When state insurance commissioners meet this weekend, high on the list of topics will be a discussion of the crisis that American International Group, New York has faced, and potentially how a new reserving program that allows greater flexibility would fare if tested by similar circumstances.

State insurance commissioners are coming closer to developing a system of principles-based reserving that would allow a company’s appointed actuary greater discretion in assessing a company’s risks and the reserving that is needed to keep a company financially healthy.

A piece of that project, Guideline VA-CARVM, which establishes reserving guidelines for variable annuities with guaranteed living benefits, will be voted on by the executive committee and plenary during the fall meeting of the National Association of Insurance Commissioners, Kansas City, Mo., which starts on Sept. 21.

Thomas Sullivan, Connecticut’s insurance commissioner, said although his state voted for the VA-CARVM measure twice so far during the process, during the Life & Health Actuarial Task Force and during the “A” Committee vote, NAIC committees, the department still believes that the project needs greater “rigor.” Toward that end, he continues, Connecticut will be working with the American Academy of Actuaries, Washington, to create “a healthy balance” between professional assessment and more formal guidelines to ensure the safety of all stakeholders.

Sullivan says that there is a need for efficient deployment of capital based on risk but also expresses concern that counterparty risk management is an area of concern for the department and that “the lens needs to be tighter and a more vigilant one.”

The current situation AIG is experiencing is an example that could be used as a case study to look at what would happen to companies both with and without principles-based reserving, he notes. “Dynamic hedging concerns me deeply. There needs to be scrutiny and careful risk management,” Sullivan adds.

“As we are seeing right now, you are only as good as your counterparty,” he adds. PBR needs to be “battle-tested,” Sullivan stresses.

Donna Claire, a life actuary with Claire Thinking, Fort Salonga, N.Y., who has been spearheading an effort by the Academy to develop a system of principles-based reserving, declined to comment specifically on AIG. However, she did discuss how the system would work with a hypothetical company.

With a PBR system, all risks would be identified including certain risks that might not be currently highlighted such as credit default swaps. These risks would show up and have to be considered, she explains.

An insurer would be required to look at all major risks and what would happen in the event that the market went bad, she adds.

When asked if the new system would include a list of all major risks, Claire says they would not because “as soon as you create a checklist” other risks may develop or some companies could find a way to circumvent that list. Rather, she says, companies would need to identify risks more broadly such as asset risks.

Off-balance sheet items would have to be considered under the system, Claire continues.

Additionally, a risk focus exam looking at the entire enterprise risk management system would be conducted, she says.

If an insurer was part of a holding company that included other operations, she said that PBR would consider this and what would happen if there was a possibility of a transfer of assets, according to Claire.

“If you know what the triggers are, and can identify potential risk” then you can watch for that risk, she adds. Theoretically, that would prevent the likelihood of a disaster if a company’s fortunes reversed quickly she adds.

But, Claire notes, even if all risks are identified, “You are never going to be able to prevent everything.” However, an appointed actuary, senior management team and regulator has a better chance if they know a company’s risks, she says.