What’s Next in Store for PBR?
Dave Neve, FSA, MAAA, CERA
Vice President, Capital Management - Aviva USA
Chairperson, American Academy of Actuaries
Life Financial Soundness / Risk Management Committee
Overview
1. Update of Valuation Manual Adoption
2. PBR Review and Updating Process
3. Outstanding VM-20 Issues
4. VM-22 Update
5. Overview NAIC Implementation Plan
6. Implementation Issues and Challenges
7. PBR Implementation Resources
Valuation Manual Adoption Process
1.
2.
NAIC Adoption
•
Revisions to the Standard Valuation Law (SVL) were completed and
adopted by the NAIC in 2009
•
NAIC adopted the Valuation Manual in December of 2012
•
Culmination of over 8 years of work on VM-20, the principle-based reserve
requirements for life products
Next Step: Legislative approval of SVL by states. VM becomes operative
January 1 following the first July 1 in which the following occurs:
•
Adoption by 42 states (out of 56 jurisdictions, or 75%)
•
Adoption by enough states that represent at least 75% of industry direct
premiums in 2008
3.
Work will continue to revise the VM during the legislative approval process
4.
Timeline: earliest operative date is probably January 1, 2016
PBR Review and Updating Process
1. A well-conceived and designed PBR Review and Updating Process
(formerly referred to as a "PBR Feedback Loop") is essential to ensure that
there is an ongoing evaluation of the effectiveness of the PBR
methodology and prescribed assumptions defined in the Valuation Manual.
2. The Academy developed a proposal that provides a summary of the
importance, purpose, and goals of such a process.
3. A key element of the PBR Review and Updating Process is providing
support to state insurance regulators regarding the necessary expertise,
resources, data, and tools to effectively review PBR models and reporting
for products subject to PBR requirements.
4. LATF adopted the Academy proposal (with some modifications) in section
VM-00 of the Manual.
Process to Update Valuation Manual
1. Changes to the valuation manual shall be effective on January 1 following the
date when the changes have been adopted by the NAIC by an affirmative vote
representing both of the following.
a) At least three-fourths (3/4) of the members of the NAIC voting to
approve, but not less than a majority of the total membership, and
b) Members of the NAIC representing jurisdictions totaling greater than
75% of the direct premiums written as reported in annual statements
that are most recently available prior to the vote.
2. A significant change in the process, since all future reserve changes will be
decided by the NAIC, not by states.
3. However, a state still has the authority to impose their own reserve
requirements if they don’t support the changes to the Valuation Manual.
NAIC Support of Valuation Manual
1.
Support of the VM by the NAIC is mixed.
•
NAIC vote to adopt the VM passed by only one vote (43 out of 56).
•
New York has publically stated their opposition to the adoption of the VM.
2.
Expect NY to lobby keys states to defeat the proposed SVL revision authorizing
the Valuation Manual
3.
Concerns with PBR raised in letter from NY Superintendent Lawsky on 11/26/12
–
PBR reserving in the banking sector proved disastrous
–
Under PBR, reserves will decrease, increasing risk of insolvency
–
It is not clear that a PBR regime will benefit consumers
–
Regulators are ill-equipped to implement and oversee PBR
–
Even if rule-based approaches has it shortcomings, does not mean PBR is
necessarily the answer.
Outstanding VM-20 Issues
1) Aggregate Margin to replace individual margin
2) Investment Return on Starting Assets
3) Credibility Method for Mortality Assumptions
4) 98% - 102% collar on starting assets
Aggregate Margin
•
VM-20 currently requires a margin on each individual assumption.
•
Due to concerns on the impact of individual margins on the reserve from the NAIC
Impact Study, a proposal to permit the use of an aggregate margin was submitted
to LATF in early 2012.
• Due to timing issues, LATF deferred the decision on the use of an aggregate margin
until after adoption of the Valuation Manual by the NAIC.
• LATF has formed a subgroup, chaired by Mark Birdsall of Kansas to study the issue
• LATF has asked the Academy to develop a recommendation on the use of an aggregate
margin.
•
The Academy formed a Task Force, chaired by Patricia Mattson, to make a
recommendation.
• Proposal to determine an aggregate margin using a cost of capital approach was
submitted by the Academy several years ago, but rejected by LATF.
• Goal is to submit recommendation to LATF before the end of 2013.
Concerns with Individual Margins
1.
Per assumption margins are time-consuming to set and in many cases involve a high
degree of judgment.
2.
Poses the challenge of how to incorporate correlation between risks. In practice,
quantifying such correlation is time consuming, onerous and rarely done or, if done, is
performed on a very approximate basis.
3.
The cumulative individual margins are likely to produce a distorted picture of the cumulative
uncertainty associated with the set of modeling assumptions, thereby producing overly
conservative reserves.
4.
It is very difficult to determine appropriate margins on certain policyholder behavior
assumptions, such as premium pattern assumptions, and allocation between available
investment funds.
5.
Establishing assumptions for NGEs is problematic under an individual margin approach
since the margin in each individual assumption represents adverse experience that the
NGE assumptions are designed to mitigate
Requires that a “Best Estimate” Reserve
be Defined in VM-20
Explicit and implicit margins in VM-20 would need to be removed from the current stochastic and
deterministic reserve calculations. These include:
1. Mortality assumption
– Eliminate both sets of prescribed margins (the percentages applied to company experience rates and
the percentages applied to the industry basic table).
– Eliminate the prescribed grading to an industry table
– Permit the use of mortality improvement beyond the valuation date, using the company’s anticipated
experience assumption for mortality improvement.
– Eliminate the required adjustment to modify mortality assumptions for term polices following the end
of a level term period.
2.Policyholder behavior assumption
– to modify lapse assumptions for term polices following the end of a level term period. Eliminate the
explicit margin requirement applied to the anticipated experience assumption.
– Eliminate the prescribed use of the Canadian lapse table for ULSG products.
– Eliminate the required adjustment
Best Estimate” Reserve (cont.)
3. Revenue sharing assumption
– Eliminate the explicit margin requirement applied to the anticipated experience
assumption.
– Eliminate the prescribed caps (i.e. haircuts) on net revenue sharing income.
4. For all other prudent estimate assumptions, eliminate the explicit margin requirement that is
applied to the anticipated experience assumption.
5.
Asset default assumption
– For assets with an NAIC designation:
o Modify the baseline annual default cost factors to base the cost factors on
historical mean industry experience, rather than basing them on a 70 CTE metric.
o Eliminate the maximum net spread adjustment.
– For assets without an NAIC designation, eliminate the requirement that the net yield be
capped at 104% of the applicable Treasury yield rate,.
Best Estimate Reserve (cont.)
6. For reinvestment spread assumptions, eliminate the cap that is based on a 50/50 blend of
A2/A and Aa2/AA net asset spreads
7. Interest rate and equity return assumptions
– For the deterministic reserve, use Scenario 9 from the set of prescribed scenarios used
in the stochastic exclusion test (baseline scenario with no shocks), rather than Scenario
12 (deterministic scenario that assumes one-standard deviation shocks for the first 20
years).
– For the stochastic reserve, replace the CTE 70 metric with a CTE O metric, so that the
resulting reserve is based on the mean reserve from the distribution of stochastic
outcomes, not the amount based on the “worst 30%” stochastic outcomes.
Aggregate Margin:
Approaches Being Considered
1. Cost of Capital method
2. Confidence Interval method
3. Simple percentage method
4. Stress Testing
5. Pure Exit Value method
6. Adjustment to discount rate
Starting Assets
1. New York has expressed concerns over use of low investment grade assets to
increase the discount rate and lower reserves in VM-20 PBR calculations.
2. New York is exploring the use of a cap on the return of starting assets
– Equal to current “A” market spread for each asset (similar to AG38, section 8D)
– Discussions took place with the ACLI and the Academy in late 2012
3. At the December LATF meeting, the American Academy of Actuaries reviewed the
requirements in this portion of VM-20 to address these concerns, and the history
behind the process to develop the requirements, and areas that provide some
address of New York’s concerns.
4. American Council of Life Insurers (ACLI) has prepared proposals to address these
concerns.
5. Further discussion and examples of calculations on these proposals will be
discussed at April LATF meeting.
VM-20 Mortality Calculation
1.
Determine mortality segments (Subsection 9.C.1.a).
2.
Determine company experience rates (or use applicable industry table)
3.
If the company determines company experience mortality rates, determine the
applicable industry table for each mortality segment to grade company
experience to the industry basic table.
4.
Determine the level of credibility of the underlying company experience
•
the credibility maybe at either the mortality segment level or at a more aggregate
level
5.
Apply prescribed mortality margins. Separate mortality margins are determined
for company experience mortality rates and the applicable industry basic tables.
6.
Grade company experience to an industry table using a prescribed grading table
based on the level of credibility of the data.
Credibility Methodology for Mortality
1.
VM-20 does not prescribe the credibility method
2.
Mortality requirements for the credibility calculation
a. For valuations prior to 1/1/2015, the methodology must follow common
actuarial practice as published in actuarial literature (for example but not
limited to the Limited Fluctuation Method or Panjer method).
b. For valuations after 1/1/2015 the level of credibility shall be determined such
that the minimum probability is at least 95% with an error margin of no more
than 5% (which are parameters use in the Limited Fluctuation Method).
3.
The 95% / 5% credibility requirements may need to be revised/redefined to apply
to other methods.
4.
LATF plans to form a subgroup to study the overall mortality methodology, with
an emphasis on credibility requirements.
VM-22: PBR for Fixed Annuities
•
LATF has asked the Academy’s Annuity Reserve Work Group (ARWG), chaired
by Jim Lamson, to develop an initial draft of the PBR requirements for fixed
annuities
•
The ARWG is developing a proposal that will include:
•
•
A stochastic principle-based component
•
A prescribed deterministic floor based on modifying AG33
•
An exclusion test for the stochastic component
The ARWG has set a target date of delivering a proposed framework to LATF
during 2013
NAIC Implementation Plan
NAIC has prepared a discussion draft (available on NAIC website). Key
elements of plan:
1. Regulatory Support for PBA Review
– NAIC Actuarial Staff Support
– Actuarial Analysis Working Group (AAWG)
2. Defining Statistical Data
3. Standardized Financial Reporting and Analysis Tools
4. PBR Asset Spread Data
5. Training
6. Accreditation
NAIC Implementation Plan – ACLI comments
Comments from the ACLI:
1. Need to develop a high level outline of the topics, issues and questions
that need to be addressed, followed by a series of issue papers that
provide additional granularity about each topic. Two draft issues papers
were submitted:
– State regulatory review process
– Process for changes to Valuation Manual
2. Regulator should assume the role of lead state
3. External peer review of reserves should be required.
4. Recommend creation of a new NAIC subgroup, the Valuation Manual
Working Group (VMWG) that is charged with maintenance of the
Valuation Manual.
NAIC Implementation Plan – Academy comments
Comments from the Academy
1. Resources are needed to address two concerns:
– Support state review of individual company reserves
– Evaluate the overall effectiveness of the PBR methodology at large
2. Greater emphasis is needed to evaluate the overall effectiveness of the
PBR methodology. Essential elements include:
– Sanitization of confidential data
– Periodic progress reports
– Evaluation of capital requirements
– Definition of stakeholder roles
PBR Implementation: What Can I do Now?
Leverage:
• Risk Management process to identify and measure material risks in products;
• Model Audit Rule controls and procedures for assumption setting and model controls
• Asset Adequacy tools for Stochastic and Deterministic reserves
Begin Testing:
• Impact on reserves by duration, product features.
• Efficient modeling techniques.
Communication & Processes:
• Actuaries – Pricing and Valuation
• Management
• Board
• External
Key Elements Needed to Implement PBR
1. Cash flow liability model
2. Selecting approach to model assets
•
Left up to company to decide what approach to use
•
Company can use actual assets of the company, or simplified proxy
assets.
3. Determining assumptions
•
Some set by the company
•
Some prescribed by regulators
4. Deciding whether or not to perform Exclusion Tests (are optional)
Impact of PBR on Pricing
1. Currently, total reserves are known up-front & throughout the pricing
process. Under PBA, reserves are company specific and dependent on
product
2. Need early and ongoing interaction with valuation team
3. Issues to address
•
Include all liability cash flows?
•
Do you have one model for all product features and riders or have
separate models been used?
•
Are all material liabilities being modeled?
•
Use prudent estimate assumptions are Subject to individual subjectivity
•
Will likely need to develop a proxy reserve for pricing purposes.
Document, Document, Document
Documentation is extremely important.
•
Basis for assumptions, especially those that deviate from experience
•
Level of margins in assumptions and methodology for margin
development
•
Approach to grouping and segmentation within model
•
Scenario development
•
Exclusion tests
•
Actual to expected relationships for assumptions
•
Controls/governance on models
•
Benchmark modeled results to actual results
•
Independent peer review
Resources: Life PBR Practice Note
•
Work Group to prepare a draft PN has been formed, chaired by
Todd Erkis, to update initial draft prepared several years ago
•
Q&A format that addresses practical issues on implementation
•
Goal: document industry practice. This is difficult since VM-20 is
not in place yet (and may still be changing somewhat).
•
Objective is to put in a range of practice believed to be
appropriate
•
Not binding
•
Goal is to complete first draft for comment by mid-2013
Resources: Discussion Draft of PBR ASOP
• An ASB Task Force led by Frank Irish is developing a
draft ASOP to provide guidance to actuaries on PBR
• ASB has authorized the Task Force to distribute a
Discussion Draft (not an Exposure Draft)
• Expect the Discussion Draft to be completed in early 2013
• The Task Force expects to create an Exposure Draft after
discussions with interested parties.
Resources:
SOA Research on PBR Implementation
• New research initiated by SOA Financial Reporting Section
• Objective: utilize current literature, studies and experience to provide
a resource that outlines key considerations for a company
implementing PBA
• Not designed to duplicate practice notes
• Sample of issues to be addressed (not complete):
•
How large a staff is needed?
•
What system modifications may be needed?
•
What data will be required?
•
What information may be needed by external auditors?
•
What are good control processes?