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Letters Seek To Educate Treasury On Principles-Based Reserving

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Life actuaries and life insurers are responding to an IRS Notice requesting input on a proposed principles-based reserving system currently under development and a proposed actuarial guideline, VA-CARVM, that establishes reserving guidelines for variable annuities with guarantees.

In response to Notice 2008-18, the American Academy of Actuaries offered insight in a May 5 letter by Dave Sandberg, a life actuary who is chairing the AAA’s life tax steering group.

In an interview with National Underwriter, Sandberg said the letter is part of a dialogue and seeks to inform Treasury about technical details of the project.

One of the points the Washington-based Academy is trying to establish is that reserves are designed to ensure that promised benefits can be funded and capital is more about extreme events.

Those involved with developing PBR “have been living this for 3 years,” he continued, but for those who are not so involved, there needs to be an understanding that there are a lot of standards and requirements in place.

There also needs to be an understanding that PBR results are auditable, Sandberg explained. Documentation of how assumptions are reached makes the approach auditable, he added, and the assumptions can be verified.

The comments in the 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.

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

But, the Academy letter goes on to say that there are prescribed assumptions that are used for risks such as the projected new money interest rates on future new investments in which a company has very little or no control over the outcome.

And, there are also stochastically modeled assumptions used for risks that fall within prescribed parameters as well as prudent estimate assumptions for risks where companies have some influence over the outcome of the risk factor.

The Academy letter says that “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.”

And, it also notes that 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.”

The letter notes that there are elements of PBR currently in the proposal that require prudent best estimate assumptions “based on relevant, available and credible experience.”

On the issue of auditing, the letter states that “while PBR will create complexity, the selection of assumptions is not an unfettered process. Additionally, there are full documentation and disclosure requirements to enable validation of the assumptions and methodology by peer reviewers, outside auditors and state examiners.”

In a May 9 letter, the American Council of Life Insurers, Washington, started out by stressing the importance of the issue to the life insurance industry because it would help life insurers and state regulators to ensure that reserves are appropriate with company risk.

The letter addresses the definition of “life insurance reserves” under section 816(b); the reserve prescribed by section 807(d) first with respect to the standard scenario and then with respect to the stochastic portion of the reserve; discusses the effect of designation of the new methodologies as CRVM or CARVM; and, provide updated information on the status of efforts to model the methodological changes and on the timetable for adoption of AG VACARVM.

Among the points that the ACLI makes in its letter is that AG VACARVM reserves should satisfy the definition of “life insurance reserves” in section 816(b).

The trade group says that there would be a “different route to determine reserved need to cover future unaccrued claims but there would not be a change in what the regulators would require to be covered by the reserves (i.e., reserves sufficient to provide for a company’s obligations to its contract holders).”

On the issue of mortality tables, the ACLI writes that “the Notice’s suggested use of the mortality tables used to determine the standard scenario amount with respect to a contract for AG VACARVM is mechanically possible, but very burdensome. The substitution of the standard scenario mortality tables would require the rerunning of all of the hundreds or thousands of scenarios to determine the stochastic portion. It runs counter to the purpose of the stochastic calculation, which is to produce results that are a better reflection of anticipated claims than industry tables.”

And, regarding the tax implications of actuarial discretion, the ACLI states that “in situations where discretion is permitted, various constraints, such as state regulatory requirements and industry standards, and countervailing pressures, such as concerns about surplus, should operate to minimize the impact of tax motivations in setting reserves.”

The letter notes that “in certain contexts, Treasury has allowed for the use of actuarial discretion in choosing assumptions in addition to the prescribed mortality tables and interest rates when determining life insurance reserves. These areas include long-term care insurance, disability insurance and substandard reserves.”

ACLI asserts in the letter that auditability of reserves is required to satisfy state regulators and should enhance the IRS’s ability to audit those reserves.


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