Guardrails or Fences

Denver
Regulators say they need “guardrails” to ensure conservatism as the final piece of a principles-based approach to reserving advances toward completion, but actuaries are expressing frustration that it seems more like fence building, boxing companies into prescribed requirements.

During the spring meeting of the National Association of Insurance Commissioners here, actuaries openly expressed disappointment that with a targeted August time frame of advancing a valuation manual, the final piece of the six-year effort to create a principles-based approach to reserving, the whole point of the project is being lost in a list of prescribed requirements designed to create more conservatism. The frank discussion took place during the opening session of the Life & Health Actuarial Task Force.

“In an effort to cover every contingency, we may be drifting away from the focus of true principles-based reserving,” cautioned Donna Claire of Claire Thinking, who is spearheading the massive actuarial effort by the American Academy of Actuaries, Washington. Claire referred to recent decisions by regulators such as not permitting aggregation of business lines for reserving purposes as preference for conservatism that is “actually defeating the purpose of a principles-based approach to reflect a company’s structure and the risk that it is actually taking on. Eliminating aggregation changes how a company manages its business to report for principles-based reserving, Claire explained. Eliminating aggregation eliminates the effect of hedging offsets. For example, she said, a block of deferred annuities and payout annuities are natural offsets.

“We are concerned that PBR changed over last couple of years and just becoming another regulatory requirement. If that happens, it will marginalize its use to look at risk and be expensive for companies. If it becomes just a regulatory tool with little or no gain to regulators or industry, with just prescribed margins, it will not reflect actual risk levels of companies. But rather, it will create just more complex reserving requirements.”

South Carolina regulator Leslie Jones asked for specific examples of where regulators had gone too far in prescribing formulas. David Sandberg, speaking for the Academy, said that the concept of risk offsets is a “key foundation” of the PBR approach. Not allowing risk offsets is a violation of a major principle of PBR. He cited what he called prescriptive requirements such as the elimination of a company using its own stochastic generator, now replaced by what he called a “prescribed set of scenarios that may not capture specific risks of a particular company.” He also cited a risk transfer rule for reinsurance which he called “a black and white arbitrary in or out transfer rule” rather than letting a model capture real risk.

Tomas Serbinowski, a Utah regulator, said that a “few fundamental problems” are the source of disagreement on the issue. It is one thing to have a system that uses data and company experience, he said. But, he continued, there is very little chance for a regulator to verify data and the concern is that regulators will end up relying too much on actuarial judgment. “A system where you don’t have anywhere to anchor assumption is completely meaningless to me. It is just a guess. You can call guess or actuarial judgement but you don’t have much to go on to decide that it is what it actually is.”

Sandberg countered that the whole foundation of PBA is based on company mortality experience and some lapse experience but “fundamentally based on not just a guess but experience.”

Later in the session, Alaska regulator Katie Campbell proposed an amendment that makes it easier for small companies to participate in PBR by using a certification process that these companies perform anyway in asset adequacy analysis to simplify their participation in PBR. Companies who used the certification could avoid stochastic scenario testing and possibly deterministic testing and a proposed net premium reserving test being developed by the American Council of Life Insurers, Washington. The motion was adopted by LHATF.

Following the full-day session, Claire said that such efforts by LHATF made her more optimistic that the project would be put back on track.

The full-day session also included a description of the net premium approach presented by John Bruins and Paul Graham, life actuaries with the ACLI. Bruins argued that regulators should consider a net premium floor rather than creating new tables for a net premium reserve. The reason, he explained, is that new tables could be problematic from a tax viewpoint because it conceivably could create a perception that companies are trying to manipulate reserves by referencing the tables instead of the current CRVM tables.

Regulators and companies are still considering the net premium reserve piece of PBA.