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Principles-Based Update - Annuities


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Principles-Based Update - Annuities

SEAC Fall 2008 Meeting

Concurrent Session – Life Insurance

Cheryl Tibbits, FIAA, FSA, MAAA Towers Perrin


Current Status of PBA for Annuities

 Variable Annuities  Reserves

—Actuarial Guideline VACARVM adopted as AG 43 —12/31/2009 effective date

—Replaces AG 34 and AG 39  Capital

—C-3 Phase 2 in place since year-end 2005

 Other Annuities  Reserves

—Component of Valuation Manual (VM 22) —ARWG working on issues papers


 Decision made September 2008, after many years of work

 Redefines CARVM for all variable annuity products

 Focus is on variable annuities with guaranteed death & living benefits

 Deterministic Standard Scenario

 Calculation with prescribed assumptions (drop and recovery)  Similar to but still different than current rules-based calculations

 Stochastic testing

 Conditional tail expectation (CTE 70)

 Reserve is maximum of:  Cash surrender value

 “Basic” reserve using AG 33  Standard Scenario

 Additional stochastic amount allocated back to contract level



 Conceptually similar to C-3 Phase 2; key differences:  Definition of standard scenario

 Limits on revenue sharing

 Fundamental differences related to reserves vs capital — tax

— seriatim vs aggregate  VACARVM further developed

— anticipated experience vs best estimate — prudent estimate vs prudent best estimate — more guidance on assumption setting

 Next steps:

 Planned update to Practice Note

 Comparison (consistency?) of AG 43 and C-3 Phase 2  Implementation!

VA CARVM (AG 43) effective December 31, 2009


Aside: Interim Measures Proposed by ACLI

 In response to “current market turmoil” and perceived redundancy in current reserving / capital requirements

 Proposals for VA:

 Eliminate stand-alone asset adequacy testing for AG 39

 Waive standard scenario floor for C-3 Phase 2 for year-ends 2008 and 2009


Another Aside - Regulatory Perspectives

 Discussion of recent developments / observations on PBA

 With Fred Anderson, NYSID and

 Allen Elstein, Connecticut Insurance Department

 Both are experienced in reviewing C3P2 and other filings


 Did not review any particular companies filings

 Comments are generalized and not focused on any one or set of companies

 Nothing in this summary represents the official guidance or is an official report from either insurance department


Level of Documentation - C3 Phase 2

 Documentation has improved since 2005 LHATF review

 Particularly from large companies

 Some of the improvement has been from regulatory reviews and / or requirements like the NY Special Considerations letter

 View that many companies are looking at this as a regulatory exercise instead of risk management process.

 Additional information / documentation of the following would be helpful:

 Policyholder behavior and hedging assumptions

 Scenario results by benefit type


Assumptions / Margins – Regulatory Perspectives

 Concern about setting assumptions without credible experience

 Example: lapse rates on VAs with guarantees in the money

 Little information about margins provided

 Need more information to help gauge appropriateness of margins used

 Feel that additional detail around assumption setting and margins will be particularly important as more products fall under PBA


PBR for (Non-Variable) Annuities

 Annuity Reserve Working Group tasked with developing requirements

 General approach

 VM 20 (Life reserves)

 Some consideration of VACARVM  Some cases, clean slate

 Developing issue papers for presentation to LHATF

 VM 22 placeholder in Valuation Manual

 Expected scope:

 Annuities to which AG 43 does not apply

 Including Payout Annuities, Longevity Insurance, Structured Settlement Annuities, Traditional deferred annuities Two-tiered Annuities, Market Value Adjusted Annuities, Equity Indexed Annuities, Bond Indexed Annuities, Modified Guaranteed Annuities, etc.

 Expected timing: 2012?


Principle-Based Capital – Market Risks

 Phases of “C3” standards

 C3 Phase I – interest rate risk on fixed annuities

 C3 Phase II – variable annuities with guarantees

 C3 Phase III – life insurance and annuities

 Combination of Life Capital and Annuity Capital Workgroups

 C3 Workgroup (C3WG) formed in June 2008

 Report focused on life at this time but will include annuities as well

 Envisioned in the future that one C3 standard will apply to all products in one standard

 May have some differences by product


C-3 Framework

 Scope applies to all life insurance products in-force  Will expand to cover annuities also

 General framework:

 C3 Amount = A + B + C + D

De minimus Blocks

CTE 90 Stochastic Scenario Calculation

Stochastic Exclusion Test

Other Equivalent Methods


Unmodeled Amount Stochastic Amount Factor Based Amount

Alternative Amount



Good News: May Not Need Stochastic

 Simplifying methods available

 Stochastic Exclusion Test

 Same approach as established by the LRWG

 Reserve adequacy test

 Alternative Amount

 Designed to produce result comparable to CTE90 stochastic result

 Must be demonstrated

 Reserve adequacy test

 Subject to minimums


Stochastic Amount

 Calculated in aggregate over a broad range of scenarios

 Cash flow projections using Prudent Estimate Assumptions for all assumptions not stochastically modeled

 Average of 10% highest (CTE 90) Scenario Amounts for all scenarios

 Policies may be grouped based on actuarial judgment


Determination of the Scenario Amount

 Calculate net accumulated asset amount

 Determined for each segment at end of every future year  Equals starting assets plus accumulated net cash flows  Starting assets must be at least 98% of statutory liabilities  Net accumulated asset amount can be either positive or


 Accumulated deficiency

 Equals the excess of working reserve over the aggregate net

accumulated asset amount at each duration

 Working reserve = cash surrender value (0 if no CSV)  Scenario Amount = Greatest PV of accumulated deficiency


Prudent Estimate Assumptions

 For assumptions not stochastically determined or prescribed

 Anticipated experience plus a margin for uncertainty

 Margins should be consistent with those for reserves

 Assumptions not locked in and based on principles

 Actuaries future expectations based on company experience

 Industry or other data if no credible company experience

 Supported by a documented process to reassess appropriateness in future


Hedging on Life Products – C3P3

 Clearly defined hedging strategy like C3P2

 Must include both costs and benefits

 Note that addition could increase requirements

 New or revised program must be in place (or shadow) for 3 months to lower requirements

 Needs to recognize all risks, costs, imperfections, mismatch

 Can the hedging be implemented / revised in timely manner in tail scenarios?



 Counterparties are assumed to be sophisticated parties

 Assumptions should be based on past practice

 Usual and customary actions under the treaties

 Recapture / termination provisions

 May need to be determined by scenario depending on specific projected experience

 Credit risk

 Assumption is that without known financial impairment reinsurer is projected to perform – handled in C1 risk

 Known financial impairments should be taken into account


Other Items

 No Standard Scenario

 Reinvestment / disinvestment assumptions

 Consistent with company strategy for segment

 Spreads based on actuarial judgment



 Some simplifications for products with immaterial market risk

 Complicated projections for other products

 “If you sell these products, you should be able to understand the risk”

 Big job but worth the effort

 Development of more sophisticated projection capabilities

 Better understanding / management of risk

 Leverage the information in other areas

 Time to start getting ready!!!!


Cheryl Tibbits, FIAA, FSA, MAAA

Senior Consultant

Towers Perrin

3500 Lenox Road

Atlanta, GA 30326

Phone: 404 365 1935

E-Mail: cheryl.tibbits@towersperrin.com


Questions / Comments


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