Individual Chapter 6: Reserves and Liabilities Flashcards
Types and Uses of Reserves
1. Uses
a. Major reason of reserves is matching of revenues to costs over time
b. Holding reserves is critical to the measurement of company solvency
c. Inaccurate reserve provide false sense of security
d. Needed later to cover expenses
i. Future increases in expenses being funded currently (policy reserves)
ii. Claims incurred but not yet paid (claim reserves)
iii. Administrative expense (expense reserves)
iv. Coverage (premium reserves)
v. Combined with future revenue and interest will meet obligations over the lifetime of policies in force (gross premium reserves)
2. Liability (already incurred and accrued) vs. reserve (have not yet been incurred or are not yet accrued)
3. Types of reserves
a. By function
i. Premium reserve, Claim reserve, Policy reserve, Gross premium reserve
ii. Each serves separate purpose
iii. Each has its own calculation techniques and typical assumptions
iv. Premium and claim reserves convert cash accounting into accrual accounting
v. Policy reserves account for long term differences between slop of revenue and benefit
vi. Gross premium reserves set aside money to cover the shortfall of current reserves plus future revenue less future costs
b. By context
i. Statutory statement
1. Standards set by each state, applied to all companies licensed in the state
2. States use statement blanks, instructions, and accounting of NAIC
3. Focused on solvency of the insurer, more conservative
4. Requirements in Statutory Statements of Accounting Principles (SSAPs), Model Regulations, Actuarial Guidelines
ii. GAAP
1. Standards set by FASB
2. Focus on matching of profit and revenue streams
3. Solvency is also a secondary concern, not as conservative as statutory
4. Some conservatism explicitly in both assumptions and process, called PAD
iii. Tax Statement
1. IRS requirements
2. Least conservative assumptions
iv. Internationally
1. Embedded value based statements
2. Set by IASB, IFRS
Premium Reserves
1. Reflect Premiums that:
a. Received by the valuation date for coverage after the valuation date
b. Not yet received but relates to coverage provided prior to valuation date
2. Unearned Premiums
a. Part of premium that has been received for coverage which hasn’t occurred
b. Often pro-rata portion of the actual gross premium received
c. Gross UPR is sometimes approximated as 1/2 of all modal premiums in force
i. Assumption that renewal dates uniformly distributed throughout modal period
ii. Assumption is typically conservative
d. When hold policy reserves for a block, for statutory purposes the gross UPR is replaced by a net UPR
i. Net UPR is based on net premium used in the calculation of benefit reserves. Net premium refers to premium excluding non-claim costs.
ii. Gross UPR is required minimum amount to be held for unearned + policy reserves
e. Mean reserves: the reserve is based on a factor that assumes all prem payments are annual. This reserve is overstated, so it is offset by a deferred premium asset
3. Deferred Premium Asset
a. Required if policy reserves based on Mean Reserve calculation instead of Mid Terminal calculation
b. Represents net premiums unpaid, not yet due, which are included in Mean Reserve calculation
4. Premium paid in Advance
a. More premium is received than required for the current renewal period on the valuation date
b. Set up a reserve until the period occurs for which they apply
5. Premium Due and Unpaid
a. Premium payments made late
b. Credit is taken as an asset
c. Limited to smaller of 90 days past due or one modal premium
Policy Reserve
1. Theory
a. Referred to as contract reserves, additional reserves, or active life reserves (combination of policy reserves and unearned premium reserves)
b. If net premium stream matches claim stream over time, no need for policy reserves
c. In many coverages, the claim stream increases over time
i. If the net premium doesn’t rise, it is known as “net level premium” or “issue age” rating
ii. The premium is set higher than the initial claim cost and ends up lower than the final claim cost
iii. If net premium higher than initial claim cost, the excess money is set aside into policy reserve
d. Prospective Formula
i. V = PV(Future Claims) - PV(Future Net Premiums)
e. Retrospective Formula
i. V = PV(Past Net Premiums) - PV(Past Claims)
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2. Variations to Reserve Formula
a. Statutory accounting an implicit recognition of expenses
i. 2YFPT - for non-LTC
ii. 1YFPT used for LTC and Return of Premium (ROP)
b. GAAP accounting expenses are explicitly reflected
i. Policy reserve is calculated using net premiums
ii. Net premiums are assumed to change proportionately to gross premiums
iii. To recognize expenses calculation is done using expenses other than benefits
iv. The resulting expense reserve is actually an asset, called deferred acquisition cost
c. DAC is composed of:
i. Cost selling, underwriting, and issuing the policy
ii. Accumulated value of deferreable expense less accumulated value of net expense premiums
iii. DAC = AV(Deferrable Expense) - AV(Net Expense Premiums)
iv. Net Expense Premiums = Gross Premium * Deferrable Expense / PV(Gross Prem) = Gross Prem * Net Expense Ratio
d. Maintenance expenses are similar to benefit reserves. Often included as loading on the benefit reserves.
e. End of year reserve is called a terminal reserve
f. Mid-terminal Reserve
i. Assume a uniform distribution of issues throughout the year
ii. Arithmetic mean of the two terminal reserve
g. Reserve flow year to year
i. Methods assume the new premium is paid beginning of year
ii. Reserve jumps by the value of net premium
iii. During year reserve accumulates with interest
iv. Claims all occur at end of year lowering reserve
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3. Purchase GAAP
a. When a company is acquired, the GAAP effect is:
i. DAC is released
ii. Acquiring company creates a VOBA
b. VOBA calculated as the PV(Cash profits) discounted at a risk rate of return
c. VOBA amortized over the future lifetime of the business
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4. Pre-funding trends
a. Medical insurance has 3 sources of increasing claim cost: inflationary, aging of insured, and durational trends
i. Not feasible to completely pre-fund the claim cost increases
ii. Typically pre-fund aging of the insured and a few years of durational deterioration
iii. Future rate increases are assumed sufficient to cover claim trend and future durational deterioration
b. Major medical do not pre-fund trends
c. DI and LTC recognize aging and durational effects
d. Prefunding will increase initial rates, hurt competitiveness
e. Prefunding helps eliminate antiselection spirals
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5. When required to policy reserves
a. For DI and LTC, policy reserves are required
b. Not required for medical, and regulators oppose its use in measuring past experience
c. Regulators may not allow change in policy reserves to be used in minimum loss ratio compliance
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6. Rate increases
a. Eiher reserve factors might need to change as premiums are changed, or
b. Leave existing stream of factors alone
i. Calculate a reserve based solely on the increments in net premium and claim costs
ii. Stream of factors is stored for each policyholder
iii. Increments added to the existing reserve stream
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7. Reserve bases
a. Policy Reserves for Individual health usually based on NAIC statutory basis
b. NAIC Model Regulation
i. Contract reserves are required for:
1. Individual contracts with level premiums
2. Contracts when future benefits at any time exceeds future valuaton net premiums
ii. Minimum assumption specifications
iii. Net premiums are a constant proportion of gross premiums
iv. Termination rates
1. Shall be on the basis of a mortality table except:
a. When premium rates are not guaranteed and effects of underwriting are used by policy duration in the valuation morbidity standard
b. Return of Premiuim
2. Total Termination = min(80% of total termination used in calculation of gross premium, 8%)
3. LTC policies issued between 1/1/97 and 1/1/05
a. Mortality as specified
b. Terminations other than mortality
i. Policy Years 1-4, min(80% of voluntary lapse rate used in gross premium calculation, 8%)
ii. Policy Years 5+, min(100% voluntary lapse rate, 4%)
4. LTC policies issued after 1/1/05
a. Mortality as specified
b. Terminations rather than mortality
i. PY1, min(80% of voluntary lapse rate, 6%)
ii. PY2-4, min(80% voluntary lapse rate, 4%)
iii. PY5+, min(100% voluntary lapse rate, 2%)
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8. Policy Reserve and Experience Monitoring
a. Ratio of net to gross lifetime anticipated loss ratio
b. Actual reported loss ratio equals lifetime anticipated loss ratio only if:
i. Add policy reserve changes each year to incurred claims
ii. Interest adjust claims for interest earnings on reserves
Claim Reserves
1. Triangulation Method
- Other adjustments include: Averaging the completion ratios, Averaging the completion factors, Rolling sums of multiple months of incurrals
- Major shortcoming is paid claims can fluctuate significantly in recent incurred months
2. Claim Cost Methods (Loss Ratio or Pure Premium Method)
- Develop estimate of claim cost as incurred claims in a month divided by the exposure
- Trend typically taken into account
- Multiply claim costs by exposures for months in question
3. Tabbular Methods
- Standard table for DI is 1985 Commissioners Individual Disability-A (85CIDA)
4. Regression method examples
- Regression to determine reserves for backlog claims
- Regression to predict claim payments by lag month
- Time series to predict reserves
5. Average size claim method
- Expected claim size against a count of known claims
6. Formula Method
- Past relationships of reserve to other statistics are calculated, and then applied to those statistics on valuation date
7. Seriatim Case Reserve
Deficiency and Other Reserves
1. Deficiency Reserve is Specialized form of gross premium reserve
a. Developed for statutory blank
b. Specific block of policies rather than insurer’s entire business
c. Limited period of time for which the current rates are expected (equivalent to assumption that future rates can be raised)
2. Gross Premium reserve will typically occur when:
a. The policy is non-cancellable, and premium rates cannot be raised
b. Regulators are unlikely to allow premium rates to rise
c. Size of increases needed might trigger an antiselection spiral
3. Recoverability testing is GAAP equivalent to a gross premium valuation
a. If DAC is not sufficient to cover excess of future costs over current reserves plus future revenue:
i. GAAP assumptions are released, known as loss recognition
ii. A new set of assumptions about future experience become locked in
iii. Cause a one-time increase in reserves
4. Cash Flow Testing
a. Actuarial opinion and memorandum regulation (AOMR)
i. Requires an appointed actuary to file an opinion annually
ii. Opinion includes asset adequacy analysis and cash flow testing
b. Six risks important to cash flow testing
i. Morbidity, mortality, lapse, asset credit quality, reinvestment, disintermediation
ii. Morbidity and premium increase limits drive the cash flow projections for individual medical market
iii. Medical coverages tend to be short term, with lower asset accumulation
c. DI and LTC develop substantial reserves and require conventional cash flow testing
i. Time period at least 20 years
ii. Assets modeled stochastically
5. Time Periods
a. Increasing focus on obtaining accurate quarterly statements
b. High deductible plans are subject to more severe seasonality than low deductible plans
c. Important that management understand the impact of seasonality in monitoring its financial results
6. Other reserves
a. Refund reserves for Medicare Supplement
b. Risk sharing reserves for Medicare Part D
c. Special reserves needed for state Medicaid programs
d. Provider-related (withholds, bonsuses, or other cost-sharing)
e. Reserves for potential future cash flows under the ACA premium stabilization programs (risk adjustment, transitional reinsurance, risk corridors)
Reserve Bases
1. Statutory
a. Reserve bases are set by each state
b. Man states adopt the NAIC’s model standards
2. GAAP
a. There is not a well-defined standard
3. Tax
a. Based on statutory accounting principles
