How reliable are stochastic scenarios are in assessing reserving needs of companies selling variable annuities?

That was the subject of a recent discussion of the Life & Health Actuarial Task Force of the National Association of Insurance Commissioners, Kansas City, Mo. The task force has been working for several years to create a new actuarial guideline, Commissioners Annuity Reserve Valuation Method, or AG CARVM, which will establish reserving guidelines for VAs with guaranteed benefits..

The task force wants to create a more lasting way to reserve for risks in these guarantees to replace temporary solutions embodied in the NAIC’s current Actuarial Guideline 39 and recent revisions to Actuarial Guideline 34.

A stochastic approach is a major part of AG CARVM. A standard scenario to create a reserving floor has also become part of the proposal. Stochastic scenarios are becoming more popular in financial markets and in the financial planning communities as a way to assess the likelihood of particular outcomes.

During the recent task force discussion, Allan Elstein, a Connecticut regulator, argued that “stochastic results do not necessarily create reality.” He referred to a news report noting that stochastic results did not accurately predict the recent direction of stock prices.

In stochastic scenarios under CARVM, “bad” events that happen later in contract years are not being reflected, Elstein noted. Almost all of the loss scenarios in the stochastic examples occur early on, he continued. The reason that losses in later years are not being reflected is because gains precede losses and thus recognition of those losses for reserving purposes is deferred, he said.

Tom Campbell, a life actuary with Hartford Life Insurance Co., Hartford, and a representative for the American Academy of Actuaries, Washington, argued that a stochastic approach involves a broad range of scenarios that would cover losses in later periods.

He also noted that most companies are holding risk-based capital well in excess of company action levels and would take these levels into account before paying out dividends or using available capital to invest in new business opportunities.

Regulators also held a related discussion was how to treat the sunset provision in Actuarial Guideline 39.

New York regulators recommended eliminating the sunset period to ensure that a floor is maintained for VA guaranteed living benefit reserves beyond Jan. 1, 2008.

Elstein said that because it is important to continue to offer guidance on the reserving of these products, the sunset should be extended to Jan. 1, 2010.

AG 39 should be retained only as a temporary solution, according to John Bruins, a life actuary with the American Council of Life Insurers, Washington. The guideline has “severe limitations,” he said.