ARWG Report to LATF's VM-22 Subgroup Concerning Potential VM-22 Reserve Methodology

Transcription

1 ARWG Repor o ATF's VM-22 Subgroup Concerning Poenial VM-22 Reserve Meodology Indianapolis, IN Augus 22, 2013 The Annuiy Reserve Work Group (ARWG) of e American Academy of Acuaries 1 is pleased o provide you is repor on is progress owards fulfilling e reques made by e ife Acuarial Task Force a e NAIC Spring 2012 Naional Meeing o develop a draf of VM-22 covering all non-variable annuiies and deposi funds. There has been considerable ough and work expended owards is goal. This repor provides e VM-22 Subgroup wi an updae on e progress made. Equally imporan, i provides e Subgroup wi a descripion of e direcion we are currenly aking for recommendaions on VM-22 and also idenifies e major differences beween ese recommendaions and e requiremens of VM-20 and VM-21. Please noe e following: Some of e proposals we've made are enaive and we anicipae furer review of e srucure described in is repor. In paricular, e approach oulined in is repor anicipaes e inroducion of lapse raes ino e Floor Reserve. This should no be regarded as a final recommendaion by e ARWG, as is will require addiional discussion and sudy. The conceps behind many aspecs of e "Modeled Reserve" discussed in is repor are relaively new and ere are many deails o be considered in e fuure as we coninue o explore e meodology. Finally, e ARWG anicipaes a e Kansas Insurance Deparmen will conduc a field es involving a small number of producs and companies' acual business in force for which sample calculaions of e reserves described in is repor will be made. The field es is expeced o be compleed by e end of e year and will be based on e approach oulined in is repor. The ARWG anicipaes a e resuls of is field es will be shared wi i and is will furer inform us and may help furer develop e meodologies described in is repor. However, e ARWG will no direcly paricipae in e es; i is our undersanding a e design and requiremens of e field es are being developed solely by e Kansas Insurance Deparmen. A is ime we are focusing our aenion on deferred annuiies wi cash values bu will consider oer annuiies in scope a a laer dae. 1 The American Academy of Acuaries is a 17,000-member professional associaion whose mission is o serve e public and e U.S. acuarial profession. The Academy assiss public policymakers on all levels by providing leadership, objecive experise, and acuarial advice on risk and financial securiy issues. The Academy also ses qualificaion, pracice, and professionalism sandards for acuaries in e Unied Saes. 1

2 Our goal for e meodology underlying VM-22 requiremens is o propose a sound principlebased reserve sandard for annuiies oer an variable annuiies, incorporaing: 1. an appropriae formulaic floor reserve a exends e curren CARVM meodology o reflec is use as a minimum reserve insead of as e primary reserve; 2. an audiable modeled reserve a properly reflecs e key risks of oday's complex annuiy produc designs; and 3. assurance of an adequae reserve sandard by exploring possible expansion of asse adequacy analysis requiremens, if necessary. Minimum Reserve Sandard. Under e VM-22 requiremens currenly under consideraion, e reserve for a given block of business would equal (i) e sum, for all policies in e block, of e larger of e Floor Reserve and e policy cash value, plus (ii) e excess, if any, of e Modeled Reserve over (i). Floor Reserve. The Floor Reserve being considered by e ARWG provides subsanial conracolder proecion; e Modeled Reserve (described laer in e repor) may require an increase over is floor when analysis of e risks underaken by e issuer indicaes a one is needed. A significan aspec of e proposed Floor Reserve is a i should resul in values a are reasonably comparable o e reserves currenly required under CARVM and Acuarial Guideline XXXIII (AG 33) / Acuarial Guideline XXXV (AG 35), 2 while a e same ime reflecing e greaer variey and complexiy of curren non-variable deferred annuiy producs. To provide greaer flexibiliy in e formulaic Floor Reserve calculaion, a designaion of ree ypes of benefis was creaed as a firs sep: (i) cerain conrac benefis referred o as ised Benefis, 3 (ii) "rich" non-lised benefis (such as Guaraneed Minimum Dea Benefis (GMDBs) wi dea benefis significanly higher an e conrac accoun value, and (iii) all oer benefis. Then, e Floor Reserve was defined as e greaer of α and β, where: 2 References wiin is documen o AG 33 should generally be inerpreed o also include AG 35 inasmuch as AG 35 mus currenly be followed regarding CARVM valuaion of Equiy Indexed Annuiies (EIAs); mos of e producs for which GIBs are currenly offered are EIAs. 3 Examples of ised Benefis are GIBs, annuiizaions oer an GIB elecions, and annuiizaion wiin e annuiizaion ier of a wo-iered annuiy. TC benefis provided under a deferred annuiy may also be considered a ised Benefi if e conracolder may elec wheer or no o receive benefis once e TC disabling even has occurred. Because many ised Benefis may include charges or fees o pay for e benefi, ey will have e effec of reducing e amoun of cash value a is available and may also serve o increase e ulimae dea benefi beyond a provided by a radiional waiver of surrender charge by adding a benefi equal o a refund of fees a have been deduced from e accumulaion value. 2

3 α represens e scenario in which e ised Benefis are no eleced by e conracolder erefore no fuure charges are deduced for ese benefis afer e valuaion dae and no cos for em is refleced. The reserve is compued as currenly required by CARVM, excep a prescribed lapse raes are uilized in every Inegraed Benefi Sream (IBS) and i is assumed a any ised Benefis are erminaed on e valuaion dae (and reflecing erminaion of any charges for e ised Benefi). β, on e oer hand, represens e scenarios in which e conracolder coninues o pay for e ised Benefis afer e valuaion dae and inends o use em a some fuure poin (unless dea or an immediae need for cash inervenes, as represened in e valuaion formulas as specified lapse raes). The reserve is e larges presen value of IBSs, one for each ised Benefi and is defined by prescribed assumpions for all elecive conracolder behavior, wi e assumpions incorporaing a es for ised Benefis a are "in e money." As such, ere would need o be prescribed assumpions for elecion of ose ised Benefis and prescribed incidence rae assumpions for oer elecive behavior such as lapse raes. A measure of in-e-money-ness (ITM) of e "rich" non-lised benefis would be used o adjus e prescribed lapses for bo α and β. ike curren CARVM, e calculaion of α considers all fuure Inegraed Benefi Sreams (excep a prescribed lapse raes are incorporaed) - while assuming a ised Benefis have been erminaed, while e calculaion of β considers e group of Inegraed Benefi Sreams (one IBS for each ised Benefi) in which e ised Benefis are eleced wi β being e larges presen value of ese IBS's. α is a Greaes Presen Value calculaion considering a poenially infinie se of IBSs, while β is e larges of a small number of Presen Value calculaions. For bo α and β, prescribed dynamic lapse raes are uilized, which are modified for adjusmen by an in-e-money-ness (ITM) funcion of e respecive benefis. Prescribed incidence raes for e ised Benefis are included in e calculaion of β. When no ised Benefis are presen in a conrac, only α is needed for reserve calculaion. When a ised Benefi has already been eleced as of e valuaion dae (and no oer ised Benefis are available), en e calculaion of α would be unnecessary and e lapse raes, if any, following elecion are considered in e β calculaion. Please noe a for e field esing of ese calculaions, e resuls wi and wiou e use of lapse raes in e calculaions of α and β will be considered. Following review of ose resuls, e use of prescribed lapse raes in e calculaion we are considering for α may be revisied by e ARWG wi possible subsequen modificaion in our direcion. Thus, for conracs no involving a ised Benefi, we expec a e Floor Reserve under consideraion would be less an e currenly required reserve o e exen a e prescribed lapse raes produce a GPV smaller an a which requires consideraion of lapse raes from 0% o 100%. In addiion, for conracs a conain a ised Benefi, we expec ere may also be a furer reducion from curren CARVM o e exen (a) e greaes presen value under CARVM is deermined from an IBS involving uilizaion of e ised Benefi and (b) e presen value of e single, idenified IBS for e Floor Reserve is lower. 3

4 However, e Floor Reserve includes a cash value minimum, so e Floor Reserve per policy will never be less an e conrac cash value. Thus, e decreases discussed above will effecively never come ino being once e cash value is reached. I is wor noing a cash values for deferred non-variable annuiies are very significan as a percenage of premium, us esablishing a maerial minimum reserve amoun. This can be conrased wi a for some forms of life insurance, which are eier exemp from cash values or provide very minimal values. The curren annuiy nonforfeiure law requires e cash value o be a very high percenage of e accumulaion value a all imes (generally 90% or more) and causes surrender charges o grade off over ime, even if new surrender charges are creaed rough paymen of addiional premiums or crediing of excess ineres. 4 I is imporan o noe a e Floor Reserve has been designed so a adding a GIB benefi o an exising conrac will no lower e Floor Reserve below wha would resul wiou i. The formulas specified for e Floor Reserve in Appendix B may help o explain why is is so. I should also be noed a e formulas for β assume coninuaion pas e valuaion dae of all ised Benefis while e formulas forα assume all ised Benefis are erminaed on e valuaion dae. Furer, i is worwhile noing a under e VM-22 requiremens currenly under consideraion by e ARWG, all business, including conracs wi a GIB, will no have a reserve less an e Modeled Reserve described in e repor. We undersand a ATF may wan any poenial modificaions o reserve requiremens prior o adopion of VM-22 (e.g., o address reserves for GIB business currenly resuling from AG 33) o be consisen wi e β porion of e Floor Reserve described in is repor. Thus, providing e Subgroup wi e informaion in is repor may prove valuable in is consideraion of changes o exising GIB reserve requiremens. Refer o Appendix B for formulas specifying how α and β are o be calculaed. Modeled Reserve. The counerpar o e Sochasic Reserve under VM-20 or e Condiional Tail Expecaion Amoun under VM-21 (AG 43) is e Modeled Reserve. However, ere are key differences beween em under our curren proposal: 4 A recen possible excepion o is rule is inroduced by e curren rend in deferred annuiy produc developmen o incorporae benefis no recognized by e curren annuiy nonforfeiure law, such as wi Guaraneed ifeime Income Benefis (GIBs). Producs wi ese benefis may sill have significan cash values, bu ere is ypically no componen of e cash value a recognizes ese benefis despie e reducion in e accumulaion value (and cash value) where charges are deduced for e exra benefi. 4

5 Insead of a large number (perhaps a ousand or more) scenarios focusing solely on e ineres rae and/or marke risks, we anicipae proposing a a small number of scenarios for each of e criical risks for each produc group will be used o develop e reserve. The proposed scenario projecions will be performed using e company's anicipaed experience assumpions for ose assumpions wiin e company's conrol and use prescribed meods for seing all oer assumpions. The resul derived from e scenarios will be an amoun called e Curren Esimae Reserve. An aggregae margin (a.k.a. Margin over Curren Esimae) will be added o e Curren Esimae Reserve o produce e Modeled Reserve. This resul will be compared o e Floor Reserve. I has been suggesed a some ype of addiional scenario esing may need o be performed on e larger of e Floor Reserve and e Modeled Reserve o produce e final reserve bu we have no considered is in any dep. Comparison of Reserve Feaures. To faciliae a comparison beween e enaive requiremens described in is repor wi (i) ose currenly required for sauory reporing and (ii) ose conained wiin VM-20 & VM-21, we have prepared e following wo chars: 5

6 Annuiy Reserve Change Comparison Aspec Curren Requiremen Currenly Envisioned for VM-22 CARVM wi AG 33 and oer Acuarial Guidelines. Defined Subjec o aggregae asse Reserve adequacy analysis a e company level. Magniude of Curren Reserve and Floor Reserve Reserve Assumpions CARVM Reserve under AG-33 is Greaes Presen Value of all possible Inegraed Benefi Sreams, subjec o e Cash Value Floor Those required under e curren Sandard Valuaion aw Greaer of Floor Reserve and Modeled Reserve. 5 Subjec o asse adequacy analysis a eier e company level or perhaps a a block-of-business or line of business level. α is similar o exising CARVM, bu wi prescribed lapse raes adjused for ITM of rich non-lised benefis. For α, no fuure charges or benefis relaed o ised Benefis are included in e calculaions. α is a GPV calculaion. For β, prescribed lapse raes, adjused for ITM of e ised Benefis and "rich" non-lised benefis, and prescribed ised Benefi incidence raes are included in e calculaions. β is a PV calculaion of a single Inegraed Benefi Sream for each ised Benefi. The Floor Reserve for each conrac is e larger of α and β, subjec o e Cash Value Floor. For e Floor Reserve, assumpions are ose currenly required for CARVM sauory valuaion excep for e prescribed lapse assumpions, adjused for ITM (α and β) and e prescribed incidence raes for e ised Benefi Inegraed Benefi Sream (β). For e Modeled Reserve, assumpions are e acuary's anicipaed experience assumpions plus prescribed variaions 6 in e criical assumpions for e calculaion of e Curren Esimae Reserve wi margins provided by e Margin over Curren Esimae (aggregae margin). 5 Noe a we expec o propose a is be expressed in VM-22 as e Floor Reserve, plus e excess, if any, of e Modeled Reserve over e Floor Reserve. 6 See Appendix C 6

7 Reserve Feaures Comparison VM-20 & VM-21 vs. Currenly Envisioned for VM-22 Aspec VM-20 & VM-21 Currenly Envisioned for VM-22 Curren Assumpion Reserve Number of Scenarios Risks Tesed Using Scenarios General Conservaism Requiremen Theoreical Goal of Principle-based Reserve Assumpion Margins Guardrails Audiabiliy of Curren Assumpion Reserve Deerminisic Reserve (VM-20), Sochasic Reserve (VM-20 and VM-21) Generally considered o be a large number (>= 1,000?) for Sochasic, 1 for Deerminisic Generally limied o ineres rae and marke risk. Oer risks are esed by adding margins o anicipaed experience assumpions. CTE 70 + individual assumpion margins CTE measure applied o model resuls where each criical assumpion incorporaing randomness is sochasically modeled. However, curren pracice under VM-20 and VM-21 generally only sochasically model ineres and marke risks. Curren pracice generally resuls in margins added o each assumpion Many required margins or assumpions Time consuming; difficul o manage Modeled Reserve Small number per risk wi muliple risks All criical risks Evaluaion of Criical Risks wi reflecion of possible oucomes in Curren Esimae Reserve plus explici sauory conservaism buil ino e Margin over Curren Esimae (aka Aggregae Margin) Modeled Reserve may ake a large, pracical sep owards is eoreical goal. Margin over Curren Esimae added o Curren Esimae Reserve Requiremens around assumed probabiliy disribuion of curren esimae reserve assumpions, including specified meods for deermining assumed experience for risks ouside e conrol of e company The meodology being considered is inended o make e audi process more manageable 7

8 Minimum Reserve Guaraneed Minimum Dea Benefis Tax Reserve Reserve Assumpions VM-20: arges of Ne Premium Reserve (wi Cash Value Floor), Deerminisic Reserve, and Sochasic Reserve VM-21: arger of Sandard Scenario Reserve (wi Cash Value Floor) and CTE Reserve Refleced in bo reserve componens wi special requiremens in e calculaion of e Accumulaed Ne Revenue, especially o avoid assuming lapses when oer more valuable benefis exis. VM-20: Ne Premium Reserve (wi Cash Value Floor) VM-21: Sandard Scenario Reserve (wi Cash Value Floor) VM-20: Experience Based Assumpions wi margins for Deerminisic Reserve and Sochasic Reserve (wi many margins a are prescribed) and prescribed assumpions for Ne Premium Reserve. VM-21: Prescribed assumpions (including lapse and elecion raes for Accumulaed Ne Revenue porion) for e Sandard Scenario Reserve. Pruden esimae for e CTE Reserve. arger of e Floor Reserve and e Modeled Reserve, where e Floor Reserve is based on e greaes of e Cash Value, α and β, as discussed above. GMDBs are no ised Benefis bu are refleced in α and in β (o e exen e GMDB sill exiss if e ised Benefi is erminaed) componens. An "in e money-ness" es for "rich" non-lised benefis will be included in e lapse rae assumpions o avoid e assumpion of surrendering a policy when a significanly larger dea benefi is available. Expeced o be Floor Reserve (wi Cash Value Floor) α is similar o exising CARVM, bu wi prescribed lapse raes along e GPV pa. The lapse raes would be adjused for ITM if ere are rich non-lised benefis. For α, no fuure charges or benefis relaed o ised Benefis are in e calculaions. For β, prescribed lapse raes (adjused for ITM of e lised benefis and rich non-lised benefis) and ised Benefi incidence raes are included in e calculaions. β is e larges of a PV calculaion of a single Inegraed Benefi Sream for each ised Benefi. Reserve is larger of α and β, subjec o e Cash Value Floor. Coordinaion wi Asse Adequacy Analysis The resuling reserves are required o be included in e companywide asse adequacy analysis. Some acuaries believe eier e Sochasic Reserve consiues a Cash Flow Tesing exercise or a modificaions of e sochasic esing can be used for CFT. Similar coordinaion is expeced, bu in addiion, e need for addiional scenario esing is under consideraion. 8

9 Appendix A Imporan Issues Being Considered A. Decrease complexiy from a in AG-43 and VM Make e meodology easier o implemen 2. Make e meodology less dependen on large amouns of compuer power 3. Increase e opporuniy o explain volailiy of resuls beween valuaion daes B. Increase audiabiliy C. Develop a meod (Modeled Reserve) a considers e producs key risks in e reserve calculaion (i.e., no jus ineres and equiy risks) D. Develop a meod a is flexible enough o encompass combinaion producs and oer produc innovaion E. Develop a meod a produces reserves and analysis a provides value o Company Managemen F. Poenially allow a company a passes an exclusion es o hold reserves greaer an e Floor Reserve in lieu of calculaing a Modeled Reserve G. Ensure a any changes made o AG-33 before VM-22 is finalized are considered in drafing VM-22, and a discussions regarding VM-22 are considered in any changes made o AG-33. 9

10 n V x α = i= 1 { αβ} = max, i n { PVIBSx } Appendix B Documenaion of Floor Reserve Formulas CARVM Reserve compued assuming all ised Benefis have been erminaed wi no furer charges assessed * i= = max * furer charges no o be deduced following e valuaion dae for all ised Benefis where: i represens an index of e (generally) infiniely large number of Inegraed Benefi Sreams o be considered under CARVM, Ω x n Ω x n i n i i NE i NE i i w i PVIBSx v 1px+ n qx+ n+ 1 NEBn+ v px+ n qx+ n+ CVn+ NE = 1 = 1 q = + + Ω x n = 1 i NE i f x+ n+ x+ n+ 1 and v p q FPW q { i NE, i f Vqx n Vqn n} i i f i x+ n x+ n+ n+ are elemens of e i se of assumed incidence rae vecors, + + corresponding o i IBS n, e x i Inegraed Benefi Sream, wi e "V" i NE lef-subscrip indicaing "vecor" and Vq x + represening a collecion of vecors, one n for each Non-Elecive Benefi (such as i d for moraliy raes), and for valuaion a e i f Vq n + n Vq x + n q = q q q q Ω 1 and e oer i NE Vq x + vecors, n i d i d i d i d i d n duraion, wi V x+ n { x+ n, x+ n+ 1, x+ n+ 2,..., }, of Elecive Benefis defined similarly i q + + are elemens of i w x n w Vq x + n, a prescribed vecor of lapse (surrender) raes i 0 p x + n= 1, wi successive values defined recursively, where i i NE n ( 1 ) ( 1 ) p = p q q q i i i w i f i NE x+ n 1 x+ n x+ n+ 1 x+ n+ 1 x+ n+ 1 NE NEB + is e Non-Elecive Benefi amoun a ime n+ for e For example, for e conrac dea benefi, is would be i DB + NE Non-Elecive Benefi. and would include e dea benefis provided by any Guaraneed Minimum Dea Benefis CV n + is e conrac cash value a e end of year n+. The conrac cash value as of e valuaion dae will reflec all pas premiums, charges and benefis. n 10

11 FPW n + is e assumed amoun of free widrawal aken a e end of year n+. Noe a is is no necessarily e maximum free widrawal amoun, bu raer e amoun assumed as e free widrawal. In pracice, of course, is is ypically se equal o e maximum free widrawal amoun. i n β = max{ PVIBSx}, where Ω x n Ω x n n NE NE wb PVIBSx v 1px+ n qx+ n+ 1 NEBx+ n+ v px+ n qx+ n+ CVn+ NE = 1 = 1 Ω x n f v px+ n qx+ n+ FPWn+ + = 1 Ω x n v px+ n qx+ n+ = 1 where = + + Ω ( x+ ) k = 1 k 1 a NEa a v k 1px+ n+ v qx+ n+ + k 1 NEBn+ + k + AP + v q CV NE wa a n+ x+ n++ k n++ k is among e se of ised Benefis (GIB, regular annuiizaion, upper ier annuiizaion of a wo-iered annuiy, ec.) and indicaes a paricular such benefi, wi e maximum over all values of providing e conribuions o e presen value of all such ised Benefis aken ogeer. All vecors of incidence raes (excep ose specifically noed below) are as defined as for e calculaion of i PVIBS n excep a ey are specific prescribed values for e x ised Benefi insead of being elemens of e assumpion vecors for e i Inegraed Benefi Sream Drafing Noe: Benefis and incidence raes below are annoaed wi o indicae a a eir value may be dependen on or differen afer uilizaion of e lised benefi. NE NEB n + is e Non-Elecive Benefi amoun a ime n+ for e NE Non-Elecive Benefi. For example, for e conrac dea benefi, is would be DB + and would include any dea benefis provided by e ised Benefi and any Guaraneed Minimum Dea Benefi a CV n ++ k is e conrac cash value a e end of year n++k and reflecs any changes from CV n + (e cash value derived assuming ised Benefi is in force bu prior o elecion of e ised Benefi) a resul from elecion of ised Benefi. For example, if Benefi is a GIB, en widrawals made under e GIB will ypically also be deduced from e conrac accumulaion value and a consequen 11 n

12 n reducion in CV n + will resul. Noe a bo ese values are disinc from i CV n + for e i Inegraed Benefi Sream in e calculaion of α where i is assumed a e ised Benefis are erminaed on e valuaion dae. FPW + is e assumed amoun of free widrawal aken a e end of year n+ on a basis wb x n consisen wi e calculaion of i PVIBS n and us also reflecs elecion of ised x Benefi. q + + is e prescribed lapse rae applicable before uilizaion or elecion of a lised benefi wa q x + n ++ k is e prescribed lapse rae, if any, applicable afer uilizaion or elecion of a lised benefi DRAFTING NOTE: An example of prescribed lapse raes migh be a e lapse rae is a consan percenage a does no vary excep by In-The-Moneyness Percenage (ITM%) caegory. ITM% = 100 * ((Max PV (Benefi) / CV) 1): ITM% Caegory apse% ITM% < 10% 1.00 * apse% 10% <= ITM% < 20% 0.50 * apse% 20% <= ITM% < 50% 0.25 * apse% 50% <= ITM% 0.00% When e policy cash value is depleed, apse% = 0%. NEa NEB n ++ is e Non-Elecive Benefi amoun a ime n+ for e k NE Non-Elecive Benefi afer elecion of benefi. AP + is e "annuiy paymen" (or GIB widrawal amoun) under benefi. n q x + n + is e prescribed incidence rae for benefi p a k 1 x+ n+ survivorship values reflec e moraliy and lapse raes afer elecion of benefi, a a a wa NEa so a 0 px+ n+ = p and x+ n p = 1p (1 q 1) (1 q 1) k x+ n+ k x+ n+ x+ n+ + k x+ n+ + k NE 0 p x + n= 1, wi successive values defined recursively, where p = p 1 q w q f 1 q NE ( ) ( ) x+ n 1 x+ n x+ n+ 1 x+ n+ 1 x+ n+ 1 NE 12

13 Appendix C Deailed Descripion of e Modeled Reserve Meodology Being Examined by ARWG The inen of e meodology for e Modeled Reserve is o approximae e reserve a would be deermined using e approach specified for e sochasic reserve under VM-20 or VM-21 bu sochasically modeling all assumpions whose values could be considered o vary randomly (or have a random componen). However, e desire is o approximae a kind of reserve using a process a is less calculaion-inensive and more audiable. In shor, e idea is o use a small number of specially consruced scenarios in place of e full complemen of scenarios generally required under sochasic scenario simulaions. A se of such scenarios would be required for each of e major risks affecing a given produc group and no resriced o jus invesmen risks. The resuls from e small number of scenarios are o be used in a very mechanical and specified way. We are hopeful is will make e process more ransparen and less burdensome. From an audi poin of view, i could us become more pracical o audi bo e consrucion of e scenarios across all major risks and e process by which scenario resuls are used o calculae bo e Curren Esimae Reserve (i.e., e reserve calculaed wiou margins) and e aggregae margin over curren esimae in e Modeled Reserve. In order o apply e meodology, one mus idenify a block of business for which e specrum of criical risks is e same and e supporing asses o be valued for reserve purposes. These asses and liabiliies will be used in an asse / liabiliy model o calculae e scenario reserves (defined below) a will be used o deermine e Modeled Reserve for a given block of business sharing e same primary risk drivers. The uni of accoun for e Modeled Reserve is erefore e block of business. The meodology can be oulined as follows: 1. Deermine a small number of primary risk drivers for is business. This may include e invesmen environmen, moraliy, persisency, and one or more ypes of conracolder behavior (e.g., opion elecion raes) depending on e produc. 2. For each primary risk driver, deermine e anicipaed experience assumpion. Ideally is deerminaion would be deermined using e principles ariculaed in e Valuaion Manual, bu ATF may wish o pu some limis on e range of experience a can be assumed. 3. For each primary risk driver, develop a probabiliy disribuion around e anicipaed experience a each fuure period. These disribuions need o be specific enough a e experience a a specified percenile level ("prescribed variaion" o be specified in VM-22) in e disribuion can be calculaed. For example e mean, sandard deviaion, and skewness may be specified. 4. For each primary risk driver, use e anicipaed experience and e disribuion around a experience o develop a small number of scenarios. These scenarios will be defined formulaically based on e anicipaed experience and e disribuions. The resul will be a small se of scenarios a represens a sample of e acual disribuion of resuls for a risk driver. One of ese scenarios mus be e anicipaed experience, and one mus be e wors 13

14 realisic experience a e sum of reserves and capial is expeced o cover someing a perhaps e 99 percenile level. For every bad scenario, an equally good scenario mus be included in e group of scenarios. A probabiliy will be assigned o each scenario, wi e sum of e probabiliies adding o 100% wiin a risk driver. However, e exac number of such probabiliies and eir values have ye o be deermined. 5. Calculae a scenario reserve for each scenario for each risk driver. The scenario reserve is e presen value of e fuure produc cash flows and expenses in a scenario, discouned using e monly invesmen reurns in a scenario. 6. Calculae e curren esimae reserve. This is e probabiliy-weighed average of all e scenarios across all risks. This represens a mean raer an a median, and may be higher an e anicipaed experience scenario reserve due o e opionaliy of e asses and liabiliies and e skewness of e disribuion of scenario resuls. 7. Calculae e componen risk amoun for each primary risk driver. This is e excess of e greaes scenario reserve for a risk driver over e Curren Esimae reserve. 8. Calculae a composie risk amoun. This is inended o be e sum of e componen risk amouns, adjused for correlaions beween risks. The general concep for calculaing is combined sum have no ye been specified bu migh resemble e formula used o combine C- 1, C-2, C-3, and C-4 risks in RBC, which akes accoun of independen and dependen risk facors. 9. Use e composie risk amoun o calculae an aggregae reserve margin. Two meods are under consideraion for e aggregae reserve margin e confidence level meod and e cos of capial meod. The composie risk amoun can be used wiin eier meod o calculae a reserve margin. Deails of e way e composie risk amoun would be used in each meod are beyond e scope of is repor. Acuarial judgmen mus be applied in several seps in is process. ATF may wish o pu limis on e exercise of professional acuarial judgmen in e following areas: 1. Deerminaion of e anicipaed experience. For assumpions a are largely ouside e conrol of e company, such as e invesmen environmen and some elemens of conracolder behavior, regulaors may specify e meodology for developing e anicipaed experience. For assumpions for which experience is relevan and emerging bu no fully credible, regulaors may wish o pu limis on e range of wha can be anicipaed experience. 2. Deerminaion of e probabiliy disribuion around anicipaed experience. ATF may wish o specify e meodology for developing assumpions a are largely ouside e conrol of e company. For oer assumpions, regulaors may wish o specify e wid and/or skewness of e disribuion a mus be used. Since we would anicipae a a grea deal of judgmen may be required in is area, regulaors may ake e approach of specifying e range and skewness a mus be used for mos common risk drivers, allowing excepions only wi e approval of e commissioner. Alernaively, a qualified, independen organizaion could be assigned o make ese esimaes and updae em periodically. 14

15 3. Assigning probabiliies o each scenario. This needs o be done a wo levels. Firs ere is a se of probabiliies for each scenario wiin a risk driver, and second ere is a relaive weigh o be given o each risk driver. The relaive probabiliies for scenarios wiin a risk driver will be specified because ey mus be consisen wi e means by which e scenarios emselves are formulaically consruced. However, our recommendaions for e relaive weigh given o each risk driver (i.e., e oal weigh for all is scenarios) are sill an open issue. Consideraion should be given o e sensiiviy of e modeled reserve o e risk facor in developing e weighs. ATF may wish o consider wheer more guidance is needed in is area. Modeled Reserve Exclusion Tes I is uncerain a is ime wheer we will recommend a an exclusion es be provided under which companies may exclude blocks of business from e calculaion of e Modeled Reserve. However, in e even is is deemed necessary and appropriae, a es could be developed a would allow e reserve for blocks of business passing e es o be equal o e curren CARVM reserve or oer amoun. 15