Evolution of RBC System in the USA
Lou Felice
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© 2012 The National Association of Insurance Commissioners
Presentation Agenda
•
•
•
•
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Overview of Current RBC System
Milestones and Developments Since
the Launch of the RBC System
Key Areas and Challenges of Current
Reforms
Differences between RBC and
Solvency II in Terms of Capital
Requirements
RBC in Context of Group-wide
Supervision
2
© 2012 The National Association of Insurance Commissioners
OVERVIEW OF CURRENT
RBC SYSTEM
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© 2012 The National Association of Insurance Commissioners
Current U.S. RBC –
Framework / Structure
RBC Is Part of Regulatory Safety Net
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Licensing in Each State
Restrictions on and Regulatory
Approval of Key Risk Transactions
Statutory Accounting and Reporting,
CPA Audit and Actuarial Opinion
RBC, Other Intervention Tools and
Financial Analysis
Corporate Governance and ERM
(ORSA)
Risk-Focused Financial Examinations
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© 2012 The National Association of Insurance Commissioners
US Solvency Framework

Primary goal is to ensure financial health
of insurers for purposes of protecting
policyholders
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Work with companies to remedy areas of concern
More severe interventions if company continues to deteriorate
e.g. regulators will run off or liquidate the insurer if necessary
to ensure protection of existing policyholders
Provide a consistently applied set of standards
Additional goals include availability and
affordability of insurance, stable and
competitive markets
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© 2012 The National Association of Insurance Commissioners
Current RBC Formula Regulatory
Purpose / Use

Rules Based, Formulaic / Factor Driven
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Some company results adjust factors for Life
Some modeling used for interest rate and market risk
Industry Averages used for some risks
Reflects Unique Risks Inherent in Operating an
Insurance Company (Compared to Banks, etc.)
Reflects Risk profile of Company Type (Life v. P&C)
and Specific Company (e.g. Investment Strategy and
Insurance Lines of Business)
Not All Risks Are Accounted for; Material Risks by
Industry
Provides Regulatory Authority for Timely Action
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© 2012 The National Association of Insurance Commissioners
Overview of NAIC RBC Formulas
Formula vs. Full Modeling Approach
 Signaling Mechanism between
Regulators and Insurers to Identify
Poorly Capitalized Companies
(Different Levels)
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
Unlike Banking RBC that also Has:
•
•
“Well Capitalized”
“Adequately Capitalized”
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© 2012 The National Association of Insurance Commissioners
NAIC RBC System
• Four formulas:
• Life, Fraternal (copy of Life), P & C, and Health
• NAIC Risk-Based Capital for Insurers Model
Act serves as a guide
• RBC law adopted in each state makes the
system operational and consistently applied
• RBC Law incorporates the formulas by
reference so Law need not be changed when
formula changes
• NAIC produces the RBC formulas but the
content is maintained and modified by State
regulators
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© 2012 The National Association of Insurance Commissioners
Overview of Formula Construction
Generic Component Information
 Asset Risk – Affiliated Investment Risk
 Asset Risk – Default Risk / Market Risk
 Asset Risk – Credit / Other
 Underwriting/Insurance Risk
 Other Types of Risk (Varies by Formula)
•
•
Business Risk (Life & Health)
Interest Rate Risk (Life)
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© 2012 The National Association of Insurance Commissioners
Overview of Formula
Construction (Cont.)
Asset Risk – Investments
 Bonds = Default on Principal and/or Interest
 Preferred Stock = Default and Past
Dividends
 Common Stock = Decrease in Fair Value
 Mortgages = Default on Principal and/or
Interest
 Real Estate = Decrease in Fair Value
 Schedule BA Assets = Risk Similar to
Underlying Characteristics
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© 2012 The National Association of Insurance Commissioners
Overview of Formula
Construction (Cont.)
Asset Risk – Receivables (Credit Risk)
 Risk of Non-Recovery of Receivable
Amounts
Asset Risk – Other
 Investment Concentration Risk = Additional
Risk of High Concentrations in Single
Exposures
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© 2012 The National Association of Insurance Commissioners
Overview of Formula
Construction (Cont.)
Underwriting/Insurance Risk
Reserve Risk = Obligations from Past
Business Are Understated (Underestimated
Reserves)
Premium Sufficiency Risk = Premiums
Are Inadequate to Cover Claims and
Expenses for Policies Written (UnderPriced)
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© 2012 The National Association of Insurance Commissioners
Overview of Formula
Construction (Cont.)
Other Types of Risk (Varies by Formula)
 Business Risk (Life and Health) =
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Primarily Litigation and Guaranty Fund Risk
Life Formula Adds a Risk Charge for Separate Account Reserves
P&C and Health Formulas Add Growth Risk
Interest Rate Risk/Market Risk (Life) =
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
Risk of Losses Due to Changes or Mismatch in Interest Rate
Levels (See Presentation Section on C-3 Interest Rate Risk)
Risk of market fluctuation in asset values vs. liability cash flows
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© 2012 The National Association of Insurance Commissioners
Overview of Formula
Construction (Cont.)
Detail in the Formulas was Developed to Focus
on the Areas of Most Material Risk for Each
Formula
•
•
Life – Asset Risks
P&C – Underwriting Risks (Pricing and
Reserving)
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© 2012 The National Association of Insurance Commissioners
Life Industry Distribution of
Risk Components
Life RBC Components:
•
•
•
•
•
•
•
•
•
C-0 Asset Risk - Affiliates
C-1cs Asset Risk - Common Stock
C-1o Asset Risk - All Other
C-2 Insurance Risk
C-3a Interest Rate & Market Risk
C-3b Health Credit Risk
C-3c Market Risk
C-4a Business Risk
C-4b Business Risk Admin. Expenses
15%
16%
33%
18%
10%
0%
2%
5%
1%
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© 2012 The National Association of Insurance Commissioners
P/C Industry Distribution of Risk
Components
Property/Casualty RBC Components:
•
•
•
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R0 – Asset Risk Affiliated Insurance
Company Assets
R1 – Asset Risk Fixed Income Investments
R2 – Asset Risk Equity Investments
R3 – Credit Risk
R4 – U/W Risk Reserve
R5 – U/W Net Premiums Written
15%
2%
25%
5%
34%
19%
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© 2012 The National Association of Insurance Commissioners
Overview of Formula
Construction (Cont.)
Health RBC Components:
•
H0 = Asset Risk – Affiliated Company Investments
11%
•
H1 = Asset Risk – Other Invested Assets
15%
•
H2 = Insurance/Underwriting Risk
60%
•
H3 = Credit Risk
•
H4 = Business Risk
4%
10%
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© 2012 The National Association of Insurance Commissioners
How Does the Formula Work?
Data Sources and Calculation
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Financial Amounts:
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Automated Data Pulls from the Statutory Annual Statement
Manual Data Entry from Company Records
Multiplied by Risk Factors
Equals Risk Charges
Covariance Calculation
Groups Correlated Risk Charges into Same
Component Recognizing Independence vs.
Correlation of the Risks
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© 2012 The National Association of Insurance Commissioners
Overview of Formula
Construction (Cont.)
Covariance Calculation (Continued):

Square Root of Sum of Component
Amounts Squared = Adjustment to Reflect
the Remote Likelihood of Losses from
Multiple Formula Components Occurring
Simultaneously (Uncorrelated)

Combination of Risks < Sum of Each
Component Risk
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© 2012 The National Association of Insurance Commissioners
Overview of Formula
Construction (Cont.)
Covariance Calculation:
Life RBC
C0+ C4a+
(C1o+C3a)2+(C1cs+C3c)2+(C2)2+(C3b)2+(C4b)2
Property/Casualty RBC
R0 +
(R1)2+(R2)2+(R3)2+(R4)2+(R5)2
Health RBC
H0 +
(H1)2+(H2)2+(H3)2+(H4)2
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© 2012 The National Association of Insurance Commissioners
How Does the Formula Work?
The Ratio and Action Levels
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The RBC formula calculates Total Adjusted
Capital (Capital and Surplus from the
Statutory Balance Sheet Adjusted for
Certain Items)
The RBC formula also calculates a minimum
capital level (Authorized Control Level RBC)
The other Action and Control Levels are
calculated from the ACL RBC:
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Company Action Level = 200% of ACL
Regulatory Action Level = 150% of ACL
Authorized Control Level (ACL) = 100% ACL
Mandatory Control Level = 70% of ACL
© 2012 The National Association of Insurance Commissioners
21
Overview of Formula
Construction (Cont.)
Total Adjusted Capital (TAC):
Capital & Surplus from Liabilities Page
 Adjustments
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AVR (Life and Life Subs)
Dividends (Life & Life Subs)
Hedging Credit (Life)
Non-US Insurance Subsidiaries (Life)
Non-tabular Discount (P/C & P/C Subs)
Tabular Discount (P/C & P/C Subs)
Credit for Capital Notes (Subject to a Limit)
= Official TAC
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© 2012 The National Association of Insurance Commissioners
Overview of Formula
Construction (Cont.)
Total Adjusted Capital (Continued):

Tax Sensitivity Total Adjusted Capital

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
Total Adjusted Capital + Additional Adjustments
 DTA, DTL
 Subsidiary DTA, DTL
= FYI TAC
Additional Sensitivity Tests


Remove Surplus Notes
Additional Charge for Off-Balance Sheet Items
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© 2012 The National Association of Insurance Commissioners
Overview of Formula
Construction (Cont.)
Action/Control Levels:
Authorized Control Level RBC (ACL RBC)
= 50% of Calculation after Covariance
•
•
•
•
Company Action Level
= 200% of ACL RBC
Regulatory Action Level
= 150% of ACL RBC
Authorized Control Level RBC
Mandatory Control Level
= 70% of ACL RBC
© 2012 The National Association of Insurance Commissioners
24
Overview of Formula
Construction (Cont.)
Comparison of Total Adjusted Capital (TAC) to
Action Levels:
 “Official” TAC, NOT (Tax) Sensitivity TAC
 Level of Action Indicators
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None
Company Action Level
Regulatory Action Level
Authorized Control Level
Mandatory Control Level
RBC Ratio = TAC/ACL RBC
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© 2012 The National Association of Insurance Commissioners
Overview of RBC Model Laws
Section 3 - Company Action Level Event:
• TAC >= Regulatory Action Level RBC but
• TAC < Company Action Level RBC
OR
• Trend Test Triggered
=
• Insurer Submits RBC Plan to Commissioner
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© 2012 The National Association of Insurance Commissioners
Overview of RBC Model Laws
(Cont.)
RBC Plan:
•
•
•
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Identify Conditions
Proposed Corrective Actions
Current + 4 Year Financial Projections
Key Assumptions for Projections
Quality of & Problems with Insurer’s Business
Submitted within 45 Days of Company Action
Level Event
Commissioner Response to RBC Plan (60 Days):
• Plan to be Implemented, or
• Unsatisfactory (Revised RBC Plan or Reg. A.L.
Event)
© 2012 The National Association of Insurance Commissioners
27
Overview of RBC Model Laws
(Cont.)
Section 4 - Regulatory Action Level Event:
TAC >= Authorized Control Level RBC but
 TAC < Regulatory Action Level RBC
=
 RBC Plan (within 45 days) to Commissioner AND
 Commissioner Examination or Analysis AND
 Commissioner’s Order for Corrective Actions AND
 Experts to Review RBC Plan at Insurer’s Expense

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© 2012 The National Association of Insurance Commissioners
Overview of RBC Model Laws
(Cont.)
Section 5 - Authorized Control Level Event:
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TAC >= Mandatory Control Level RBC but
TAC < Authorized Control Level RBC
=
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RBC Plan (within 45 days) to Commissioner AND
Commissioner Examination or Analysis AND
Commissioner’s Order for Corrective Actions AND
Experts to Review RBC Plan at Insurer’s Expense
OR

Place Company under “Regulatory Control”
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© 2012 The National Association of Insurance Commissioners
Overview of RBC Model Laws
(Cont.)
Section 6 - Mandatory Control Level Event:
• TAC < Mandatory Control Level RBC
=
• Place Company under “Regulatory Control”
Section 7 – Hearings (Insurer’s Right to Challenge)
• Adjusted RBC Report
• Unsatisfactory RBC Plan or Revised RBC Plan
that Resulted in a Regulatory Action Level Event
• Notice of Failure to Adhere to RBC (or Revised)
Plan with Substantial Effect on Company Action
Level Event
• Corrective Order from Commissioner
© 2012 The National Association of Insurance Commissioners
30
MILESTONES AND DEVELOPMENTS
SINCE LAUNCH OF RBC SYSTEM
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© 2012 The National Association of Insurance Commissioners
Milestones and Development
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•
•
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Formula Implementation
 1993 = Life RBC Formula
 1994 = P/C RBC Formula
 1998 = Health RBC Formula
Sensitivity Tests Expanded over Time
C-3, Phase II Project for Life RBC
 Incorporated stochastic modeling into the
Risk Charge for Annuities
Trend Tests
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© 2012 The National Association of Insurance Commissioners
Milestones and Development

Sensitivity Tests Expanded over Time
 Increases RBC risk charges for affiliated
investments, restricted assets, contingent
liabilities and guarantees, and long-term
leases
 Added tax sensitivity adjustment to TAC
 Back out Deferred Tax Assets (DTAs)
 Add back Deferred Tax Liabilities (DTLs)
 Same adjustments for subsidiary amounts
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© 2012 The National Association of Insurance Commissioners
Milestones and Development

Trend Tests
 Life RBC
 TAC > 200% ACL and < 300% ACL; AND
 Trending downward for prior 2 years (e.g., 1st
prior year 270% and 3rd prior year 230%)
 P/C RBC
 TAC > 200% ACL and < 300% ACL; AND
 Combined Ratio > 120%
 Health RBC
 TAC > 200% ACL and < 300% ACL; AND
 Combined Ratio > 105%
© 2012 The National Association of Insurance Commissioners
34
KEY AREAS AND CHALLENGES OF
CURRENT REFORMS
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© 2012 The National Association of Insurance Commissioners
Challenges and Current Reforms
• Incorporating Catastrophe Risk Charge
• Considering Calibration of Formulas
• Assessing Asset Risk Charges
• Assessing Underwriting charges (P&C)
• How to Incorporate Operational Risk
• Role of Scenario Testing (Stress Testing)
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© 2012 The National Association of Insurance Commissioners
DIFFERENCES BETWEEN RBC AND
SOLVENCY II CAPITAL
REQUIREMENTS
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© 2012 The National Association of Insurance Commissioners
Differences between RBC and
Solvency II
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Accounting Differences
 SII market consistent balance sheet gives a going
concern view of solvency position
 US statutory balance sheet gives more of a winding
up basis
Capital Requirement Calculation Differences
 SII uses independent MCR and SCR calculations
for an insurer
 RBC uses a single formula for a specific insurer to
generate 4 action/control levels
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© 2012 The National Association of Insurance Commissioners
Differences between RBC and
Solvency II (cont.)
Capital Requirement Calculation Differences (cont.)
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RBC uses separate formulas by industry type – life (&
fraternal), property/casualty, health
SII SCR is a single formula with sub-components
utilized based upon insurer type
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© 2012 The National Association of Insurance Commissioners
Differences between RBC and
Solvency II (cont.)
Capital Requirement Calculation Differences (cont.)
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RBC is not based on an overarching calibration
target; only specific calibration at individual risks
level
SII SCR is calibrated to an overall value at risk with
a confidence level of 99.5%
RBC covers a specified list of material risks at the
industry level
SII SCR takes into account all quantifiable risks,
while the MCR is a linear formula based on a set of
risk factors applied to individual company liabilities
© 2012 The National Association of Insurance Commissioners
40
Differences between RBC and
Solvency II (cont.)
Use of Internal Models

Life RBC allows some risk factors to be modified by
insurer/industry experience; partial models are currently
limited to life/ annuity products with guarantees subject to
interest rate/market fluctuation risks
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Models are not approved, but regulators set prescribed
statistical parameters and time horizons and may apply a
standard model that acts as a floor on capital
SII MCR requires a standardized approach, but insurers
can choose between the standard approach or the use of
an internal model for either specific risk modules or for all
its risks for SCR
41
© 2012 The National Association of Insurance Commissioners
Differences between RBC and
Solvency II (cont.)
Use of the Capital Requirement
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RBC has some influence on insurers’ risk
management (e.g. Reserves reduced for
reinsurance, but not for collateral); addressed
mainly through other supervisory tools
SII is designed to provide incentives for risk
management
Capital add on may be required by regulator, but it
is not part of the RBC capital amount
SII capital add on increases SCR
42
© 2012 The National Association of Insurance Commissioners
Differences between RBC and
Solvency II (cont.)
Use of the Capital Requirement in the U.S.
 Other oversight tools are used with RBC
 Many prioritization and analysis tools focus on
specific activities within the insurer; these are
addressed to prevent a future capital problem
 Hazardous Financial Condition Regulation in addition
to RBC Specific Legal Action
 For example, a company with 1000% RBC ratio
could still trigger a Hazardous Financial Condition
trigger by having a large drop in surplus
43
© 2012 The National Association of Insurance Commissioners
Differences between RBC and
Solvency II (cont.)
Own Risk & Solvency Assessment (ORSA)
 US – exemption for insurers under $500 million in
premiums (commissioner can still require)
 SII – required of all insurers and groups
 US – legal requirement tied to analysis and
regulatory oversight with more discretion left to the
company to determine/justify risk assumption and
mitigation methods
 SII – more prescriptive legal requirement linking risk
and capital management (including how the risk
profile deviates from SCR assumptions)
44
© 2012 The National Association of Insurance Commissioners
RBC IN CONTEXT OF GROUP-WIDE
SUPERVISION
45
© 2012 The National Association of Insurance Commissioners
RBC and Group-Wide Supervision
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RBC assesses risk charges on each legal
entity insurer for ownership of parent,
subsidiaries and affiliates; but it does not
establish specific capital requirements for noninsurance entities
RBC aggregation does not recognize
diversification benefits, but those benefits tend
to disappear when groups are stressed
US system focuses on understanding the risks
outside of the insurance entities and how they
may impact the insurers
© 2012 The National Association of Insurance Commissioners
46
RBC and Group-Wide Supervision
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US does not support a consolidated approach
to a group capital calculation
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How do you construct a reasonably accurate group
capital requirement that works for the many
different group structures, types of businesses
included, differing legal system requirements, etc.?
Where does the group capital reside and how is the
priority of distribution established in a liquidation
when it resides at the holding company (and issues
of fungibility)?
47
© 2012 The National Association of Insurance Commissioners
RBC and Group-Wide Supervision

US does support a legal entity based approach to
assessing group capital which includes and
understanding and assessment of group-wide risks
that may adversely impact the legal entities as a result
of group-wide activities occurring outside of the legal
entities but within the broader group
 Perhaps use simple but effective ratios and scenario
(stress) tests to perform group capital assessments
 US system will use ORSA Summary Reports to see
the group’s material risks (including in stressed
environment) and how the capital objective is
structured to account for those risks (including in
stressed environment)
© 2012 The National Association of Insurance Commissioners
48
Questions???
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© 2012 The National Association of Insurance Commissioners
Reserves
- P/C
- Life
ASSAL – November 2012
Lou Felice
50
© 2012 The National Association of Insurance Commissioners
Property and Casualty
Reserves
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© 2012 The National Association of Insurance Commissioners
SSAP No. 55—Unpaid Claims,
Losses and Loss Adjustments
Expenses
Claims, losses, and loss/claim adjustment
expenses shall be recognized as expense when
a covered or insured event occurs.
A covered or insured event:
 Occurrence

The occurrence of an incident which gives rise to a claim or the
incurring of costs.
 Claims

Made
Reporting to the entity of the incident that gives rise to a claim.
52
© 2012 The National Association of Insurance Commissioners
Insurance Data Organization

Accident Date
• The date on which the loss occurred.


Report Date
• The date on which the loss is first reported to the
insurer.
Recorded Date
•
The date on which the loss is first entered into the statistical
records of the insurer.
53
© 2012 The National Association of Insurance Commissioners
Who Sets the Reserves?
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Case Reserves: Claims Representatives
IBNR/Bulk: Actuaries & Company Management
SSAP 55: “Management’s Best Estimate”
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By line of business and in Aggregate
Reserve will NOT be accurate with certainty.
All reasonable outcomes to be considered – not all possible
outcomes
If all points within a range are probable (RARE), record the midpoint.
54
© 2012 The National Association of Insurance Commissioners
Management’s Best Estimate
"Management's best estimate" is the value of the
ultimate settlement amount, undiscounted except for
some small amounts of fixed and reasonably
determinable claim values that can be discounted. It
can be viewed that margin exists equal to the
difference in the best estimate reserve and a
discounted reserve, but there is not to be conservatism
in the estimate. Financial reporting in Schedule P via
loss development triangles provides a means to test for
implicit margins/conservatism in a company's reserves,
showing development in accident year incurred values.
55
© 2012 The National Association of Insurance Commissioners
What Costs are Considered?
Generally, the amount necessary to settle
unpaid claims…
SSAP 55:
 Reported losses
 Incurred but not reported claims (IBNR)
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Can include “Development on Known Claims”
Loss adjustment expenses
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Defense and Cost Containment (DCC)
Adjusting and Other (AO)
56
© 2012 The National Association of Insurance Commissioners
Loss Adjustment Expenses (LAE)

DCC
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
Defense, Litigation, Medical Cost Containment
Cost of Experts …(potentially testify in court)
In DEFENSE of Claim:
 Private investigators, appraisers
 Attorney Fees – (Duty to Defend)
AO: All other LAE
 Claim Adjusters
 In Determination of Coverage:


Private investigators, appraisers
Attorney Fees – (Litigation in determining coverage)
57
© 2012 The National Association of Insurance Commissioners
How Are Reserves Estimated?
SSAP 55
 Loss Reserve Projections by line of
business


Not Just for Company in TOTAL…it’s by line
Results of More than One Method Should
be Considered
58
© 2012 The National Association of Insurance Commissioners
How Are Reserves Estimated?
Loss Development Analysis: Triangle
Loss Development = Change in Loss Over Time
Cumulative Paid Losses at Age
Accident
Year
12
24
36
48
2002
100
200
300
300
2003
100
200
300
2004
100
200
2005
100
Estimated
Ultimate
Predict
$300 each
year
59
© 2012 The National Association of Insurance Commissioners
How Are Reserves Estimated?
Are They Right?
Compare:
Indicated
Reserve: Actuarial Estimate
Carried Reserve: Amount on the Books
Are They Adequate or Inadequate?
Same as…Are They Redundant or
Deficient?
60
© 2012 The National Association of Insurance Commissioners
Salvage and Subrogation
Salvage: Car value when it’s totaled.
Subrogation: Paid claim but reimbursed by atfault person.


Received: Adjust Paid Losses for amounts
received.
Anticipated: If choose to anticipate
recoverables, then estimate & deduct from the
liability for unpaid claims or losses.
(Required to maintain data & perform actuarial tests to support
reasonableness.)
61
© 2012 The National Association of Insurance Commissioners
Discounting


Time Value of Money
No discounting, unless authorized


See SSAP 54 and 65
Fixed and reasonably determinable payments
(Issue Paper No. 65)
Example: Workers compensation
 Tabular indemnity reserves
 Long-term disability claims
62
© 2012 The National Association of Insurance Commissioners
Catastrophe Reserves

Catastrophe Loss Reserves Are
established only AFTER a
catastrophe has occurred
Hail

Any reserves for the
“Potential for a CAT” are
Special Surplus Funds
Earthquake
63
© 2012 The National Association of Insurance Commissioners
Actuarial Opinion
In the Statement of Actuarial Opinion, the
Appointed Actuary must address the risk of
material adverse deviation. This gives the
regulators better knowledge of the possibility for
unfavorable reserve development impacting the
solvency of a company. What does (or could)
impact the management best estimate is the
actuary's best estimate and/or range of estimates
in the Actuarial Opinion Summary. Significant
difference between the actuary's and the
management's
estimates
leads
to
regulator/management
discussion,
so
management is often significantly influenced by
the actuary's best estimate.
64
© 2012 The National Association of Insurance Commissioners
Life Insurance Reserves
65
© 2012 The National Association of Insurance Commissioners
Life Insurance Policy Reserves
• Excess of the present value of future
benefits over the present value of future
net premiums
1. Based on an interest rate – minimum
determined annually (largely set by
regulation)
2. Based on a mortality table – changed
every 10 – 15 years
3. Cash value floor
4. Zero Lapses in calculation
66
© 2012 The National Association of Insurance Commissioners
Life Insurance Reserves
•
Determination of future benefits
1. Face amount
2. Indexed (Cost of Living)
3. Universal / Variable Life
67
© 2012 The National Association of Insurance Commissioners
Life Insurance Reserves
•
Net premiums
1. Based on the interest and mortality of the
reserve
2. Level percentage of the guaranteed
gross premiums
3. Other patterns
•
•
•
Net level premium reserves (NLP)
Commissioners Reserve Valuation Method (CRVM)
CRVM graded to NLP
4. May limit period of insurance
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© 2012 The National Association of Insurance Commissioners
Life Insurance Reserves
• Deficiency Reserves
1. Present value of the excess of net
premiums over guaranteed gross
premiums
2. 1976 – Difference between actual
reserve and minimum reserve based on
maximum interest rate and specified
mortality table
3. 1990’s – Allowed to modify specified
mortality with actuarial certification
69
© 2012 The National Association of Insurance Commissioners
Deferred Annuity Reserves
• The greatest present value of all
possible future guaranteed benefits
streams over future considerations.
(CARVM) – discount at interest only.
1.
2.
3.
4.
Surrenders
Partial Withdrawals
Annuitizations
Death Benefits
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© 2012 The National Association of Insurance Commissioners
Heath Reserves
• Contract Reserves Similar to Life
• Claims Reserves Similar to P&C
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© 2012 The National Association of Insurance Commissioners
U.S. Solvency
Modernization Initiative
Principle-Based Reserving
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© 2012 The National Association of Insurance Commissioners
Principles-Based Valuation
Project
Why is it needed?

Good public policy
• Requires understanding of the real economic condition of the
company.
• Improves the price of products to consumers

Eliminate flaws in current methodology
• Eliminates need to constantly develop new rules
• Focused on “what could happen” instead of “what happened”

International
• More consistent with international reserving initiatives and accounting if
the NAIC moves in that direction.
• Allows U.S. to compete in the global insurance market
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© 2012 The National Association of Insurance Commissioners
SVL PBR Requirements
Include:
• Quantification of benefits, guarantees, and funding at
a level of conservatism for unfavorable events that
have a reasonable probability of occurring.
• Quantification of significant tail risk.
• Assumptions, risk analysis, financial models, and
management techniques consistent with company’s
overall risk assessment process.
• Provide margins for uncertainty such that the greater
the uncertainty the larger the margin.
• Prescribed formulaic component may be included.
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© 2012 The National Association of Insurance Commissioners
Life PBR Requirements in VM
•
•
Found in VM-20
Life PBR Scope:
–
–
–
•
Variable and Non-Variable Individual Life Contracts Issued
on and after the Operative Date of the Valuation Manual
Option Provided to Use Three Year Transition Period.
Excludes Preneed and Credit Life Products.
VM-20 PBR is the greatest of three reserves*:
–
–
–
Net Premium Reserve (NPR) – prescribed formulaic
Deterministic Reserve (DR) – single economic scenario
Stochastic Reserve (SR) – multiple economic scenarios
* Exemption criteria apply depending on product. Product may be exempted from SR or both DR & SR.
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© 2012 The National Association of Insurance Commissioners
Net Premium Reserve (NPR)
•
•
•
•
•
A non-PBR prospective calculation
Intended to be a floor for the PBR reserve
May ultimately be the basis for the tax reserve
NPR is developed for Term
NPR revisions for Universal Life with secondary
guarantees currently in discussion.
• NPR is not developed yet for other products and
would default to current reserve requirements
until developed.
• ACLI will work to develop NPR for other products.
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© 2012 The National Association of Insurance Commissioners
Deterministic Reserve (DR)




A PBR reserve calculation which models
cash flows over a single economic scenario.
Cash flows include projected benefits,
expenses, premiums and related amounts.
Assume you have blocks of business which
can be modeled together ( i.e. – only one
“model segment”)
The Deterministic Reserve is the present
value of the projected benefits, expenses,
and related amounts less the present value
of the projected premiums and related
amounts.
© 2012 The National Association of Insurance Commissioners
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Stochastic Reserve (SR)






A PBR reserve which models cash flows using stochastically generated
economic scenarios.
Assume you have blocks of business which can be modeled together
(i.e. – only one “model segment”)
For each economic scenario starting assets (& reinvestment assets) are
projected and increased/reduced at each future year by the projected the
cash flows to find any future deficits.
The largest present value of a future deficit is added to starting assets to
produce a reserve for that economic scenario.
Calculate the average of the largest 30% of the economic scenario
reserves (referred to as the 70th percentile Conditional Tail Expectation
or CTE 70).
SR = CTE 70 + any additional amount for material risk not reflected.
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© 2012 The National Association of Insurance Commissioners
PBR – Transition & Exclusions

Transition period from VM operative date




Products not subject to VM-20 continue with
current requirements.


Provides up to 3 years to apply VM-20 PBR
Must continue to apply VM-20 once elected
Current requirements apply during use of 3 year transition.
Includes Preneed life and Credit life insurance.
Products subject to VM-20 can be excluded from
the rigor of PBR requirements via exclusion tests.

Stochastic & Deterministic exclusion tests.
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© 2012 The National Association of Insurance Commissioners
Stochastic Reserve Exclusion
Tests
Products can be excluded from stochastic
reserves if:
•
Certification provided by qualified actuary of no
material interest rate risk or asset return volatility risk;
or

•
•
Does not apply to certain products such as universal life with
secondary guarantees.
Stochastic exclusion ratio test is passed; or
Demonstration provided that reserves will not increase
under stochastic requirements.
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© 2012 The National Association of Insurance Commissioners
Deterministic Reserve
Exclusion Test
•
•
Products can be excluded from the deterministic
reserve requirements if the sum of net valuation
premiums are less than the sum of the
corresponding guaranteed gross premiums.
This exclusion test cannot be used for:


Products which are required to calculate the stochastic reserve.
Universal life products with a secondary guarantee.
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© 2012 The National Association of Insurance Commissioners
Exemption - Doing Business
Only in One State
•
•
The SVL provides an option the
Commissioner may consider during
legislative adoption to exempt specified
products of a domestic company that does
business only in that state from the
requirements of the Valuation Manual.
Any products exempted will apply current
reserve requirements in addition to any
requirements established by the
commissioner by regulation.
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© 2012 The National Association of Insurance Commissioners
Questions?
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© 2012 The National Association of Insurance Commissioners