With the full adoption of a more flexible reserving guideline for variable annuities by state insurance regulators, companies will now start adjusting their reserving to reflect this new approach.

During its fall meeting, the National Association of Insurance Commissioners, Kansas City, Mo., fully adopted Actuarial Guideline VA-CARVM on Sept. 24. It will become effective on Dec. 31, 2009.

The new reserving approach relies less on reserving formulas and more on actuarial judgment. However, the approach also has a standard scenario that can be used to establish minimum reserving requirements for companies as well as regulatory discretion of state insurance commissioners.

In an interview, Tom Campbell, a life actuary with Hartford Life Insurance Company, Simsbury, Conn., who spearheaded the effort by the American Academy of Actuaries, Washington, in working with the regulators, described how the guideline will affect companies.

“The guideline will align the value of reserves with the risk management that the company is taking. It will allow companies to do a better job of assessing risks and how to manage those risks.”

For instance, the introduction of C3-Phase II, the guidelines for capital for VAs with guarantees that is in place has helped Hartford Life better manage risk through hedging and modeling, he explains.

VA-CARVM will not necessarily change variable annuities with guarantees because the industry is already creating products to meet consumer needs, according to Campbell.

But it will make it easier to make a cogent case for putting the principles-based project in place, he adds.

What will help companies prepare for VA-CARVM is an effective date at the end of 2009 and the fact that C3-Phase II is already in place, Campbell says.

The new guideline is “important for companies writing these very risky products. It is important companies understand those risks and model those risks,” he continues.

The new reserving guideline will probably not have much of an effect on product design because companies have already developed products to reflect capital guidelines in the C3-Phase II project adopted by the NAIC, says Michael Sparrow, vice president and chief financial officer with the individual investment group of Nationwide Financial Services, Columbus, Ohio.

There is, however, the opportunity for more competitive pricing of VAs with guarantees if pieces of VA-CARVM such as the standard scenario and credit given to the product for reinsurance are restructured, he adds.

Sparrow, an actuary who participated in the project at one point during its development, says VA-CARVM is a “huge step forward for regulators and the actuarial community.”

It transforms “outdated” reserving rules that were put in place prior to all the features in annuities that have been introduced into the marketplace, he adds.

VA-CARVM allows for “a dynamic interplay of insurance risk, customer behavior and economic conditions,” Sparrow explains.

But, he continues, there are points that still need to be worked on including the standard scenario, credit given for hedging, reinsurance, and mutual funds.

The project uses stochastic modeling for VA business and then compares it with a single, more conservative standard scenario to help determine reserving, he explains. The proposal restricts credit taken and the length of time that it can be taken for reimbursements given to insurance companies by mutual funds making up VA sub-accounts, Sparrow explains.

The issue of properly reserving for VAs with guarantees came to light nearly a decade ago with the growing popularity of these products, but consensus on a guideline failed to be reached prior to the vote on the current draft, exposed by NAIC’s Life & Health Actuarial Task Force on July 10. The issue has been before at least 4 LHATF chairs.