A discussion among regulators of how a new guideline for reserving for variable annuities should be crafted included talk about how reliable stochastic scenarios are in assessing reserving needs of companies.

The Life & Health Actuarial Task Force has been working for several years to create a new actuarial guideline, AG CARVM, which will establish reserving guidelines for VAs with guaranteed benefits. LHATF is a task force of the National Association of Insurance Commissioners, Kansas City, Mo.

The reason for the work on the draft is to create a more lasting way to reserve for risks in these guarantees to replace “temporary solutions” embodied in the current Actuarial Guideline 39 and recent revisions to Actuarial Guideline 34.

A stochastic scenario 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 also becoming more popular in financial markets and in the financial planning communities as a way to assess the likelihood of particular outcomes.

“Stochastic results do not necessarily create reality,” said Allan Elstein, a Connecticut regulator. He referred to a recent news report in which stochastic results did not accurately predict the direction of stocks.

In the CARVM scenarios, Elstein noted that “bad” events that happen later rather than in early contract years are not being reflected in stochastic scenarios. 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, he said, is because gains precede losses and defer recognition of those losses for reserving purposes.

Tom Campbell, a life actuary with Hartford Life, Hartford, Conn., 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 the majority of companies are holding risk-based capital well in excess of company action levels and would take RBC levels into account before paying out dividends or using available capital to invest in new business opportunities.

In conjunction with the discussion on AG CARVM, a related discussion was how to treat the sunset provision in AG 39.

New York regulators recommended eliminating the sunset period to ensure that a floor is maintained for variable annuity guaranteed living benefit reserves beyond 1/1/08.

Extending the sunset date for another year was mentioned by Larry Bruning, a life actuary with the Kansas insurance department and chair of the Life & Health Actuarial Task Force of the National Association of Insurance Commissioners, Kansas City, Mo.

Elstein said that because it is important to continue to offer guidance on the reserving of these products, the sunset should be extended from Jan. 1, 2008 to Jan. 1, 2010.

AG 39 should be retained 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.