Principle-basedJuly 21jc

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Pullquote and graph with the 10 principles

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A set of principles is starting to be crafted by regulators, insurers and actuaries with the hope of creating a principle-based system of reserving.

Toward that end, regulators at the National Association of Insurance Commissioners, Kansas City, Mo. discussed an initial draft of 10 principles prepared by the American Academy of Actuaries, Washington. A new draft will be drawn up based on these comments. The draft is in preparation for an NAIC interim meeting in mid-August in Minneapolis.

The issue creating a reserving system based on principles and actuarial judgment has been advocated since the mid-1990s when a unified valuation system was proposed by actuaries. It became an issue again when there was strident division over adoption of Actuarial Guideline 38. AG 38 establishes reserving for universal life with secondary guarantees. It is currently poised to be reviewed and possibly adopted by the NAIC Executive Committee and Plenary as a short-term solution while a long-term solution is developed.

The principles in the first draft cover guidelines such as capturing the appropriate degree of risk; blending company experience and prescribed assumptions for controllable risks; establishing a governance process; and, not locking in assumptions at issue but allowing changes as experience and economic issues change. (see complete list below.)

In fact, locking in assumptions was one issue that was discussed by regulators. Concern was expressed by New York regulator, Michael Cebula that liabilities would be valued at market value and assets at book value, creating a mismatch.

But other regulators such as Joe Musgrove of Arkansas said that a product mix could change and affect assumptions for a company that suggest that assumptions should be reviewed.

Dave Neve, who is heading up the Academy universal life working group examining the issue, says that both assets and liabilities are valued at book. And, he continued, if, for example, an assumption was made three years ago about a premium pattern and that assumption is not right, it would make sense to change it to the right value.

The American Council of Life Insurers, Washington, is emphasizing the need to also consider how the methodology would support an “appropriate” federal income tax treatment, according to ACLI actuary John Bruins.

Mike Batte, a New Mexico regulator, says that when work was done on a principle-based project in the mid-1990s, the tax issue was used to discourage it from advancing.

But, Bruins says that ACLI is in active support of the concept and will approach federal tax authorities and tell them that there is a need to implement changes so that a new system can be put in place.

Frank Dino, a Florida regulator, said that he was concerned that there would be too much latitude afforded in making assumptions, putting regulators at a disadvantage. For example, he continued, if a regulator believed that a company should be in receivership, it could be argued by the company that there were just two differing sets of actuarial judgment and the company should remain in business.

Dan Keating, a Florida regulator, said that the system should not be put in place in “one fell swoop” but rather in phases that were tested to see if they worked. Nebraska Regulator John Rink, agreed but added that work to advance a principle-based reserving approach should not slowed down but must proceed.

The Foundation

10 Principles To Reserve By

1-Capture risk appropriately.

2-Methodology can be applied to all individual life products.

3-The reserving approach could differ by product.

4-Assumptions should blend company experience and prescribed assumptions.

5-Assumptions should be based on prudent best estimates.

6-Establishment of a governance process.

7-Rely on actuarial judgment but with appropriate controls, limits and caps.

8-Assumptions will not be locked in.

9-Guidelines for stochastic cash flow model.

10-Assumption and risk management strategies should be appropriate to the business.

Source: American Academy of Actuaries, Washington.

ACLI says that it will approach tax officials about potential changes to reserving tax treatment