A.2 LFM-143 Flashcards
Problems with CRVM—why principles-based reserves are needed
CVRM is a formulaic (“rules-based”) method with unrealistic, highly conservative assumptions:
• Conservative prescribed mortality (CSO table)
• Interest assumption based on average of long-term bond returns
• Prescribed expense allowance
• Assumed lapse rate = 0%
CRVM results in the same reserve for policies that may have different levels of insurance risk
CRVM did not change as insurance products evolved rapidly in the 1980s and 1990s
Regulation XXX and AG 38 (AXXX) resulted in highly excessive reserves for competitive term
and ULSG products
Overarching principles of a principles-based valuation
Main idea: Principles-based reserves should ensure solvency without being excessive and
also correspond to contracts’ risk
1. Use conservatism that reflects:
• Unfavorable events with a reasonable probability of occurring during the contract
• Tail risk for contracts with significant tail risk
2. Use assumptions and methods consistent with company’s overall risk assessment process
3. Assumption derivation:
• Prescribed assumptions should come from the Valuation Manual
• Non-prescribed assumptions
– Use company experience if credible;
– Otherwise use other relevant, credible experience
4. Provide margins for uncertainty (adverse deviation and estimation error)
• Greater uncertainty)larger margin)larger reserve
Deterministic reserve methodology
Single economic scenario that reflects:
- US treasury yield curves
- SP 500 returns for GA assets
- Future fund performance for SA assets
Prudent estimate assumptions are used for non-prescribed assumptions. Approaches allowed:
1) PV of CF
2) Direct Iteration
Stochastic reserve methodology
- Use same underlying CF as DR
- SR = CTE 70 of scenario reserve distributions
Steps:
1. Project the segment CFs using stochastically generated scenarios
2. Discount the negative of the projected statement value of assets using 1-yr US treasuary rates * 1.05
3. sum amounts in (2) across all model segments at the end and beginning of each projection year
4. Sc reserve = sum of starting assets across all model segments.
calculate the CTE 70 across all scenarios
VM Objectives
- Consolidate Principles and rules based requirements for life, annuity, and health products into 1 doc
- Uniformity among state valuation requiremetns
- Provide efficient, timely process to update valuation requirements
- mandate and facilitate reporting reqs of experience data
enhance industry compliance with the revisions to the SVL
VM Minimum Reserve formula
NPR + max[0, max(DR, SR) - (NPR - DPA)]
formula reduces if the stochastic and/or deterministic exclusion tests pass
Deterministic Reserve - PV of CF approach
DR = APV(benefits, expenses)
- APV(premiums)
- pretax IMR allocated to policy
Deterministic Reserve - Direct Iteration approach
DR = starting asset amount that results in liquidation of all projected future benefits and expenses
Initial starting assets amount = statement value of starting assets + PIMR
VM: Net premium Reserve (NPR)
Calculation & comparison vs CRVM
NPR = PV(ben) - PV(net premium)
floor = greater of:
- Amount needed to cover COI for next paid to date
- CSV
VM vs CRVM differences:
- Different Expense allowance
- ULSG policies where lapse rates are driven by the level of funding of the secondary GT
VM vs CRVM similarities:
- prescribed Mortality = CSO
- Prescribed IRs are similar
- GP assumed = gt GP in contract
PBR: Assumptions for DR and SR
Mortality
- Blend of company and industry experience (if low credibility)
- margins vary by attained age and credibility
Policyholder behavior
- use company experience for block (or a similar block)
- consistent with economic scenarios
- include margin based on credibility of experience
Expenses
- same for both SR and DR
- align with actual expenses
- consistent between new and inforce policies
- reflect inflation
- no future expense improvements
- consistent with other related assumptions
- FULLY ALLOCATED expenses (direct, indirect, and overhead)
- consider expense efficiencies from combos and mergers
- include non-recurring expenses after val date
VM: Reinsurance considerations
& comparisons vs rules based
Under Rules based:
- Direct writer should calc the reserves of each policy BEFORE reins
- Direct writer then determines the reins credit separately using same methodology and assumptions
- Ceding Company reserve credit = reins assumed reserve
under PBR:
- Reins rsv credit = Pre-reins min reserve - post-reins min reserve
- pre-reins min reserve = VM20 min reserve excluding reins effect
PBR: Asset Modeling
starting assets should include:
- SA assets supporting the policy
- policy loans
- Derivative instruments held at val date
- enough other GA assets so that the total starting assets are (98%, 102%) of reported reserves
- include prudent estimates for call/put options and assets related to timing and uncertainty
Reinvestment assets:
- reflect investment policy of the company
- VM20 prescribes yield spreads for reinv assets
- reflect default costs
- shouldnt produce a lower reserev than VM20s “alt investment strategy” of 50/50 mix of A and AA public non-callable corp bonds
VM20: Clearly defined hedge strategy
Clearly defined hedge strategy requires:
- risk being hedged
- Hedge Objectives
- risks NOT being hedged
- Financial instruments used in the strategy
- hedge trading rules
- Metrics for measuring hedging effectiveness
- Criteria used to determine hedge effectiveness
- freq of measuring hedge effectiveness
- conditions where hedging wont take place
- persons responsible for implementing hedge strategy
- Basis, gap, assumption risks with hedging strategy
- Circumstances under which hedging strategy will not be effective in hedging risks
PBR: Economic Assumptions
DR uses a sinlge economic scenario that reflects a single path of :
- US treasury yield curves
- SP500 returns on GA assets
- future fund performance for SA assets
Economic scenarios come from Academy’s economic scenario generator based on 3 numbers for each period:
- Random shock to 20yr T rates
- random shock to spread between 1yr and 20yr T rates
- Random show to volatility
PBR: Corporate Governance
Duties for Board of Directors, Senior Management, and Actuaries
- Board of directors:
- managements process to correct any material weaknesses in PBR internal controls of the company
- infrastructure to implement PBR process
- review reports required by VM
- interact with senior management to resolve Q’s
- document action taken by the board - Senior Management:
- establish adequate infrastructure for PBR functions
- establish assumptions, methods, and models used to determine PBRs & consistency with other company risk assessment processes
- review significant issues from PBR
- review sensitivity tests of PBR
- adopt internal controls to assure PBR valuation complies with VM
- determines modeling resources are adequate - Actuaries:
- to be qualified, actuary must meet Academy’s qualification standards
- oversee PBR calc
- develop internal standards for actuarial practices, controls, and docs
- provide summary report to board and senior mgmt
- ensure assumptions, methods, models comply with VM requirements
- disclose any significant unresolved issues regarding PBR to auditors and regulators
