Session 118 PD - VM-20 Impact on Product Development: Research Study Phase 2. Moderator: Kelly J. Rabin, FSA, MAAA

Transcription

1 Session 118 PD - VM-20 Impact on Product Development: Research Study Phase 2 Moderator: Kelly J. Rabin, FSA, MAAA Presenters: Paul Fedchak, FSA, MAAA Jacqueline M. Keating, FSA, MAAA Michael W. Santore, FSA, MAAA SOA Antitrust Compliance Guidelines SOA Presentation Disclaimer

2 VM-20 Impact on Product Development: Research Study Phase 2 SOA Annual Meeting & Exhibit Kelly Rabin, Paul Fedchak, Jackie Keating, Michael Santore October 17, 2017

3 Agenda Phase 1 Case Studies High Level Background Phase 2 Case Studies Phase 2 Interviews Observations / Commentary / Impacts 2

4 Phase 1 - Pricing Situations Description Statutory Reserves Tax Reserves CSO Model 830 statutory reserves (XXX, AG38) Model 830 tax reserves (XXX, AG38) CSO with AG48 Financing NPR component of VM-20 reserves calculated using 2001 CSO Table with adjustment factors specified in AG48. DR and SR calculated as described below for PBR Model 830 tax reserves (XXX, AG38) CSO Model 830 statutory reserves (XXX, AG38) Model 830 tax reserves (XXX, AG38) CSO with AG48 Financing NPR component of VM-20 reserves calculated using 2017 CSO Table. DR and SR calculated as described below for PBR. Model 830 tax reserves (XXX, AG38) using 2017 CSO Table CSO PBR VM-20 statutory reserves using 2017 CSO table. Term: DR, NPR. ULSG: SR, DR, NPR NPR tax reserves calculated using 2017 CSO Table 3

5 VM-20 Pricing Case Studies Case Studies focus on a single pricing scenario Starts at December 31, 2015 Yield Curve, and grades to long-term expectations over three years. Uses pricing assumptions in financial results (outer loop), and VM-20 assumptions at each future valuation date node (inner loop). Profit Metrics: Profit Margin PV of Profits / PV of Premiums Surplus Strain after Target Capital IRR (adjusted for target capital and after-tax) 4

6 Term Case Study: Product Design 10 and 20 year Level Premium Term to A95 Design Premiums represent average rates available in top quartile of market (as of early 2016); $60 policy fee Issue ages for 10T; for 20T Premiums guaranteed during initial level period Tail premiums set at 250% of 2017 CSO Ultimate rates 4 NS; 2 S class structure 5

7 Term Phase 1 Case Study: Assumptions Risk Factor Margin for Situations 2, 4, and 5 Mortality From Limited Fluctuation table when 2015 VBT is the industry basic table; assuming 99% credibility, no mortality improvement beyond node. Lapse Term 10: (1-3) +5%; (4+) -10% Term 20: (1-5) +5%; (6+) -10% Expense 5% on maintenance expenses Reinsurance Premiums Increased to reflect the VM-20 mortality margin. Some call this a margin, others may think of it as reconciling the economics of the reinsurance with the PBR valuation. 6

8 20 Year Term Case Study Profitability Results PT Profit Margin* AT Profit Margin** Adjusted AT Profit Margin*** Surplus Strain IRR Adjusted After-Tax Low Band Model Office 1) XXX Stat/Tax, 2001 CSO 18.4% 11.2% 6.5% -180% 6.6% 2) AG48 Stat, XXX Tax 2001 CSO 15.4% 16.0% 11.6% -172% 25.2% 3) XXX Stat/Tax, 2017 CSO 18.4% 11.1% 6.6% -180% 7.4% 4) AG48 Stat, XXX Tax, 2017 CSO 16.8% 13.7% 9.3% -172% 16.5% 5) PBR NPR+DR Excess Stat, NPR Tax, 2017 CSO 18.4% 11.1% 6.7% -172% 9.9% High Band Model Office 1) XXX Stat/Tax, 2001 CSO 19.9% 12.0% 6.5% -169% 6.4% 2) AG48 Stat, XXX Tax 2001 CSO 16.0% 18.4% 13.2% -147% 37.5% 3) XXX Stat/Tax, 2017 CSO 19.9% 11.9% 6.6% -169% 7.1% 4) AG48 Stat, AG38 Tax, 2017 CSO 17.8% 15.3% 10.1% -147% 22.8% 5) PBR NPR+DR Excess Stat, NPR Tax, 2017 CSO 19.9% 11.9% 6.7% -147% 10.4% * Pretax profit margin is calculated with discount at the pretax NIER. ** After-tax profit margin is calculated with discount at the pretax NIER. *** Adjusted after-tax profit margin includes target capital effects and is calculated with discount at the pretax NIER. 7

9 Deterministic Reserve Attribution DR Baseline: DR from the Phase 1 Situation 5 DR1 Remove Mortality Margins: For each future DR calculation, mortality improvement is included in cash flows beyond the valuation date, or node, and the VM-20 margin is omitted. This effectively brings the mortality assumption back to the company s anticipated experience. Note that for Phase 1 term, because of the assumed availability of credible mortality data, there was no grading to industry tables over the level term period. DR2 Remove Lapse Margins: Starting with DR1 assumptions, the lapse margin is omitted from the inner loop cash flows DR3 Remove Expense Margin: Starting with DR2 assumptions, the expense margin is omitted from the inner loop cash flows DR4 4% Discount Rate: Starting with DR3 assumptions, the Deterministic Reserve discount rate is assumed to be 4% level 8

10 Term Phase 1 Case Study: Key Reserve Pattern Observations The driver of the PBR reserve for term is product/companyspecific NPR floor often the winner in the early and late LTP durations The ability to forecast DR with mortality improvement to future valuation dates is an important element in the pricing exercise (metrics are lower without reflecting mortality improvement in forecast DR) 9

11 Term Phase 1 Case Study: DR Attribution 3000 Term DR Attribution Thousands NPR DR Baseline DR1¹ DR2² DR3³ DR4⁴ 1 DR1: Remove mortality margins 2 DR2: Remove lapse margins 3 DR3: Remove expense margin 4 DR4: Level discount rate (4%) 10

12 ULSG Phase 1 Case Study: Product Design Multi-Tier Shadow Account Design Competitive in top quartile of market (as of early 2016) Minimal Cash Value Accumulation Potential Lifetime Guarantee Assume level premium to provide coverage to age

13 ULSG Phase 1 Case Study: Assumptions Risk Factor Margin for Situations 2, 4, and 5 Mortality From Limited Fluctuation table when 2015 VBT is the industry basic table; assuming 99% credibility, no mortality improvement beyond node. Lapse 10%, grade to Term-to-100 table after year 10 Expense 5% on maintenance expenses Reinsurance Premiums Increased to reflect the VM-20 mortality margin. Some call this a margin, others may think of it as reconciling the economics of the reinsurance with the VM-20 valuation. 12

14 ULSG Phase 1 Case Study: Stochastic Reserve Approach Deferred Valuation Approach Best Estimate Project to the Valuation Date (Node) Then Branches into Stochastic Scenario Sets from the Node Greatest PV of Negative Assets Discounted to Node CTE70 Calculated Calculated Explicitly at Six Nodes (1, 5, 10, 20, 30, 50) Ratio of SR to DR at each node, Interpolate Ratios Between Nodes 13

15 ULSG Case Study: Profitability Results ULSG with Level Premiums for Coverage to A110 PT Profit Margin* AT Profit Margin** Adjusted AT Profit Margin*** Surplus Strain IRR Adjusted After-Tax Low Band Model Office 1) AG38 Stat/Tax, 2001 CSO 22.5% 12.6% 10.5% -331% 7.0% 2) AG48 Stat, AG38 Tax 2001 CSO 18.9% 18.7% 17.1% -180% 18.5% 3) AG38 Stat/Tax, 2017 CSO 21.9% 7.8% 5.5% -610% 5.9% 4) AG48 Stat, AG38 Tax, 2017 CSO 16.7% 16.7% 15.0% -183% 16.0% 5) PBR NPR+DR+SR Stat, NPR Tax, 2017 CSO 23.7% 8.6% 6.9% -196% 7.3% High Band Model Office 1) AG38 Stat/Tax, 2001 CSO 18.3% 9.0% 6.8% -395% 6.3% 2) AG48 Stat, AG38 Tax 2001 CSO 14.9% 14.8% 13.1% -267% 11.5% 3) AG38 Stat/Tax, 2017 CSO 17.9% 4.9% 2.6% -633% 5.6% 4) AG48 Stat, AG38 Tax, 2017 CSO 13.2% 13.0% 11.3% -270% 10.2% 5) PBR NPR+DR+SR Stat, NPR Tax, 2017 CSO 19.5% 4.4% 2.6% -285% 5.9% *Pre-tax profit margin is calculated with discount at the pre-tax NIER **After-tax profit margin is calculated with discount at the pre-tax NIER *** Adjusted after-tax profit margin includes target capital effects and is calculated with discount at the pre-tax NIER 14

16 ULSG Case Study: Statutory Reserve Patterns $100,000 ULSG 350k Face 2017 CSO Reserve Patterns $90,000 $80,000 $70,000 $60,000 There is an excess of DR over NPR in all policy durations $50,000 $40,000 $30,000 $20,000 $10,000 There is only an excess of SR over DR in early durations, and the excess is small $ AG38 Stat Reserve NPR Stat Reserve DR Excess Reserve Total PBR Stat Reserve SR Excess Reserve 15

17 ULSG Case Study: Statutory Reserve Patterns $8,000 ULSG 350k Face 2017 CSO Reserve Patterns $7,000 $6,000 $5,000 As the account value dwindles, SR Excess declines $4,000 $3,000 $2,000 $1,000 $ SR Excess Reserve Account Value 16

18 ULSG Phase 1 Case Study: Key Reserve Pattern Observations There is an excess of DR over NPR in all policy durations There is only an excess of SR over DR in early durations, and the excess is small As the account value dwindles, SR Excess declines Interest sensitivity declines with account value Level of NPR to DR is important, assuming NPR will be tax deductible 17

19 ULSG Phase 1 Case Study: DR Attribution 80,000 ULSG - DR Attribution 70,000 60,000 50,000 40,000 30,000 20,000 10, (10,000) (20,000) NPR Baseline DR_1 DR_2 DR_3 DR_4 1 DR1: Remove mortality margins 2 DR2: Remove lapse margins 3 DR3: Remove expense margin 4 DR4: Level discount rate (5.2%) 18

20 Phase 2 Phase 2 expands on the Phase 1 case studies to include the following situations: Small company with limited data Simplified issue term product Guaranteed YRT premiums Level term product with post-level-term projection 30-year level term product Short pay ULSG product 19

21 Small Company Case Study The Phase 1 case studies reflected characteristics of a large company in that the mortality experience was assumed to be fully credible with a 15-year sufficient data period Step Acquisition Expense per Unit Mortality Credibility & Sufficient Data Period Reinsurance Phase 1 $ % and 15 years Non-Guaranteed YRT, $1,000,000 Retention Step 1 $ % and 15 years Non-Guaranteed YRT, $1,000,000 Retention Step 2 $ % and 3 years Non-Guaranteed YRT, $1,000,000 Retention Step 3 $ % and 3 years 80% Coinsurance with $100,000 limit on retention* Expense allowances are 100% first year, 11% renewal years 20

22 Term: Small Company Pricing Results Small Company 20 Year Level Term Pretax Profit Margin 1 After-Tax Profit Margin 2 Adjusted After-Tax Profit Margin 3 Surplus Strain IRR Adjusted After-Tax High-Band Model Office Phase 1 Situation % 11.9% 6.7% -147% 10.4% Step 1: Increase Per Unit Acquisition to $ % 8.5% 3.3% -178% 7.1% Step 2: Inner loop mortality 28% credibility; 3 Yr 14.7% 1.0% -4.5% -472% 4.2% SDP Step 3: Coinsurance 8.1% 1.9% -0.5% -75% 4.5% 1 Pretax profit margin is calculated with discount at the pretax net investment earnings rate (NIER). 2 After-tax profit margin is calculated with discount at the pretax NIER. 3 Adjusted after-tax profit margin includes target capital effects and is calculated with discount at the pretax NIER. 21

23 Term Small Company: Reserve Levels Year Plan $1.2MM 20-Year Term, High Band Thousands Phase 1 DR Phase 1 NPR Step 1¹ DR Step 2² DR Step 3³ DR Step 3 NPR XXX 2017 CSO 1 Step 1: Higher Acquisition Expenses 2 Step 2: Lower Mortality Credibility 3 Step 3: Coinsurance 22

24 Small Company Sensitivity - ULSG ULSG with Level Premiums for Coverage to A110 PT Profit Margin* AT Profit Margin** Adjusted AT Profit Margin*** Surplus Strain IRR Adjusted After-Tax High Band Model Office Step 1) Phase 1 Pricing Situation % 4.4% 2.6% -285% 5.9% Step 2) Small Company Reserve Assumptions 18.5% -1.1% -3.0% -503% 4.9% Step 3) Small Company with Coinsurance 4.9% 2.5% 2.3% -31% 13.4% *Pre-tax profit margin is calculated with discount at the pre-tax NIER **After-tax profit margin is calculated with discount at the pre-tax NIER *** Adjusted after-tax profit margin includes target capital effects and is calculated with discount at the pre-tax NIER Preliminary Draft - Subject to Change 23

25 Small Company Sensitivity - ULSG 25,000 Small Company Reserve Patterns - $1.2M Band 20,000 15,000 10,000 5, (5,000) (10,000) (15,000) Small Co w Coin DR Small Co NPR Phase 1 with Coin Preliminary Draft - Subject to Change 24

26 Guaranteed YRT Sensitivity Term Outer Loop Inner Loop Mortality Company anticipated experience, includes improvement into future Company anticipated experience with VM-20 margin, but assuming improvement only to the point of valuation, i.e. the future node YRT premiums Baseline with $200,000 retention (YRT premiums not guaranteed) YRT premiums Guaranteed 120% YRT premiums are assessed at a level equal to 110% of the mortality rates in the outer loop YRT premiums are assessed at a level equal to 120% of the mortality rates in the outer loop DR calculation assumes YRT premiums equal to 110% of the mortality level in the inner loop which includes the VM-20 margin and improvement only to the point of valuation, i.e. the future node DR calculation assumes YRT charge level equal to 120% of the best estimate mortality rates, therefore the inner loop YRT premiums are the same as the outer loop YRT premiums Preliminary Draft - Subject to Change 25

27 Guaranteed YRT Sensitivity 20 Year Term Term PT Profit Margin* AT Profit Margin** Adjusted AT Profit Margin*** Surplus Strain IRR Adjusted After-Tax High Band Model Office Situation 5 from Phase 1 report 19.9% 11.9% 6.7% -147% 10.4% Revised Baseline with $200,000 retention 12.9% 7.1% 5.8% 55% 15.0% YRT premiums at 120% of expected mortality 7.2% 3.6% 2.4% 55% 11.7% *Pre-tax profit margin is calculated with discount at the pre-tax NIER **After-tax profit margin is calculated with discount at the pre-tax NIER *** Adjusted after-tax profit margin includes target capital effects and is calculated with discount at the pre-tax NIER Preliminary Draft - Subject to Change 26

28 Guaranteed YRT Sensitivity 20 Year Term 4, year Plan $1.2 MM DR, NPR 3,500 3,000 2,500 Thousands 2,000 1,500 1, ,000 DR Baseline ($200K retention) DR 120%² NPR Preliminary Draft - Subject to Change 27

29 Guaranteed YRT Sensitivity - ULSG ULSG with Level Premiums for Coverage to A110 PT Profit Margin* AT Profit Margin** Adjusted AT Profit Margin*** Surplus Strain IRR Adjusted After-Tax High Band Model Office Situation 5 from Phase 1 report 19.5% 4.4% 2.6% -285% 5.9% Revised Baseline with $200,000 retention 14.0% -2.6% -4.2% 393% 4.6% YRT premiums at 120% of expected mortality 10.1% 4.9% 3.7% 64% 13.9% *Pre-tax profit margin is calculated with discount at the pre-tax NIER **After-tax profit margin is calculated with discount at the pre-tax NIER *** Adjusted after-tax profit margin includes target capital effects and is calculated with discount at the pre-tax NIER Preliminary Draft - Subject to Change 28

30 Guaranteed YRT Sensitivity - ULSG 350,000 Total VM-20 ULSG Reserve - Guaranteed YRT Study 300, , , , ,000 50, Increased Reinsurance (New Baseline) Guaranteed YRT Preliminary Draft - Subject to Change 29

31 Simplified Issue 20-year Term Single Cell Simplified Issue (Single Cell) 20-year Term Pretax Profit Margin 1 After-Tax Profit Margin 2 Adjusted After-Tax Profit Margin 3 Surplus Strain IRR Adjusted After-Tax 20-Year Term Phase 1, Situation % 12.8% 8.5% -164% 8.3% SI_1: SI Experience Assumptions -53.1% -37.3% -40.7% -356% -13.6% SI_2: $100,000 Average Policy Size; Higher Per Unit Premium 10.9% 6.3% 4.8% -120% 8.8% SI_3: Implement VM-20 Reserves 10.9% 6.1% 4.6% -120% 10.6% 1 Pretax profit margin is calculated with discount at the pretax net investment earnings rate (NIER). 2 After-tax profit margin is calculated with discount at the pretax NIER. 3 Adjusted after-tax profit margin includes target capital effects and is calculated with discount at the pretax NIER. 30

32 Simplified Issue VM-20 Impact 20 Simplified Issue Single Cell DR, NPR Phase 1, Situation 3 SI_1¹ SI_2² SI_3³: DR, unfloored SI_3: NPR 1 SI_1: Simplified issue assumptions 3 SI_3: Simplified issue VM-20 2 SI_2: Simplified issue average size and premiums 31

33 Simplified Issue VM-20 Impact DR is negative at issue because the cell has been priced for statutory profit NPR prevails from issue until the 6 th duration Reserve build up is delayed compared to XXX DR is higher than NPR reserve after duration 6 which creates tax inefficiencies during those years Other considerations: Is 2017 CSO appropriate table to use What if mortality expectations are higher than any available industry tables? With partial credibility, the company must choose what table to grade to How does the actuary demonstrate a mapping to the industry table? 32

34 30 Year Term Case Study: Pricing Results Low Band, Single Cell 30-Year Term (Single Cell) Pretax Profit Margin 1 After-Tax Profit Margin 2 Adjusted After-Tax Profit Margin 3 Surplus Strain IRR Adjusted After-Tax Cell: Issue age 45 Male N3, $350,000 Size Situation 3) XXX Stat/Tax, 2017 CSO 25.2% 14.8% 12.4% -351% 7.5% Situation 5) VM-20 NPR+DR Excess Stat, NPR Tax, 2017 CSO 25.2% 15.7% 13.5% -112% 15.0% 1 Pretax profit margin is calculated with discount at the pretax net investment earnings rate (NIER). 2 After-tax profit margin is calculated with discount at the pretax NIER. 3 Adjusted after-tax profit margin includes target capital effects and is calculated with discount at the pretax NIER. 33

35 Short Pay - ULSG ULSG - Short Pay Single Cell PT Profit Margin* AT Profit Margin** Adjusted AT Profit Margin*** Surplus Strain IRR Adjusted After-Tax 1) Level Pay 55 MN 30.4% 15.5% 14.0% -61% 15.4% 2) Ten Pay 55 MN 22.3% 12.9% 10.9% -94% 10.2% 3) Single Pay MN 27.2% 16.9% 15.0% -11% 19.8% *Pre-tax profit margin is calculated with discount at the pre-tax NIER **After-tax profit margin is calculated with discount at the pre-tax NIER *** Adjusted after-tax profit margin includes target capital effects and is calculated with discount at the pre-tax NIER 34

36 Short Pay Study - ULSG 160,000 Total VM-20 Reserve - Short Pay Study 140, , ,000 80,000 60,000 40,000 20, Level Pay Ten Pay Single Pay 35

37 Phase 2 Interviews One hour discussions with product development actuaries Fourteen different companies Consistent set of open-ended questions 36

38 Phase 2 Interviews Preparedness Implementation Collaboration Pricing Process Simplifications 37

39 Phase 2 Interviews (Preparedness) VM-20 Czar or special VM-20 committee. Valuation area lead effort in some companies. In others, pricing lead. Companies doing AG48 reserve financing ahead and valuation focused. Resources: conferences, webinars, boot camps, and pilot studies, individual reading, outside consultants. Many companies doing trial runs with VM-20, but only a few planning product launches in 2017 or early Term likely to come before ULSG. VM-20 may eventually produce Term and ULSG product design changes, but no company indicated they worked through all the details. Most taking a waitand-see approach. 38

40 Phase 2 Interviews (Implementation Concerns) Fluctuation of reserves and profits Unlocking of assumptions and potential future changes in methodology Explaining movements to senior management Definition of tax reserves Guidance for assumptions and margins, particularly for newer features and underwriting regimes with limited experience (e.g., accelerated underwriting) Lower profitability Small companies with limited or near-zero credibility Companies currently engaged in reserve financing Allocation of VM-20 excess reserves to profit cells 39

41 Phase 2 Interviews (Implementation Concerns, cont.) Complexity of calculations Most systems can handle, but effort still required: upgrading, custom coding, training Separate inner-loop versus outer-loop assumptions Auditability Coordinating multiple systems (e.g., NPR versus DR and SR) Moving to asset / liability approach (for companies previously using liability only) Runtime Longer time-to-market in initial years following VM-20 implementation 40

42 Phase 2 Interviews (Collaboration) Almost all companies noted increased cooperation and communication between company areas: Pricing and Valuation Corporate Modeling Tax Promote consistency in assumptions More cross functional meetings, work groups, and governance committees Variety of levels of formality Common theme: VM-20 accelerating or strengthening already existing governance structures and plans 41

43 Phase 2 Interviews (Changes to Pricing Process) Same basic steps to pricing process as currently Slower process expected, at least initially, due to: Collaboration / Communication (interdepartmental, regulators, reinsurers) Initial decision-making regarding various aspects of VM-20 calculations Increased runtime More sensitivity testing More challenging auditing and validation More reserves to calculate than currently (NPR, DR, SR) Potential adjustments to reinsurance agreements/rates; reinsurer input being sought more often throughout pricing process Stochastic pricing exacerbates the challenges 42

44 Phase 2 Interviews (Anticipated Simplifications) Likely to start with fewer shortcuts and after gauging materiality Liability grouping, cluster modeling, asset grouping Setting certain assumptions in the outer loop equal to the VM-20 compliant assumptions of the inner loop Using an aggregate margin rather than margins on specific assumptions Calculate DR discount rates and SR only at selected nodes Assume no changes to future credibility or sufficient data period Particularly for sensitivity testing, use relationship between DR and SR to approximate the SR, or only change outer loop assumptions 43

45 VM-20 Research Wrap Up Phase 1 Term, not Financed: PBR increases internal rates of return (IRRs) Term, Financed: PBR decreases internal rates of return (IRRs) ULSG, not Financed: PBR has no material impact internal rates of return (IRRs) ULSG, Financed: PBR decreases internal rates of return (IRRs) Companies that finance statutory reserves may have incentive to delay implementation The intuitive idea of PBR reducing reserves and therefore premiums is not a given under VM-20 44

46 VM-20 Research Wrap Up Phase 2 Case Studies For both term and ULSG, moving from anticipated experience mortality to VM- 20 mortality assumptions had the biggest impact on the level of reserves Small Company Study: Deterministic Reserves is as great as, or greater than, XXX reserves in many durations Guaranteed YRT case studies produced different results for the term and ULSG products SI: VM-20 reserving methods may improve IRR compared to Model 830 methods 45

47 VM-20 Research Wrap Up Phase 2 Industry Interviews Even mix between the pricing and valuation areas regarding where VM-20 expertise resided Higher level of unpredictability and fluctuation in their reserves and anticipated profits under VM-20Guaranteed Intensiveness and complexity of the computations necessary for VM-20 Lower anticipated profitability upon moving to VM-20 reserving Wait-and-see approach on product design changes Not much thought to other products in a VM-20 context 46

48 Questions? 47