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RBC Standard Scenario Floor Prompts Debate

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Many life insurers and insurance regulators are opposing the idea of creating a mechanism that would add a floor to a new flexible reserving methodology for variable annuities.[@@]

The issue will come up for discussion later this month at the summer meeting of the National Association of Insurance Commissioners, Kansas City, Mo.

But insurance executives and regulators say regulation writers should put “floors,” or minimum capital requirements, in regulations governing use of stochastic modeling only for informational purposes and not for purposes of setting risk-based capital standards.

A stochastic model is a mathematical tool for determining what might happen to a product by seeing how that product would perform under many different scenarios. Advocates of stochastic modeling are promoting it as an alternative to use of traditional, “deterministic” formulas for reserving.

Some executives and regulators involved in the “C3-Phase II” project say shifting toward stochastic modeling would help life insurers create proper reserves while becoming more flexible. Other participants in the discussion say they are still more comfortable with the traditional formulas. Some are trying to compromise by creating a “standard scenario” that would act as a floor in stochastic model analyses.

Implementing a shift to stochastic modeling will take a lot of work, and requiring companies to test products both with stochastic scenarios and a standard scenario could create extra expenses during the implementation phase, regulators and others say in discussions of the C-3 Phase II reserving project.

But executives and several regulators say they would rather see regulations start by including a standard scenario as a point of information rather than as a component of the risk-based capital calculation.

New Mexico opposes use of the standard scenario because, while it might be valuable as an oversight tool, it could “punish companies that are using good risk management,” says New Mexico regulator Mike Batte.

Other regulators say the best way to find out if something works is to do it.

Allen Elstein, a Connecticut regulator, says there should be a floor to ensure that derivatives risks and options risks are properly accounted for.

“The curse of an option is that, if you make a mistake, it is a big one,” Elstein says.