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IRS Official Raises Yellow Flags On Reserving Shift

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An Internal Revenue Service life actuary has expressed concerns about efforts to replace the current formula-based reserving system.

The IRS actuary, Allen Booth of Brookfield, Wis., participated in a recent teleconference on principles-based reserving sponsored by the Affordable Life Insurance Alliance, Washington.

Advocates of principles-based reserving want insurers, regulators and actuaries to focus more on general principles and modern statistical modeling techniques, and less on use of static formulas, when creating and analyzing life company reserves.

Booth said the conversation about principles-based reserving tax issues that he heard during the teleconference sounded like “wordsmithing.”

“There are extreme differences [between] where we are and where we need to be,” Booth said.

“There are all kinds of word nuances that would be appropriate under principles-based reserving,” but a question to address is whether the new reserving system is “closer to economic reserves or farther away,” Booth said.

The current system has worked well, as evidenced by the fact that there have been no major insolvencies in 15 years, Booth said.

Booth did not say that principles-based reserving would not work or that related tax issues could not be resolved, but he said care is needed to put a system in effect that can work both today and in 15 years.

Also during the call, tax experts from Davis & Harman L.L.P., Washington, a law firm, said they think principles-based reserving can work within the current tax system.

Section 807(d) of the Internal Revenue Code, a section that regulates efforts to set the interest rates used to value life insurance and annuity products, is an example of a section that is flexible enough to accommodate principles-based reserving, according to John Adney, a partner at Davis & Harman.

In related news, participants in an earlier principles-based reserving teleconference sponsored by the American Academy of Actuaries, Washington, talked about the status of principles-based reserving projects.

The valuation manual team at the AAA should have a “substantively complete” version ready in September, in time for the fall meeting of the National Association of Insurance Commissioners, Kansas City, Mo., according to Mike Boerner, a Texas regulator and chair of the team.

The manual is important, because some states might adopt an NAIC principles-based valuation model, then allow for easy updates by simply requiring use of the NAIC’s most recent manual.

Even in states that would have to go through a rule-making process to incorporate manual updates in their regulations, regulators could simply propose one rule calling for adoption of the updated NAIC manual, rather than proposing separate amendments to implement each NAIC-recommended change in valuation rules, regulators said.

Dave Neve, who is chairing the AAA’s life reserve working group, said his group could come up with approaches for handling technical points, such as assumption margins and refinements in the credibility weighting process for mortality, by the end of the year.