additional liability assumption overview...q4 2016 q1 q2 q3 q4 2017 q1 q2 q3 without formal model...

© 2016 American Academy of Actuaries. All rights reserved. May not be

reproduced without express permission.

ADDITIONAL LIABILITY ASSUMPTION OVERVIEW

© 2016 American Academy of Actuaries. All rights reserved. May not be reproduced without express permission.

2 PBR Boot Camp: Basic Training and Beyond for PBR Implementation September 21 - 23, 2016

Agenda

Model Validation/Governance of Assumptions General Assumption/Margin Development Expenses and Taxes Term Life Assumptions ULSG Assumptions Case Study



Model Validation/Governance of Assumptions

Key topics to be covered o Why it is important o General areas to consider o Initial baselining and types of deliverables o Continuation of validation controls o Best practices o Typical areas of major findings



Model Validation Can Create Opportunities

Why should companies undertake model validation? Model validation adds credibility in the eyes of senior management

Allows for a thorough understanding of the strengths and limitations of existing processes, and identifies areas of possible remediation (errors, operational risks and/or inefficiencies)

Increases confidence that the results are “right”

A parallel model build in a different platform is a more robust/stronger statement for auditors than simply reviewing a model



An Earnings Argument for Robust Model Validation

Q4 2016 Q1 Q2 Q3 Q4 2017 Q1 Q2 Q3

Without Formal Model Validation and Governance

Earnings without Errors Earnings with Errors Realized over Time

Errors discovered and addressed

in the course of normal operations,

or operational issues discovered later



An Earnings Argument for Robust Model Validation

Q4 2016 Q1 Q2 Q3 Q4 2017 Q1 Q2 Q3

After Formal Model Validation and Governance

Earnings without Errors Earnings with Errors Corrected in Q4 2016

Sum of Errors discovered in advance and addressed via MV



What Do We Mean by Model Validation?

Sensitivity testing

Other types of Model Validation



What Do We Mean by Model Validation?

Micro Validation (Technical review)

Macro Validation

Controls



Baselining

A fundamental first step to ensure ongoing compliance with validation requirements

Requires prioritization Much more time and resource consuming than the typical

model change validation activities Advantages of centralized resources to assist with baselining:

o Independence o Dedicated and scalable resources o Knowledge of typical and best practices o Experienced in developing audit approaches o Broader view model interaction across model owner groups



Types of Deliverables for Validation Effort

Overview of Models Including: Historical use Description of key risks (product, policyholder, market, operational, etc.) Description of methodology and assumptions Data flow and process maps, including data used and labeling of controls at various stages Report on Baselining Review: Justification for plan mapping and model compression (e.g., cell structure) Review of model inputs for product specifications and assumptions Application code review for intended purposes Appropriate use of reporting output Test sample illustrations Continued Monitoring: Model change documentation with reason, impacts, technical review, fit for purpose peer

review, and approvals



Continuation of Validation Controls

A formalized process for continuing validation controls after baselining Conduct in-line with model development lifecycle Examples: Separate testing environment for model changes Roll-forward analysis via a “waterfall” or “ladder” of results Maintenance of documentation suited to each model aspect Archive of current assumptions Model change documentation with levels of peer review and acceptance:

o Development o Technical Review o Testing Documentation o Peer Review o Model owner/management sign-off

Process is much easier to build upon the baseline deliverables



Best Practices

Start with models subject to highest risk o Materiality vs. complexity

Baselining of all inputs, formulas, and reports is more effective than ad hoc review on a narrower scope, which can be biased in terms of focus

The baseline report should stand on its own without the need to access the models (include work papers where needed)

Ensure independence during the review process, but obtain buy-in on findings from model owners

Cover the gaps between: o Initial generation of administration data and assumptions and inputs to the model o Model outputs to final delivery of results to stakeholders



Typical Areas of Major Findings

Misuse of data or results delivered between different areas of the company

Key risks ignored or insufficiently modeled

o Non-modeled business or features

o Lack of economic rate variation

Unexpectedly material simplifications

Model assumptions or approaches applied outside of actuarial guidelines or

recommended practices

Legacy practices or calculations invalidated by new events

Errors in back-end processes used in support of the primary projection model



General Assumption/Margin Development

Prudent estimate assumptions = anticipated experience + margin

Company experience o Relevant o Credible

Industry experience, with adjustments as needed Sensitivity testing Annual review



Expenses and Taxes

Expenses o Valuation Manual guidance o Company/industry experience o Inflation

Taxes o Premium tax o Income taxes



Expense Assumptions: VM Guidance

IT costs/other capital expenditures o VM-20 Section 9.E.1.b: “May spread certain information

technology development costs and other capital expenditures over a reasonable number of years in accordance with accepted SAP . . .”

Expense basis o VM-20 Section 9.E.1.d: “Shall choose an appropriate

expense basis that properly aligns with actual expense” (for example death benefits expenses modeled per death)




Allocation o VM-20 Section 9.E.1.i: “Use fully allocated expenses”

(direct costs associated with block plus allocated indirect and overhead costs per 9.E.1.l)

o VM-20 Section 9.E.1.j: “. . . Allocation method consistent across company lines of business consistent with ASOPs”




New Business o VM-20 Section 9.E.1.n: “For policies sold under a new

policy form . . . use expense factors that are consistent with expense factors . . . from an existing block of mature policies . . .)



Expense Assumptions: Company Experience

Typically based on unit cost studies produced by the company – frequently these support AAT expense assumptions

Use industry data (such as SOA studies or GRET) if company experience lacking or outdated

Use fully allocated expenses per VM guidance



Expense Assumptions: Inflation

Typically based on historical national inflation data such as: o Consumer Price Index (CPI) o GDP deflator o Central bank inflation forecasts

Use historical average, consider a “select and ultimate” approach

Increase rate for margin



Tax Assumptions

Premium tax o Typically, the state premium tax rate applicable to the

product (i.e., averages around 2% for life insurance) Income taxes

o Per 9.E.1.n.g, shall NOT include assumptions for federal and foreign income taxes (reserve calculations are pre-tax)



Term Life Assumptions

Lapse rates o Level period o Shock o Post level period

Conversions Post level period profits



Term Life Assumptions: VM Guidance

Lapse rates o VM-20 Section 9.D.3.b: “The company must assume

that policyholders’ efficiency will increase over time unless the company has relevant and credible experience or clear evidence to the contrary.”




Conversions o VM-20 Section 9.D.1.e: “Reflect the likelihood that

policyholder behavior will be affected by any significant increase in the value of a product option, such as term conversion privileges or policy loans.”




Post-level period profits o VM-20 Section 9.D.6: “For the calculation of the deterministic

reserve, for a term life policy issued 1/1/2017 and later that guarantees level or near level premiums for more than five years until a specified duration followed by a material premium increase, or for a policy for which level or near level premiums are expected for more than five years, followed by a material premium increase, for the period following that premium increase the cash inflows or outflows shall be adjusted such that the present value of cash inflows does not exceed the present value of cash outflows.”



ULSG Liability Cash Flow Assumptions

Company assumptions: o Expenses o Credited rate strategy o Other NGE



ULSG Assumptions

Policyholder behavior: o Premium patterns and persistency o Partial (or full) withdrawals/surrenders o Other benefit utilizations o Lapse (if secondary guarantee not in force)



ULSG Assumptions

Required Sensitivity tests: (Section 9.D.4) i. Minimum premium scenario ii. No further premium scenario iii. Pre-payment of premiums as single premium scenarios iv. Pre-payment of premiums as level premium scenarios



ULSG Assumptions

Considerations: o Section 9.D.1.a. is specifically directed at policyholder

behavior assumptions, and indicates consideration of “expectations regarding variations in anticipated policyholder behavior relative to characteristics that have a material impact on the minimum reserve.”

o Section 9.D.1.e. “Reflect the likelihood that policyholder behavior will be affected by any significant increase in the value of a product option.”



ULSG Assumptions

Review model granularity needs Validation of total terminations Incorporation of prescribed industry lapse rates

from the 2007 CIA study Approaches to setting margins



Additional Liability Assumption Overview

Questions

Break-outs

additional liability assumption overview...q4 2016 q1 q2 q3 q4 2017 q1 q2 q3 without formal model...

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