How Emerging Accounting and Regulatory
Developments Will Impact the Insurance
Industry
Actuaries’ Club of Boston - Annual Meeting
Jeff Johnson – John Hancock Financial Services
Dom Lebel – Towers Watson
September 22, 2011
AGENDA
Agenda

Introduction

Solvency II

Own Risk and Solvency Assessment

Principles Based Reserves

Future IFRS
2
Introduction
3
INTRODUCTION
A global shift in regulatory requirements is prompting
change in the U.S.

Broader financial sector
regulation



International Monetary Fund 
Financial Sector Assessment Program
(FSAP)
U.S. Department of the Treasury 
Financial Stability Oversight Council
Evolving insurance regulation

International Association of Insurance
Supervisors  Insurance Core
Principles

European Insurance and Occupational
Pensions Authority  Solvency II
The International Monetary Fund reviewed the U.S. system of financial regulation in 2010 as part
of its Financial Sector Assessment Program and will perform a peer review in 2012
4
INTRODUCTION
Solvency Modernization – Framework
International
G-20
Creates
Financial
Stability
Board
IAIS
IASB
IMF/World Bank
I0SC
OECD
Basel
Global alignment to implement international standards
5
INTRODUCTION
The emerging importance of the
International Association of Insurance Supervisors (IAIS)

IAIS is an association of insurance regulators, representing 190 countries
around the globe, with two stated objectives

Promote effective and globally consistent supervision of the insurance industry

Contribute to global financial stability

IAIS publishes regulatory principles and standards, defining requirements
for effective insurance supervision of the insurance industry

NAIC must demonstrate that it observes IAIS principles and standards
under Financial Sector Assessment Program (FSAP)

FSAP created jointly by IMF and World Bank in 1999 in response to Asian financial
crisis, applies to all financial services sectors

2010 review indicated that NAIC generally observes 25 of 28 core principles, but
recommended strengthening of group supervision, risk management and corporate
governance
— Also, greater need for PBA
6
Solvency II
7
SOLVENCY II
High-level overview of Solvency II

Risk-based regulatory framework for
all insurers based in EU (may be
extended to pension schemes at
some point)

Principles-based not rules-based

Aims to harmonize standards across
the EU

Currently due to be implemented on
January 1, 2013, but the timeline is
a subject of debate
8
SOLVENCY II
Solvency II framework
SOLVENCY II
Pillar 1
Quantitative requirements

Assets and liabilities
measured market-consistently

Eligibility and classification of
own funds
Pillar 2
Qualitative requirements

Solvency Capital Requirement
(SCR)


Minimum Capital Requirement
(MCR)


Risk margin

Supervisors shall review
system of governance,
capital structure and capital
needs, and take any actions
required
Corporate governance and
effective risk management
Pillar 3
Disclosure requirements

Public disclosure in form of
Solvency and Financial
Condition Report (SFCR)

Disclosure to supervisors in
Report to Supervisors (RTS)

Information includes details of
business and performance,
system of governance, risk
exposures, concentrations,
mitigation and sensitivities

Quantitative reporting
templates
Own risk and solvency
assessment (ORSA)
Integrated risk and capital management framework
9
SOLVENCY II
The Solvency II Balance Sheet
Excess Assets
Own
funds
SCR
Required
capital
MCR
Market
Value of
Assets
Risk Margin
Best
Estimate
Liabilities
Technical
provisions
10
SOLVENCY II
Solvency II – SCR and MCR
Internal
model
Level of SCR

Standard
approach
Level of MCR

Solvency Capital Requirement (SCR)
– level of capital that enables an
institution to absorb significant
unforeseen losses and gives
reasonable assurance to policyholders
and beneficiaries; 99.5% VaR over 1year

Minimum Capital Requirement (MCR)
– a safety net that reflects a level of
capital below which ultimate
supervisory action would be triggered;
85% VaR over 1 year
Risk margin
Best
estimate
liability
Technical Provisions (TP) – amounts
set aside in order for an insurer to fulfil
its obligations towards policyholders
and other beneficiaries; market
consistent valuation
11
SOLVENCY II
Different methods to calculate the SCR

Solvency II provides a range of methods to calculate the SCR, which
allows undertakings to choose a method that is proportionate to the
nature, scale and complexity of the risks that they face
Full IM
Standard formula
and PIM
Standard formula
with USP
Standard formula
Standard formula with simplifications
12
SOLVENCY II
The EU has established a program to harmonize
Solvency II with other regulatory schemes via
Equivalence and Transition

European subsidiaries of a U.S. parent:



Will need to calculate local Solvency II capital requirement using the Solvency II
methodology regardless of the final decision on equivalency
If the U.S. is not granted equivalence, then the European supervisor could require the
U.S. group to set up a European insurance holding company
European parent company with U.S. subsidiaries


If the U.S. is granted equivalence, capital for U.S. subsidiaries will be based on (lower)
NAIC RBC capital requirements in group Solvency II calculations
If the U.S. is not granted equivalence, Solvency II rules will need to be applied on a
consolidated basis (i.e., including their U.S. business)

The first three countries to undergo equivalence assessments under the
Solvency II regime are Bermuda, Switzerland and Japan

Rather than undertake a full assessment of the U.S., the European
Commission has instead proposed a transitional regime


Countries eligible for this regime would be deemed equivalent for 5 years
It seems clear that the U.S. will be included in this transitional regime
13
SOLVENCY II
Potential implications of Solvency II for U.S. companies

U.S. subsidiaries of European multinationals are currently undertaking
multimillion dollar projects to prepare for Solvency II

If the U.S. is not deemed equivalent and current standards are ultimately
implemented

Capital increases for U.S. subsidiaries of European multinationals for certain products
(e.g., spread based products such as payout annuities)
— Competitive benefit for U.S. domestic companies
— Decreased credit ratings for U.S. subsidiaries of European multinationals
— Withdrawal of U.S. subsidiaries of European multinationals from these product lines

U.S. subsidiaries of European multinationals enjoy better risk management framework
— Better link between risk identification, risk appetite, risk management and economic capital
— More timely risk information
— Improved risk culture


U.S. parent companies of European subsidiaries set up European holding companies
U.S. regulatory and rating agency changes
14
ORSA
15
ORSA
The IAIS and Solvency II both require an ORSA as part of
solvency regulation; the NAIC and others are following
suit
Territory/
Domicile
Regulatory/ Supervisory
Authority
Risk and Solvency
Assessment
Status/Comment
European Insurance and
Occupational Pensions
Authority (EIOPA)
Own Risk and Solvency
Assessment (ORSA)
Expected implementation January 2013
US National Association
of Insurance
Commissioners (NAIC)
Own Risk and Solvency
Assessment (ORSA)
Under consultation — implementation
would presumably be in 2013
Bermuda Monetary
Authority (BMA)
Commercial Insurer’s
Solvency Self Assessment
(CISSA)
To become effective in 2011
Swiss Financial Market
Supervisory Authority
(FINMA)
Risk Management/Internal
Control System Tool
(RM/ICS Tool)
Developed in 2007 as part of the Swiss
Quality Assurance (SQA)
Australian Prudential
Regulation Authority
(APRA)
Internal Capital Adequacy
Assessment Process
(ICAAP)
Final standard expected to be
implemented in 1 January 2013
Superintendent of
Financial Institutions
Canada (OSFI)
Dynamic Capital Adequacy
Testing (DCAT)
In 2009, OSFI published guidance on
stress, scenario, and sensitivity testing to
extend the use of testing beyond DCAT
16
ORSA
Overview of current (8/5/11) ORSA guidance manual draft

ORSA shall be completed at least annually



Regulator may or may not request the
confidential filing each year
Some insurers/groups may be exempt

Individual insurers with gross premium less than
$500M

Groups with gross premium less than $1B
Insurer’s/Group’s ORSA should contain three
major sections:



Section 1 – Description of the Risk Management
Policy
Section 2 – Quantitative Measurements of Risk
Exposure in Normal and Stressed Environments
Section 3 – Group Economic Capital and
Prospective Solvency Assessment
17
ORSA
The NAIC has been developing a Guidance Manual for
regulators to use in the implementation of ORSA
February
11

NAIC issues “U.S.
Own Risk and
Solvency
Assessment
(ORSA) Proposal”
March
2/11 – 3/18
June
18

7
21
25
Comment period ends


July
Comment period


NAIC issues initial guidance draft, “NAIC
Own Risk and Solvency Assessment
(ORSA) Guidance Manual”
NAIC hosts “2011 ERM Symposium”: CRO Council
members present on ERM
NAIC releases revised guidance manual draft
18
ORSA
The Manual will be refined over the next couple of
months and will be ready for use at the end of the year
August
November
28 – 31
5

October
NAIC target date to
finalize guidance manual
draft to send to industry
for comments

GSIWG
National
Meeting (to
review newly
revised draft of
ORSA
proposal)

GSIWG Public Hearing on ORSA (final
edits before adoption)

SMI Task Force
 Receive and discuss proposal
The NAIC has not announced an exact date for ORSA implementation  the NAIC feels pressure
to meet 2012 FSAP requirements but companies are pushing for a longer timeline
19
PBR
20
PBR
U.S. NAIC Principle-Based Reserves



Why PBR

150 years of prescription

Change, complexity and capability
What is PBR

Reserves calculated using deterministic and stochastic (stochastic interest and equity) modeling

Many assumptions are based on company experience when credible, but some assumptions are
prescribed

Reserves set at a conservative level consistent with statutory reporting

Reserve greater of NPR, DR and SR
Evolution of PBR

Asset adequacy analysis/cash flow testing (1989 in New York, 1992 and later for other states)
—
Can only increase formula reserves

Actuarial Guideline 35 – Reserves for equity-indexed annuities (1998)

Actuarial Guideline 43 – Reserves for variable annuities (2009)
—
VASFRI to address
–
–
–
–
–
—
Disincentives to hedge risks
Domination of the standard scenario
Volatility of results
Pro-cyclicality of capital requirements
Unpredictable results
Tax reserve issues
21
PBR
U.S. NAIC Principle-Based Reserves

Where is PBR Today

NAIC adopted SVL to permit PBR November 2009

Life Product Methodology being tested (VM-20 Impact Study)

NAIC Earliest completion date March 2012

2014? 2015? (US State approval and US Treasury Guidance)
— Valuation Manual 20 – Reserves for life insurance
— Valuation Manual 22 – Reserves for fixed annuities
— Will only apply to business issued after the effective date
22
PBR
VM-20 participation summary and product coverage
Product
ULSG
Count of Products Being Tested in VM-20 Impact Study
Phase I
Original
Submitted
Phase I
Count
Current Count
Count
Resubmissions
Phase II
Submitted Count
10
10
10
9
4
5
4
2
1
1
13
12
12
3
5
Traditional Whole Life
5
5
5
3
3
Simplified Issue Whole Life
4
3
3
2
3
Variable Universal Life
6
5
4
1
2
Indexed Universal Life
2
0
0
0
0
Reinsurance
3
3
0
0
0
48
42
36
19
18
UL without SG
Term
Total

We recently received a significant amount of resubmissions to the Phase I submissions

All values in this presentation include the resubmitted results

Indexed Universal Life products are not included in this impact study due to lack of participation

Six participants have not submitted Phase I results yet, but expect to submit by mid September


In general, Phase I results often took participants much longer to submit than initially planned

Phase II results are coming in much quicker than Phase I results
At least a couple reinsurers had issues with resources, delaying obtaining mirror reinsurance reserves
23
PBR
Not all companies provided all aspects of VM-20
VM-20 Impact Study – Participation
and Exclusion Test Statistics for 1
year of business
Initial number of products planned for
study
Usable products submitted
Average number of model segments per
product
Model segments with usable Phase I
results
Whol Simplifi
ULSG
e Life ed Issue
30
year
Term
Aggregat
e Term
10
5
4
6
6
7
5
7
9
5
3
4
5
6
4
6
1
1
1
1
1.2
1.2
1.3
1.2
9
5
3
4
6
7
5
7
8
6
7
7
9
9
5
5
3
3
-
3
3
1
1
1
1
4
4
3
3
3
3
6
5
4
4
2
2
7
6
5
5
1
1
5
5
3
3
2
2
7
7
6
6
5
5
No. of cos. who supplied CRVM
No. of cos. who supplied NPR
No. of cos. who supplied DR Alt 1
No. of cos. who supplied DR Alt 2
No. of cos. who supplied SR Alt 1
No. of cos. who supplied SR Alt 2

VUL
10 year 20 year
Term
Term
Usable products submitted is less than initial number of products planned for study due to:

A few products lost due to dropouts

A few products yet to be submitted

Average number of model segments per product is sometimes greater than one because some Term
participants also provided results for ROP Term

As you can see, not all participants provided all reserves or exclusion tests
24
PBR
Summary impact of VM-20 on 1 year of business – Product
“Per $1,000’s” are averages across participants, weighted by
each participant’s amount
CRVM Total
Reserve
VM-20 Overall
Impact
($M)
Face
Inforce
Amount
Per
$1,000
4
1.4
VM-20 Alt 1 Reserve
VM-20 Alt 2 Reserve
Change
Change
Per
from
Per
from
Amount
$1,000
CRVM Amount $1,000 CRVM
1 Year – Direct
SIWL
1.5
9%
4
1.5
6%
142
2.2
0%
142
2.2
0%
58.5
2,158
88.1
51%
1,690
69.0
18%
143
22.5
142
22.5
0%
142
22.5
0%
34,758
65
1.9
73
2.1
12%
73
2.1
12%
64,648
184
2.9
109
1.7
-41%
92
1.4
-50%
2.4
-48%
77
1.8
-60%
2,689
Whole Life
65,598
142
2.2
ULSG
24,493
1,433
6,343
Term 10
Term 20
VUL
Term 30
4.6
4
41,516
191
99
Agg. Effect
0
0
Agg. Term
115,915
327
2.8
568
4.9
74%
524
4.5
60%
2,689
4
1.4
4
1.5
10%
4
1.5
6%
133
2.0
0%
(82)
(71)
1 Year – Net
SIWL
Whole Life
64,723
133
2.0
133
2.0
0%
ULSG
16,469
1,416
86.0
1,774
107.7
25%
1,415
85.9
0%
2,175
115
52.8
115
52.7
0%
115
52.7
0%
Term 10
22,158
34
1.5
38
1.7
12%
38
1.7
12%
Term 20
48,229
166
3.4
55
1.1
-67%
48
1.0
-71%
Term 30
31,027
186
6.0
74
2.4
-60%
56
1.8
-70%
Agg. Effect
0
0
Agg. Term
72,953
257
6.7
90%
VUL
(39)
3.5
533
(35)
7.3
107%
488
25
PBR
Comments on the summary impact of VM-20 to today’s
reserve levels

For Term, in most cases the reserves decrease, but because of one large term participant that gave us
results in the aggregate, we get conflicting results for Aggregate Term




For ULSG we see reserves increasing under VM-20

1 year of ULSG increased 51% and 25% under Alt 1 on a direct and net basis, respectively

5 year of ULSG increased 22% and 7% under Alt 1 on a direct and net basis, respectively

The increase is less pronounced under Alt 2 and reserve even decrease 8% for five years of ULSG business under Alt 2
on a net basis

It is notable that statutory reserves increase, but tax reserves decrease
Whole Life reserves didn’t change because the DRET and SRET are always passed so the VM-20
reserve equals NPR which is defined to be CRVM for Whole Life
For VUL, there is not much change in the aggregate


Were it not for this participant, Aggregate Term reserves would have decreased by 26% under Alt 1 and 31% under Alt
2 for 1 year of direct business, and decreased by 52% under Alt 1 and 53% under Alt 2 for 5 years of direct business,
which is more in line with the other Term results
But one VUL participant shows a slight increase, one show VM-20 reserves at zero, and the others show no change
SIWL reserves increase, which is counterintuitive and being investigated

This is due to one SIWL participant showing significantly increasing reserves while the others show no change
26
PBR
VM-20 Observations

We are awaiting the results of Phase II, follow up questions and a survey, but so far we
can say:

With help, companies have been able to work their way through VM-20 and calculate a number
— However, this required hundreds of questions and much clarification
— Plus, results took longer than expected

– Often due to constraints on resources, but not always
– The mortality process, NPR issues and starting asset iterations also played a role
Results are sometimes counterintuitive and unexpected
— ULSG results are generally higher than CRVM/AG-38
— There are some outliers in the SRET
— More data and analysis is needed to answer these questions

– Certain results may be due to specific product features and specifications
Results often vary by significantly by product, and sometimes even within products

Aggregation results in lower VM-20 reserves for Term participants (by 25%, but only a small
sample)

The number of scenarios ran by participant varied widely
27
PBR
VM-20 Other Concerns

Mature block impact

Reinsurance

Initial scope of VM

Consistency with international standards
28
Future IFRS
29
FUTURE IFRS
Measurement of long-term insurance contracts

Eliminates any gain
at inception (cannot
be negative)
Residual
margin
Composite
margin
Estimate of the effects
of uncertainty about
the amount and timing
of cash flows
Risk
adjustment
Estimate of future
cash flows, adjusted
for the time value of
money
Discounted
future
cash flows
Discounted
future
cash flows
IASB
FASB
The discounted future cash
flows represent a marketconsistent value of the
obligations arising from the
contract
 Include time value of money
 Reflect all possible scenarios
 Use current estimates
 Reflect options and
guarantees
A hybrid approach has been proposed that includes both economic
as well as deferral and matching elements
30
FUTURE IFRS
Presentation  Statement of comprehensive income
Illustrative and simplified
Item
Year
X
Year
X−1
Change in risk adjustment
+2
−1
From subsequent re-measurement
Release of residual margin
+1
+1
Subsequent release of residual margin
Gains and losses at initial recognition
0
−1
Unprofitable contracts (and other reasons)
Non-incremental acquisition costs
−1
−1
Experience adjustments
−1
0
Differences between actual cash flows for the current
period and previous estimates of those cash flows
Changes in estimates of cash flows
+2
−1
Impact of subsequent changes in non-financial and
financial assumptions underlying the discounted cash
flows, including discount rates
Investment income
+3
+1
Investment return on assets
Interest on insurance contract liabilities
−2
−2
Unwind of discount rate over period
Items from other standards
−1
−1
Potentially including general overhead costs (if not part
of experience adjustments)
Profit
+3
−5
Insurance contracts standard
Comment
Financial instruments standard
Other standards
31
FUTURE IFRS
Several key issues still unclear



Unbundling

Current proposal to unbundle embedded derivatives and certain explicit
account balances

Guidance based on revenue recognition standard
Presentation

ED proposed a “release of margins” presentation

Significant pushback from industry has led to redeliberation
Transition

ED proposed a simplified method for transition that would not require
significant margins for IF business

Significant negative feedback has led to redeliberation
32
FUTURE IFRS
Timeline

Revised Exposure Draft/Review Draft – Q2 2012


Likely to be much more limited in scope for soliciting comments
Further timing now uncertain

Final standard now unlikely before end of 2012

Effective date uncertain – will not be before YE 2015
33
FUTURE IFRS
Implications

Responding to exposure drafts and quantifying financial impact of changes

Practical Implementation Concerns


Significant increase in actuarial input necessary

Derivation of numbers might require new systems (software and/or hardware)

Reengineering of reporting function including increased controls
Communication of results




—
Likely to be increased volatility due to current nature of framework
—
Increased focus on explanation of results
May require reconciliation to other reporting frameworks
Interpretation/Usability

“Rules of thumb” may no longer be applicable

Likely need for different analytics

Might other metrics be necessary?
New business strategy and product design/pricing


Results will behave differently than before
Management of potentially unprofitable lines of business under the new accounting framework
Managing the potentially increased earnings volatility, for example, via improved asset/liability
management and/or hedging
34
Contacts

Jeffrey L. Johnson, FSA, MAAA
John Hancock Financial Services
AVP and Actuary – Actuarial Policy US Finance
jeff_johnson@jhancock.com

Dominique LeBel, FSA, FCIA, MAAA
Towers Watson
Director and Leader, Hartford Life Practice
dominique.lebel@towerswatson.com
35