Introduction to PBA:
An Overview of a Principle-Based
Approach to Life Reserves and
Capital
Dave Sandberg, Chair
American Academy of Actuaries
Solvency and Risk Management Committee
June 18, CAS Quebec City
Copyright © 2008 by the
American Academy of Actuaries
CAS Spring Meeting
June 16, 2008
Outline
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US History & Current Status
Compare & Contrast US & Solvency 2
Concluding Observations on ERM &
Regulation of Solvency
Copyright © 2008 by the
American Academy of Actuaries
CAS Spring Meeting
June 16, 2008
History of Valuation
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1858 Massachusetts Legislation
Commissioner to calculate reserves on all policies
of all licensed Companies
Actuary Elizur Wright appointed commissioner
Wright selected Net Level Premium Reserve
Method and Combined Experience (1843 British)
Mortality Table and 4% Interest Rate
Controversial decision of immense importance
Copyright © 2008 by the
American Academy of Actuaries
CAS Spring Meeting
June 16, 2008
While Risk-Focused Exams are effective January 1,
2010 in US there is no requirement for life risk
focused financial reporting.
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Standard Valuation Law
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Risk-Based Capital
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Statute: References NAIC RBC Instructions
Regulations
Financial Statement Filing
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State Statute & Regulations plus Actuarial Guidelines
Statute: References NAIC Accounting Practices and Procedures &
NAIC Blanks
Regulations
Examination of Financial Condition
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Statute: References NAIC Examiners Handbook
Regulations: Annual Examination by Independent CPA
Copyright © 2008 by the
American Academy of Actuaries
CAS Spring Meeting
June 16, 2008
Definition of Principle-based
Approach
1.
Captures all of the identifiable, quantifiable and material risks,
benefits, and guarantees associated with the contracts
2.
Utilizes risk analysis and risk management techniques to
quantify the risks; this may include stochastic models
3.
Allows the use of company experience to establish assumptions
for risks over which the company has some degree of control or
influence
4.
Uses assumptions and methods that are consistent with, but not
necessarily identical to, those utilized within the company’s
overall risk assessment process
Copyright © 2008 by the
American Academy of Actuaries
CAS Spring Meeting
June 16, 2008
Evolution of PBA
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Asset Adequacy Testing
Equity Indexed Annuity Regulation
RBC C-3 Phase I
RBC C-3 Phase II
Proposed Actuarial Guideline VACARVM
Proposed Valuation Manual
Proposed RBC C-3 Phase III
Copyright © 2008 by the
American Academy of Actuaries
CAS Spring Meeting
June 16, 2008
Needed Regulatory Changes
For PBA Reserve requirements, two changes are needed:
1.
Update the current Standard Valuation Law (and the
respective valuation laws of each state) to enable principlebased reserves (PBR)
2.
Create a new Valuation Manual to define the detailed PBR
requirements
For PBA Capital requirements, changes can be made
through the existing process to update the RBC
requirements
Copyright © 2008 by the
American Academy of Actuaries
CAS Spring Meeting
June 16, 2008
Changes to Standard Valuation Law
Major Challenges to proposed SVL Changes
1.
2.
3.
Will state insurance departments be willing to give
up some of their control in order to achieve
uniformity?
Will state legislatures be willing to delegate to the
NAIC the authority to make future changes to
reserve requirements?
Will the industry support the experience reporting
and independent review process?
Copyright © 2008 by the
American Academy of Actuaries
CAS Spring Meeting
June 16, 2008
Valuation Manual Objectives
 Implement principle-based reserves (PBR)
 Provide reserve requirements in one place (both PBR
and non-PBR valuations)
 Provide reporting requirements in one place
 Construct Valuation Manual so that the APPM can use
the same requirements
 Enhance uniformity and efficiency by coordinating with
APPM to achieve one exposure and one adoption
process
Copyright © 2008 by the
American Academy of Actuaries
CAS Spring Meeting
June 16, 2008
Valuation Manual
The Manual will also include:
•
Definition of principle-based reserves
•
The process to update the manual
•
PBA reserve disclosure and reporting requirements
•
PBA experience reporting requirements
•
Coordination with APPM (Accounting Practices and
Procedures Manual)
Copyright © 2008 by the
American Academy of Actuaries
CAS Spring Meeting
June 16, 2008
Possible NAIC Timeline
By June/Sept 2008 NAIC meeting:
• NAIC Plenary Adoption of Amended SVL
• NAIC Plenary Adoption of Valuation Manual
2009 State Legislative Sessions: Introduce
Amended SVL and Valuation Manual
Copyright © 2008 by the
American Academy of Actuaries
CAS Spring Meeting
June 16, 2008
Overall Possible NAIC
Timeline
By December 2010 NAIC meeting:
• NAIC Plenary
• NAIC Plenary
Changes
• NAIC Plenary
• NAIC Plenary
• NAIC Plenary
• NAIC Plenary
Adoption of Revised Valuation Manual
Adoption of Accounting and Blank
Adoption of
Adoption of
Adoption of
Adoption of
Examination Changes
Financial Analysis Changes
Corporate Governance
RBC Changes
Copyright © 2008 by the
American Academy of Actuaries
CAS Spring Meeting
June 16, 2008
US vs. EU
Copyright © 2008 by the
American Academy of Actuaries
CAS Spring Meeting
June 16, 2008
Objectives
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'The solvency system should be designed in such a way that it gives
incentive to the supervised institutions to measure and properly
manage their risks''
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1.
2.
3.
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EU Commission - Framework for consultation, June 2006
Develop a reserve methodology for life insurance products that results
in a reserve that is closer to economic reality.
Have an approach that allows the company to develop a reserve that
matches its risk, thus reducing the need to game the system.
Have a method that results in more comparability with financials in
other countries.
Commissioner Hampton to ACLI Board – Oct. 2007
Copyright © 2008 by the
American Academy of Actuaries
CAS Spring Meeting
June 16, 2008
Similarity of U.S. and
International Frameworks
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Report true risk
Blend of company and market experience
Auditable and verifiable
Uniformity
Establishment of control levels
Practical Options
Disclosure of margin in assumptions
Copyright © 2008 by the
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CAS Spring Meeting
June 16, 2008
Differences between U.S. and
International Frameworks
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Scope
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Time Horizon
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U.S. framework is more product & risk specific
International looks at both long-term and short term
U.S. looks long-term, using greatest present value
Basis
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U.S. is book-value based (similar to asset valuation)
International is market-value based
Copyright © 2008 by the
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CAS Spring Meeting
June 16, 2008
Difference between U.S. and
International Frameworks (cont.)
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Governance
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Neither jurisdiction has decided how to “recognize” other
regulatory jurisdictions, nor finalized its own governance
requirements
International recognizes governance may be country-specific
U.S. is considering a centralized approach that is integrated
with the financial examination process
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Regulatory tool/safeguard
Means to develop consistent use of assumptions
Measurement Metrics
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U.S. is fairly consistent – e.g., CTE(90) for TAR over life of
Business and only for Life business
99+% for one year time horizon for all insurance lines
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CAS Spring Meeting
June 16, 2008
What is Still to be Resolved for
Solvency II?
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Passage by European Parliament
Prior consultation to understand impact
Regulators - Legal jurisdictional rights related to Group lead
supervisors
Less country specific guidance - leave uniform at CEIOPS level
Specific Incentives for use of internal models
When to use capital add-ons and how much to require?
Credit for geographic diversification
Implications on Taxation
Issue of small companies & use of standard formulas
Copyright © 2008 by the
American Academy of Actuaries
CAS Spring Meeting
June 16, 2008
US Key Issues (per Commissioner
Hammond to ACLI Board Fall 2007)
1.
2.
3.
4.
5.
6.
7.
8.
9.
Adoption by States & Uniformity
Phase-in Process –New Products Only
Governance
Coordination with Capital Requirements
Analysis & Examinations –more like P&C
Training of Personnel
Data Collection
Federal Taxes
Small Company Issues
Copyright © 2008 by the
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CAS Spring Meeting
June 16, 2008
Structure of Pillar 2 & 3 Requirements for
Insurance Regulation Still a New Topic
1.
2.
3.
Banking Community has spend last 10 years on this
topic.
Insurance Solution should not copy the banks, but
we will need to go through a similar process to get to
what works best for insurance.
FSA report on 2006 Principle Based Self Reporting
Copyright © 2008 by the
American Academy of Actuaries
CAS Spring Meeting
June 16, 2008
Implications
1.
2.
ERM – Is it just diversification? (Bigger is Better) Or is it
creating a learning based reporting and management culture?
Can ERM be used to manage the regulatory process as well?
Copyright © 2008 by the
American Academy of Actuaries
CAS Spring Meeting
June 16, 2008