1 9 8 7 V A L U A T I O N A C T U A R Y H A N D B O O K C h a p t e r I I N S U R A N C E C O M P A N Y S T A T U T O R Y V A L U A T I O N S e c t i o n 1: I n t r o d u c t i o n A s t a t u t o r y v a l u a t i o n of a l i f e i n s u r a n c e c o m p a n y ' s l i a b i l i t i e s is p e r f o r m e d p r i m a r i l y to d e m o n s t r a t e the c o m p a n y ' s s o l v e n c y to its r e g u l a t o r s . E v e r y s t a t e has laws and r e g u l a t i o n s which r e q u i r e an annual v a l u a t i o n and p r e s c r i b e
1
s t a n d a r d s for it. The v a l u a t i o n is n e c e s s a r y for t h e c o n s t r u c t i o n of t h e s t a t u t o r y b a l a n c e s h e e t . This b a l a n c e s h e e t m a y b e u s e d in m a n y u n d e r t a k i n g s -- analysis o f gains and losses b y s o u r c e , d i s t r i b u t i o n o f surplus t o p a r t i c i p a t i n g p o l i c y h o l d e r s , e s t i m a t i o n of a c o m p a n y ' s m a r k e t value, r e v i e w of c a p a c i t y to e x p a n d new b u s i n e s s or o t h e r a c t i v i t i e s , and so f o r t h - b u t it is f i r s t a m e a s u r e o f a c o m p a n y ' s a b i l i t y to m e e t its f u t u r e obligations.
Though laws and r e g u l a t i o n s d e f i n e a l a r g e p a r t of t h e v a l u a t i o n p r o c e s s , t h e r e has b e e n growing r e c o g n i t i o n t h a t a l e g a l s t r u c t u r e is t o o i n f l e x i b l e to b e s u f f i c i e n t b y i t s e l f . I n c r e a s i n g l y , t h e v a l u a t i o n a c t u a r y is b e i n g a s k e d t o u s e his j u d g m e n t to e v a l u a t e risks and e s t a b l i s h s u p p l e m e n t a l l i a b i l i t i e s when r e s e r v e s r e q u i r e d b y law or r e g u l a t i o n are not enough. He is a s k e d to furnish an a c t u a r i a l c e r t i f i c a t i o n in which he opines t h a t the r e s e r v e s and o t h e r a c t u a r i a l i t e m s " m a k e a g o o d and s u f f i c i e n t p r o v i s i o n for all u n m a t u r e d o b l i g a t i o n s of the
See, for e x a m p l e , S e c t i o n s 4Z17, 4Z18, and 4Z34 of t h e N e w Y o r k I n s u r a n c e L a w .
c o m p a n y g u a r a n t e e d u n d e r t h e t e r m s of its policies," and "include provision for all a c t u a r i a l r e s e r v e s and r e l a t e d s t a t e m e n t i t e m s which ought to be e s t ablishe d. "Z
The m e a n i n g of "good and s u f f i c i e n t provision" has e v o l v e d with the role of t h e v a l u a t i o n a c t u a r y . F o r years~ a p r e s e n t v a l u e of f u t u r e obligations b a s e d on s t a t i c a s s u m p t i o n s was t h e m e a s u r e of liability. T o d a y t h e v a l u a t i o n a c t u a r y is e x p e c t e d to c o n s i d e r s e v e r a l " f u t u r e s " w i t h d i f f e r e n t p a t t e r n s of i n t e r e s t r a t e s ; p e r s i s t e n c y , i n f l a t i o n , a n d o t h e r e x p e r i e n c e f a c t o r s . Also, he is e x p e c t e d to c o n s i d e r n o t only p r e s e n t values of liabilities, but c a s h flow p a t t e r n s as well, involving b o t h a s s e t s and liabilities. The s c o p e of t h e v a l u a t i o n a c t u a r y ' s i n v e s t i g a t i o n is expanding.
F o r t u n a t e l y , a body of l i t e r a t u r e and e x p e r i e n c e has d e v e l o p e d . R e g u l a t o r y and p r o f e s s i o n a l o r g a n i z a t i o n s h a v e published m a t e r i a l s ; and a c t u a r i e s p e r f o r m i n g v a l u a t i o n s h a v e e n c o u n t e r e d m a n y p r a c t i c a l p r o b l e m s and found solutions. This h a n d b o o k is i n t e n d e d to be b o t h a c a t a l o g of published m a t e r i a l s and a s u m m a r y of v a l u a t i o n e x p e r i e n c e .
S e c t i o n Z: B a e k ~ - o u n d
H i s t o r i c a l l y , t h e a c t u a r y r e s p o n s i b l e for v a l u a t i o n s has o p e r a t e d within a n a r r o w l y d e f i n e d s t r u c t u r e o f r e s p o n s i b i l i t i e s and duties. For a long t i m e , t h e
Z F i n a n c i a l R e p o r t i n g R e c o m m e n d a t i o n 7 of t h e A m e r i c a n A c a d e m y of A c t u a r i e s : S t a t e m e n t of A c t u a r i a l Opinion f o r L i f e I n s u r a n c e C o m p a n y S t a t u t o r y Annual S t a t e m e n t s .
a c t u a r y m e r e l y had to m a k e sure t h a t the v a l u a t i o n p r o c e s s was p e r f o r m e d a c c u r a t e l y and t h a t the r e s e r v e s e s t a b l i s h e d b y the c o m p a n y m e t t h e m i n i m u m l e g a l r e q u i r e m e n t s . T h e s e minimum r e q u i r e m e n t s w e r e p r e c i s e l y d e f i n e d in t e r m s of p r e s c r i b e d m e t h o d s and s p e c i f i e d i n t e r e s t r a t e s and m o r t a l i t y t a b l e s .
In J u n e 1975~ the NAIC a d o p t e d a r e q u i r e m e n t t h a t the annual s t a t e m e n t m u s t c o n t a i n t h e s t a t e m e n t of a q u a l i f i e d a c t u a r y s e t t i n g f o r t h his opinion r e l a t i n g to p o l i c y r e s e r v e s and o t h e r a c t u a r i a l i t e m s . " Q u a l i f i e d a c t u a r y " was d e f i n e d as a m e m b e r in good s t a n d i n g o f t h e A m e r i c a n A c a d e m y of Actuaries~ or a p e r s o n who has o t h e r w i s e d e m o n s t r a t e d his a c t u a r i a l c o m p e t e n c e to t h e s a t i s f a c t i o n of t h e i n s u r a n c e r e g u l a t o r y o f f i c i a l of t h e d o m i c i l i a r y s t a t e . The s t a t e m e n t of a c t u a r i a l opinion m u s t i n c l u d e a p a r a g r a p h i d e n t i f y i n g the a c t u a r y , a s c o p e p a r a g r a p h b o t h i d e n t i f y i n g t h e s u b j e c t s on which an opinion is to b e e x p r e s s e d and d e s c r i b i n g t h e s c o p e of the a c t u a r y ' s work, and an opinion p a r a g r a p h e x p r e s s i n g his opinion with r e s p e c t to s u c h s u b j e c t s . Among o t h e r things9 the opinion p a r a g r a p h should i n d i c a t e tha% in the a c t u a r y ' s opinion, t h e r e s e r v e s and o t h e r a c t u a r i a l i t e m s are:
. c o m p u t e d in a c c o r d a n c e w i t h c o m m o n l y a c c e p t e d a c t u a r i a l s t a n d a r d s ;
2. m e e t the r e q u i r e m e n t s of the i n s u r a n c e l a w s of the s t a t e of d o m i c i l e ;
. m a k e a g o o d and s u f f i c i e n t p r o v i s i o n for all u n m a t u r e d o b l i g a t i o n s of a c o m p a n y t h a t are g u a r a n t e e d u n d e r t h e t e r m s of its policies; and
. i n c l u d e provision for all a c t u a r i a l r e s e r v e s and r e l a t e d s t a t e m e n t i t e m s which ought to b e e s t a b l i s h e d .
An a c t u a r y u n a b l e to f o r m an opinion should r e f u s e to issue a s t a t e m e n t . If the a c t u a r y ' s opinion is a d v e r s e or q u a l i f i e d , the a c t u a r y should e x p l i c i t l y s t a t e the reason(s) for s u c h opinion.
The a c t u a r i a l p r o f e s s i o n , t h r o u g h the A m e r i c a n A c a d e m y of A c t u a r i e s , has i s s u e d r e c o m m e n d a t i o n s and i n t e r p r e t a t i o n s d e l i n e a t i n g t h e r e s p o n s i b i l i t y of the a c t u a r y in d e v e l o p i n g t h e a c t u a r i a l opinion.
In t h e l a t e 1970s, a n u m b e r of e v e n t s g a v e r i s e to a m o v e m e n t within the a c t u a r i a l p r o f e s s i o n and the r e g u l a t o r y c o m m u n i t y t o e x p a n d and f o r m a l l y d e f i n e t h e r o l e and r e s p o n s i b i l i t i e s of the a c t u a r y who f o r m s the opinion. This e x p a n d e d s c o p e o f t h e a c t u a r y ' s f u n c t i o n has l o o s e l y b e c o m e known as the c o n c e p t of t h e " v a l u a t i o n a c t u a r y . "
The i n c r e a s e d v o l a t i l i t y of f i n a n c i a l m a r k e t s and i n t e r e s t r a t e s and the i n t r o d u c t i o n of i n t e r e s t - s e n s i t i v e p r o d u c t s w e r e p r i n c i p a l f a c t o r s initiating this m o v e m e n t . The v a l u a t i o n laws had o p e r a t e d on the t h e o r y t h a t f l u c t u a t i o n s in i n t e r e s t r a t e s would o c c u r g r a d u a l l y and within r e l a t i v e l y n a r r o w ranges; s o m e c h a n g e s s e e m e d n e c e s s a r y if t h a t t h e o r y no l o n g e r applied. The p r o d u c t r e v o l u t i o n t h a t was taking p l a c e in the l i f e i n s u r a n c e i n d u s t r y and in o t h e r p a r t s o f the f i n a n c i a l s e r v i c e s m a r k e t p l a c e was c h a r a c t e r i z e d b y i n c r e a s i n g l y c o m p e t i - t i v e l o n g - t e r m g u a r a n t e e s . It was f e l t t h a t it was no l o n g e r p o s s i b l e to p r e s c r i b e s p e c i f i c s t a t u t o r y v a l u a t i o n s t a n d a r d s a p p r o p r i a t e for all p r o d u c t s u n d e r all c i r c u m s t a n c e s . A n o t h e r p e r t i n e n t d e v e l o p m e n t during this p e r i o d was an
a c c e l e r a t i o n of s t a t e e n a c t m e n t s of
guaranty
f u n d l a w s for l i f e i n s u r a n c e c o m p a n i e s .T h e s e m a j o r c h a n g e s s u g g e s t e d a p u b l i c - i n t e r e s t n e e d t o assign m o r e r e s p o n s i b i l i t y to t h e a c t u a r y to p r o f e s s i o n a l l y j u d g e t h e a d e q u a c y of r e s e r v e s . This j u d g m e n t should b e b a s e d on an a n a l y s i s of an insurer's risks as o p p o s e d to a m e r e d e t e r m i n a t i o n t h a t r e s e r v e s are a t l e a s t e q u a l to a rigidly d e f i n e d m i n i m u m s t a t u t o r y s t a n d a r d .
This c o n c e p t of the r o l e of the v a l u a t i o n a c t u a r y was a d o p t e d in the U n i t e d Kingdom s o m e y e a r s ago. It was a d o p t e d in C a n a d a in 1978.
S e c t i o n 3: T h e C o n c e p t o f t h e V a l u a t i o n
Acbmry
in t h e U n i t e dKingdom
and C a n a d aIn the U n i t e d Kingdom, the D e p a r t m e n t of T r a d e and I n d u s t r y (DTI), the e q u i v a l e n t of the s t a t e i n s u r a n c e d e p a r t m e n t s , r e q u i r e s t h e a p p o i n t m e n t of an a c t u a r y by the B o a r d of D i r e c t o r s . The a p p o i n t m e n t m u s t b e f i l e d w i t h t h e DTI. The s t a t u t o r y d u t i e s o f t h e a p p o i n t e d a c t u a r y are d e s c r i b e d in t h e s t a t u t e and e l a b o r a t e d on b y the I n s t i t u t e of A c t u a r i e s , t h e m a j o r p r o f e s s i o n a l a c t u a r i a l b o d y in t h e U n i t e d Kingdom. The a p p o i n t e d a c t u a r y is r e q u i r e d to h a v e a c c e s s to t h e Board. The a p p o i n t e d a c t u a r y m u s t p r e p a r e a c e r t i f i c a t e s t a t i n g t h a t l i a b i l i t i e s h a v e b e e n v a l u e d in a c c o r d a n c e w i t h t h e r e g u l a t i o n s , t h a t t h e y do not e x c e e d t h e a s s e t s , and t h a t a p r o p e r a c c o u n t of t h e r e l a t i o n s h i p b e t w e e n t h e n a t u r e and t e r m of t h e a s s e t s and l i a b i l i t i e s has b e e n t a k e n i n t o c o n s i d e r a t i o n . If at any t i m e (including b e t w e e n valuations), t h e a p p o i n t e d a c t u a r y b e l i e v e s : t h a t
p r e m i u m r a t e s for new b u s i n e s s a r e n o t adequate$ t h a t the c u r r e n t i n v e s t m e n t p o l i c y is i n a p p r o p r i a t e ; or t h a t t h e r e is any o t h e r j e o p a r d y to s o l v e n c y , he m u s t m a k e a r e p o r t to the B o a r d of D i r e c t o r s advising p o s s i b l e c o u r s e s of action9 including a l i m i t a t i o n on t h e v o l u m e o f b u s i n e s s t h a t m a y b e a c c e p t e d . If t h e c o m p a n y p e r s i s t s , t h e a p p o i n t e d a c t u a r y m u s t a d v i s e the DTI, a f t e r so i n f o r m i n g t h e c o m p a n y .
In C a n a d a , a f r a m e w o r k which v e s t s r e s p o n s i b i l i t y for v a l u a t i o n in a v a l u a t i o n a c t u a r y a p p o i n t e d b y a l i f e i n s u r a n c e c o m p a n y ' s B o a r d of D i r e c t o r s was i n s t a l l e d in 1978 t h r o u g h m a j o r l e g i s l a t i v e changes. The law does not p r e s c r i b e a s p e c i f i c v a l u a t i o n s t a n d a r d , b u t i n s t e a d r e q u i r e s t h e v a l u a t i o n a c t u a r y to c o n d u c t a v a l u a t i o n of the a c t u a r i a l l i a b i l i t i e s of the c o m p a n y , a p p r o p r i a t e to t h e c i r c u m s t a n c e s o f t h e c o m p a n y . The v a l u a t i o n a c t u a r y ' s c e r t i f i c a t e m u s t b e p u b l i s h e d in the c o m p a n y t s annual r e p o r t , and the a u d i t o r is e n t i t l e d to r e l y on t h e opinion. The v a l u a t i o n a c t u a r y p r e p a r e s a d e t a i l e d r e p o r t ( o f t e n 100 p a g e s or more) for t h e f e d e r a l D e p a r t m e n t o f I n s u r a n c e , outlining all d e t a i l s of t h e v a l u a t i o n . To a r r i v e a t a p p r o p r i a t e a s s u m p t i o n s , t h e a c t u a r y m u s t r e v i e w the i n c o m e - e a r n i n g p o t e n t i a l of t h e a s s e t s and f u t u r e c a s h flow e x p e c t a t i o n s . T h e r e is no s p e c i f i c r e q u i r e m e n t to j u d g e t h e s u i t a b i l i t y of the i n v e s t m e n t p o l i c y or o t h e r w i s e to e v a l u a t e t h e r e l a t i o n s h i p of a s s e t s to l i a b i l i t i e s . Nor is t h e r e a r e q u i r e m e n t to r e p o r t on d i f f i c u l t i e s b e t w e e n v a l u a t i o n s . The C a n a d i a n I n s t i t u t e o f A c t u a r i e s has d e t a i l e d f i n a n c i a l r e p o r t i n g r e c o m m e n d a t i o n s s u p p o r t i n g its G u i d e to P r o f e s s i o n a l C o n d u c t . I-5
T h e C a n a d i a n v a l u a t i o n s e r v e s t h e dual p u r p o s e of m e e t i n g t h e s t a t u t o r y r e q u i r e m e n t s and p r e s e n t i n g a s t a t e m e n t b a s e d on G A A P a c c o u n t i n g . T h e s e t w o p u r p o s e s a r e s o m e w h a t in c o n f l i c t . T w o s i g n i f i c a n t d e v e l o p m e n t s t e n d t o p o i n t t h e C a n a d i a n v a l u a t i o n a c t u a r y in t h e d i r e c t i o n of t h e U n i t e d K i n g d o m ' s a p p o i n t e d a c t u a r y . The C a n a d i a n I n s t i t u t e of A c t u a r i e s a p p o i n t e d a s p e c i a l c o m m i t t e e t o e v a l u a t e t h e r o l e of t h e v a l u a t i o n a c t u a r y . The c o m m i t t e e ' s r e p o r t r e c o m m e n d s t h a t t h e opinion s h o u l d h e a s o l v e n c y opinion; t h a t is, it s h o u l d b e c o n t i n u o u s and ongoing, a n d t h e v a l u a t i o n a c t u a r y s h o u l d b e r e q u i r e d to r e p o r t a t l e a s t a n n u a l l y t o t h e c o m p a n y ' s B o a r d o f D i r e c t o r s . This w o u l d m a k e t h e v a l u a t i o n a c t u a r y ' s r o l e c o n s i s t e n t w i t h t h a t of t h e a p p o i n t e d a c t u a r y in t h e U n i t e d K i n g d o m . T h e r e p o r t w a s a d o p t e d b y t h e C o u n c i l o f t h e I n s t i t u t e and will n o w b e e x p o s e d to t h e m e m b e r s h i p . The s e c o n d e v e n t r e l a t e s to t h e d e v e l o p m e n t o f t h e f i n a n c i a l s e r v i c e s i n d u s t r y in C a n a d a . In t h e s u m m e r of 1985, t h e g o v e r n m e n t e x p o s e d a p a p e r r e c o m m e n d i n g s o m e s w e e p i n g c h a n g e s in t h e s t r u c t u r e , powers~ and a d m i n i s t r a - t i o n o f i n s u r a n c e a n d b a n k i n g i n s t i t u t i o n s . T w o b a n k s b e c a m e i n s o l v e n t a r o u n d t h a t t i m e (the f i r s t b a n k i n s o l v e n c i e s in o v e r 50 y e a r s ) , and s o l v e n c y a n d p r o t e c t i o n a r e n o w u p p e r m o s t in t h e m i n d s of l e g i s l a t o r s . C o m m e n t s on t h i s g o v e r n m e n t p a p e r w e r e r e v i e w e d b y a H o u s e o f C o m m o n s c o m m i t t e e , w h i c h p r o d u c e d a r e p o r t t h a t will s e r v e as a b a s i s f o r f u r t h e r d i s c u s s i o n and p r o b a b l e a c t i o n . T w o o f t h e c o m m i t t e e r e c o m m e n d a t i o n s a r e o f p a r t i c u l a r i n t e r e s t t o a c t u a r i e s . T h e f i r s t r e q u i r e s v a l u a t i o n a c t u a r i e s to r e p o r t i m m e d i a t e l y all n o n - a r m s - l e n g t h t r a n s a c t i o n s t h e y b e c o m e a w a r e o f to a R e v i e w C o m m i t t e e o f t h e B o a r d o f D i r e c t o r s . T h e s e c o n d r e c o m m e n d a t i o n s u g g e s t s a r e s p o n s i b i l i t y f o r 1-7
v a l u a t i o n a c t u a r i e s c o m p a r a b l e t o t h a t of the U n i t e d Kingdom's a p p o i n t e d a c t u a r i e s .
S e c t i o n 4: The Concept of the Valuation A c t u a r y in t h e U n i t e d S t a t e s
The c o n c e p t o f t h e v a l u a t i o n a c t u a r y f i r s t r e c e i v e d s e r i o u s c o n s i d e r a t i o n in t h e U n i t e d S t a t e s with t h e a d o p t i o n of t h e 1980 a m e n d m e n t s to the NAIC S t a n d a r d V a l u a t i o n Law. The i n c r e a s e d v o l a t i l i t y of f i n a n c i a l m a r k e t s and i n t e r e s t r a t e s in the l a t t e r p a r t of the 1970s c a u s e d t h e ACLI t o p r o p o s e c h a n g e s in t h e law to m a k e t h e s t a t u t o r y minimum v a l u a t i o n s t a n d a r d s of i n t e r e s t and m o r t a l i t y r e s p o n d a u t o m a t i c a l l y and m o r e r a p i d l y to changing e c o n o m i c and d e m o g r a p h i c conditions.
The ACLI p r o p o s a l was an a d a p t a t i o n of the e x i s t i n g v a l u a t i o n s t r u c t u r e to r a p i d l y changing conditions~ r a t h e r t h a n a m a j o r r e f o r m of v a l u a t i o n p r a c t i c e . C o m m e n t i n g on the p r o p o s e d 1980 amendments~ t h e T e c h n i c a l A d v i s o r y C o m m i t t e e on D y n a m i c I n t e r e s t and R e l a t e d M a t t e r s to t h e NAIC (C-4) Life~ Accident~ and H e a l t h S u b c o m m i t t e e s t a t e d :
"The A C L r s p r o p o s e d d y n a m i c law would n o t change t h e b a s i c e x i s t i n g legal s t r u c t u r e and t r a d i t i o n . As a r e s u l t of a c c e p t i n g this p r a c t i c a l constraint9 t h e p r o p o s a l n e i t h e r c o o r d i n a t e s v a l u a t i o n of a s s e t s with the v a l u a t i o n of l i a b i l i t i e s nor e x p a n d s the p r o f e s s i o n a l r e s p o n s i b i l i t y of t h e a c t u a r y signing t h e a c t u a r i a l s t a t e m e n t of opinion . . . . It is the opinion of the a d v i s o r y c o m m i t t e e t h a t a n y p r o p o s a l should n e i t h e r r e s t r i c t nor inhibit p u r s u i t of m o r e f u n d a m e n t a l solutions of t h e v a l u a t i o n - n o n f o r f e i t u r e q u e s t i o n s and t h a t such e v e n t u a l s o l u t i o n s m a y well i n c o r p o r a t e r e q u i r e m e n t s for c o n s i d e r a t i o n of a s s e t v a l u a t i o n , r e l i a n c e on p r o f e s s i o n a l or r e g u l a t o r y judgment~ and r e c o m m e n d a t i o n s for r e v i s e d surplus s t a n d a r d s . "
T h e c l e a r m e s s a g e f r o m t h e a d v i s o r y c o m m i t t e e w a s t h a t t h e 1980 a m e n d m e n t s w e r e only an i n t e r i m s t e p . The c o m m i t t e e f e l t t h a t t h e s t a t u t o r y v a l u a t i o n s y s t e m t h a t h a d l a s t e d o v e r a h u n d r e d y e a r s , w h e n i n t e r e s t r a t e s w e r e r e l a t i v e l y s t a b l e , w a s i n a d e q u a t e to m e a s u r e t h e r i s k s i n h e r e n t in a v o l a t i l e i n t e r e s t r a t e e n v i r o n m e n t . A t a b o u t t h e s a m e t i m e , t h e S o c i e t y o f A c t u a r i e s C o m m i t t e e on V a l u a t i o n and R e l a t e d M a t t e r s p r e s e n t e d a d i s c u s s i o n d r a f t e n t i t l e d , " V a l u a t i o n , Surplus and R e l a t e d P r o b l e m s , " w h i c h s u g g e s t e d a c o n c e p t u a l f r a m e w o r k f o r t h e b a l a n c e s h e e t of an i n s u r a n c e e n t e r p r i s e and t h e v a l u a t i o n of p o l i c y l i a b i l i t i e s . It i d e n t i f i e d t h r e e a d v e r s e c o n t i n g e n c i e s , d e s i g n a t e d as t h e C - 1 , C-Z and C-3 risks, f o r w h i c h p r o v i s i o n m u s t b e m a d e in t h e b a l a n c e s h e e t . T h e C - 1 risk r e l a t e s t o a s s e t l o s s e s a r i s i n g f r o m d e f a u l t s , d e s t r u c t i o n o f a s s e t s , or o t h e r d e c l i n e s in a s s e t v a l u e o t h e r t h a n c h a n g e s in m a r k e t v a l u e d u e s o l e l y t o c h a n g e s in t h e p r e v a i l i n g i n t e r e s t r a t e s . T h e C-Z risk r e l a t e s t o l o s s e s a r i s i n g f r o m p r i c i n g i n a d e q u a c y . T h e C - 3 r i s k r e l a t e s to l o s s e s r e s u l t i n g f r o m s w i n g s in i n t e r e s t r a t e s . This c o m m i t t e e is c o n t i n u i n g t o p r o d u c e b a s i c and p r a c t i c a l r e s e a r c h on t h e s e r i s k s as w e l l as t h e i r c o m b i n e d e f f e c t . The c o m m i t t e e ' s d i s c u s s i o n d r a f t g a v e a g o o d e x p o s i t i o n of t h e C-3 risk. It i n d i c a t e d t h e p r o b l e m s t h e a c t u a r y f a c e s in d e t e r m i n i n g t h e d e g r e e t o w h i c h t h e c o m p a n y is i m m u n i z e d a g a i n s t f u t u r e i n t e r e s t r a t e v a r i a t i o n s t h r o u g h t h e m a t c h i n g o f f u t u r e a s s e t and l i a b i l i t y c a s h f l o w s . It a l s o p o i n t e d to t h e d e f i c i e n c i e s of t h e c u r r e n t v a l u a t i o n s y s t e m , w h i c h a s s u m e s o n l y one p a t h f o r f u t u r e e v e n t s , and s u g g e s t e d t h e n e e d f o r a c t u a r i a l a n a l y s i s o f f u t u r e c a s h f l o w s u n d e r a v a r i e t y of i n t e r e s t r a t e a s s u m p t i o n s . I-9
The n e x t s i g n i f i c a n t s t e p in the d e v e l o p m e n t of the c o n c e p t was the D e c e m b e r 1983 e s t a b l i s h m e n t of t h e J o i n t C o m m i t t e e on the Role of t h e V a l u a t i o n A c t u a r y in the U n i t e d S t a t e s by t h e b o a r d s of the A m e r i c a n A c a d e m y o f A c t u a r i e s and t h e S o c i e t y of A c t u a r i e s . The j o i n t c o m m i t t e e was asked to m a k e r e c o m m e n d a t i o n s c o n c e r n i n g t h e a p p r o p r i a t e r o l e for the v a l u a t i o n a c t u a r y in t h e U n i t e d S t a t e s and d e f i n e what is n e c e s s a r y to e f f e c t and support this role.
In its final r e p o r t published in F e b r u a r y 1985, t h e c o m m i t t e e ' s first major r e c o m m e n d a t i o n was t h a t e a c h s t a t e e n a c t a s t a t u t e r e q u i r i n g t h e d i r e c t o r s of a l i f e i n s u r a n c e c o m p a n y l i c e n s e d in t h a t s t a t e to a p p o i n t by r e s o l u t i o n a v a l u a t i o n a c t u a r y and to i n f o r m t h e a p p r o p r i a t e s t a t e r e g u l a t o r of t h a t a p p o i n t m e n t or any s u b s e q u e n t a p p o i n t m e n t of a v a l u a t i o n a c t u a r y . V a l u a t i o n a c t u a r i e s who a r e m e m b e r s of t h e A m e r i c a n A c a d e m y of A c t u a r i e s would be s u b j e c t to its q u a l i f i c a t i o n s t a n d a r d s to assure t h a t t h e y r e m a i n k n o w l e d g e a b l e c o n c e r n i n g c u r r e n t v a l u a t i o n p r i n c i p l e s and s t a n d a r d s of p r a c t i c e . The c o m m i t t e e ' s s e c o n d m a j o r r e c o m m e n d a t i o n was for t h e e s t a b l i s h m e n t of principles and d e v e l o p m e n t o f p r a c t i c e s u n d e r l y i n g t h e v a l u a t i o n of l i f e i n s u r a n c e c o m p a n i e s for s o l v e n c y and s o l i d i t y purposes. Initially, t h e s e p r i n c i p l e s and p r a c t i c e s would be s u p e r - i m p o s e d upon t h e e x i s t i n g s p e c i f i c legal s o l v e n c y r e q u i r e m e n t s . In t i m e , t h e s o l v e n c y s t a n d a r d s p r o m u l g a t e d by s t a t u t e or r e g u l a t i o n might evolve to c o v e r only p r i n c i p l e s , and possibly a m i n i m u m s t a n d a r d m e t h o d o l o g y . The assumptions s e l e c t e d and t h e a s s o c i a t e d m e t h o d s used in m a k i n g a v a l u a t i o n would be l e f t to t h e p r o f e s s i o n a l j u d g m e n t of the v a l u a t i o n a c t u a r y and would be fully d e s c r i b e d in t h e v a l u a t i o n a c t u a r y ' s r e p o r t to m a n a g e m e n t , w h i c h would be available to r e g u l a t o r s on a c o n f i d e n t i a l basis.
The p r o p o s e d v a l u a t i o n s y s t e m would envision an a c t u a r i a l opinion to t h e e f f e c t t h a t r e s e r v e s m a k e good and s u f f i c i e n t provision for all f u t u r e obligations on a basis s u f f i c i e n t to c o v e r f u t u r e r e a s o n a b l e d e v i a t i o n s f r o m e x p e c t e d assumptions. The opinion would f u r t h e r s t a t e t h a t r e s e r v e s plus a d d i t i o n a l i n t e r n a l l y d e s i g n a t e d surplus m a k e good and s u f f i c i e n t provision for all f u t u r e obligations on a basis s u f f i c i e n t to c o v e r f u t u r e plausible d e v i a t i o n s f r o m e x p e c t e d assumptions. "Plausible" d e v i a t i o n s a r e a s s u m e d to h a v e a m u c h l o w e r p r o b a b i l i t y of o c c u r r i n g t h a n "reasonable" d e v i a t i o n s . The a m o u n t of i n t e r n a l l y d e s i g n a t e d surplus and its d e t e r m i n a t i o n would be a v a i l a b l e for r e v i e w by r e g u l a t o r s , but would not be shown s e p a r a t e l y on t h e b a l a n c e s h e e t . (Note: The ACLI Task F o r c e on t h e V a l u a t i o n A c t u a r y does not support t h e v a l u a t i o n s y s t e m p r o p o s e d h e r e . See Appendix 4, s e c t i o n 4.1.)
The c o m m i t t e e also r e c o g n i z e d and r e c o m m e n d e d f u r t h e r work to: 1. develop p r o p o s e d c h a n g e s in laws and r e g u l a t i o n s ;
Z. c o n t i n u e r e s e a r c h o n v a l u a t i o n principles;
3. e d u c a t e s t u d e n t s and p r a c t i c i n g a c t u a r i e s in t h e p r i n c i p l e s and s t a n d a r d s of t h e new v a l u a t i o n s y s t e m ; and
4. d e v e l o p and c o d i f y p r i n c i p l e s and s t a n d a r d s of a c t u a r i a l p r a c t i c e .
Since p r e s e n t i n g its r e p o r t , t h e j o i n t c o m m i t t e e has b e e n e x e r c i s i n g a m o n i t o r i n g and o v e r s i g h t f u n c t i o n to e n s u r e t h a t p r o g r e s s on i m p l e m e n t i n g t h e c o n c e p t of t h e v a l u a t i o n a c t u a r y p r o c e e d s a t a s a t i s f a c t o r y p a c e . M e a n w h i l e , work has b e e n continuing within t h e a c t u a r i a l p r o f e s s i o n a l t o w a r d a c h i e v i n g o b j e c t i v e s Z, 3 and 4 p r e v i o u s l y m e n t i o n e d .
It is c l e a r f r o m all t h e s e e f f o r t s t h a t no consensus has b e e n r e a c h e d c o n c e r n i n g t h e t h e o r e t i c a l or p r a c t i c a l c o n s i d e r a t i o n s u n d e r l y i n g t h e c o n c e p t of
t h e v a l u a t i o n a c t u a r y . For e x a m p l e , d r a f t s of p a p e r s r e l a t i n g to v a l u a t i o n p r i n c i p l e s and to s t a n d a r d s of p r a c t i c e in c o n n e c t i o n with t h e a c t u a r i a l opinion in t h e annual s t a t e m e n t h a v e g e n e r a t e d c o n s i d e r a b l e discussion and d i f f e r e n c e s of opinion. Also, t h e discussion at a s y m p o s i u m held by t h e S o c i e t y of A c t u a r i e s in N o v e m b e r 1985 i n d i c a t e d t h a t t h e m e t h o d o l o g y n e c e s s a r y for i m p l e m e n t i n g t h e c o n c e p t of t h e v a l u a t i o n a c t u a r y is f a r f r o m c o m p l e t e . The symposium p a r t i c i p a n t s p o i n t e d to a wide v a r i e t y of e x i s t i n g a c t u a r i a l t e c h n i q u e s and m a n y u n s o l v e d p r o b l e m s in c o n n e c t i o n with t h e t y p e s o f a n a l y s e s t h a t kwould be r e q u i r e d u n d e r t h e c o n c e p t . At t h e r e g u l a t o r y l e v e l , s o m e a s p e c t s of t h e c o n c e p t of t h e v a l u a t i o n a c t u a r y h a v e a l r e a d y b e e n i n t r o d u c e d into the v a l u a t i o n s y s t e m on a l i m i t e d basis by t h e NAIC and a f e w s t a t e s , e s p e c i a l l y New York. In 198Z New York e n a c t e d l e g i s l a t i o n r e q u i r i n g t h e opinion of a q u a l i f i e d a c t u a r y as a condition f o r using h i g h e r v a l u a t i o n i n t e r e s t r a t e s (thus c r e a t i n g l o w e r r e s e r v e s ) f o r c e r t a i n a n n u i t y and g u a r a n t e e d i n t e r e s t c o n t r a c t s . I n s u r a n c e D e p a r t m e n t C i r c u l a r L e t t e r No. 33 d e f i n e s " q u a l i f i e d a c t u a r y " and c o n t a i n s g u i d e l i n e s t h a t s e t f o r t h r e q u i r e m e n t s for an a c t u a r i a l opinion. T h e g u i d e l i n e s c o n t a i n v e r y d e t a i l e d s p e c i f i c a t i o n s for m a k i n g t e s t s of f u t u r e a s s e t and l i a b i l i t y cash flows.
In 1985 New York a m e n d e d its v a l u a t i o n law to e n c o u r a g e use of t h e c o n c e p t of t h e v a l u a t i o n a c t u a r y . The s t a t u t e s p e c i f i c a l l y r e q u i r e s insurers to hold - - with r e s p e c t to a n n u i t i e s , a n n u i t y b e n e f i t s , and g u a r a n t e e d i n t e r e s t c o n t r a c t s - - such a d d i t i o n a l r e s e r v e s as t h e v a l u a t i o n a c t u a r y d e e m s n e c e s s a r y t o m a k e good and s u f f i c i e n t provision f o r t h e liabilities. The c u r r e n t s t a t u s {1987) o f r e g u l a t i o n s p r e s c r i b i n g r e q u i r e m e n t s for the a c t u a r i a l opinion r e q u i r e d by New York a r e d e s c r i b e d in Appendix 3.
In D e c e m b e r 1983 the NAIC a d o p t e d a U n i v e r s a l L i f e Insurance Model R e g u l a t i o n , which has s i n c e b e e n a d o p t e d in 11 s t a t e s . A s e c t i o n of t h a t r e g u l a t i o n c o n t a i n s s p e c i a l r e q u i r e m e n t s for i n t e r e s t - i n d e x e d universal life i n s u r a n c e p o l i c i e s , one of which is an opinion of a v a l u a t i o n a c t u a r y c o n c e r n i n g t e s t s o f i n s u r a n c e and i n v e s t m e n t c a s h f l o w s arising f r o m t h e s e p o l i c i e s and r e l a t e d a s s e t s . A d o p t i o n of this r e q u i r e m e n t p r o m p t e d t h e A m e r i c a n A c a d e m y of A c t u a r i e s to a d o p t a r e c o m m e n d a t i o n and an i n t e r p r e t a t i o n r e l a t i n g to a c t u a r i a l opinions for i n t e r e s t - i n d e x e d u n i v e r s a l life i n s u r a n c e policies.
In J u n e 1985 t h e NAIC a d o p t e d a M o d i f i e d G u a r a n t e e d Annuity Model R e g u l a t i o n , which p e r m i t s i n s u r e r s to sell g u a r a n t e e d a n n u i t i e s w h e r e a s s e t s b a c k i n g the c o n t r a c t are held in a s e p a r a t e a c c o u n t and cash v a l u e s are s u b j e c t to a m a r k e t - v a l u e a d j u s t m e n t f o r m u l a . The r e g u l a t i o n calls f o r the opinion of t h e v a l u a t i o n a c t u a r y t h a t a s s e t s in the s e p a r a t e a c c o u n t are a d e q u a t e to p r o v i d e all f u t u r e b e n e f i t s t h a t are g u a r a n t e e d .
At its D e c e m b e r 1985 m e e t i n g , the NAIC c o n s i d e r e d a r e c o m m e n d a t i o n f r o m its L i f e and H e a l t h A c t u a r i a l T a s k F o r c e t h a t t h e NAIC a d o p t an a c t u a r i a l g u i d e l i n e , d e v e l o p e d b y a s p e c i a l a d v i s o r y c o m m i t t e e , t h a t would d e f i n e e x p e c t a - tions r e l a t i n g to the a c t u a r i a l opinion. The p r o p o s e d g u i d e l i n e would a p p e a r in t h e NAIC F i n a n c i a l C o n d i t i o n E x a m i n e r s H a n d b o o k , w h i c h is u s e d as a guide for i n s u r a n c e d e p a r t m e n t e x a m i n a t i o n s o f insurers. It w o u l d d e s c r i b e the kind of a c t u a r i a l r e p o r t to m a n a g e m e n t t h a t should b e p r e p a r e d b y t h e v a l u a t i o n a c t u a r y to s u p p o r t t h e a c t u a r i a l opinion in t h e NAIC annual s t a t e m e n t . The a c t u a r i a l r e p o r t would m e n t i o n the e x t e n t to which f u t u r e i n s u r a n c e and i n v e s t m e n t cash flows, u n d e r a r a n g e o f f u t u r e i n t e r e s t r a t e s c e n a r i o s , w e r e c o n s i d e r e d in f o r m i n g the opinion for i n t e r e s t - s e n s i t i v e p r o d u c t s .
At the s a m e m e e t i n g , the A C L I a s k e d for d e f e r r a l of a c t i o n to e n a b l e a m o r e s t u d i e d c o n s i d e r a t i o n of t h e p r o p o s a l . The A C L I s t a t e m e n t also i n d i c a t e d c o n c e r n o f s o m e m e m b e r c o m p a n i e s a b o u t the r e l a t i v e l y high c o s t of c o m p l i a n c e w i t h t h e p r o p o s a l , p a r t i c u l a r l y f o r s m a l l e r c o m p a n i e s , in view of t h e lack o f e s t a b l i s h e d guides and p r o c e d u r e s to c o m p l y w i t h a n u m b e r of its r e q u i r e m e n t s . The NAIC d e c i d e d to d e l a y t h e i m p l e m e n t a t i o n o f a m a j o r p a r t of t h e p r o p o s a l and to r e f e r it to t w o of its t a s k f o r c e s to c o n s i d e r its inclusion in t h e E x a m i n e r s H a n d b o o k f o r 1986 and in t h e annual s t a t e m e n t f o r 1987. In t h e spring of 1986, t h e p r o p o s a l was f u r t h e r m o d i f i e d b y t h e NAIC so t h a t it could b e e n t i r e l y c o n t a i n e d in t h e E x a m i n e r s H a n d b o o k w i t h o u t b e i n g a p a r t o f the annual s t a t e m e n t . S e c t i o n 5: W h a t is t h e C o n c e p t o f a "Valuation A c t u a r y ' ? The c o n c e p t o f t h e v a l u a t i o n a c t u a r y is in an e a r l y e v o l u t i o n a r y s t a g e in t h e U n i t e d S t a t e s . E v e n within the a c t u a r i a l p r o f e s s i o n , t h e r e is no u n i v e r s a l c o n s e n s u s on t h e p r e c i s e m e a n i n g o f the c o n c e p t . H o w e v e r , t h e r e are a f e w b a s i c i d e a s which m o s t p e o p l e would a g r e e a r e a p a r t of the c o n c e p t of a v a l u a t i o n a c t u a r y , n a m e l y :
. The r e n d e r i n g o f an opinion as to t h e a d e q u a c y of r e s e r v e s is so i m p o r t a n t t h a t t h e d i r e c t o r s of a l i f e i n s u r a n c e c o m p a n y should b e m o r e e x p l i c i t l y i n v o l v e d in the s e l e c t i o n of the a c t u a r y who is given t h a t r e s p o n s i b i l i t y . One r e c o m m e n d a t i o n is t h a t t h e d i r e c t o r s b e r e q u i r e d b y s t a t u t e to appoint the v a l u a t i o n a c t u a r y , or to d e s i g n a t e
an i n d i v i d u a l to m a k e s u c h a p p o i n t m e n t s , r e g u l a t o r y a u t h o r i t y o f s u c h a p p o i n t m e n t s a p p o i n t m e n t s . a n d to n o t i f y t h e s t a t e or c h a n g e s in p r e v i o u s Z. W i t h t h e i n c r e a s e d v o l a t i l i t y of f i n a n c i a l m a r k e t s and i n t e r e s t r a t e s , it is no l o n g e r s a t i s f a c t o r y f o r a c t u a r i e s t o m a k e j u d g m e n t s a b o u t t h e a d e q u a c y o f r e s e r v e s w i t h o u t t a k i n g i n t o a c c o u n t , w h e r e a p p r o p r i a t e , t h e n a t u r e and t e r m o f t h e a s s e t s s u p p o r t i n g t h e r e s e r v e s . . Q u a l i f i c a t i o n s t a n d a r d s f o r v a l u a t i o n a c t u a r i e s w o u l d b e e s t a b l i s h e d b y t h e p r o f e s s i o n a n d t h e r e g u l a t o r s . . S t a n d a r d s of p r a c t i c e w o u l d b e e s t a b l i s h e d b y t h e p r o f e s s i o n . T h e s e p r o f e s s i o n a l s t a n d a r d s w o u l d s e t o u t s p e c i f i c c o n s i d e r a t i o n s t h a t b e a r on t h e p r o f e s s i o n a l w o r k p r o d u c t o f t h e v a l u a t i o n a c t u a r y . A c c o r d i n g l y , t h e a c t u a r y w o u l d b e e x p e c t e d t o u t i l i z e a11 o f t h e a p p r o p r i a t e t o o l s a v a i l a b l e t o t e s t a n d m a k e s o u n d j u d g m e n t s as t o t h e a d e q u a c y o f r e s e r v e s , c o n s i d e r i n g t h e n a t u r e a n d t e r m of t h e s u p p o r t i n g a s s e t s . . T h e r e q u i r e d p u b l i c s t a t e m e n t of o p i n i o n w o u l d i n c l u d e a s t a t e m e n t t h a t c u r r e n t s t a n d a r d s o f p r a c t i c e w e r e o b s e r v e d w h e n m a k i n g t e s t s a n d f o r m i n g j u d g m e n t s . T h e m a i n o b j e c t i v e o f t h e c o n c e p t o f a v a l u a t i o n a c t u a r y is t o a l e r t m a n a g e m e n t a n d r e g u l a t o r s t o p o t e n t i a l i n s u r a n c e c o m p a n y i n s o l v e n c i e s . As
conceived,
t h e c o n c e p t w o u l d p r o v i d e g r e a t e r a s s u r a n c e t o r e g u l a t o r s , t o t h e 1-15p u b l i c , and to c o m p a n y m a n a g e m e n t s t h a t c u r r e n t s t a n d a r d s of p r a c t i c e w e r e f o l l o w e d b y q u a l i f i e d a c t u a r i e s in valuing the l i a b i l i t i e s of all life i n s u r a n c e c o m p a n i e s in the U n i t e d S t a t e s . H o w e v e r , althgugh the e x p e r t i s e of the a c t u a r i a l p r o f e s s i o n is expanding, t h e v a l u a t i o n a c t u a r y ' s c a p a b i l i t i e s will p r o b a b l y n e v e r expand to the p o i n t w h e r e he or she can give an opinion on s o l v e n c y with r e s p e c t to all a s p e c t s o f a life i n s u r a n c e c o m p a n y . R a t h e r , t h e v a l u a t i o n a c t u a r y ' s opinion should be r e g a r d e d as a n e c e s s a r y , b u t not s u f f i c i e n t , c o n d i t i o n to a s s u r e c o m p a n y s o l v e n c y .
One b e n e f i t of the v a l u a t i o n a c t u a r y c o n c e p t is t h a t it will l e a d to g r e a t e r f o c u s on t h e a c t u a l l e v e l s of risk a s s u m e d by individual c o m p a n i e s . The v a l u a t i o n a c t u a r y will b e r e q u i r e d to use g r e a t e r skills to d e t e r m i n e v a l u a t i o n r e s e r v e s t h a t p r o p e r l y r e f l e c t t h o s e risks. This will e n c o u r a g e c o m p a n i e s to c o n t r o l risks a s s u m e d b y using sound i n v e s t m e n t and m a n a g e m e n t p r a c t i c e s .
The r e s e r v e l e v e l s d e v e l o p e d b y a v a l u a t i o n a c t u a r y could b e m a t e r i a l l y d i f f e r e n t f r o m r e s e r v e l e v e l s d e v e l o p e d in a c c o r d a n c e with s t a t u t o r y m i n i m u m r e s e r v e s t a n d a r d s , which a r e o f t e n i n t e n d e d to b e s e t at v e r y c o n s e r v a t i v e levels. The e n d r e s u l t could b e a s t a t u t o r y v a l u a t i o n s y s t e m t h a t e n c o u r a g e s risk c o n t r o l within t h e i n d u s t r y . This would r e w a r d t h o s e c o m p a n i e s who c o n t r o l risk b y a l l o w i n g l o w e r m i n i m u m s t a t u t o r y r e s e r v e s t h a t a r e m o r e c o n s i s t e n t w i t h r e s e r v e s as d e v e l o p e d b y a v a l u a t i o n a c t u a r y .
S e c t i o n 6: E m e r g i n g S t a t u t o r y V a l u a t i o n P e r s p e c t i v e s
S t a t u t o r y v a l u a t i o n c o n c e p t s for life i n s u r a n c e c o m p a n i e s are moving a w a y f r o m the s t r i c t l y d e f i n e d rules of 1985 and e a r l i e r and t o w a r d a new p e r s p e c t i v e . I n s u r e r s , r e g u l a t o r s , and a c t u a r i e s are b e g i n n i n g to r e a l i z e t h a t the e n t i r e s t a t u t o r y v a l u a t i o n p r o c e s s is i n t e n d e d to m e e t only one p u r p o s e : to p r o v i d e an ongoing m e a s u r e of a c o m p a n y ' s a b i l i t y to m e e t the r e a s o n a b l e e x p e c t a t i o n s of its p o l i c y h o l d e r s . U n f o r t u n a t e l y , no s e t of s p e c i f i c r u l e s for c a l c u l a t i n g r e s e r v e s can p r o v i d e such a m e a s u r e in a d y n a m i c m a r k e t p l a c e . I n f o r m e d and e x p e r i e n c e d j u d g m e n t f r o m an a c t u a r y highly f a m i l i a r w i t h t h e o p e r a t i o n s of a c o m p a n y is a b s o l u t e l y e s s e n t i a l . In c u r r e n t l i t e r a t u r e , this individual is c a l l e d t h e V a l u a t i o n A c t u a r y .
This c h a p t e r will discuss p e r s p e c t i v e s f o r t h e w o r k of the V a l u a t i o n A c t u a r y which h a v e e m e r g e d during t h e f i r s t h a l f of t h e 1980's. Such p e r s p e c t i v e s h a v e grown f r o m p r o f e s s i o n a l discussions, r e g u l a t o r y a c t i v i t i e s , i n d u s t r y a c t i v i t i e s , and p r o d u c t d e v e l o p m e n t s in t h e m a r k e t p l a c e . The c h a p t e r will c o v e r : V a l u a t i o n i m p l i c a t i o n s of new m a r k e t i n g a p p r o a c h e s and p r o d u c t s which b e c a m e m o r e popular in t h e f i r s t h a l f of t h e 1980's, V a l u a t i o n i m p l i c a t i o n s of a f o c u s on c u s t o m e r s i n s t e a d of p o l i c i e s in m a r k e t i n g e f f o r t s , and a s h i f t f r o m p r o s p e c t i v e l y - c a l c u l a t e d r e s e r v e s to retrospectively-calculated account values,
- Valuation i m p l i c a t i o n s of i n t e r e s t s e n s i t i v i t y and p r o d u c t flexibility,
The n a t u r a l m o v e m e n t f r o m s t a t u t o r y m i n i m u m r e q u i r e m e n t s for r e s e r v e s to a m o r e e n c o m p a s s i n g a d e q u a c y s t a n d a r d s u p p o r t e d by s t a t u t o r y guidelines and an e x p a n d e d i m p o r t a n c e for the a c t u a r i a l opinion, and
- O u a l i f i c a t i o n s t a n d a r d s for Valuation A c t u a r i e s .
A f t e r c o m p l e t i n g this c h a p t e r , it is h o p e d t h a t t h e r e a d e r will h a v e a b e t t e r u n d e r s t a n d i n g of the e m e r g i n g v a l u a t i o n issues and p o t e n t i a l role of V a l u a t i o n A c t u a r i e s in resolving t h o s e issues.
Valuaticm Implicmtions of New Prcx~cts and Marketing Appremches
One of t h e r e a s o n s for c o n t r o v e r s y r e g a r d i n g t h e Valuation A c t u a r y opinion p r o p o s e d by the J o i n t C o m m i t t e e is t h e d i f f i c u l t y in expressing such an opinion on m a n y of t h e p r o d u c t s i n t r o d u c e d during t h e f i r s t h a l f of t h e 1980's. Some a c t u a r i e s h a v e s u g g e s t e d t h a t V a l u a t i o n A c t u a r i e s m a y p e r h a p s b e r e q u i r e d to t a k e r e s p o n s i b i l i t y for i r r e s p o n s i b l e decisions m a d e by pricing a c t u a r i e s and m a r k e t i n g o f f i c e r s . While f e w would c o n t e n d t h a t t h e Valuation A c t u a r y ' s job with r e s p e c t to t h e s e new p r o d u c t s is impossible, m o s t would a c k n o w l e d g e t h a t m a n y of t h e new p r o d u c t s p r e s e n t a r e a l v a l u a t i o n c h a l l e n g e . In this s e c t i o n , s e v e r a l r e p r e s e n t a t i v e p r o d u c t c h a l l e n g e s a r e discussed.
P o s s i b l y the one p r o d u c t m o s t r e s p o n s i b l e for r e c e n t discussions a b o u t an e x p a n d e d V a l u a t i o n A c t u a r y r o l e is t h e s i n g l e - p r e m i u m d e f e r r e d a n n u i t y (SPDA). This p r o d u c t ' s s u b s t a n t i a l i n v e s t m e n t o r i e n t a t i o n and s i g n i f i c a n t m a r k e t a c c e p t a n c e h a v e c r e a t e d c o n c e r n a m o n g a c t u a r i e s r e s p o n s i b l e for s t a t u t o r y v a l u a t i o n s . While o t h e r a n n u i t y p r o d u c t s h a v e i n v o l v e d a g r e a t e r i n v e s t m e n t orientation~ t h e y w e r e g e n e r a l l y issued on a group basis and t h e r e f o r e not s u b j e c t t o t h e s t a n d a r d n o n f o r f e i t u r e law for individual annuities. This law, in effect~ r e q u i r e s a b o o k - v a l u e c a s h - o u t option. While b o o k - v a l u e c a s h - o u t options are n o t h i n g n e w for the life i n s u r a n c e industry~ t h e y h a v e n e v e r b e e n p r o v i d e d on p r o d u c t s w i t h s u c h s u b s t a n t i a l i n v e s t m e n t o r i e n t a t i o n . Further~ m a n y of t h e SPDA's h a v e b e e n sold by s t o c k b r o k e r s and i n v e s t m e n t f i r m s r a t h e r t h a n t r a d i t i o n a l l i f e i n s u r a n c e a g e n t s . S t o c k b r o k e r s a r e m u c h m o r e a c c u s t o m e d to s h o r t - t e r m c o m m i t m e n t s for t h e i r c u s t o m e r s and in m a n y c a s e s m a k e their living b y t r a d i n g t h e i r c u s t o m e r s ' i n v e s t m e n t s f r o m one f o r m t o a n o t h e r . Since i n s u r a n c e p r o d u c t s are g e n e r a l l y d e s i g n e d for l o n g - t e r m c o m m i t m e n t s , l i f e c o m p a n i e s t h a t d i s t r i b u t e t h r o u g h s t o c k b r o k e r s o f t e n m u s t m o d i f y t h e i r p r o d u c t design. SPDA's will c e r t a i n l y b e one of the f i r s t p r o d u c t s t o r e c e i v e s i g n i f i c a n t s c r u t i n y f r o m V a l u a t i o n A c t u a r i e s .
In p e r f o r m i n g his w o r k on SPDA's, the V a l u a t i o n A c t u a r y m u s t w r e s t l e w i t h t h e s e n s i t i v i t y of f u t u r e b e n e f i t c a s h f l o w s t o f u t u r e i n t e r e s t r a t e s . While p u b l i s h e d e x p e r i e n c e s t a t i s t i c s axe not g e n e r a l l y a v a i l a b l e , one can c l e a r l y e x p e c t s u r r e n d e r r a t e s on a b l o c k of SPDA's to go higher when the i n t e r e s t r a t e c r e d i t e d to t h a t b l o c k is s i g n i f i c a n t l y l o w e r than the i n t e r e s t r a t e a v a i l a b l e to n e w l y - s o l d c o n t r a c t s . The e x t e n t of t h o s e a d d i t i o n a l s u r r e n d e r s might d e p e n d o n :
- T h e a c t u a l d i f f e r e n c e b e t w e e n c r e d i t e d r a t e s and new m o n e y r a t e s ,
The d i s t r i b u t i o n s y s t e m which sold the c o n t r a c t (stock brokers, life agents, or others), and
P r o d u c t provisions which d i s c o u r a g e s u r r e n d e r ( s u r r e n d e r c h a r g e s ,
etc.).
A s s u m p t i o n s r e g a r d i n g t h e s e additional s u r r e n d e r s will g e n e r a l l y be based on l i m i t e d e x p e r i e n c e d a t a , and will be highly s u b j e c t i v e e v e n when such d a t a a r e a v a i l a b l e . Also, s t a t u t o r y r e s e r v e s for " r e a s o n a b l e " or "plausible" f l u c t u a t i o n s in this e x p e r i e n c e will be s e n s i t i v e to t h e s e assumptions.
Group a n n u i t y c o n t r a c t s will also p r e s e n t s u b s t a n t i a l c h a l l e n g e s to V a l u a t i o n A c t u a r i e s . In this discussion, only g u a r a n t e e d i n v e s t m e n t c o n t r a c t s issued to e m p l o y e r pension p r o g r a m s will be c o n s i d e r e d . These c o n t r a c t s are f r e q u e n t l y issued e x c l u s i v e l y for i n v e s t m e n t purposes, and few, if any, m o r t a l i t y g u a r a n t e e s a r e provided. M a r k e t - v a l u e a d j u s t m e n t provisions a r e f r e q u e n t l y i n c l u d e d . These provisions adjust any s u r r e n d e r values for a c t u a l or a s s u m e d c h a n g e s in t h e m a r k e t values of supporting assets. Such a d j u s t m e n t s p r o v i d e s u b s t a n t i a l p r o t e c t i o n agaim~t t h e b o o k - v a l u e c a s h - o u t s discussed u n d e r SPDA's. H o w e v e r , b e c a u s e group a n n u i t i e s a r e g e n e r a l l y p u r c h a s e d by m o r e s o p h i s t i c a t e d b u y e r s , p r o d u c t provisions a r e likely to be m o r e c o m p l i c a t e d and o f t e n a r e u n i q u e for e a c h individual group. Finally, group a n n u i t i e s a r e m u c h m o r e likely to h a v e l o n g - t e r m g u a r a n t e e s .
V a l u a t i o n A c t u a r i e s r e s p o n s i b l e for group a n n u i t i e s will f a c e s u b s t a n t i a l c h a l l e n g e s in u n d e r s t a n d i n g e a c h of the c o n t r a c t s o u t s t a n d i n g . F u r t h e r , a s s e t s e g m e n t a t i o n will b e m o r e critical~ b e c a u s e p r o d u c t p r o v i s i o n s a r e likely to b e s e t in light o f i n v e s t m e n t conditions at t h e t i m e t h e c o n t r a c t was issued. Any m a r k e t - v a l u e a d j u s t m e n t provisions built into t h e c o n t r a c t s will b e s p e c i f i c a l l y d e s i g n e d f o r an a c t u a l or a s s u m e d a s s e t p o r t f o l i o . F i n a l l y , l o n g - t e r m g u a r a n t e e s m u s t b e t e s t e d a g a i n s t i n t e r e s t s c e n a r i o s w h e r e i n v e s t m e n t i n c o m e r a t e s are declining b u t c r e d i t e d i n t e r e s t r a t e s are not.
U n i v e r s a l l i f e will also pose s o m e i n t e r e s t i n g c h a l l e n g e s for V a l u a t i o n A c t u a r i e s . While m o s t UL p r o d u c t s will n o t b e as i n v e s t m e n t - o r i e n t e d as group a n n u i t i e s and SPDA's~ s i g n i f i c a n t e x c e p t i o n s will e x i s t . S u b s t a n t i a l d i f f e r e n c e in t a x t r e a t m e n t b e t w e e f l l i f e i n s u r a n c e and a n n u i t i e s will p r o m p t s o m e c o m p a n i e s to issue u n i v e r s a l l i f e p r o d u c t s d e s i g n e d to c o m p e t e with annuities. S o m e UL p r o d u c t s p r o v i d e only t h e m i n i m u m d e a t h b e n e f i t s r e q u i r e d to q u a l i f y as l i f e i n s u r a n c e for t a x p u r p o s e s . Such p o l i c i e s also i n c l u d e all of the s t a t e - o f - t h e - a r t p r o v i s i o n s f o u n d in SPDA c o n t r a c t s . Thus, t h e V a l u a t i o n A c t u a r y for a b l o c k of U n i v e r s a l L i f e m u s t f i r s t c o n s i d e r w h e t h e r his p r o d u c t s w e r e sold p r i m a r i l y for i n s u r a n c e or i n v e s t m e n t p u r p o s e s .
F l e x i b l e p r e m i u m p r o v i s i o n s will c o m p l i c a t e the V a l u a t i o n A c t u a r y ' s work w i t h U n i v e r s a l L i f e . If f u t u r e p r e m i u m s a r e c o n s i d e r e d in t h e V a l u a t i o n A c t u a r y ' s cash f l o w p r o j e c t i o n s , t h e n l i a b i l i t i e s might a p p e a r to be q u i t e long indeed. On t h e o t h e r hand, f u t u r e p r e m i u m s p a y m e n t s c o u l d well be s e n s i t i v e to f u t u r e i n t e r e s t r a t e s , so t h e y could e a s i l y "dry up" if c r e d i t e d r a t e s are n o t c o m p e t i t i v e w i t h n e w p o l i c i e s . Those a c t u a r i e s d e v e l o p i n g a s s e t / l i a b i l i t y s t u d i e s
for U n i v e r s a l L i f e h a v e found t h a t p r o f i t s t u d i e s which consider all cash flows u n d e r a v a r i e t y of i n t e r e s t s c e u a r i o s a r e n e c e s s a r y in o r d e r to u n d e r s t a n d t h e risks involved in a l t e r n a t i v e i n v e s t m e n t and i n t e r e s t - c r e d i t i n g s t r a t e g i e s .
This discussion has only s c r a t c h e d t h e s u r f a c e of c h a l l e n g e s f a c e d by Valuation A c t u a r i e s in addressing s o m e of the new p r o d u c t s . Vast bodies of l i t e r a t u r e a r e sure to develop as Valuation A c t u a r i e s a d d r e s s t h e p r o b l e m s posed by t h e p r o d u c t s of individual c o m p a n i e s . Also, as new p r o d u c t s a r e developed, new v a l u a t i o n c h a l l e n g e s will be p r e s e n t e d . It is a b s o l u t e l y c l e a r t h a t s u b s t a n t i a l j u d g m e n t will b e r e q u i r e d of V a l u a t i o n A c t u a r i e s in addressing t h e p o t e n t i a l risks
of e a c h individual p r o d u c t .
F o c u s on C u s t o m e r s R a t h e r ThAn P o l i c i e s
L i f e i n s u r a n c e c o m p a n i e s h a v e b e c o m e i n c r e a s i n g l y c u s t o m e r o r i e n t e d r a t h e r t h a n p o l i c y o r i e n t e d during t h e f i r s t h a l f of t h e 1980's. The i n d u s t r y has d e v e l o p e d "life c y c l e " p r o d u c t s i n t e n d e d to s e r v e the f i n a n c i a l n e e d s of c u s t o m e r s t h r o u g h changing n e e d s and c h a n g i n g e c o n o m i c c i r c u m s t a n c e s . While a c u s t o m e r o r i e n t a t i o n is q u i t e logical for t h e l i f e i n s u r a n c e i n d u s t r y , it has s e v e r a l i m p l i c a t i o n s f o r V a l u a t i o n A c t u a r i e s . I t e m s which might be c o n s i d e r e d in t h e Valuation A c t u a r y ' s cash flow p r o j e c t i o n s include:
. A r e t r o s p e c t i v e f o c u s on a c c u m u l a t e d values r a t h e r t h a n a p r o s p e c t i v e f o c u s on p o l i c y r e s e r v e s .
Z. R e c o g n i t i o n of g u a r a n t e e d f u t u r e p u r c h a s e options.
3. R e c o g n i t i o n of p e r i o d i c r e u n d e r w r i t i n g and c h a n g i n g h e a l t h s t a t u s . . I m p l i c a t i o n s of i n a d e q u a t e a c c u m u l a t e d v a l u e s on f u t u r e m o r t a l i t y a n d m o r b i d i t y e x p e r i e n c e . T h e s e a r e b u t a f e w o f t h e c h a l l e n g e s p o s e d b y l i f e - c y c l e p o l i c i e s . This s e c t i o n will p r o v i d e a g e n e r a l d i s c u s s i o n o f t h e V a l u a t i o n A c t u a r y ' s p o s s i b l e c o n s i d e r a t i o n s in d e a l i n g w i t h s u c h p o l i c i e s . H i s t o r i c a l l y , l i f e i n s u r a n c e h a s b e e n s o l d to fill a p r o s p e c t i v e n e e d f o r f u n d s a t d e a t h . R e s e r v e s w e r e d e v e l o p e d as a r e s u l t o f f u n d i n g an i n c r e a s i n g p r o b a b i l i t y o f d e a t h w i t h a l e v e l a n d / o r l i m i t e d - p e r i o d p r e m i u m p a y m e n t . Thus, r e s e r v e s and r e l a t e d c a s h s u r r e n d e r v a l u e s w e r e d e v e l o p e d as an i n t e g r a l p a r t o f t h e t o t a l l i f e i n s u r a n c e p r o d u c t s c h e m e . I n c r e a s i n g l y , h o w e v e r , l i f e c y c l e p o l i c i e s ( p a r t i c u l a r l y u n i v e r s a l life) v i e w r e s e r v e s as a r e t r o s p e c t i v e a c c u m u l a t i o n o f e x c e s s p r e m i u m p a y m e n t s . A c t u a r i a l l y , t h e s e t w o v i e w s g e n e r a t e t h e s a m e r e s u l t . H o w e v e r , p r a c t i c a l l y , a v a s t d i f f e r e n c e in p e r c e p t i o n e x i s t s on t h e p a r t o f t h e p o l i c y h o l d e r . P o l i c y h o l d e r s b e g i n to v i e w a c c u m u l a t e d v a l u e s or r e s e r v e s as a c u r r e n t a s s e t s i m i l a r t o c a s h in t h e b a n k . T h e y s e e p l a i n l y t h e r e t u r n r e a l i z e d b y t h a t i n v e s t m e n t a n d a r e a p t to s e e k a l t e r n a t i v e i n v e s t m e n t s w h e n t h a t r e t u r n is n o t a c c e p t a b l e . In s h o r t , a r e t r o s p e c t i v e f o c u s is l i k e l y to d i v e r t a p o l i c y h o l d e r ' s a t t e n t i o n a w a y f r o m l o n g - t e r m o b j e c t i v e s (such as d e a t h b e n e f i t s ) and t o w a r d s h o r t - t e r m o b j e c t i v e s (such as y e a r - t o - y e a r r a t e o f r e t u r n ) .
A r e t r o s p e c t i v e p o l i c y h o l d e r focus has s i g n i f i c a n t i m p l i c a t i o n s for v a l u a t i o n a c t u a r i e s . First, h i s t o r i c a l lapse and s u r r e n d e r e x p e r i e n c e on policies sold with a p r o s p e c t i v e f o c u s has l i t t l e r e l e v a n c e to e x p e c t e d f u t u r e e x p e r i e n c e on policies with a r e t r o s p e c t i v e focus. S u r r e n d e r r a t e s a r e c e r t a i n to c o r r e l a t e p o s i t i v e l y with the d i f f e r e n c e b e t w e e n c r e d i t e d i n t e r e s t r a t e s on old policies and such r a t e s available on n e w policies. Finally, and most obviously, r e s e r v e s on s u c h policies should c o n s i d e r the u n d e r l y i n g assets. T r a d i t i o n a l a p p r o a c h e s using c o n s e r v a t i v e v a l u a t i o n i n t e r e s t r a t e s a r e not a c c e p t a b l e for policies with book- value cash out provisions and less s i g n i f i c a n t l o n g - t e r m g u a r a n t e e s . In short~ l i f e - c y c l e policies s h a r e m a n y of t h e s a m e p r o b l e m s discussed e a r l i e r with SPDA's.
G u a r a n t e e d f u t u r e p u r c h a s e options in m a n y l i f e - c y c l e p r o d u c t s c r e a t e an o p p o r t u n i t y for a n t i - s e l e c t i o n which m u s t be r e c o g n i z e d by v a l u a t i o n a c t u a r i e s . Many l i f e - c y c l e policies provide g u a r a n t e e d o p p o r t u n i t i e s to i n c r e a s e d e a t h b e n e f i t s with i n c r e a s e s in a c o s t - o f - l i v i n g index. Some policies could also g u a r a n t e e physical i n s u r a b i l i t y if f i n a n c i a l u n d e r w r i t i n g r e q u i r e m e n t s are s a t i s f i e d ( d e a t h b e n e f i t s equal to s o m e multiple of i n c o m e ) . P r o b l e m s for l i f e - c y c l e p r o d u c t s a r e n o t l i m i t e d to life i n s u r a n c e . The s a m e c h a l l e n g e s would be f a c e d w i t h U n i v e r s a l D i s a b i l i t y I n c o m e , a p r o d u c t being c o n s i d e r e d by s e v e r a l c o m p a n i e s , only to a m u c h l a r g e r e x t e n t .
In p r e p a r i n g t h e i r cash flow projections~ Valuation A c t u a r i e s m a y n e e d to a d d r e s s t h e g u a r a n t e e d f u t u r e p u r c h a s e options in l i f e - c y c l e p r o d u c t s m o r e e x p l i c i t l y t h a n has b e e n t h e c a s e with m o r e t r a d i t i o n a l policies. Clearly~ s o m e of t h o s e p o l i c y h o l d e r s who e x e r c i s e f u t u r e p u r c h a s e options will be s e l e c t i n g
a g a i n s t t h e c o m p a n y . H o w e v e r , the p o t e n t i a l a m o u n t of t h a t s e l e c t i o n will be d e p e n d e n t upon c o n d i t i o n s b e y o n d the c o m p a n y ' s c o n t r o l . Specifically~ f u t u r e r a t e s of i n f l a t i o n would d e t e r m i n e the a m o u n t of a n t i s e l e c t i o n a v a i l a b l e . Such i n c r e a s e d risks might b e o f f s e t to s o m e e x t e n t b y i n c r e a s e d i n v e s t m e n t i n c o m e , b u t t h e r e is no g u a r a n t e e t h a t higher i n t e r e s t r a t e s will c o v e r higher inflation. Also, r e s e r v e s f o r such risks m u s t b e h e l d o u t s i d e t h e p o l i c y h o l d e r a c c u m u l a t i o n a c c o u n t , or t h e higher i n v e s t m e n t i n c o m e would b e p a s s e d along as higher c r e d i t e d i n t e r e s t r a t e s . In s h o r t , f u t u r e p u r c h a s e o p t i o n s i n c l u d e d in l i f e - c y c l e p o l i c i e s c r e a t e a n o t h e r i n t e r e s t - s e n s i t i v e risk which m a y r e q u i r e c o n s i d e r a t i o n in s t a t u t o r y r e s e r v e c a l c u l a t i o n s .
One of t h e a t t r a c t i v e f e a t u r e s of l i f e - c y c l e p r o d u c t s is the ability t o a c c o m m o d a t e f u t u r e c h a n g e s in i n s u r a n c e a m o u n t w i t h one policy. Such c h a n g e s c o u l d w e l l i n v o l v e new u n d e r w r i t i n g i n f o r m a t i o n which is o b t a i n e d s e v e r a l y e a r s a f t e r original issue. If a p o l i c y h o l d e r ' s risk c l a s s i f i c a t i o n should change f r o m one u n d e r w r i t i n g t o a n o t h e r , w h i c h risk c l a s s i f i c a t i o n should b e u s e d by the V a l u a t i o n A c t u a r y ? The initial a n s w e r m i g h t b e t h a t e a c h l a y e r o f c o v e r a g e should b e r e s e r v e d b a s e d on its original u n d e r w r i t i n g c l a s s i f i c a t i o n . N o r m a l d e t e r i o r a t i o n o f h e a l t h s t a t u s is c o n s i d e r e d in m o s t s e l e c t and u l t i m a t e m o r t a l i t y t a b l e s . H o w e v e r , s e l e c t i v e l a p s a t i o n on l i f e - c y c l e p r o d u c t s c o u l d w e l l b e g r e a t e r t h a n t h a t e x p e r i e n c e d on t h e m o r e t r a d i t i o n a l p o l i c i e s u s e d t o d e v e l o p s t a n d a r d m o r t a l i t y t a b l e s . Also, V a l u a t i o n A c t u a r i e s c o u l d well b e r e q u i r e d to b a s e t h e i r p r o j e c t i o n s on t h e b e s t c u r r e n t l y - a v a i l a b l e i n f o r m a t i o n . Thus, a n u m b e r of a r g u m e n t s could be m a d e for a d j u s t i n g s t a t u t o r y r e s e r v e s with e a c h new u n d e r w r i t i n g on l i f e - c y c l e p o l i c i e s .
T h e final c h a l l e n g e to be discussed in this s e c t i o n deals with l i f e - c y c l e p o l i c i e s with d e c l i n i n g a c c u m u l a t e d values, h: t h e past, t r a d i t i o n a l policies could e x p e r i e n c e declining n e t cash values as policy loans began to a c c u m u l a t e . M o r t a l i t y e x p e r i e n c e on such policies has a l w a y s b e e n worse than on policies w i t h no loans o u t s t a n d i n g . Similar e x p e r i e n c e is likely to develop on l i f e - c y c l e p o l i c i e s w i t h declining a c c u m u l a t e d values. Should i n t e r e s t r a t e s d e c l i n e or c o s t - o f - i n s u r a n c e r a t e s i n c r e a s e , s u b s t a n t i a l i n c r e a s e s in p r e m i u m s ( c o m p a r e d with t h o s e i l l u s t r a t e d at issue) could be r e q u i r e d to k e e p t h e s e policies in f o r c e . W h e n e v e r an i n c r e a s e in p r e m i u m is r e q u i r e d , a p o l i c y h o l d e r is likely to r e - e v a l u a t e his i n s u r a n c e n e e d s a n d / o r shop f o r a l t e r n a t i v e products. Those p o l i c y h o l d e r s who p a y the h i g h e r r e q u i r e d p r e m i u m s a r e quite likely to be s u b s t a n d a r d risks w h e r e a claim is i m m i n e n t . Thus, Valuation A c t u a r i e s m a y n e e d to c o n s i d e r an a d d i t i o n a l e l e m e n t of m o r t a l i t y a n t i s e l e c t i o n in declining i n t e r e s t e n v i r o n m e n t s .
A f o c u s on c u s t o m e r s r a t h e r than policies is p r o b a b l y a positive e l e m e n t f o r t h e life i n s u r a n c e i n d u s t r y . C e r t a i n l y t h e r e c e n t l y - d e v e l o p e d l i f e - c y c l e p r o d u c t s a r e s u p e r i o r p r o d u c t f o r m s f r o m a n u m b e r of c o n s u m e r - o r i e n t e d p e r s p e c t i v e s . H o w e v e r , t h e s e f o r m s will c r e a t e a n u m b e r of c h a l l e n g e s f o r V a l u a t i o n A c t u a r i e s w h e n s p e c i f i c r e q u i r e m e n t s for s t a t u t o r y m i n i m u m r e s e r v e s m a y no l o n g e r be r e l i e d upon as a s a f e h a r b o r . I n t e r e s t S e r s i t i v i t 7 A n u m b e r of v a l u a t i o n p r o b l e m s posed by i n t e r e s t s e n s i t i v i t y h a v e b e e n d i s c u s s e d as r e l a t e d to individual p r o d u c t s (SPDA's and Universal L i f e s p e c i f i c a l l y ) . All o f t h e s e p r o b l e m s c a n be c o n s i d e r e d as a f o r m of a d v e r s e
