finally, a simplified approach could–calculate a deterministic reserve as in thecurrent PBR requirements, but with theseriatim reserve based on option b.above. Use an NAIC rate for interest anda CSO table chosen by an underwritingscoring test. The stochastic exclusiontest would be a cash flow test with prede-fined extreme scenarios set by a regulato-ry body, such as the CentralizedExamination Resource Office, each year.The predefined extreme scenarios couldvary by product. The use of this test maybe deemed by the regulatory body to beinappropriate for some products, inwhich case the stochastic exclusion testsin the current LRWG draft would be re-quired. Any deficiency means the test isfailed and the stochastic reserve is com-puted as in the PBR model. If no defi-ciency, the recalculated deterministicreserve is computed using the greatestpresent value of accumulated deficien-cies (GPVAD).

Subgroup 4 will continue to work with theLRWG on the approaches outlined in this re-port. A combination of these approaches may beconsidered as well, such as initial product exemp-tions where the number of product exemptionsare reduced based on additional flexibility pro-vided in the LRWG. Any input LHATF can pro-vide to help focus the efforts is welcome.

We support the direction of the ValuationManual to handle new approaches as products,methods, and techniques evolve which will en-able this manual to handle the options providedin this report. n

Reprint permission granted by the AmericanAcademy of Actuaries, 2007

For contracts with non-guaranteed elements, theapproach is simplified further by use of a “valuation basis underlying guarantees.”


Aspokesman for the LRWG and I gave our Academy presentations. Ispoke on behalf of Subgroup 4 of the

Valuation Team.

One regulator asked me a question aboutreinsurance under PBR. I said our subgroup re-ally hadn’t discussed the matter much.However, I personally believed that reinsurerswould be more particular about the type of re-serves and the documentation provided them.There would be a learning period, involvingsome pain, until everyone was comfortable.

With hindsight, I would also have added thatwith the need for industry assumptions in settingreserves, reinsurers could perform valuable service for their clients. Due to credibility re-quirements, small companies would likely not beable to use their own experience in setting assumptions, or only to a limited extent. With abroader base, the experience of reinsurers mightserve as a quasi-industry base for mortality, lapseand related reserve assumptions.

I mentioned our FIT discussions and the possibility that the Code would not necessarilypreclude options, i.e., differences among compa-nies for the same product, as to methodology.However, an ACLI spokesman made one signifi-cant audience comment. He said that, regard-less of this wording, Treasury wouldundoubtedly zero in on requiring the lowest re-serve among any options. If so, this would makeit very important that we contest any general no-tion that stochastic reserves are the lowest. If thisbelief became prevalent, it could mean thateveryone would have to test stochastic reservesfor FIT. Obviously, this would represent a verynegative result for small companies.

Afterwards, I thought to myself that wordingfor “deterministic” reserves could properly bebroad enough as an umbrella to include the “sto-chastic” version.

I believe that PBR suffered several setbacksduring the LHATF meeting, although not fatalones. Also, it was clear that key procedural issuesare still unresolved.

First, I thought it had been settled that thecompany would hire the PBA reviewing actuary.However, several regulators as well as a consumerrepresentative said that the insurance depart-ments should do the hiring. One reason was thatsome state laws might not be broad enough toallow forms of delegation of InsuranceCommissioner’s powers. In other words, a PBAreview opinion from a company appointee mightnot suffice as a replacement for Department appointee opinions. Double work and billingwould thus be required.

One prominent regulator seemed to have agenerally negative attitude about PBR. He argued the following:

• For variable products, apparently for reservesunder either PBR or VACARVM, dynamichedging “will not work.” (However, I be-

lieve the assumption of dynamic hedging isvery important to those writers.)

• PBR should only be in addition to the current formulaic structure.

• The 2nd reserve floor, a reserve with risk freeinterest (net or gross premiums, althoughstill unspecified) should be tested cell on cell,not aggregate. Presumably, FIT currentlyrequires a cell by cell test. A double applica-tion of cell by cell tests would make reservecalculations much more complex.

However, one other step was discussed, whichcould wind up positive for PBR and the industryin general. The LHATF staff person urged that ajoint committee of LHATF and Life CapitalAdequacy be formed to keep both methodolo-gies consistent. As I indicated elsewhere, thecurrent risk-based capital proposal from theAcademy (on C3, Phase 3) has glaring inconsis-tencies with current tendencies for PBR. Therewas talk of South Carolina being Chairman,since the state is represented on both NAICgroups. This might make it easier to discuss PBRand RBC together. I don’t think this new com-mittee is set up yet, pending the CapitalAdequacy Task Force’s concurrence.

Update forPrinciples-BasedReserves at NAIC/LHATF SpringMeeting, New York, March 9 - 10, 2007By Norman E. Hill



Related MattersThe NAIC’s Capital Adequacy Task Force met on Sunday.There was no separate meeting of the Life RBC subgroup,which would have meant further discussion of theAcademy’s RBC C3 Phase III proposal. However, they willbe holding several conference calls this month.

On Friday, a preliminary Academy presentation on PBRfor long-term care was made to LHATF. It was structuredas a series of questions for regulators, rather than a specificproposal.

Small companies in several cases have small blocks ofLTC. Even on a preliminary basis, it seemed clear to methat several contentious regulatory issues could arise for thisproduct.

For example, one regulator objected strongly to any in-clusion of future rate increases in setting assumptions forPBR reserves. One industry spokesman replied that a distri-bution of test scenarios for reserves would naturally includesome with less favorable experience. For guaranteed renew-able policies, sound company management would requirereliance on rate increases in such unfavorable scenarios.

Although it was not discussed, the question of future im-provement in morbidity could also become controversial.LHATF had previously precluded such improvement informulaic statutory reserve assumptions. However, it is fre-quently used in pricing and reserve testing.

The question of “moderately adverse experience” wasalso discussed. LHATF pointed out that the Academy hadpreviously declined to issue specific guidelines as to whatconstitutes moderately adverse. One regulator stated thathe has seen rate filings with only 1 percent variance definedas “moderately adverse.” In truth, this term may needtighter definitions, as it is likely to be used in describingPBR assumptions.

Another regulator stated that long-term care reservesunder PBR should be twice as high as current levels.Actually, only new issues would be covered under PBR.PBR reserves for new issues would not be expected to differsignificantly from current formulaic reserves that are basedon comparable or the same assumptions.

Newest AlternativeA member of our Valuation Manual Team has proposed aslight variation of the deterministic gross premium re-serve/cash value floor method. This method would be op-tional, in lieu of using the LRWG methods.

For policies not subject to Material Tail Risk, determin-istic GPR’s may include assumptions deemed by regulatorsto be appropriate (such as interest and mortality) or deter-mined by a simplified process approved by regulators.

An attempt is made to define Material Tail Risk, albeitindirectly. A policy is deemed not subject to this risk if it can“pass” cash flow tests with certain prescribed scenarios,again, set by regulators. Presumably, these present values of cash flows would have to be at least equal to formulaic reserves.

This proposal deserves further study. Key questions thatmust be resolved include:

1. Are the prescribed scenarios practical for small companies?

2. Are there alternative ways to determine a successful cashflow test that would confirm that the policy is not sub-ject to Material Tail Risk?

If a policy is deemed subject to Material Tail Risk, itwould have to be reserved under the LRWG methods,meaning stochastic reserves including tests for the greatestvalue of accumulated deficiencies.

ConclusionResolution of critical matters under PBR for small compa-nies and for the industry in general has a long way to go.Especially for small companies, several alternative reservemethods are still on the table. At the same time, resolutionof RBC and needed consistency with PBR are still highlyunresolved. This means that small companies need to re-main watchful for a threefold area of ongoing proposals:

1. PBR reserves

2. RBC C3 Phase III

3. Federal Income Tax n


Issue 28


Norman E. Hill, FSA,

MAAA, is executive vice

president and chief

actuary with Kanawha

Insurance Company in

Lancaster, S.C. He can

be reached at

norm.hill@

kmgamerica.com.

Managing the investment portfolio ofan insurance company is a challengein today’s competitive marketplace

with the increased focus by both regulators andrating agencies on the companies’ operationalmetrics and product pricing. The goal of man-agement is to define its asset portfolio in order toback the company’s unique liability mix, whileadhering to its risk profile and incorporatingcurrent market conditions and operating needsinto this analysis. The first step in this process isdeveloping an effective set of investment guide-lines for the company to follow.

In the smaller insurance company environ-ment adopting an overall goal of managing theinvestment assets to provide the company withcash flows that meet expected liability needs iscritical to the organization’s growth. This con-cept of Asset/Liability Management is a disci-pline with widespread acceptance throughoutthe insurance industry. The 2005 Society ofActuaries exposure draft, Principles UnderlyingAsset/Liability Management, addresses thewidely accepted concept of Asset/LiabilityManagement (ALM) as “the ongoing process offormulating, implementing, monitoring and re-vising strategies related to assets and liabilities toachieve financial objectives, for a given set of risktolerances and constraints.” Applying the princi-ples of ALM will vary from entity to entity, butthe concept will often allow management toidentify and manage the risks within their port-folios and help achieve desired returns or appro-priate portfolio structure to contribute to theorganization’s growth and stability.

Managing an investment portfolio under anALM process requires commitment from man-agement to help establish investment policy thatwill deliver satisfactory investment while notsubjecting the organization to undue risk.Investment guidelines and the specific con-

straints and risk profile contained within becomethe foundation for that investment policy.

When designing investment guidelinesunder an ALM mandate, it is important to con-sider the company’s liability structures in addi-tion to its risk appetite. The liability structure isbest represented by the expected liability cashflows of the company for policies issued or as-sumed by the entity. The key word here is “ex-pected,” since cash flows seldom unfold exactlyas projected. However, management must makerealistic assumptions in order to allow for appro-priate portfolio design. The selection of permit-ted asset classes and duration is dependent onunderstanding both the structure of the liabili-ties and the candidate asset classes. In today’s in-vestment marketplace, expertise in managingthose various asset classes is readily available ei-ther in-house or through external managers. Theprocess of defining what is permitted should bealigned with management’s understanding of theasset classes in the context of the company’sunique liability characteristics.

Investment managers will work with yourcompany to understand the multitude of invest-ment securities available, but it is important thatmanagement remain vigilant in understandingthe risks associated with each of these securities in

all market environments. The lack of compre-hension of an asset class can lead to future pitfallsif the performance of a selected asset class devi-ates from its desired objectives and an investmentprocess to manage for such deviation is not inplace.

Risk is also unique to every entity. It is de-fined, by Webster’s, as “the chance of injury, damage, or loss.” Risk is subject not only to spe-cific company management appetite, but also tomanagement’s understanding of the total enter-prise’s operations. Risk includes duration expo-sure, quality, diversity, size, liquidity and creditamong others. Management must understand itslimits—both regulatory and operational—inorder to allow optimal guideline rules that do notoverly inhibit portfolio returns, or allow the port-folio to expose the company to unnecessary risk.As an example, an investor can purchaseCommercial Mortgage-Backed Securities(CMBS) at the AAA, AA and single-A level.However, the pickup in spread in current marketconditions, and thus income, between the high-er quality paper and lower quality paper may notbe sufficiently incremental in current marketconditions to warrant the additional exposure torisk (liquidity or default) that the lower quality is-sues contain.

InvestmentManagement for aSmaller InsuranceCompanyBy Arthur Aaronson




Issue 28

Once drafted, guidelines should be tested to de-termine if they will allow the portfolio to be invest-ed in asset classes that can deliver a diversifiedportfolio to support the company’s ALM needs,while managing the portfolio in a disciplined, butflexible manner. Management must also exercisecommon sense, and a recognition of changing mar-ket dynamics, in allowing for asset classes to be in-cluded in guidelines, but restricting asset class investmentswhen conditions warrant. As an example, current creditmetrics and issuance indicate potential signs of stress inmany sectors. In such market conditions, exposure to lowerquality credits, like high yield corporates, needs to be sup-ported by strong credit research to manage such exposure.Alternatively, when such diligence is not available, it may beprudent to avoid the sector.

A company’s guidelines should allow management theability to enhance an entity’s income, cash flow or tax needswhile remaining consistent with its ALM metrics, if needed.The use of flexible constraints that allow management toalter the portfolio structure, recognizing both changingmarket conditions and the company’s dynamic liability ex-posures, will generally enhance the ability of the portfolio todeliver more consistent, positive investment results.

In summary, developing investment guidelines allowscompanies’ investment professionals and actuaries to createa portfolio roadmap that includes an assessment of invest-ment classes available to the insurance company and met-rics to measure the investment portfolio’s risk. When donewithin a framework that supports a disciplined ALMprocess, the portfolio will reward the company with effec-tive investment management, in different market cycles,whether they be investment or insurance related. n

The views expressed in this article are those of the author and donot necessarily reflect those of GE Asset Management, its direc-tors, officers, employees or affiliates. Nothing presented herein isintended to constitute investment advice, nor sales materialand no investment decision should be made solely based on anyinformation provided herein. Any forward looking statementsor forecasts are based on assumptions and actual results are ex-pected to vary from any such statements or forecasts. No relianceshould be placed on any such statements or forecasts when mak-ing any investment decision. No guarantee of investment per-formance is being provided and no inference to the contraryshould be made.

A company’s guidelines should allow management the ability to enhance an entity’s income, cash flow or tax needs while remainingconsistent with its ALM metrics, if needed.


Arthur Aaronson, CPA,

is an insurance portfolio

manager with GE Assét

Mangement. He can

be reached at

Arthur.Aaronson@

ge.com.

After over two years of work, the SOAProject Oversight Group (POG),working in connection with the

Deloitte-UConn Actuarial Center, has pro-duced a set of basic mortality tables for pre-need life insurance business. This articledescribes some of the background of the study,as well as certain results.

In July, 2004, Jim Van Elsen sent a letter toLeslie Jones of the South Carolina Departmentof Insurance requesting that the NAIC’s Life &Health Actuarial Task Force (LHATF) add anitem to its 2005 charges to develop and adopt anew mortality table for pre-need life insurancethat could be used for both valuation and non-forfeiture calculations. Jim Van Elsen explainedthat the unique characteristics of pre-need lifeinsurance make the use of the 2001 CSO tableinappropriate for use with pre-need business.

LHATF responded positively to his request,and later in 2004 a Project Oversight Group wasorganized to begin work on the project. In orderto ensure confidentiality and security of the dataand to perform the data analysis and calcula-tions in connection with this study, theDeloitte-UConn Actuarial Center, with JayVadiveloo as Deloitte’s project leader, was select-ed to work with the POG.

In defining the scope of the project, thePOG decided to focus only on the mortality as-pects of pre-need life insurance and not otherfacets, such as benefit growth rates or policy per-sistency. Other forms of simplified underwrit-ing business were excluded from the study, suchas final expense policies. The working definitionof pre-need life insurance that the POG usedwas as follows:

“Pre-need insurance is unique in that it isonly sold in the situation where there is a formal contract in place with a funeral home. The pre-

need policy serves to fund the contract with thefuneral home.”

The POG needed to decide how to handle thesituation in which trust account assets had beentransferred into a pre-need life insurance con-tract. For several different reasons, the POG decided to exclude this business from the study ifa contributing company could identify thosepolicies.

As is typical for Society of Actuaries mortali-ty studies, experience was also excluded forthose policies on nonforfeiture options, such asextended term in-surance or reduced paid-up.

The POG decided to perform the studybased on count, rather than units of insuranceor face amount. This is partly due to the fact thatthe range of policy sizes is comparatively smallfor pre-need business. There was also some con-

Pre-Need MortalityStudyBy Mark Birdsall



Table 1 – Female Issue Age 65

• Pre-need mortality rates exceed 80 CSO rates for five durations and gets lower than 80 CSO in later durations.

• Impact of first year anti-selection extends for six durations from issue.

cern that since many pre-need plans have non-leveldeath benefits, some inconsistencies in reportingmight affect the study results.

And so, the data request went out, asking forpre-need policy data for calendar years 2000 to2004. Data contributors were asked to providepolicy data that included issue age, gender, policy dura-tion, policy payment type (whether single pay or multi-pay), and underwriting category, among other data items.Contributing companies were asked to review their data asof June 1, 2005, or later, in order to catch late-reportedclaims. Early payoff policies were combined with themulti-pay experience, even when occurring during thefirst policy year. All policies were assigned to one of threeunderwriting categories:

1. Aggregate—any policy whose rates and benefits didnot depend on the answers to any health questions. Inother words, the company only offered one underwrit-ing class for that plan.

2. Standard—any policy whose rates or benefits were lessfavorable because of answers to health questions.

3. Select—any policy whose rates or benefits were morefavorable.

Ultimately, 10 companies contributed data to thestudy. Each company’s data was validated for accuracy and

consistency by working with the company to confirm thelevel and pattern of mortality. In aggregating the results,exposures were scaled so that the total study results reasonably represented all the contributing companies.

In total, the study was based on over 150,000 deaths.Only 1 percent of these deaths occurred on policies with anissue age less than 50.29 percent of the deaths occurred onpolicies with issue ages greater than 85. 63 percent of theexposures were on female lives. Above issue age 85, femalelives comprised 76 percent of the exposure.

The great majority of the data fell within the aggregateand standard underwriting categories, which consistentlyexhibited a reverse select and ultimate pattern for bothmale and female lives. Please see Table 1 on page 10.(Tables 1, 2 and 3 are all extracted from Vadiveloo’s March LHATF presentation. Male mortality experiencefollows a similar pattern to the female experience shown.)Note that the anti-selection period appears to persist forabout five or six years.

continued on page 26


Issue 28


Mark Birdsall, FSA,

MAAA, is appointed

actuary for Security

National Life in Salt Lake

City, and is a member of

the Project Oversight

Group for the pre-need

mortality study. He can

be reached at markb@

securitynational.com.

Table 2 - Mortality Comparison – Ultimate Ages

• Pre-need ultimate rates are close to 80 CSO rates to attained age 70. • Beyond attained age 70, pre-need ultimate rates are lower than 80 CSO rates.

In aggregating the results, exposures were scaled so that the total study results reasonablyrepresented all the contributing companies.

The focus of this discussion is the criticalimpact that the PPA has on the sale ofwhat many refer to as combination or

integrated products. The combinations are generally Life Insurance plus a Long-Term Care(LTC) feature, and Annuities plus a Long-TermCare feature.

For such products the PPA builds on existinglaw. The Health Insurance Portability andAccountability Act, fondly known as HIPAA,became law in 1996, is the key foundation forcombination products. Consequently, any dis-cussion of the key provisions of the PPA shouldbegin with a review of this law.

HIPAALife and LTC combinations have been availablefor some 20 years, well pre-dating the HeathInsurance Portability and Accountability Act of1996. HIPAA gave official Internal RevenueCode recognition to certain long-term contracts,either if standalone or in a life and LTC combina-tion, by establishing a new code section, Section7702B, to define the conditions under which anLTC contract or LTC provisions of a contractcould be considered qualified long-term care insurance. If the LTC contract met the require-ments to be qualified (in this sense), it would beconsidered Accident and Health Insurance andconsequent benefit payments would be receivedincome-tax free under the law. (There are manyplaces in the Internal Revenue Code where theterm “qualified” occurs. Here we refer to the def-inition of qualified long-term care insuranceunder Section 7702B(b)(1).) One should observe the law does not give a blanket income-tax free ride to any and all payments. There ismore devil in the details than that.

Life and LTC combinations generally accel-erate a portion of a life contract death benefiteach month, or period, while the insured ischronically ill. Typically, the percentage is 2 per-cent or 4 percent of the death benefit, payableeach month while the insured is chronically ill.When the benefit payments are made, the remain-ing death benefit of the life contract is reduced dol-

lar-for-dollar, and other policy amounts such asaccount value, loans and premiums, are reducedproportionally. (One complex area where propor-tionality does not reign, although logically itmakes sense, is the calculation of guideline premi-ums. Such calculations are driven by Section7702’s attained age decrement rules.)

So, as noted, such benefit payments escapetax in properly structured contracts. In so-calledreimbursement contracts, where the amount ofclaim dictates the amount of benefits, subject tospecific policy maximums, all benefit paymentsare received income-tax free. The law also allowsper diem contracts, those in which a payment ismade independent of the amount of qualifiedlong-term care services provided, to be received in-come-tax free as long as the payments do not ex-ceed specified thresholds, which change year toyear depending upon changes in the cost of liv-ing. For 2007, the limit is $260 a day. (An aggre-gation rule applies to individuals who own bothper diem and reimbursement contracts, the neteffect of which may be to limit the amount of theper diem limitation.)

HIPAA addresses the tax treatment of chargesmade against the cash value of a life contract topay for long-term care charges.

For starters, QLTCI contracts or policy (orrider) provisions are treated as separate contracts,and as a consequence deductions against the lifepolicy’s cash value are treated as distributionsfrom the life contract. If the life policy were a

Modified Endowment (MEC), such as would bethe case with a single premium life contract, distributions would be taxed on a LIFO (Last-In-First-Out) basis, so that taxes would arise ifthere is any gain in the contract. If the contract isa non-MEC, taxes arise on distributions if the in-vestment in the contract is at zero, as might occur,if the policyholder had withdrawn all premiumspaid as part of a program to utilize the assets of thelife contract to supplement retirement income.Smaller companies, like all insurers, need to recognize the possible tax consequence and beprepared to send 1099s as required.

As HIPAA is silent about the categorization oflong-term care as a qualified additional benefit(QAB), it is therefore not a QAB under Section7702(f )(5). Consequently, one cannot reflectthe prefunding of the LTC charges in guidelinecalculations. This consideration somewhat lim-its the accumulation efficiency of the single pre-mium contract to which the LTC is attached.

Finally, it is worth noting that HIPAA is completely silent about annuity and long-termcare combinations.

Product Story—Since HIPAASeveral insurers had already been offering inte-grated life and LTC combinations when HIPAAbecame law. At the time of enactment, and forseveral years thereafter, there certainly was con-troversy as to whether a qualified, as opposed tonon-qualified, LTC insurance contract was de-sirable. That race has been won by the QLTCI of-

The PensionProtection Act andIts ImplicationsBy Cary Lakenbach




Issue 28

fering. Offering a non-qualified LTC will at a minimum runinto competitive challenges constantly.

Several insurers have been spectacularly successful withtheir combined offerings. One has over $3 billion in force.Interestingly enough, discussions with key associates indi-cate that there were many stops and starts, wrong turns andblind alleys, before a successful strategy came into focus.

The following considerations are viewed by many ascritical (not necessarily all at the same time and in the sameproduct):

1. In the life-LTC vehicle, a benefit is always paid, so theobjection to standalone vehicles, that they are “use it orlose it,” is overcome.

2. Key Markets:

a. Over 50.

b. Males and females.

c. Income over $75-100,000.

3. Sale combines legacy aspects (life insurance) with long-term care protection.

4. Sale is often considered as a critical part of an asset allo-cation strategy, in which part of a client’s relatively risk-free assets are redeployed into the combined offering.

a. This focus, on asset allocation strategy first, ratherthan on LTC first, has led to major penetration and success with regional brokerage houses andwirehouses.

b. This sale has been (largely) single premium.

5. An integral part of the aforementioned asset allocationstrategy is a return of premium rider that assures the pol-icyholder will always at least get back his deposit.

Most of the successful offerings have been non-variable,and there is worthwhile market penetration with bothwhole life and universal life structures.

A prominent, very large Midwestern life insurer hasbeen very successful recently in offering an LTC accelera-tion rider with variable universal life. A significant percent-age of purchasers are purchasing the rider.

A more modestly sized Midwestern insurer has seen con-siderable success in offering LTC acceleration with its parsingle premium whole life plan, and an Eastern insurer of-fers an entire permanent and UL portfolio with LTC accel-eration riders.

There were a few attempts at developing annuity andLTC combinations, and their success was extremely limitedat best, no doubt due to the absence of favorable tax treat-ment in the law (HIPAA.)

Pension Protection ActThe Pension Protection Act’s stated effective date is Jan. 1, 2010. This would suggest companies have some time to prepare for the changes in law. In our view, the appropriate answer is quite the contrary, because intensiveexamination suggests attractive product and market options are available for designs in the transitional period2007 to 2009.

The PPA, most importantly, expands the definition ofqualified long-term care insurance contracts to includethose attached to annuities. This new provision effectivelymeans that annuity assets can be used to fund the long-termcare features of a contract on a basis consistent with those ofother assets. That is, prior to the change, the typical annuityand long-term care combination, such as it was, providedfor enhancements to the annuity cash value, and when suchvalues were distributed, they were taxed no differently thanany other distribution from an annuity account value.

Under PPA, then, appropriately structured qualifiedlong-term insurance contracts that are riders to an annuitywill provide (long-term care) benefit payments to annui-tants on an income-tax free basis. (We’ll keep referring toriders, but the law grants the same treatment to long-termcare provisions of an annuity contract, if they meet the re-quirements to be a qualified long-term care insurance con-tract.) The law specifically states that annuities contained intax-qualified retirement offerings (e.g., 403(b)) are not cov-ered by the aforementioned changes.

This opens up all sorts of opportunities given the signif-icant dollars resident in in-force annuities as well as the opportunities for new sales. We’ll come back to this later,but the key observation is that potentially the entire annuity is payable to a chronically ill individual without any tax consequence.

Furthermore, the law states that any distribution, fromeither an annuity or life contract account value, which isused to pay for charges for coverage under qualified long-term care insurance, will not result in taxable income to thepolicyholder. The law states that any such distributions arefirst used to reduce the investments (basis) in the contract tozero, but even when that happens, additional charges aretreated specially by not being taxed, even though they comeout of contract gain.

Readers will find this provision rather unusual. Forstarters, in annuities and modified endowments, the usual



Cary Lakenbach, FSA,

MAAA, COU, is president

of Actuarial Strategies in

Bloomfield, Conn. He

can be contacted at

[email protected].



“exit strategy” for distributions is that they come out of gainfirst. So, here, the effective order is reversed. Further, shouldthe basis reduce to zero, the law consequently allows gain toescape taxation in this special circumstance. Clearly, some-one wanted to encourage the sale of such contracts.

There are several other important provisions of the Actworthy of note.

The first has to do with the treatment of exchanges.Effective after 2009, the law specifically includes qualifiedlong-term contracts or life or annuity contracts containingqualified long-term care insurance riders (or provisions) asbeing contracts to which, or from which, (income-tax free)Section 1035 exchanges can be made.

Specifically, the revised Section 1035 says:

1. An annuity contract can include a qualified long-termcare insurance contract for purposes of Section 1035.

2. A life contract can include a qualified long-term care in-surance contract for purposes of Section 1035.

3. A life contract can now be exchanged for a qualifiedlong-term care insurance contract, an annuity, endow-ment, or another life contract (which may contain aqualified LTC insurance provision.) Note the contractbeing exchanged might also contain such an LTC provision.

4. An annuity contract can now be exchanged for a quali-fied long-term care insurance contract, or an annuity orendowment contract (which may contain a qualifiedLTC insurance provision.) Note the contract being exchanged might also contain such an LTC provision.

Beginning in 2010 another provision of the law requiresinsurers to report the amount of all charges made against thecash value of an annuity contract or the cash surrender valueof a life insurance contract to cover qualified long-term careinsurance charges. (The purpose is clear—to create aroadmap of the charges that escape income taxation.)

So how does the government plan to pay for this liberal-ization? The law specifically impacts annuity and LTC salesby requiring that the DAC tax percentage for such businessbe 7.7 percent instead of 1.75 percent for other annuities ef-fective after 2009.

This approach certainly makes sense. Otherwise (if theDAC stayed at 1.75 percent) the law would have given anunusual advantage to the combined product over the sale ofa separate annuity and the use of its funds to fund a stand-alone contract.

In this context it is worth mentioning that the law only

addresses combination annuity and LTC products. Itwould appear that a distribution from an annuity to paypremiums for a standalone LTC contract would be taxableunder the prevailing LIFO rules for annuity distributions.

High Level Implications of the LawMany questions arise as to the impact of the law. Here are afew, along with some observations.

1. What is the likely impact of the higher DAC cost on an-nuity and long-term care combinations?

Our initial calculations suggest that the cost may be inthe neighborhood of 25 points of spread, assuming the spread is charged over the 11-year period in whichthe higher first year cost is amortized. Such a cost is not inconsequential, especially in light of today’s lowinterest rate environment.

2. What happens in the next three years?Intensive study suggests that it may be possible to writeannuity and LTC combinations within the next threeyears and do so with a 1.75 percent DAC.Consequently the next three years may present a majoropportunity rather than the conventional view of a longholding pattern.

Several designs come to mind that optimize the value ofthe package while minimizing the cost.

Designs will have to be true to distributor circum-stances, in that packaging annuities and long-term caremust address the sales process reality. Said another way,if the annuity representative is one who sells annuitiesmuch the way mutual funds and similar instrumentsare sold, don’t expect such reps to agree to underwritingof the LTC risk. Folks, it generally won’t happen.Creative design and non-intrusive rapid underwritingalternatives will have the primary role.

3. What impact does the law have on existing business?

The new law will apply to business previously writtenunder HIPAA, so that companies will have to modifysystems for such business. The changes will need to beeffective beginning Jan. 1, 2010.

4. What impact does the PPA have on immediate annu-ities?

A review of the law and intensive analyses with otherknowledgeable parties suggest that the favorable provi-sions of the PPA may well apply to immediate annuitiesthat contain qualified long-term care components.Specifically, the favorable tax treatment of benefits mayapply to payments under properly structured immedi-ate annuities.



Issue 28

The law ought to be a major impetus to theimmediate annuity business, as it enables sig-nificant flexibility in the amount of the pay-ment as circumstances warrant, in factdemand, flexibility.

Small Company ConsiderationsWe know from focus groups that individuals inthe pre-retirement to recently retired years arebewildered by the financial decisions they needto address around retirement. They recognizethey have one bucket of financial assets, but mul-tiple needs to address with that one bucket. Howdo they allocate their funds wisely?

It is logical, although by no means pre-or-dained, that a product that addresses two or moreconcerns at the same time will get a favorablehearing. So life and LTC combinations, deferred annuity and LTC combinations, and immediateannuity and LTC combinations, all potentiallyfill a real need, and the sound designs may wellturn out to be successful.

These vehicles offer a smaller insurer the op-portunity to participate more fully in marketsthat address the needs of near retirees and re-tirees, a market that is growing immensely.

Here are a few observations to keep in mind:

1. Life Issues—Keeping the design relativelysimple will not necessarily put you at a disad-vantage against standalone LTC offerings.

Addressing administrative issues to mini-mize complexity and identify workable solu-tions is critical. Consider doing a feasibilitystudy to address administrative issues, in-cluding interaction with claims units. In fact,a feasibility study should address the wholerange of issues that a company will need toaddress. Such a feasibility study should de-velop sufficient information to allow seniormanagement to make a knowledgeable,measured go/no-go decision whether to pro-ceed with development.

Here are some additional considerations:

a. A per diem approach is easy to under-stand and much easier to administer.

b. On the life side, limiting the accelerationoptions to one or two percentages shouldbe more than adequate.

c. An inflation feature would be desirableduring the acceleration phase. Such afeature would address what would other-wise be comparison shortfalls with thestandalones.

d. An extended benefit rider that pays outLTC benefits should the life policy befully accelerated is attractive.

e. A residual term element that promisesthere will always be a minimum deathbenefit to pay final expenses is attractive.

f. Consider limiting underwriting to onestandard class (or at least very few.) Onedoes not need the range of classes avail-able on life products.

g. If your company does not offer LTC al-ready, consider working with an externalvendor to provide claims review, both attime of initial claim and at periodic review. There is no need to build a rela-tively high fixed-cost claims unit.

h. Making sure the policy values are appropriately adjusted for acceleration,including tax-related items such asguidelines, is critical. Quality actuarialspecifications provide needed precisionand minimize, if not eliminate, costly redo’s.

2. Deferred Annuity Issues—Simplicity reigns here as well. A feasibility study isequally critical.

a. Per diem approach.

b. The LTC amount should be structured interms of a benefit base. One approach is tohave an increasing benefit base, startingfrom a negligible level. This minimizesunderwriting need and initial anti-selec-tion concerns. Another approach mighthave a more level benefit base. In eithercase, but especially in the latter, one mightwant to consider a no-benefit period of xyears (e.g., x is three or five or …) (Ofcourse, care must be exercised that thestructure complies with the PPA.)

c. A further note on the benefit base: It ispossible to control the net amount ofLTC risk by careful structuring of the

benefit base. This may be particularlyimportant to smaller entrants.

d. Underwriting should be limited. A keywould be to screen for cognitive impair-ment in a rapid yet effective manner.

e. Surely consider the use of an outside vendor here if you don’t offer standaloneLTC.

3. Immediate Annuity Issues

a. Per diem approach.

b. As an example, the LTC benefit basewould be the sum of the (usual) annuitypayment plus an additional payment,and would be payable for x years. (x could conceivably be for life, but could be two, three or five years, moretypically.)

c. Care will be required to deal with exclu-sion ratios properly.

d. The LTC contingency acts at cross pur-poses to the longetivity risk. This maylimit the underwriting need.

e. Outside vendor for claims.

In conclusion, the confluence of market needresulting from the aging of America and thechanges in tax law due to the Pension ProtectionAct have created major opportunities for insurers of all sizes to address the needs of theircustomers. n


The Smaller Insurance CompanySection will sponsor four sessions at the2007 SOA Annual Meeting to be held

at the Marriott Wardman Park Hotel inWashington, D.C. on October 14-17, 2007.The tentative schedule includes the following sessions.

The Future of Smaller InsuranceCompaniesThe first session will be a general session on thefuture of smaller insurance companies. Comehear the presenters as they gaze into their crystalballs and relate what they believe are the defininginfluences for smaller insurance companiestoday. Who will survive the next 10 years? Howwill they do it? What needs to be done now to en-sure long-term survival of smaller insurancecompanies?

Intercompany Expense StudyYour section is jointly sponsoring a session on theIntercompany Expense Study with the ProductDevelopment Section. This session will provide aforum for current and prospective contributors,as well as users of the studies, to share informa-tion, voice their opinions and make recommen-dations for future work. This annual study hasprovided useful expense information to compa-nies for the last five years. The SOA CompanyLife Insurance Company Expense Committee isalso responsible for the annual development ofthe GRET table. Discussion regarding how thesetwo efforts are interrelated is expected.Exchanges on how they might be used to supportPrincipal Based Reserving for product develop-ment purposes is also anticipated.

Enterprise Risk ManagementEnterprise Risk Management is a current hottopic. How can the smaller company develop thenecessary tools and strategies that will benefit

them from incorporating risk managementstrategies? Come hear how smaller insurancecompanies are incorporating these ideas intotheir operations.

Anything Goes!And finally, we’ll host our popular session whereyou can discuss with your peers some of the cur-rent issues that smaller insurance companiesuniquely face. Some of the topics include the lat-est on principal based reserving, reasonable rein-surance access and how the new preferredmortality and 2001 CSO tables will affect prod-uct development during the near term.

In addition to these four sessions, the sectionwill be hosting a hot breakfast on Tuesday, Oct. 16. Attendees will have an opportunity tonetwork and enjoy a hot breakfast in an informaland casual atmosphere. A short presentation onthe Section Council activities of the past year willbe provided along with the introduction of newSection Council members. There will be time forattendees to voice their concerns and issues tocouncil members to help direct section activitiesover the course of the following year.

There are openings for speakers and modera-tors for many of the sessions. If anyone has an in-terest in speaking at the meeting they can reachme at my e-mail address.

Hope to see you in Washington, D.C. in the fall. n

Smaller InsuranceCompany Sectionto Sponsor FourSessions at AnnualMeetingBy Leon L. Langlitz

Leon L. Langlitz, MAAA,

FSA, is a vice president

and principal with Lewis

& Ellis Inc. in Overland

Park, Kan. He also serves

as the smaller insurance

company annual meeting

representative.

Langlitz can be reached

at llanglitz@

lewisellis.com.




Issue 28

At the 2006 SOA Annual Meeting, the first proto-type of the Actuarial Value Ladder was sharedwith the members of our profession. The con-

cepts of this professional development tool are being incor-porated in our 2007 Spring and Annual Meetings to assistattendees planning their sessions.

The Actuarial Value Ladder is a project of the SOAMarketplace Relevance Strategic Action Team (MRSAT)led by Chair Dan McCarthy. This career path tool articu-lates the value of the contribution actuaries can make and

the competencies required across a full range of profession-al roles. As it matures, the Value Ladder becomes a power-ful means to communicate with employers on theimportance of the profession, as well as a way to assist actu-aries in self assessment and developmental plans.

Each session at the SOA meetings is aligned to a specif-ic stage on the Value Ladder. As meeting attendees register,they can develop a “conference curriculum” that matcheswhere they are in their careers and where they aspire to be.The Value Ladder identification in meeting brochures,along with section sponsorship information, provides keysfor registrants to ensure they get the most out of any event.

As indicated, the Value Ladder is a prototype. It is beingused at these events as part of a series of “clinical trials.” TheMRSAT will be responding to feedback to improve themodel. Also planned is the development of more specificmodels to correspond to a wider range of actuarial careersaudiences. n

Actuarial ValueLadder: InsuranceMarket ModelBy Meg Weber

Meg Weber is director of

section services at the

Society of Actuaries in

Schaumburg, Ill. She can

be reached at

[email protected].

Iattended the NAIC Spring Meeting heldMarch 9-12, 2007 in New York, N. Y., including meetings of the Life and Health

Actuarial Task Force (LHATF) and selectedmeetings of the NAIC. Summarized below arethe activities that took place at these meetings.

Life and Health Actuarial Task ForceThe LHATF met on Friday and Saturday (ratherthan Thursday and Friday) under the newly in-troduced, more concentrated NAIC meetingschedule format. Larry Bruning (Kansas) chairedthe meeting because Mike Batte (Arizona) wasunable to attend.

The following Principles-Based projects andrelated matters were discussed.

1. Overview from Academy PBR SteeringCommittee: Donna Claire, chair, Life RiskManagement and Financial SoundnessCommittee of the Academy, gave a generalpresentation related to its oversight of vari-ous PBR projects and work groups. She re-viewed a PBA Master Project Sheet whichlays out the various project timelines and de-liverables. Highlights are provided below.

- NAIC Life RBC Working Group: Whilenot meeting at this NAIC meeting, it wasnoted that the life product RBC propos-al, C-3 Phase III, is nearing final stages inmany respects.

- Reinsurance Work Group: SheldonSummers chairs this Academy groupthat is reviewing all PBA documents andproposals for reinsurance considera-tions.

- Governance Work Group: Helen Galtchairs this committee that is working onchanges to corporate governance to accommodate PBR.

- Accounting Practices Work Group:William Hines chairs this group that isconcentrating on Blanks changes required for PBR.

- Economic Scenarios Work Group: Thisproject is nearing completion, which isexpected by June, 2007. More detail isprovided later in this report.

- Consistency Work Group: This workgroup released a new set of clarified prin-ciples designed to cover both reserve andcapital considerations. It is also workingon a glossary of terms and standardizedreporting formats for assumptions.

- Annuity Reserve Work Group: Thiswork group is identifying all annuityrisks, focused on consistency betweenannuities and life, which risks should beconsidered in reserves and which aremore appropriate for capital. It is in theprocess of comparing modeling resultsfor five commonly used modeling sys-tems marketed by vendors. The finalwork product will be a reserve proposalfor fixed annuities.

In summary, the goal is to create a frameworkthat provides for reasonable reserve and cap-

ital levels without stifling the life and annuitybusiness.

2. Academy Life Reserve Work Group(LRWG): A presentation was provided byDavid Neve, co-chair on recent develop-ments of LRWG and by Gary Falde, chair ofthe LRWG Asset Subgroup related to deriva-tives modeling.

David Neve indicated that the reserve modelregulation and draft actuarial guidelines AG-PBRVAL and AG-DIS have been incorpo-rated into a single document for theValuation Manual. The new document willsimply be called a life reserves Requirementsdocument. Consistent formats will be usedfor all requirements sections of the ValuationManual. The following items were high-lighted.

- C-4 risks not specific to product are excluded.

- All risks must be considered and docu-mentation is to be provided for why a riskwas not considered.

- Principle 5 places emphasis on the aggre-gate margin even though there still willbe a requirement for margins on each as-sumption, unless it can be demonstratedthat there is a correlation between as-sumptions to justify an aggregate marginacross more than one assumption.

Highlights of theMarch, 2007 NAICLife and HealthActuarial Task ForceMeeting and OtherNAIC TopicsBy Ted Schlude, Jr.




Issue 28

- Scope Section was eliminated, as it will beaddressed elsewhere in the ValuationManual. This leaves open alternative ap-proaches to PBA such as “PBA Lite” andphase-ins for certain products.

- Experience Reporting Section: was elimi-nated because it is included in theValuation Law changes.

- Terminology was modified as follows to address lia-bility concerns:

1) from “Prudent Best Estimate” to “PrudentEstimate”

2) from “Best Estimate” to “AnticipatedExperience”

- Credibility Method: the reference to the Canadianmethodology was dropped in favor of “X prof-itability of Y margin for error” where X and Y will be established by the NAIC.

- Provision for Model Understatement (PMU): Thisis a new concept intended to get at uncertainty re-lated to complex models where modeling of deriva-tives is the emphasis. A practice note will developconcepts related to the modeling of sophisticatedderivatives programs. This would be an add-on re-serve after comparison of the deterministic reserveto the stochastic reserve.

- Derivatives Requirements: The requirements havechanged significantly (streamlined).

A summary of outstanding technical issues was provid-ed next. They include:

- Assumption Margins (aggregate or individual,what if experience is lacking, etc.)

- Risks that should be excluded from reserves (a newAcademy document will soon be released).

- Reinsurance issues (non-proportional reinsur-ance/catastrophic coverages).

- Grading period for mortality credibility weighting.

- Margin ratio (Z factor): should it be retained or pos-sibly be transferred to a practice note if it does nothave any value to LHATF?

The priority for LRWG moving forward into 2007 willinclude finalizing technical issues, developing recom-mendations on prescribed elements such as CTE level,interest rate and equity assumptions for the determinis-tic scenario and net spreads on reinvestments, performadditional product modeling and testing, consideritems related to the ACLI/Treasury discussions, reviewexposure draft comments and consider simplified prod-uct approaches.

Finally, LHATF voted to expose the Life Requirementsdraft of the Valuation Manual for comment.

3. Subgroup 4 Report: Norm Hill provided the Subgroup4 report, which is a subgroup of the Valuation Law andManual Team that is addressing transitional issues andpossible approaches to the small company issues raisedin the context of PBR. Three possible approaches arebeing discussed.

(i) Phase-In: Phase in the LRWG requirements byproduct type. Would involve a deterministic re-serve with a test to see if stochastic is required.

(ii) Simplification: Add simplifying elements to theLRWG approach to address small company issuessuch as a Gross Premium Reserve with provision forrisk added.

(iii)PBA Lite: Develop a “PBA Lite” approach outsideof LRWG that meets PBA principles.

4. Economic Scenarios Work Group: Larry Gorski pro-vided an update on the refinements made to the interestrate model generator. As a result of the re-parameteriza-tion project the long rate has been revised from 5.4 per-cent to 5.5 percent (it was 6.55 percent in old interestrate model generator). Now the group has been workingon a formula to dynamically update the target long rate.

The interest rate generator would be used for C-3 PhaseI, C-3 Phase II and the PBR/PBA model. There will nolonger be a 50/12 scenario option under C-3 Phase I. Asa result, the Annuity Reserve Working Group has been

Provision for Model Understatement (PMU): This is a new concept intended to get at uncertainty related to complex models wheremodeling of derivatives is the emphasis.



Reymond Ted Schlude,

Jr., FSA, MAAA, is a

consulting actuary with

Milliman Inc. in Chicago,

Ill. He can be reached at

ted.schlude@

milliman.com.



looking at ways to speed up the run time process undera more robust stochastic framework and may be devel-oping a Practice Note along these lines.

5. Report of the SOA Project Oversight Group (POG)on the Preferred Mortality Project: Larry Gorski pro-vided a brief update on the preferred mortality projectof the SOA. There will be four to six nonsmoker tablesand two to three smoker tables differentiated by sex.Tables will be prepared with and without margins andthe LRWG will develop a proposal for how the tableswill be chosen and used. It was noted that there is a lim-ited amount of data with respect to the underwritingscoring system currently, but as more experience comesin, this mechanism will become more predictive.Finally, he shared some mortality statistics from thestudy categorized by underwriting score.

6. AG VACARVM: Tom Campbell, representing theAcademy, provided a summary of proposed changes tothe September 2006 exposure of AG VACARVM.Because LHATF is in the process of surveying compa-nies related to AG VACARVM reserve results, they de-cided not to expose this new draft document becausethe changes may create questions with respect to someof the responses. Rather, LHATF will work on the newAG VACARVM draft during conference calls and thenexpose a new AG VACARVM document after the sur-vey responses have been received.

The ACLI requested that AG VACARVM be written tokeep reserves and RBC as consistent as possible. Theyalso indicated that describing the reserve as a determin-istic standard scenario reserve plus an add-on equal toany excess of the stochastic result over the standard sce-nario is helpful for tax reserve purposes. They also indi-cated that they view the actuarial certification ascomprehensive enough and that a separate manage-ment certification does not appear to be necessary.

New York expressed concerns over recent conclusionsof the C-3 Phase II Results Subgroup regarding the vari-ance in assumptions by company and lack of completedocumentation. They indicated that C-3 Phase II capi-tal levels may be low due to the reserves that have accu-mulated under AG 39 and are not convinced thatdynamic hedging will work when it is needed the most,preferring hedges up front using long dated options.

7. Update on SVL II and Valuation Manual: Dave Neveprovided a report for Mike Boerner (Texas) who wasnot in attendance, summarizing recent developments.Four subgroups are working on the Valuation Law andManual. A description follows.

Subgroup 1. PBA review requirements for manual.Thus far an introduction and princi-ples-based preamble have been written.

Subgroup 2. Working on reserve requirements,AP&P Manual coordination, etc.

Subgroup 3. Working on requirements for submit-ting experience data.

Subgroup 4. Working on transitional and alterna-tive approaches with a focus on smallcompany issues (report provided previously).

Regulators had a discussion related to the selection ofthe PBA reviewer and their responsibilities. TheAcademy recommended that the company choose anindependent PBA reviewer. Some states believe that thestate must select the reviewer to maintain balance andmeet its responsibilities related to statutory valuation.Some regulators were also uncomfortable that the PBAreviewer was only opining on the judgment used by thevaluation actuary related to PBR and not reviewingbasic model validations. The Academy responded thatit was their view that model accuracy should be part ofthe examination done by the auditors and state examin-ers, not the PBA reviewer.

One other issue came up related to the cash value floorrequirement and whether or not it should be written di-rectly into the Valuation Law rather than in theValuation Manual. Several states appear to prefer an explicit CSV floor in the Valuation Law itself.

The ACLI asked that regulators hold a separate generalmeeting to discuss the conceptual framework and de-cide upon the general purpose of reserves and capitaland will also bring this up at the Executive Committee’sPBR Working Group meeting.

8. Non-forfeiture Law Improvement Project: JohnMacBain, chair, provided the Academy report that in-cluded a review of the report provided in December,2006 related to a set of principles for non-forfeiture thatinclude:- Based on pre-funding of benefits.- Specify a broad methodology not amounts.- No recognition of subsequent changes in insurabil-

ity status should be reflected in non-forfeiture.- Cash does not need to be paid.- Same method for life and annuities.- Non-guaranteed elements would not be regulated

until credited or charged.



Issue 28

He then asked LHATF to review and answera set of questions that were distributed at themeeting related to their views on certain keyissues.

9. SOA Experience Study Reports: The SOAgave presentations on several projects dis-cussed below.

- Pre-need Mortality Study: LHATFheard a report from Professor JayVadiveloo, related to the results of thepre-need research and experience stud-ies. The study included consideration offive-, 10- and 15-year select periods, sin-gle versus five pay, males versus femalesat various pivotal ages. Their recommen-dation is as follows:

- Split table into Male versus Female.- Five-year select period is appropriate

for pre-need.- Extended table to issue age 99, at-

tained age 104.- Below age 50, there is little data so

smoothing and trending methodswere used.

- Reverse select and ultimate periodhas much higher mortality than 80CSO. Ultimate is surprisingly closeto 80 CSO (females crossover, malerates stay above 80 CSO).

- No margins have been developedyet.

An Appendix to the presentation providesthe five-year select and ultimate qx’s. Nextsteps include: 1) margins to be added by theJune 2007 NAIC meeting, 2) the Academysignoff review, and 3) adoption of the tableby the states. Targeted implementation is1/1/2008 when the 2001 CSO Table will bemandatory for tax reserves and is viewed asan inadequate table for pre-need business.

- SOA Pandemic Study: Larry Gorski in-dicated that the SOA plans to have a LifePandemic Study completed by June2007 and work will begin on a HealthPandemic Study.

- Cancer Table Update: There has been astanding request from LHATF to update

the 1985 Cancer Table, but to date onlyfive companies have agreed to partici-pate. Regulators will contact cancercompanies in their state to try to encour-age them to participate in this table up-date.

At its second meeting, LHATF discussed thefollowing topics.

1. A&H Working Group: The A&H WorkingGroup received a presentation from theAcademy’s State Long-Term CarePrinciples-Based Work Group related toPBR for Long-Term Care products. It wasnoted that mortality, morbidity, lapses andinvestment returns make PBR for LTC morecomplicated than for life and annuities. Keyconcerns to be addressed include:

- Lack of systems for PBR on LTC prod-ucts.

- Reflection of the potential for future rateincreases in PBR.

- LTC product and marketplace changes.- Probability distributions for morbidity

and persistency assumptions.- Use of company and industry experience.- Anticipated limits on interest rates.

A Technical Subgroup is in the process of de-veloping a model to test different approachesand analyze results. The Issues Subgroup isconsidering how to define risk margins,studying statistical distributions of claims,monitoring life developments and interna-tional developments and considering theability to develop a morbidity table for use inPBR. Bill Carmello (New York) indicatedthat margins should be on individual as-sumptions unless it can be demonstratedthat assumptions are correlated, similar tothe direction of the LRWG.

Other items discussed include work on newguidance with respect to the actuarial opin-

ion for the Health Blank where currently theonly guidance is in the instructions to theHealth Blank, but there are no model laws orregulations defining qualified actuary, ap-pointed actuary, actuarial report, etc.

Also in June, 2007, a small workgroup willpresent a report to A&HWG on its conclu-sions related to the individual medical mar-ket and possible methods to analyze renewalrates by health insurers.

2. Group Term Life Waiver Table: The pro-posed group term waiver basic table and val-uation table with margins is in the process ofbeing reviewed by the Academy from a re-serve margin and policy issues standpoint.

3. Referral From Risk Assessment WorkingGroup (RAWG): LHATF is beginning toconsider the role of the actuary in a RiskFocused Examination Framework at the re-quest of the RAWG. The result is that exam-ination focus will likely extend into areasother than valuation, such as pricing. A sim-ilar request has been made of the CasualtyActuarial Task Force.

4. Actuarial Guideline TAB: Discussion con-tinues on AG TAB which would provideguidance with respect to the use of the 2001CSO Preferred Mortality Tables. The ACLIis continuing to address concerns on the partof regulators as to how a company goes aboutjustifying the use of a preferred table for re-serve valuation purposes.

5. Reinsurance Reserve Credit Proposal:LHATF, in conference call prior to this meet-ing, sent a letter to the Statutory AccountingPrinciples Working Group (SAPWG) thatstates that they could not reach a consensuson the reserve credit issue raised byCalifornia and New York. At its meeting on

The Issues Subgroup is considering how to definerisk margins, studying statistical distributions ofclaims, monitoring life developments and international developments and considering theability to develop a morbidity table for use in PBR.





March 10, 2007, the SAPWG rejected the Californiaproposal. This issue may be brought back to theEmerging Accounting Issues Working Group for fur-ther consideration.

6. Other Matters: LHATF discussed the following items.

- NAIC Statistical Agent for PBR: LHATF is consid-ering what an appropriate NAIC statistical agentwould be.

- Patents on Life and Annuity Products: An NAICstaff member noted a National Underwriter Articleon patents that are being obtained on life and annu-ity products. The question is whether or not patented processes should be regulated becausethey might result in non-competition.

- IAA Risk Margin Paper: It was noted that KrisDeFrain of the NAIC has written a four-page summary of the IAA risk margin paper.

Principles-Based Reserving (Ex) WorkingGroup (PBRWG)Topics discussed by the PBRWG included its rules of oper-ation, Academy presentations, an ACLI comment letter,and the PBA Master Project Sheet.

The working group adopted its draft rules of operationthen discussed various Academy PBR projects and interac-tions between the PBRWG and the AAA. The Academy’skey 2007 deliverables include the Valuation Manual, SVL,integration of PBA into the examination structure, corpo-rate governance, life reserve requirements, timeline and re-quirements for RBC and development of a timeline forannuity reserves.

Policy issues for PBRWG to consider include the possi-ble use of prototyping (bringing in PBR on a product levelbasis), determining the purpose of reserves in PBR, consid-ering statistical agents and data collection issues, and to de-velop a feedback loop for companies, reviewers andexaminers. PBRWG also discussed the Academy MasterProject Sheet and where regulatory input will be needed.One regulator indicated that C-3 Phase I and II feedbackneeds to be incorporated, others said that the SAPWGneeds to be in the flow. The NAIC will map out its commit-tee responsibilities and provided feedback to the Academy.

Next, the working group discussed an ACLI letter thatrequests the PBRWG to develop some overarching princi-ples and develop a project plan and timeline so the industrycan begin to prepare for PBR. Other questions posed in-cluded consistency with international standards and the

concept of an acceptable peer reviewer from the state’sstandpoint. Regulators indicated that the internationalconvergence issue is bigger than a PBRWG responsibilityand other groups in the NAIC will be working on and mon-itoring convergence.

Finally, the standardized forms for reporting assump-tions, experience and statistical agents were discussed. Itwas noted that 15 states are in the process of adopting the2001 CSO Preferred Tables that calls for a statistical agentto compile company submitted experience. The PBRWGwill have LHATF develop a definition of statistical agentand recommend forms for the data collection.Requirements for a statistical agent will include maintain-ing confidentiality, significant IT infrastructure, ability toperform experience studies, etc.

Capital Adequacy Task Force (CADTF)I attended two meetings related to the Capital AdequacyTask Force.

1. CADTF Meeting: The following projects were dis-cussed.

- Life RBC WG:This working group did not meet atthe Spring NAIC meeting, but has scheduled threecalls in March/April to discuss C-3 Phase III (3/30),C-3 Phase II (4/13) and C-3 Phase I (4/20). Face-to-face meetings will be scheduled for June andDecember, 2007 at the regular NAIC meetings.

- P&C RBC WG: One item of note relates to theRBC charge for state deposit funds. There is a 1 per-cent C-1 charge in addition to the normal C-1charge for non-controlled assets in the P&C blank.The blanks had recently been changed to isolatestate deposit funds because they tend to be veryilliquid and are not available to a regulator to payclaims generally, because each state refuses to relin-quish its deposit funds in a rehabilitation or liqui-dation. The industry argued that the 1 percent riskcharge was inappropriate because there was littledefault risk related to these deposits. One regulatorsaid that based on his experience; there should beeven a higher charge to reflect the illiquidity ofthese assets. Other regulators felt that a liquidationcharge does not belong in C-1 and that morethought needs to be given to this matter.

- Securities Lending Programs:CADTF next heard apresentation from Prudential related to the C-1charge of 1.3 percent Life (1 percent P&C) for se-curities lending programs and the fact that such acharge does not reflect the low risk of such pro-



Issue 28

grams. Prudential indicated that it hasnot had losses since it got into the securi-ties lending business in the 1980s and itis viewed today as essentially a risk-freetransaction. A regulatory study groupwas formed (Calif., N.Y., Conn., Neb.)to discuss the questions and issues. MET,Prudential and Genworth were identi-fied as the major companies involved insecurities lending. Wisconsin askedwhether or not there is some operationalrisk charge that should be reflected relat-ed to monitoring that the appropriatelevel of collateral is being maintained bythe borrower (collateral requirementsare 102 percent of market value). The in-dustry interested parties will present aproposal to replace the off-balance sheetcharge for securities lending with a rein-vestment risk charge associated with therestricted capital by May, 2007 forCADTF to consider.

- Mortgage Experience AdjustmentFactor (MEAF): Next, CADTF heard apresentation from TIAA-CREF relatedto the MEAF. Due to a single foreclosure,TIAA had a significant increase in RBCand was looking to CADTF to considersome of the newer software models avail-able in the industry today that measuremortgage portfolio risk.

They argued that the NAIC approachwas developed prior to these better soft-ware risk measurement tools and only re-flects the company’s aggregateexperience compared to industry-wideexperience but does not capture the riskinherent in the company’s in-force mort-gage portfolio.

Because this is mainly a life companyissue, the Life RBC Working Group willdecide whether to consider this issue.One regulator again commented thatitems like the MEAF or securities lend-ing program always seem to reduce baselevel RBC and perhaps considerationshould be given to increasing the NAICCompany Action Level given that mostchanges to the formula have resulted inlower capital requirements.

- Agenda for 2007: CADTF reviewed itsagenda for 2007 and noted that the C-3Phase II subgroup will be recommend-ing changes to C-3 Phase II mainly in thearea of the documentation requirementsgenerally, which they felt was somewhatlacking based on the 2005 year-end re-view that was performed. They will alsobe looking at sensitivity results to reviewthe effectiveness and value of theStandard Scenario. In the second quarter2007, the subgroup will review the 2006year-end C-3 Phase II results. TheMEAF and securities lending issues willbe added to the agenda and priorities forthese items will be set. CADTF will alsokeep track of the REO Proposal in lightof the unauthorized reinsurer topic on itsagenda (that addresses whether or notRBC credit for unauthorized reinsur-ance should be collateralized similar toreinsurance reserve credits).

2. Hybrid RBC Working Group:This workinggroup heard a report from Nancy Bennettrepresenting the Academy related to progresson the long-term solution to hybrid securityRBC. The Academy is working with interest-ed parties to better classify the risks andstructures of hybrids. They have received apresentation from Merrill Lynch on tradi-tional hybrids and have heard a presentationfrom the SVO on its view. However, experi-ence data is lacking and some newer classes ofhybrids are emerging as well. Preliminarythoughts of the Academy include:

- Hybrids should be viewed as debt instru-ments.

- NRSRO ratings do not capture all risk,but extension risk is captured somewhatin C-3 Phase I and in the charge forcallable securities in the C-3 interest raterisk framework.

- More understanding of the new hybridmarket is needed.

- Extension risk: needs to be studied be-cause there are other securities such ascollateralized debt and mortgage obliga-tions and other investments with exten-sion risk that is not currently beingcaptured in RBC. RBC is a relativelyblunt instrument and does not address alltypes of security structures so the requestwith respect to hybrids is somewhat in-consistent with the way these other secu-rities are handled.

NAIC General Session / Executive(EX) Plenary / Life (A) CommitteeMeetingsAt the general meeting session, Eric Dinello, superintendent of New York who was recentlyappointed by Elliott Spitzer, highlighted key issues that the New York department would beaddressing:

1. Regulation: will be more robust in the future.Principles-based regulation and reserving willrequire it.

2. Contract certainty: He observed that issuesrelated to contract certainty that arose as a re-sult of 9/11 will be addressed, noting that theissue of contract coverage has been solved inLondon already.

3. Transparency in the brokerage community

4. Collateralization in U.S. reinsurance

5. Suitability

6. TRIA

7. Licensing: best practices

8. Medical malpractice: is broken in New York.

9. Worker’s compensation: a change in NewYork law is resulting in improved benefitsand lower cost.

The Academy is working with interested parties tobetter classify the risks and structures of hybrids.





10. Universal health care: It has happened inMassachusetts, California and Vermont and will hap-pen in New York.

11. 49/1 Project: New York wants to work to become an ac-credited state by the NAIC. Currently, it is the onlystate that is not accredited because of its deviations fromNAIC model laws and regulations, even though it isviewed as a strong state from a regulatory perspective.

The Executive/Plenary Committee received various reports, some of which are highlighted below.

1. Life and Annuity (A) Committee report: Jim Poolmanrecommended that EX/Plenary send the ViaticalSettlements Model Revisions back to the Life (A)Committee for some changes related to a conflict be-tween the model revisions and the National Bank Actand G-L-B with respect to assignments of insurancepolicies as collateral for loans by banks and savings andloan institutions. It is anticipated that a revised modelwill be available for EX/Plenary to adopt in June 2007.Various commissioners voiced a desire to adopt theViatical Model revisions as soon as possible to stop per-ceived STOLI abuses.

2. Financial Condition (E) Committee: It was noted thatthe Financial Condition (E) Committee in December2006 adopted the SVO report on transparency as wellas the AAA work plan on hybrid security RBC and gavethe Reinsurance Task Force two new charges related tothe Reinsurance Evaluation Office (REO) proposal.

3. Special EX Committee project update: Several proj-ects were discussed.

- Military sales: A Model Regulation draft was issuedFebruary 2. A second draft will be released in thenext couple of weeks with adoption anticipated inJune 2007. A report will be given to Congress onMarch 29th and there is a meeting scheduled withthe Department of Defense regarding progressmade by the NAIC in this area.

- Broker activities: Work continues with respect tocertain practical hurdles in getting companies andagents to agree to disclosure of commissions.

- Government Affairs task force: This task force wasrenamed the Government Relations LeadershipCouncil (GRLC) and will be made up of seniorNAIC officers and zone leaders to consider key issues.

- Principles-Based Reserving (EX) task force: It wasnoted that this group will become more active in2007 as discussed previously in this report.

The Life Insurance and Annuity (A) Committee metand discussed the following topics.

1. Consumer Buyer’s Guides charge: The buyer’s guidesfor annuities and life insurance will be revised in con-junction with the respective disclosure model regula-tion revisions. The viatical settlements brochures willbe reviewed as well.

2. Foreign travel exclusions: A contentious discussion re-lated to the revisions to the Unfair Trade Practices Actand foreign travel exclusion took place. The concept isthat past or future lawful travel not be used arbitrarily asan underwriting factor without support by actuarialrisk analysis. In an amendment proposed by Alabama,an underwriting practice filing requirement for foreigntravel was eliminated from the revisions at the objectionof Florida one of the main sponsors. The document willbe discussed further at the next meeting.

3. Viatical settlements model: It was noted that themodel revisions (to address Stranger Owned orInitiated Life Insurance) will come back to the Life (A)Committee for a quick revision related to G-L-B andthen go back to EX/Plenary in June 2007 for adoption.

Accounting Practices and Procedures TaskForce and Related MeetingsI attended several other meetings related to certain account-ing issues described below.

1. Emerging Accounting Issues Working Group(EAIWG) and Statutory Accounting PrinciplesWorking Group (SAPWG): SAPWG heard a reportfrom Larry Bruning of LHATF related to Principles-Based Reserves. Currently, a capital structure is in placefor variable annuity GMDB/VAGLB risk. Reservingfor VAs is close. Proposals for life reserves and capital areclose to being finished as well. The A&H WorkingGroup heard a report on LTC PBR and there is anAnnuity Reserve Work Group working on reserves forfixed annuity products.

Key issues will include:

- Phasing-in requirements for different producttypes will be a long range goal for a principles-basedmethodology to work for all business.



Issue 28

- Who hires the reviewing actuary? (com-pany or state)

- Delegation of state authority to a cen-tralized Valuation Manual (are stateswilling to give up power?)

- Corporate governance issues

Future updates on PBR for SAPWG will beprovided as necessary.

Secondly, the SAPWG rejected a proposal toconsider the reinsurance credit issue on poli-cies where reinsurance premiums are paidannually but the underlying policy mode ismore frequent than annual. This creates aperception by certain states that reserve cred-it is overstated by the ceding company insuch an instance due mainly to the net valua-tion premium exceeding the gross premium.It appears that this issue may be brought backto the Emerging Accounting Issues WorkingGroup to consider these issues further.

2. Financial Regulation Standards andAccreditation Committee: This committeeadopted updates to the Blanks instructions,RBC instructions, SVO Purposes andProcedures Manual and the AccountingPractices and Procedures Manual. It exposedfor 30 days changes to the FinancialCondition Examiners Handbook related tothe risk-focused examination review teamguidelines and the Model Audit RuleRevisions for best practices with respect toauditor independence, internal controls andcorporate governance. The timeframe for theModel Audit Rule Revisions was acceleratedfrom a 1/1/2011 normal effective date to1/1/2010 because of the importance of theserevisions that incorporate certain aspects ofSOX, deemed appropriate for insurers, intothe NAIC Model Audit Rule.

Valuation of Securities Task ForceUnder other matters, the VOS Task Force heardobjections from various industry groups relatedto an SVO research report on the hybrid securitymarket that the industry characterized as mis-leading. The SVO report focused on the impactof SVO actions related to its classification of hy-brid securities. Turmoil in the marketplace wascreated on March 15 when the SVO classified a

hybrid security as equity. This caused a signifi-cant decrease in the value of hybrids generally (es-timated at about $1 billion), as well as a decreasein the ability to liquidate the securities for a tem-porary period until the NAIC implemented itsone notch down preferred stock classification,short-term solution for financial reporting andcapital requirements. The SVO report focusedon two points in time March 1 and Oct. 1 inreaching its conclusions related to market im-pact, ignoring what happened on March 15. Theindustry re-emphasized the importance of trans-parency with respect to the SVO rating process.

Other MattersI attended several other meetings that may be ofinterest.

1. Reinsurance Task Force: The ReinsuranceTask Force received presentations from theIAIS and the FFSA (European IndustryUpdate-France) on developments with re-spect to mutual recognition, reinsurance di-rectives, solvency II framework and IFRS IIaccounting developments. The goal of mostof these initiatives is mutual recognitionwithin the EU and promoting new risk man-agement techniques that will lead to marketconsistent valuations without hidden mar-gins in reserves. Prudence would be reflectedin capital margins.

Next, they discussed the FinancialCondition (E) Committee charges related tothe Reinsurance Evaluation Office (REO)proposal that calls for a more detailed pro-posal by the September 2007 NAIC meet-ing. Regulators plan to have a two-dayExecutive Session to begin drafting. The second charge from E Committee is to devel-op a longer range framework for the regula-tion of reinsurance.

2. Risk Assessment Working Group: It wasnoted that the 2007 Examiners Handbookhas been released and it includes the risk fo-cused examination guidance and contains athree year phase-in period. The RAWG iscontinuing to work on defining the actuary’srole in a risk-focused examination, notingthat for P&C examinations, focus historical-ly was on loss reserves but it appears that thisshould be expanded to: 1) corporate gover-nance issues related to the policy for settingloss reserves, and 2) providing for a review ofpricing risk inherent in the premium rate set-ting process.

Work is underway to put the FinancialAnalysis Handbook in sync with the risk fo-cused emphasis now reflected in theExaminer’s Handbook.

The RAWG also discussed the implementa-tion process that includes a formal processfor maintaining the Examiners Handbook(maintenance agenda process) as well as thetraining sessions that are ongoing related torisk-focused examinations.

3. Casualty Actuarial Task Force: Two sum-maries related to international accountingactivities were mentioned: 1) a paper by KrisDeFrain of the NAIC summarizing the IAArisk margins paper, and 2) a paper by AlanSeeley of New Mexico that is a summary ofthe UK General Insurance ResearchOrganization (GIRO) Risk MarginWorking Party Report.

The next NAIC meeting will be held in SanFrancisco in June, 2007. n

The goal of most of these initiatives is mutualrecognition within the EU and promoting new risk management techniques that will lead to market consistent valuations without hidden margins in reserves.


In Table 2 on page 11, we can see another feature of thedata, the level of the ultimate mortality relative to the 1980CSO mortality. Note that the two sets of mortality rates arefairly close below attained age 70, but then the pre-needmortality is lower than the 1980 CSO mortality rates at thehigher attained ages.

Note that both the level and the slope of a mortalitytable affect reserve calculations. With a five-year select pe-riod for both male and female mortality rates, combinedwith the lower level of ultimate mortality than the 1980CSO table, the pre-need male and female basic tables areflatter than the corresponding 1980 CSO male and femaletables. Of course, the pre-need mortality table is unloaded;it is a basic table, not a valuation mortality table. At thetime of this writing, the POG is beginning work on addingmargins to the basic table and will be collaborating with the American Academy of Actuaries in finalizing the valuation table.

Keeping in mind the fact that the pre-need basic mor-tality tables are unloaded, look at Table 3 above which illustrates several sample reserve calculations for single-paypolicies. The Reserve Ratio on the vertical axis is the ratioof the reserves calculated using the pre-need mortalitytable to the corresponding reserves calculated using 1980CSO mortality. The typical pattern is a U-shape that be-gins above 100 percent and then decreases for several dura-

tions before starting to rise again.

Remember that all the above comparisons are to re-serves based on the 1980 CSO table, not to the 2001 CSOtable. The 2001 CSO table is currently required for use fortax reserves beginning in 2008 and for statutory reservesbeginning in 2009. The POG expects to make a recom-mendation to LHATF either before or at the June NAICmeetings. Once this valuation mortality proposal has beenapproved, it will be important to seek state adoption of the new pre-need valuation mortality table as quickly as possible. n


Table 3 - Reserve Analysis for Single Pay

• Actual mean reserves compared to 80 CSO are highest in duration 1 and generally decrease by duration and go below 80 CSO reserves.

• For issue age 75, A/E mean reserves start to increase after duration 6 but stay below 100percent throughout.

• The first year A/E decreases as the issue age increases.• Pre-need mortality above is without margin. Reserves using loaded mortality would be

higher than shown.




Issue 28

Besides developing webcasts and semi-nars, the Product Development Sectionalso sponsors a great deal of research to

meet member needs for information, tools andinsights to help them in their daily practice. Onesuch project underway examines the possibleimpact of the change in premium after the end ofthe level premium period for individual term in-surance products on mortality and lapse experi-ence. A company survey of the top terminsurance writers was recently conducted andthe results are currently being analyzed by aMilliman research team led by Jeff Dukes andKathy Dziedzic. Findings will be made availablein a report to be posted on the SOA’s Web site by mid 2007.

“Stochastic Pricing For Embedded Optionsin Life and Annuity Products” is another projectinitiated by the section and is currently in the be-ginning stages. A formal Request For Proposalshas been issued to find a qualified researcher toexamine the nature of stochastic analysis for embedded options, develop a stochastic pricingmethodology that can be utilized by insurers, illustrate the application of the method and iden-tify implementation considerations. More infor-mation about the project is available at:http://www.soa.org/research/other-research-projects/proposal-requests/research-request-for-proposal-stochastic-pricing-for-embedded-op t ion s - in- l i f e - in surance -and-annui t y -products.aspx

A recently completed section project that isreceiving much attention and was featured in theNational Underwriter is the “SubstandardAnnuities Report.” In this paper, the LIMRAInternational and Ernst & Young authors de-

scribe the substandard annuity products current-ly available in the marketplace, discuss the mar-ket opportunity for these products and theassociated risk management issues of offeringthese products. To view more on this subject,visit: http://www.soa.org/research/life/research-substandard-annuities-report.aspx.

When you have finished reading about substandard annuities, peruse the report on non-traditional guarantee products which containsthe findings of a survey of company practices thatsummarize the various individual life and annu-ity product guarantee features found in the marketplace, their associated risks, the method-ologies used to analyze, quantify, and managethese risks and their impact on policyholder be-havior. This is also available on the SOA Web siteat: http://www.soa.org/research/life/research-non-traditional-guarantees-on-life-and-annuity-products.aspx.

If you would like more information about anyof these projects or are interested in getting in-volved in section-sponsored research or have anidea for a research project that would benefitProduct Development Section members, pleasecontact Ronora Stryker, SOA research actuary, [email protected]. n

Note: This article was originally published in theFebruary 2007 issue of Product Matters! Copyright2007 by the Society of Actuaries, Schaumburg,Illinois. Reprinted with permission.

What’s New InResearch?By Ronora Stryker

Ronora Stryker, FSA,

MAAA, is a staff actuary

with the Society of

Actuaries in

Schaumburg, Ill. She can

be reached at

[email protected].

475 North Martingale Road • Suite 600

Schaumburg, Illinois 60173

www.soa.org

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