To:
All NAIC Members
From:
Superintendent Joseph Torti III and Commissioner Julie Mix McPeak,
Co-Chairs, Principle-Based Reserving Implementation (EX) Task Force
Date:
March 16, 2015
Re:
PBR Small Company Exemption
At the Commissioners’ Conference we reported on consideration by the Principle-Based Reserving Implementation (EX)
Task Force (Task Force) of a small company exemption for principle-based reserving (PBR). On February 11, the Task Force
adopted regulatory criteria for such an exemption based on company premium writings, risk-based capital (RBC), and other
risk characteristics.
The purpose of this memo is to provide further information on the Task Force’s actions and future plans. The following
provides background information to help you understand the product line exclusions already included in the Valuation
Manual, the details of the proposed small company exemption, the plans for final adoption of the small company exemption,
and, most importantly, our recommendation that your state not legislate a small company exemption in your state’s
Standard Valuation Law.
Background
Presently, life insurance reserves are formulaic in nature and are established using a regulatory-prescribed methodology
called the Commissioners Reserve Valuation Methodology (CRVM). The reserve is the present value of future benefits
minus the present value of future premiums. NAIC models prescribe the valuation interest rate and the one mortality table to
use in the calculation. These statutory reserves will often vary significantly from the economic value of the reserves.
The principle-based reserving framework will have three levels of reserve calculations, ranging from an advanced
calculation/modeling method for riskier products to a relatively simpler method based on projections of benefits and premium
cash flows. Stochastic reserves are calculated using modeling techniques and thousands of scenarios, and apply to product
lines such as Universal Life with Secondary Guarantees. Deterministic reserves are similar to stochastic reserves but are
limited to one scenario, a much simpler calculation. The net premium reserve (NPR), is effectively a “floor” for the reserves
and is cash-flow based. (See Appendix A for detailed descriptions.)
PBR Small Company Exemption
In addition to the product line exclusions (See Appendix A for detailed descriptions), the Task Force adopted an approach to
exempt an entire company. On February 11, the Task Force considered the following PBR small company exemption
proposal and adopted the proposal with one modification (as shown below with a strikethrough):
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Companywide Exemption: Unlike the existing product line exclusions, this exemption would apply to the entire
company.
Exempt from Performing PBR Exclusion Tests: Rather than being exempted from the Valuation Manual entirely
(and thus not subject to reporting requirements, etc.), the company would be exempted from performing PBR
exclusion tests.
Premium threshold: The company’s ordinary life premiums must be less than $300M for the legal entity and less
than $600M for the associated group.
Risk-Based Capital (RBC) threshold: The company’s RBC must be at least 450%.
ULSGs: There can be no material Universal Life with secondary guaranty business in force.
Reserve methodology that applies for exempted companies: PBR’s Net Premium Reserve CRVM
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Location of Small Company Exclusion: The exemption will be included in the Valuation Manual as opposed to being
added to the model Standard Valuation Law.
Based on 2013 financial data and other information, we estimate approximately 362 insurance companies, accounting for $9
billion or 4.6% of industry life premiums, could meet the above exemption criteria. Some of these companies would also be
eligible for exclusion because they are single state companies.
Next Steps at the NAIC
As noted above, the Task Force adopted criteria for the PBR small company exemption on February 11. The NAIC Executive
Committee is scheduled to consider adoption of the criteria at the upcoming Spring National Meeting. On March 12 the Life
Actuarial (A) Task Force adopted an amendment to the NAIC Valuation Manual to incorporate the criteria. Upon adoption
by the Life Insurance (A) Committee, the amendment will advance for Plenary consideration by the Summer National
Meeting.
Recommendation Regarding States’ Standard Valuation Laws
It is important to note that the 2009 revisions to the Standard Valuation Law, or legislation including substantially similar
terms and provisions, must be adopted by 42 jurisdictions representing greater than 75% of direct written premiums in order
for the Valuation Manual (including PBR) to become operative. The Task Force is currently considering what to use as the
substantially similar terms and provisions to determine the Valuation Manual Operative Date. Inclusion of a small company
exemption in a state’s laws that is inconsistent with the Valuation Manual’s small company exemption could potentially be
an issue in considering whether a state’s laws are substantially similar for purposes of the Valuation Manual Operative Date.
In addition, the Financial Regulation Standards and Accreditation (F) Committee is currently considering revising the
accreditation standards based upon the current language of the Standard Valuation Law, which does not include a small
company exemption. For these reasons, we are encouraging states to not add a small company exemption into your
Standard Valuation Law, but rather rely on the collective decisions included in the Valuation Manual to provide
uniformity on this important issue.
If you have any questions, please give us a call. Or you can contact NAIC staff:
Dan Schelp, NAIC Managing Counsel, DSchelp@naic.org, 816-783-8027
Larry Bruning, NAIC Life Actuary, LBruning@naic.org, 816-783-8231
Reggie Mazyck, LATF Staff, NAIC Life Actuary, RMazyck@naic.org, 202-471-3991
Kris DeFrain, PBRI TF Staff, NAIC Director of Research and Actuarial, KDeFrain@naic.org, 816-783-8229
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APPENDIX A1
Explanation of Reserve Methodology and PBR Product Line Exemptions
PBR RESERVE TYPES (in order from advanced to simpler):
Stochastic Reserve -- Stochastic reserving involves modeling of assets and benefits over time, utilizing assumptions of
mortality, policyholder behavior (i.e. lapses, policy loans), and company expenses. The company can utilize the industrywide
assumptions or prove credibility of its own data to use more specific company mortality or policyholder behavior. Modeling
involves using 1000 randomly-generated interest rate scenarios over 30+ years and averaging of the 300 worst modeled
reserve results (CTE 70 methodology) to determine the deficiency to book as the reserve. The stochastic reserving
methodology is similar to that used for AG43, except interest rate returns are utilized rather than the S&P 500 returns. A
company’s product line of UL policies with secondary guarantees cannot be exempt from stochastic reporting if that product
line’s volume is significant.
Deterministic Reserve – A deterministic reserve is a reserve amount calculated under a single defined economic scenario
and a single set of assumptions. It is equal to the present value of benefits and expenses less the present value of
premiums. Discount rates used are investment returns under a prescribed economic scenario. One caveat is that if the ULSG
product line for a company is deemed not to be significant and is excluded from the stochastic reserve, then those ULSG
products cannot test out of deterministic reserving.
Net Premium Reserve -- The net premium reserve (NPR) is the amount by which future benefits exceed future net
premiums. The NPR is very similar to CRVM except NPR includes more different assumptions (for interest and mortality)
and includes lapse assumptions and expenses. Expenses are based on a prescribed formula.
PBR PRODUCT LINE EXCLUSION TESTS
Stochastic Exclusion Tests
To be excluded from stochastic modeling for a particular product line, a company has two choices of main methods, both
having some options to simplify the methodology should a company choose.
The first main method is a Stochastic Exclusion Ratio Test. An original calculation was supplemented with an optional shortcut for ease of calculation. The original calculation is to determine the percentage of a change in deterministic reserves from a
baseline scenario to the worst-case of 15 scenarios, all divided by the present value of benefits under the baseline scenario. A
ratio less than 6.0% passes the test. The short-cut version is the same except the deterministic reserve calculations can be
replaced by gross premium reserves developed from the cash flows from the company’s Asset Adequacy Analysis models.
This main advantage of the “short-cut” is that companies can use the Asset Adequacy Analysis model that they are already
required to use for the current Asset Adequacy Analysis Test.
The second method for exclusion from stochastic modeling is to perform a Stochastic Exclusion Demonstration Test in the
PBR Actuarial Report once every three years. The demonstration must provide “reasonable assurance” that a stochastic
reserve would not be greater than the higher of the deterministic reserve and the NPR. At the option of the company, the
stochastic reserve can be the full-blown stochastic reserve calculation, a stochastic reserve calculation on a representative
sample of policies, or a reserve using a sufficient number of adverse deterministic scenarios. Effectively, the qualified actuary
would attest that the product line is not subject to material interest rate risk.
Deterministic Exclusion Test
If a product line is exempt from stochastic modeling, the product line would be tested for exclusion from deterministic
reserving. The Deterministic Exclusion Test is a comparison of the net premiums (as required by regulators) to the gross
premiums (charged per the insurance contract). If the net premiums are less than the gross premiums, the policy line is
excluded from calculating the deterministic reserve.
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Deterministic Reserve and Net Premium Reserve explanations are revised from the original letter to add clarity.
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