The American Academy of Actuaries is trying to help federal officials analyze the effects of shifting the insurance industry away from static reserving formulas.

The AAA, Washington, has submitted a comment letter responding to Internal Revenue Service Notice 2008-18.

In the notice, IRS and U.S. Treasury Department officials asked for comments about the federal income tax consequences of adopting a new “principles-based” reserving system, which would depend less on static formulas and more on use of general principles, modern statistical forecasting techniques and sound actuarial judgment.

AAA members are helping with efforts at the National Association of Insurance Commissioners, Kansas City, Mo., to develop a PBR system and an actuarial guideline, VA-CARVM, that would establish reserving guidelines for variable annuities with guarantees.

The AAA comment letter seeks to advise Treasury officials about the technical details of the PBR efforts, Dave Sandberg, chair of the AAA life tax steering group, says in an interview.

Sandberg, the author of the AAA letter, says the AAA is emphasizing that reserves are designed to ensure that promised benefits can be funded and that capital is more about extreme events.

Those involved with developing PBR “have been living this for 3 years,” Sandberg says.

Those who have not been as involved in the project’s development need to understand that there are many standards and requirements in place, Sandberg says

Interested parties also need to understand that PBR results are auditable, and that documentation of how assumptions are reached makes the underlying assumptions auditable, Sandberg says.

The comments in the AAA PBR letter fall into 5 topic areas:

- Constraints on setting assumptions for PBR.

- Why a provision of uncertainty is included in PBR.

- A discussion of the gross premium valuation method.

- Determination of mortality assumptions.

- Auditing of PBR.

“Upon an initial examination, it may appear that the actuary is given wide latitude in setting valuation assumptions used to determine reserves under principles-based reserves,” Sandberg writes in the AAA letter.

But there are prescribed assumptions, involving factors such as the projected new money interest rates on future new investments, over which a company has very little or no control, Sandberg writes.

There also are stochastically modeled assumptions used for risks that fall within prescribed parameters, as well as prudent-estimate assumptions for risks that are partly under the company’s influence, Sandberg writes.

“There is a requirement to provide full disclosure and documentation of the rationale and methods used to determine the prudent-estimate assumption for each material risk,” Sandberg writes

The PBR approach has a “requirement for companies to submit their company experience data (e.g., mortality, lapse, etc.) to a centralized statistical agent to be used to develop frequently updated industry experience tables,” Sandberg notes.

In addition, there are elements of PBR currently in the proposal that require prudent best estimate assumptions “based on relevant, available and credible experience,” Sandberg writes.