Clear as Actuarial Mud Premium Deficiency Reserves vs. Asset Adequacy Testing vs. Contract Reserve Strengthening

Transcription

1 Clear as Actuarial Mud Premium Deficiency Reserves vs. Asset Adequacy Testing vs. Contract Reserve Strengthening David M. Dillon, FSA, MAAA Lewis & Ellis, Inc.

2 Over-Riding Questions Are the Company s reserves enough? How do you know? What are the testing methods? Where are extra reserves reported?

3 Additional Actuarial Liabilities Premium Deficiency Reserves (PDR) Premium adequacy Test of short-term rate sufficiency Reasonable or best estimate assumptions Asset Adequacy Analysis (AAA) Long-term solvency Ultimate test of reserve adequacy Assumptions satisfy moderately adverse conditions Reserve Strengthening (RS) Annual review of prospective reserves Determine continuing adequacy and reasonableness

4 Misconceptions Additional Actuarial Liabilities The loss ratio is really low, so a PDR is not needed. Dental products are short term in nature and do not exceed one year. Therefore, a PDR is not applicable. Only need to test blocks with rate guarantees longer than 1 year. Since both assets and liabilities are short-term, there are no assetliability mismatches. Therefore, liabilities are adequate in light of the assets held. Once reserve factors are developed, they are set in stone.

5 Regulations and Guidance Statutory Accounting Principles SSAP #54 Individual and Group Accident and Health Contracts AAA Sections 10, 23 & 25 PDR Section 18 RS Section 21 SSAP Appendix A-010 Minimum Reserve Standards for Individual and Group Health Insurance Contract RS No. 37 AAA (PDR?) No. 23 & 24 SSAP Appendix A-822 Asset Adequacy Analysis Requirements NAIC Health Annual Statement Instructions - Revised NAIC Actuarial Opinion Effective PDR Section 5

6 Regulations and Guidance Actuarial Standards of Practice No. 7 Analysis of Life, Health, or Property/Casualty Insurer Cash Flows No. 28 Statements of Actuarial Opinion Regarding Health Insurance Liabilities and Assets (Revised 2011) AAA Section 3.12 No. 22 Statements of Opinion Based on Asset Adequacy Analysis by Actuaries for Life or Health Insurers (Revised 2011) No. 42 Determining Health and Disability Liabilities Other Than Liabilities for Incurred Claims PDR Section 2.9, 3.4 RS Section Additional Guidance NAIC 2007 Health Reserves Guidance Manual PDR Section 6 Academy 2011 Practice Note Revised 2010 Actuarial Opinion Academy 2010 Practice Note Practices for Contract Reserves Academy 2007 Discussion Paper -Premium Deficiency Reserves Academy 2004 Practice Note Asset Adequacy Analysis

7 Premium Deficiency Reserves SSAP #54 Section 18 When the expected claims payments or incurred costs, claim adjustment expenses and administration costs exceed the premiums to be collected for the remainder of a contract period, a premium deficiency reserveshall be recognized by recording an additional liability for the deficiency, with a corresponding charge to operations NAIC 2007 Health Reserves Guidance Manual A premium deficiency reserve is a reserve that is established when future premiums and current reserves are not sufficient to cover future claim payments and expenses for the remainder of a contract period. ASOP NO. 42 A liability established when, for a period of time, the value of future premiums, current reserves, and unpaid claims liability are less than the value of future claim payments and expenses plus anticipated at the end of the period.

8 PDRs - Issues & Assumptions Grouping of Business Time Period of Calculation Reasonable Assumptions Enrollment Premium Rate Increases Claim Trends Expenses Interest Rate Investment Income Taxes

9 PDRs - Grouping of Business Deficiencies shall not be offset by anticipated profits in otherpolicy groupings. SSAP #54..grouped in a manner consistent with how policies are marketed,serviced, and measured. HRGM..reflect how premium rates are developed and applied. This willusually result in groupings by product type and group size. Other criteria: marketing methods, geographic ratings, guarantee periods Materiality. ASOP #42 consider blocks of business in a manner consistent with applicable financial reporting requirements Characteristics of a block of business may include: Benefit type Contract type Demographic grouping Length of rate guarantee

10 PDRs Time Period of Calculation SSAP #54..remainder of a contract period. HRGM The ending of the time period is more difficult to determine, and requires a substantial amount of judgment in many cases. A deficiency period is defined for any block where the internal calculations result in a positive result if the values vary for different periods, the deficiency period is the period with the greatest value...there may be a block of business that renews annually, but for which the premiums are subject to regulatory restrictions the contract period implicitly lasts until the business can be restored to profitability or lapses completely. Cancellation of groups in a loss position is technically an option, but may not always be a realistic option in practice. Any assumptions made about cancellation of groups must be justifiable ASOP #42 The end of the time period is generally the earlier of the contract period or the point at which the block no longer requires a premium deficiency reserve.

11 PDRs Other Assumptions Enrollment Reasonable assumptions Tied to morbidity and should reflect mortality, lapses, and the impact of expected premium rate increases Premium Rate Increases Reasonable in relation to the projected claim costs and regulatory restrictions (by law or by expectation) Claim Trends Should include durational wear-off and adverse selection resulting from premium increases

12 PDRs Other Assumptions Expenses Reasonable allocation of all expenses May reflect that some expenses not applicable to a specific grouping, e.g. new business expenses If other groupings can cover overhead, then the deficiency test can use direct expenses Interest Rate Reasonable and consistent based on period of deficiency. Investment Income May reflect investment income that is appropriately attributable. Commonly ignored for short-duration products Taxes PDR calculated on a pre-tax basis

13 PDRs Other Considerations In-force vs. New Business A PDR should consider: Contracts in force at the valuation date, including any increase or decrease in enrollment under group contracts reasonably anticipated to occur after valuation date Contracts expected to become effective after the valuation date, for which rate guarantees were made prior to the valuation date ( e.g. Medicare Advantage plans) Documentation HRGM and ASOP #41 Even if a PDR is not required, the testing and results that determined it was not necessary should be documented. Documentation should include: Description of groupings The rational for the groupings LOBs combined due to immateriality Changes from prior years All assumptions used in projections Rationale for time periods chosen

14 PDRs HRGM Calculation Reserve Equals Sum of: PV of future paid claims thru end of deficiency period PV of future expenses & commissions PV of claim & contract reserves at end of deficiency period Less the sum of: PV of future earned premiums Current claim & contract reserves Current accrual for future expenses

15 PDR 2011 Delta Dental Annual Statements Annual Statements available via NAIC Company Loss Ratio Expense Ratio 2011 Profit % 2011 PDR 2010 PDR % 22.7% -2.7% No Yes % 22.9% -0.7% No No % 14.8% 0.0% No No % 25.7% 0.1% No No % 16.0% 0.1% No No % 16.3% 0.3% No No % 14.5% 1.0% No No % 38.7% 2.4% No No

16 PDR 2011 Delta Dental Annual Statements Company Loss Ratio Expense Ratio 2011 Profit % 2011 PDR 2010 PDR % 18.4% 2.5% No No % 19.6% 2.6% No No % 13.3% 2.7% No No % 17.5% 3.0% No No % 15.8% 3.3% No No % 12.3% 3.5% No No % 14.6% 3.6% No No % 22.7% 5.0% Yes No

17 PDR 2011 Delta Dental Annual Statements Company Loss Ratio Expense Ratio 2011 Profit % 2011 PDR 2010 PDR % 12.0% 5.6% No No % 49.4% 6.4% No No % 12.0% 6.6% No No % 9.3% 7.2% No No % 13.6% 7.5% No No % 15.9% 8.1% No No % 10.5% 8.6% No No % 43.9% 9.7% No No

18 PDR Contract Grouping Example Underwriting Cash Flows Testing Grouping PDR Test Lg Grp Dental Sm Grp Dental Ind Dental Grp Vision Ind Vision

19 PDR Contract Grouping Example Underwriting Cash Flows Combined PDR Report All Combined Underwriting Cash Flows PDR Report Grp D&V Ind D&V

20 Combined PDR Contract Grouping Example Underwriting Cash Flows PDR Report Dental G&I Vision G&I

21 All Separate PDR Contract Grouping Example Underwriting Cash Flows PDR Report Lg Grp Dental Sm Grp Dental Ind Dental Grp Vision Ind Vision

22 PDR Projection Period Examples Year UW G/L PDR Prior YE Year UW G/L PDR Prior YE

23 PDR Projection Period Examples Year UW G/L PDR Prior YE Year UW G/L PDR Prior YE

24 Asset Adequacy Analysis Statutory Accounting Principles SSAP #54 Individual and Group Accident and Health Contracts Section 25 (b) Additional reserves required based on asset adequacy analysis as discussed in Appendix A-822 Actuarial Standards of Practice No. 28 Statements of Actuarial Opinion Regarding Health Insurance Liabilities and Assets (3.12) This standard does not obligate the actuary to undertake evaluation of the adequacy of the assets supporting the stated liability amount except as may be needed to comply with any applicable law, regulatory requirement, or other ASOP. Guidance on statements of opinion based on asset adequacy analysis is provided in ASOP No. 22 No. 22 Statements of Opinion Based on Asset Adequacy Analysis by Actuaries for Life or Health Insurers (pg. v) Actuaries performing work for health benefit plans such health insurers, health service plans, and HMOs should note that this standard potentially applies to each of these types of plans. Applicable law will determine for which of these types of plans an appointed or qualified actuary is required to submit a statement of actuarial opinion based on asset adequacy analysis subject to this standard.

25 AAA Methods ASOP No Analysis Methods A number of asset adequacy analysis methods are available to, and used by, actuaries. The most widely used method is cash flow testing (see ASOP No. 7). Cash flow testing is generally appropriate where cash flows of existing assets, policies, or other liabilities may vary, or where the present value of combined asset, liability, or other cash flows may vary under different economic or interest-rate scenarios. Asset adequacy analysis test methods other than cash flow testing may be appropriate in other situations... These methods would test moderately adverse deviations in the actuarial assumptions, except for the investment rate-of-return assumptions.

26 AAA Methods ASOP No Analysis Methods Gross Premium Valuation A gross premium valuation may be appropriate where the policy and other liability cash flows are sensitive to moderately adverse deviations in the actuarial assumptions underlying these cash flows, but are not sensitive to changes in interest rates. Loss Ratio Methods For short-term health insurance business that tends to be supported by short-term assets, loss ratio methods may be appropriate. Demonstration of Extreme Conservatism Risk Theory Techniques Product Design Limitations

27 AAA Moderately Adverse Conditions ASOP No Conditions that include one or more unfavorable, but not extreme, events that have a reasonable probability of occurring during the testing period. Examples 10% increase in lapse 10% increase in morbidity 5% increase in lapse & 5% increase in morbidity Stochastic simulation where reserves are adequate 75-80%.

28 AAA Measures of Reserve Adequacy Present value of ending surplus PDR-like calculation Sum of: PV of future paid claims thru end of deficiency period PV of future expenses & commissions PV of claim & contract reserves at end of deficiency period Less the sum of: PV of future earned premiums Current claim & contract reserves Current accrual for future expenses

29 Grouping of Business AAA Differences versus PDR More aggregation typically allowed since Actuarial Opinion is based on aggregate ASOP No the actuary may offset deficiencies in one business segment withsufficiencies in another business segment for the purposes of reporting and documenting the results of testing. The actuary should review applicable law regarding the aggregation of results. Time Period Typically years ASOP No Asset adequacy should be tested over a period that extends to a point at which, in the actuary s professional judgment, the use of a longer period would not materially affect the analysis. Assumptions Moderately Adverse vs. Reasonable

30 AAA 2011 Delta Dental Annual Statements CFT was not necessary and not performed, due to the high degree of liquidity of the asset portfolio and the short duration nature of dental claim liabilities (1 Incidence) I have not examined the company s assets, and have formed no opinion as their validity or value (2 incidences) Silent (All others)

31 Reserve Strengthening Use GPV to determine if needed Recalculate Contract Reserves using new assumptions regarding claim costs, terminations, etc.

32 PDR Blue Book Exhibit 6 Reporting Line 2 Additional contract reserves Line 3 Additional actuarial reserves Asset/Liability analysis Orange Book U&I Exhibit 2D Line 2 Additional policy reserves Line 5 Aggregate write-ins for other policy reserves Notes to Financial Statements 30.

33 AAA Blue Book Exhibit 6 Reporting Line 3 Additional actuarial reserves Asset/Liability analysis Orange Book U&I Exhibit 2D Line 2 Additional policy reserves Line 5 Aggregate write-ins for other policy reserves Reserve Strengthening Blue Book Line 2 Additional contract reserves Notes to financial statements 2.

34 Testing When to do what Considerations Product line groupings PDR typically by line AAA in aggregate (within reason) RS typically by line Tax deductibility PDRs not tax-deductible, Title 26 Section 807 (d) Title 26 Section 816 (h) Additional contract reserves generally are tax-deductible with 10-year spread Title 26 Section 807 (f)

35 Testing When to do what Considerations Tax deductibility Asset Adequacy Reserves -? Title 26 Section 807 (d) (6) o The term statutory reserves means the aggregate amount set forth in the annual statement with respect to items described in section 807(c). o AAA reserves not mentioned in (c) Title 26 Section 816 (c) (3) o all other insurance reserves required by law. Title 26 Section 816 (h) o For purposes of this section, the terms life insurance reserves and total reserves shall not include deficiency reserves. Generally considered non-tax deductible CONSULT WITH TAX EXPERT!

36 Testing When to do what Considerations Flexibility Change in valuation more permanent PDR and AAA Amortized Typically calculated more frequently Flexibility in assumptions