ASOP 7: Analysis of Life, Health, or Property/Casualty Insurer Cash Flows

Question 1

Section 1 - Purpose and Scope

Answer 1

1. Purpose - Provide guidance to actuaries who perform professional services involving the analysis of asset, policy or other liability cash flows for life, health or property/casualty insurers
2. Scope - Applies to the following services (does not apply for pension plans, retiree plans, retiree group benefit plans or social insurance plans):
   - Determination of Reserve Adequacy
   - Determination of Capital Adequacy
   - Product Development or Ratemaking Studies
   - Evaluations of Investment Strategy
   - Financial Projections or Forecasts
   - Actuarial Appraisals
   - Testing of Future Charges or Benefits That may vary at Discretion of Insurer

Question 2

Section 3 - Analysis of Issues and Recommended Practices

Answer 2

1. Determining the Level of Analysis of Cash Flows - actuary should consider the type of asset, policy or other liability cash flows and the severity of risk associated with those cash flows
2. Reasons for Cash Flow Testing
   - Material Asset Risks
   - Liabilities That Have Cash Flow Far Out Into the Future
   - Company has New or Rapidly Growing Line of Business
   - Options Have Been Granted to Policyholders or Borrowers and There is Likelihood of Anti-Selection
3. When Cash Flow Testing May Not be Necessary
   - Risks to be analyzed are products with short-term liabilities
   - Block of business is relatively insensitive to influences such as changes in economic conditions or interest rate scenarios
   - Risk being evaluated is unanticipated sources of signficiant claims (past examples: AIDS, or asbestos)
4. If appropriate, actuary may use analyses performed prior to the valuation date (but document reasonableness, assumptions, and material events that would invalidate this analysis)
5. Identification of Assets
   - Choice of Asset Subsets - same assets shouldn’t be used to support different blocks of policy cash flow
   - Notional Asset Portfolios - if liability is based on performance of a notional asset, this should be included in the analysis
   - Other Assets - whether policy loans, deferred premiums, etc should be included in cash flow analysis
6. Asset Characteristics - should consider the following:
   - Sensitivity to Economic Factors
   - Limitations on ability to use cash flows to support policy or liability cash flows
   - Impact on cash flow associated with asset quality (relating to default or deays)
   - Associated costs of maintaining asset or converting assets to cash when necessary
   - Historical experience of similar assets
   - Other known factors with material effect
7. Investment Strategy - should consider the following
   - Insurer’s strategy for sale of assets prior to maturity
   - Asset segmentation
   - Strategy for sale of assets with declining market value
   - Strategy for investment of future cash flows
   - Exent that strategy comtemplates borrowing to cover negative cash flows
   - Insurer’s use of derivative contracts
   - Extent tht strategy contemplates capital contributions from another source
   - Costs or gains due to foreign currency
   - Other known factors with material effect
8. Policy Cash Flow Characteristics - should consider the following
   - Risk of insolvency by providers of services
   - Costs of maintaining, collecting or paying out the policy cash flows
   - Historical experience of similar cash flows
   - Effect of exernal factors (interest rates, equity returns, inflation)
   - Ability of policyholder to exercise options that affect policy cash flows
   - Effect of changes in premium or policy charges
   - Other known factors with material effect
9. Materiality, Reinsurance, Effects of Separate Accounts should all be considered as well
10. Scenarios
    - Range of scenarios consistent with Purpose of Analysis
    - Number of scenarios - sufficient to reasonably represent the underlying variability of the asset
11. Sensitivity testing, internal consistency, projection period and limitations of models and data are also briefly addressed as items to consider

Question 3

Section 4 - Communications and Disclosures

Answer 3

1. Reliance on Others for Data, Projections and Supporting Analysis - should be disclosed (may be related to ASOP #23 regarding Data Quality)
2. Documentation - should include the following:
   - Whether Analyses Prior to Valuation Date were Used
   - Purpose of analysis and risks analyzed
   - Results of analysis
   - Actuary’s conclusion or recommendations
   - Sensitivity test conclusions or recommendations
3. Data, Assumptions and Methods - with sufficient clarity that another actuary could evaluate the reasonableness. Should include:
   - Asset characteristics
   - Limitations on ability to use asset cash flows to support policy cash flows
   - Investment strategy
   - How policy cash flow characteristics are reflected in analysis
   - Cash flows not attributed to specific asset
   - Off-balance sheet items included
   - Relevant cash flows specifically excluded due to immateriality
   - Reinsurance agreements
   - Effect of separate account asset on the general account
   - Model used
   - Scenarios used
   - External factors
   - Time period
   - Existence of Negative Interim Earnings
   - Reliance on Other analyses or Projections of Assets
   - Other Material Factors
4. Retention - Should be held for reasonable period of time (must comply with regulatory and statutory requirements)
5. Disclosures - must include:
   - If any material assumption or method was prescribed by law
   - Reliance on other sources
   - If actuary has deviated materially from the guidance of the ASOP