Impact of VM-20 on Life Insurance Product Development Phase 2

Transcription

1 Impact of VM-20 on Life Insurance Product Development Phase 2 July 207

2 2 Impact of VM-20 on Life Insurance Product Development Phase 2 SPONSORS Product Development Section Smaller Insurance Company Section Reinsurance Section Committee on Life Insurance Research AUTHORS Paul Fedchak, FSA, MAAA Jacqueline Keating, FSA, MAAA Karen Rudolph, FSA, MAAA Uri Sobel, FSA, MAAA Andrew Steenman, FSA, MAAA The Sponsors and Authors would like to thank the following members of the Project Oversight Group: Rebecca Scott Chair Illya Golanek Mark Rowley Donna Megregian Vice Chair Edward Hui Ronora Stryker Erik Anderson Russ Kolman Jan Schuh Nanna Cho Tracy Lark John Di Meo Kelly Rabin Caveat and Disclaimer This study is published by the Society of Actuaries (SOA) and contains information from a variety of sources. It may or may not reflect the experience of any individual company. The study is for informational purposes only and should not be construed as professional or financial advice. Neither the SOA, the authors, nor Milliman recommend or endorse any particular use of the information provided in this study. Neither the SOA, the authors, nor Milliman make any warranty, express or implied, or representation whatsoever and assume no liability in connection with the use or misuse of this study. Copyright 207 by the Society of Actuaries. All rights reserved.

3 3 TABLE OF CONTENTS Section : Background... 4 Section 2: Disclaimer of Liability... 4 Section 3: Research Phases and Report Content... 5 Section 4: Executive Summary... 5 Section 5: Recap VM-20 Results from Phase... 7 Section 6: Small Company Case Studies... 2 Section 7: Guaranteed YRT Case Studies Section 8: Other Case Studies Years of Post-Level Term Cash Flows... 3 Simplified Issue Single Cell Year Level Premium Term Single Cell Short-Pay ULSG Single Cell Section 9: Industry Interviews References... 47

4 4 Impact of VM-20 on Life Insurance Product Development Phase 2 Section : Background The new principle-based framework for U.S. statutory reserves as defined in Chapter 20 of the National Association of Insurance Commissioners (NAIC) Valuation Manual (VM-20) may be used for life products issued starting in 207. While there have been research and educational materials produced to help actuaries and others better understand the implications and implementation of the new requirements from a valuation perspective, little has been developed emphasizing the product development actuary s perspective. The Society of Actuaries (SOA) Product Development Section, Smaller Insurance Company Section, Reinsurance Section and the Committee on Life Insurance Research engaged Milliman to examine the impact of the new reserve standard for the product development actuary. The research examines the impact of VM-20 from a product development actuarial perspective to help actuaries and others enhance current practices to optimize pricing and product development activities within a VM-20 framework as well as enhance intracompany communication and efficiencies related to VM-20. Section 2: Disclaimer of Liability This report is to be reviewed and understood as a complete document. Any distribution of this report must be in its entirety. Nothing contained in this report is to be used in any filings with any public body, including but not limited to state regulators, the Internal Revenue Service and the U.S. Securities and Exchange Commission. This report has been published by the Society of Actuaries (SOA) and contains information based on input from companies engaged in the U.S. life insurance industry. The SOA and Milliman do not recommend, encourage or endorse any particular use of the information provided in this report. Any results or observations made may not be indicative of the impact on any particular product or company and may not be representative of the life insurance industry as a whole. It is for informational purposes only. It is not intended to guide or determine any specific individual situation, and persons should consult qualified professionals before taking specific actions. The opinions expressed and conclusions reached by the authors are their own and do not represent an official position or opinion of Milliman or the SOA or its members. Neither Milliman nor the SOA makes any warranties, guarantees or representations whatsoever regarding the accuracy or completeness of the content of this report. The study should not be construed as professional or financial advice. Neither the SOA nor Milliman shall have any responsibility or liability to any person or entity with respect to damages alleged to have been caused directly or indirectly by the content of this report. With the January, 207, effective date of VM-20, we expect that actuarial practice in calculating VM-20 reserves will evolve over time as companies, actuaries and regulators gain experience in calculating such reserves. The evolving actuarial practice may differ from what is assumed in the case studies. The methodology and assumptions used in developing VM-20 reserves for the case studies are illustrative and should not be viewed as recommendations of Milliman or the SOA with respect to the application of VM-20. Further, future changes are expected in VM-20, including changes to certain prescribed assumptions such as defaults and spread assumptions as well as potential re-parameterization of the Net Premium Reserves (NPR). In addition, there is a lack of guidance from the U.S. Treasury concerning the appropriate tax reserves after VM-20 becomes effective. The reserves deductible for federal income taxes may differ from what is portrayed in the case studies.

5 5 Section 3: Research Phases and Report Content The research is organized in two phases. The objective of Phase was to investigate the changes to the product development process as a result of VM-20 through the development of case studies for term and universal life with secondary guarantees (ULSG) products. The case studies were intended to illustrate profitability changes from current statutory reserving methods for hypothetical products and identify issues and considerations for the product development actuary. The Phase report was published in November 206 and is available at SOA.org. Elements of the Phase report are referenced in this report. Phase 2 of the research expands on the Phase case studies and includes additional case studies focused on smaller companies and the impact of reinsurance. Phase 2 also discusses the industry s preparedness for pricing under VM-20 and identifies pricing and product design issues through interviews and discussions with product development actuaries. This report constitutes Phase 2 of the research. The Phase and Phase 2 reports are not intended to provide a primer on VM-20, and the reader is expected to be familiar with the basic requirements of VM-20. Background information on VM-20 is provided in some of the entries included in the References section at the end of the Phase 2 report. The structure of the Phase 2 report is as follows: Section 4 provides an executive summary of the Phase 2 results Section 5 recaps the VM-20 term and ULSG results (Situation 5) from the Phase report and provides an attribution analysis of the Deterministic Reserve (DR) Section 6 provides small company case studies for term and ULSG Section 7 provides guaranteed yearly renewable term (YRT) case studies for term and ULSG Section 8 provides other term and ULSG case studies Section 9 provides a summary of the interviews with product development actuaries Section 4: Executive Summary Our Phase 2 research included pricing case studies and interviews with industry participants. The key conclusions from our Phase 2 case studies are as follows, but these results are dependent on the specific case study assumptions and may not apply under different assumptions: When we analyzed the factors contributing to the excess of the DR over a best estimate gross premium reserve for the Phase VM-20 case studies (Situation 5), we found that for both term and ULSG, moving from anticipated experience mortality to VM-20 mortality assumptions had the most significant impact on the level of reserve. For the small company case studies, our assumptions of less credible mortality experience and shorter sufficient data period increased the DR significantly above the level for the large company case study of the Phase research. Under our assumptions, which assumed no change in premiums, for the term products the DR is as great as, or greater than, the Model 830 XXX Reserve in many durations. Compared to the large company case study, the higher acquisition expenses and reserves resulted in considerable additional surplus strain and noticeably lower profit margins. Our analysis suggests that small companies may continue to look to coinsurance to manage the surplus strain on new business. The guaranteed YRT case studies produced different results for the term and ULSG products. For the term products, there was a tension between the cost of the assumed increase in YRT premiums versus the impact of the guaranteed premiums on the VM-20 reserves, producing varying impacts on profitability, depending on the product and profit metric under consideration. For the ULSG block, the increase in YRT premiums on its own decreases profitability, but it is more than offset by the decreased reserve strain realized by not including margins on the YRT reinsurance premiums. The profit margins are increased marginally, but the decreased surplus strain results in considerably higher internal rates of return (IRRs).

6 6 Under the case study of specified post-level term assumptions, the post-level term period cash flows are clearly beneficial to the profitability metrics. For a company issuing a term product under a simplified issue (SI) underwriting program, the single-cell example in this report indicated that the adoption of VM-20 reserving methods together with current expectations for policy size and premium amounts imply a similar and perhaps improved IRR when compared to the IRR under Model 830 reserving methods. However, this outcome is dependent upon the chosen VM-20 assumption set, product design and premium levels. For the 30-year term single cell, the tax impacts together with the reduction in reserve requirements and material surplus relief make for a significant increase in profitability under VM-20. For the ULSG product, the case study indicated that a 0-pay premium pattern is less profitable than the level-pay situation, but the single-pay is more profitable. The higher single-pay profitability is driven largely by the initial strain, which is quite small in the single-pay situation. The reduced initial strain in the single-pay case is largely due to the commission level relative to the initial premium, which is a phenomenon not unique to a VM-20 pricing situation. We spoke to pricing and product development actuaries at 4 companies of varying size that issue individual life business. Key comments from those interviews are summarized below: There was an even mix between the pricing and valuation areas regarding where VM-20 expertise resided and which area leads or led the effort to be VM-20-ready. Generally, companies that had executed or worked on Actuarial Guideline 48 reserve financing transactions were more prepared than companies that had not, and at those companies, the VM-20 knowledge in the valuation area was ahead of the pricing area. On the flip side, at companies that were looking to roll out VM-20 products in 207 or early 208, the pricing area led the learning curve. In companies where the corporate structure was organized across product lines rather than function, term was generally more VM-20-ready than ULSG. Many companies expressed concern over a now higher level of unpredictability and fluctuation in their reserves and anticipated profits under VM-20. This concern stems from the potential unlocking of assumptions (in particular, the interest assumptions), as well as potential regulatory changes in VM-20 methodology. There was consistent concern among interviewees regarding the future definition of tax reserves. One participant commented on the positive side of the fluctuation issue, in that it will allow for faster reactions or corrections than in the past. More than half the participants raised concerns regarding the intensiveness and complexity of the computations necessary for VM-20. Several companies commented on lower anticipated profitability upon moving to VM-20 reserving. This was particularly true for small companies with limited or near-zero mortality credibility, as well as for companies already engaged in reserve financing. While most companies acknowledged that there could be reasons to change their term or ULSG product designs under VM-20, no interviewee indicated they had worked through the details of changing product design under VM-20. Most companies were taking a wait-and-see approach. Most companies were at a beginning stage of thinking about how their use of reinsurance may change under VM-20. Some companies described themselves as listening to reinsurers thoughts and waiting for ideas from the reinsurers. In our discussions, companies generally indicated that their plates were full enough with term and ULSG, and that they had not given much thought to other products in a VM-20 context.

7 7 Section 5: Recap VM-20 Results from Phase In Phase we developed case studies that began with profit metrics for hypothetical products under the 200 CSO table, assuming Model 830 statutory reserves, which are commonly referred to as XXX for term or Actuarial Guideline 38 (AG38) for ULSG. Because many market participants have used reserve financing to improve profits on currently issued term and ULSG products, we also examined profits after reflecting reserve financing in accordance with Actuarial Guideline 48 (AG48). We then showed the impact of the introduction of the 207 CSO table, both with and without reserve financing according to AG48. Finally, we showed profits after the introduction of VM-20. It was this final iteration (Situation 5) from Phase that generally provides the starting point for the sensitivities examined in Phase 2. The Phase case studies showed that: For term business that was not financed, VM-20 increases IRRs, as a combined result of lower statutory and tax reserves. For ULSG business that was not financed, VM-20 did not have a material impact on IRRs, as the statutory reserve decrease under VM-20 was largely offset by the lower tax reserve deduction under VM-20. For term or ULSG business that was financed under AG48 prior to VM-20, and assuming no financing after VM-20, VM- 20 lowers IRRs as a result of the loss of tax benefits. In the Phase report, we described the three components of VM-20 reserves and how we modeled each for purposes of the case studies. A summary of the modeling approach is included here for reference, but more detail is available in the Phase report: The NPR is a closed-form solution formula prescribed in VM-20. Our models calculated the NPR at issue and at each node. We assumed no variation in future valuation interest rates, valuation lapse rates or valuation mortality for the NPR determination. The DR at each node is based on a projection of cash flows that reflect pricing assumptions up until the node and prudent estimate valuation assumptions after the node. The projection system develops these reserves in a single pass, using the pricing assumptions to project the in-force as of the valuation date in the outer loop and using the DR assumptions after the valuation date in the inner loop reserve calculation. The Stochastic Reserve (SR) must be calculated through the projection of a number of stochastic scenarios from the Academy s generator. At a present valuation date, this is a seemingly straightforward task, but in a pricing or projection exercise it creates a need for a nested stochastic projection that entails additional calculation challenges. One possible approach, which we employed for the case studies, is the use of deferred valuation projections. For these projections, the model runs forward to a node using pricing assumptions and then branches off into the set of stochastic interest rate paths with the application of the VM-20 prudent estimate assumptions. The greatest present values of negative assets are then discounted back to each node, added to the starting asset amount, and the conditional tail expectation is determined for the node. In the Phase analysis for ULSG, we used the approach described above to calculate the SR explicitly at six nodes: durations, 5, 0, 20, 30 and 50. We determined the ratio of the SR to the DR at these nodes. We then interpolated this ratio between the nodes and applied those ratios to the DR to calculate the SR at the intermediate nodes. We used 200 stochastic scenarios at each of the six valuation nodes in order to keep run times manageable for this level of analysis. We believed that the six future nodes provided a reasonable picture for how the SR will progress relative to the DR. Throughout this Phase 2 report, we have inserted reference tables with assumptions from the Phase analysis, contrasted with the changes to assumptions that are relevant for the Phase 2 analysis. Some of these tables will show the reader assumptions from the outer loop contrasted with assumptions from the inner loop. The outer loop assumptions, or projection assumptions, are used to project the inforce and cash flows of the business. The inner loop assumptions, or valuation assumptions, are used to calculate reserves. A current valuation date DR is determined by applying inner loop VM-20 prudent estimate assumptions to the

8 8 group of policies in scope of valuation. A future valuation date DR is determined by applying outer loop projection assumptions up to the future valuation date, or node, and adopting inner loop VM-20 prudent estimate assumptions, to project the cash flows from the node forward to calculate the DR at that future node for the expected population at that future valuation date. As this process is repeated annually, a future forecast of DRs is developed together with the company s forecasted financial performance. This process relies on an actuarial projection system with outer loop and inner loop capability. The remainder of this section analyzes the forecasted DR calculated for term and ULSG in the Phase case study to understand the contributions to the DR from the various assumptions and margins relevant to VM-20. Deterministic Reserve Attribution 20-Year Term $350,000 The foundation for the term model office in the Phase case studies was a top-quartile 0- and 20-year level premium term plan with an insurance benefit period to attained age 95. Anticipated experience for mortality and lapse was developed based on representative experience from top-quartile companies or experience from available industry studies specific to this type of term insurance. Mortality improvement is included in the pricing assumption. Pricing Situation 5 from Phase assumed full VM-20 implementation without financing. This section focuses on decomposing the DR from Situation 5 by removing specific components of conservatism layer by layer. Attribution steps defined in the list below were designed to quantify the impact of mortality improvement, margins, and discount rates on the forecast DR. The 20-year product at the $350,000 band size was used as the subject for this demonstration. In this analysis, the DR is not floored at $0. The NPR is also shown. DR Baseline: DR from the Phase Situation 5 DR 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 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 DR 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 DR discount rate is assumed to be 4% level; whereas, for Phase, the discount rate was derived from the assumed pretax earnings rate, starting at approximately 4.25% and grading up to 5.0% over the study period. Figure shows us that the first attribution step related to moving from VM-20 mortality assumptions back to anticipated experience assumptions (DR Baseline to DR Remove Mortality Margins) has the biggest impact. Since it is difficult to see the impact of steps DR2 Remove Lapse Margins, DR3 Remove Expense Margins and DR4 4% Discount Rate in Figure, Figure 2 is provided, which shows the DR for each attribution step by policy year.

9 9 Figure : Deterministic Reserve Attribution 20-Year Term, Low-Band Term DR Attribution Thousands NPR DR Baseline DR¹ DR2² DR3³ DR4⁴ DR: Remove Mortality Margins 2 DR2: Remove Lapse Margins 3 DR3: Remove Expense Margin 4 DR4: Level Discount Rate (4%) Period is not shown for DR, DR2, DR3 or DR4 data points to improve readability of the graph.

10 0 Figure 2: Deterministic Reserve 20-Year Term, Low-Band Policy Year Baseline Term Deterministic Reserve 20-Year Term $350,000 DR In Thousands DR DR2 DR3 Remove Remove Remove Mortality Lapse Expense Margins Margins Margins DR4 Apply 4% Discount Rate $ (,423) $ (2,343) $ (2,389) $ (2,433) $ (2,458) 2 (94) (,786) (,82) (,862) (,862) 3 (540) (,38) (,347) (,384) (,355) 4 (59) (890) (96) (95) (906) 5 85 (50) (525) (558) (503) (46) (72) (203) (40) , , ,438,06,040,09,088 2,499,73,55,36,98 3,55,239,224,207,262 4,482,254,242,227,273 5,393,22,203,9,227 6,247,0,04,094,2 7, The 4% level discount rate of Step 4 is lower than the projected earnings rate in Baseline DR for nodes after the second year. This impact works to move the Deterministic Reserve for DR4 above that of DR3. For term insurance, the most material risk factor is clearly mortality. For this case study, the NPR is driving the reserve requirements. Only changes made to the DR that would cause it to exceed the NPR would impact the profitability outcomes. Deterministic Reserve Attribution Low-Band ULSG The foundation for the ULSG model office in Phase was a multitiered shadow account design that was intended to be representative of a product that is competitive at the top quartile of carriers as of early 206. Anticipated experience for mortality and lapse was developed based also on representative experience from top-quartile companies or experience from available industry studies. Mortality improvement is included in the pricing assumption. Pricing Situation 5 from Phase assumes full VM-20 implementation without financing. This section focuses on decomposing the DR for the low-band ULSG product using the same steps defined above for the term demonstration.

11 Figure 3: Deterministic Reserve Attribution ULSG, Low-Band 80,000 70,000 60,000 50,000 40,000 30,000 20,000 0,000 ULSG DR Attribution - (0,000) (20,000) NPR DR Baseline DR¹ DR2² DR3³ DR4⁴ DR: Remove Mortality Margins 2 DR2: Remove Lapse Margins 3 DR3: Remove Expense Margin 4 DR4: Level Discount Rate (5.2%) Figure 3 shows that the first attribution step related to moving from VM-20 mortality assumptions back to anticipated experience assumptions (DR Baseline to DR) has the biggest impact. In Figure 3, the lines for DR Remove Mortality Margins, DR2 Remove Lapse Margins and DR3 Remove Expense Margins essentially overlap. This indicates that the lapse margins and expense margins are relatively small. Figure 4 shows the DR for each attribution step for the first 20 policy years.

12 2 Figure 4: Deterministic Reserve ULSG, Low-Band Policy Year Baseline DR Remove Mortality Margins ULSG Deterministic Reserve Low-Band DR In Thousands DR2 Remove Lapse Margins DR3 Remove Expense Margins DR4 Apply 5.2% Discount Rate $ 6,669 $ (4,496) $ (5,040) $ (5,086) $ (3,75) 2 8,28 (2,44) (2,946) (2,989) (0,074) 3 0,93 (28) (604) (645) (6,499) 4 3, 2,684 2,229 2,89 (2,94) 5 6,877 6,246 5,788 5, ,646 9,793 9,337 9,298 4, ,744 2,680 2,248 2,20 7, ,547 6,29 5,795 5,758, ,367 9,75 9,340 9,304 4, ,093 23,82 22,82 22,777 8,430 38,78 26,565 26,235 26,20 2, ,82 30,37 30,07 29,984 25, ,30 33,479 33,229 33,97 28, ,570 36,424 36,204 36,73 3, ,724 39,225 39,025 38,994 34, ,727 4,866 4,679 4,650 37, ,527 44,292 44,9 44,09 40,20 8 6,232 46,585 46,434 46,407 42, ,833 48,739 48,605 48,579 45, ,239 50,674 50,560 50,535 47,76 We originally used a 4% level discount rate, like term, for Step 4. Because 4% is lower than the projected earnings rate in Baseline DR, this change offset a considerable amount of the margin released in the prior steps. In other words, the 4% level discount rate introduced a margin compared to the best estimate assumption. For illustration purposes, we changed the 4% discount rate to 5.2% to better reflect the long-term earned rate in the outer loop projection. The 5.2% is between the average earned rate over the course of the projection (roughly 5.6%) and the ultimate rate (5.23%). Using a level rate results in an uneven estimate of the margin impact. As a percentage of the total margin, the DR4 discount rate step is relatively high during the early projection years when best estimate earned rates are expected to be lower. The margin is diminished over time as the best estimate earned rate approaches and then exceeds the level discount rate. Like term, the most material margin for ULSG is clearly the margin on underlying mortality. The impact of each step could be different depending on the order in which they were removed, but mortality is still likely the driving factor. Section 6: Small Company Case Studies The Phase case studies reflected characteristics of a large company in that the mortality experience was assumed to be fully credible, with a 5-year sufficient data period (SDP). Fully allocated expense factors were in line with large company profiles, and the company wrote enough business to justify financing excess statutory reserves. This Phase 2 small company sensitivity presents the situation for a small company by changing relevant assumptions and demonstrating the impact on VM-20 pricing for term insurance and ULSG. Term Small Company Case Study Figure 5 outlines the stepwise assumption changes from Phase Situation 5 to the Phase 2 small company sensitivity for term. The item highlighted in bold in each row is the assumption being changed in that step. Step shows the impact of higher

13 3 acquisition expenses for small companies. Step 2 shows the impact of less credible mortality experience. Step 3 shows the impact of coinsurance, a tool small insurers often consider to address surplus strain. Figure 5: Term Small Company Assumption Changes Step Acquisition Expense per Unit Mortality Credibility and Sufficient Data Period Reinsurance Phase $ % and 5 years Non-Guaranteed YRT, $,000,000 Retention Step $.00 00% and 5 years Non-Guaranteed YRT, $,000,000 Retention Step 2 $.00 28% and 3 years Non-Guaranteed YRT, $,000,000 Retention Step 3 80% Coinsurance with $00,000 limit on retention* $.00 28% and 3 years Expense allowances are 00% first year, % renewal years *For the $350,000 policy size, $70,000 is retained while $280,000 (80%) is ceded. *For the $,200,000 policy size, $00,000 is retained while $,00,000 (9.667%) is ceded. The changes described in Figure 5 impact the projections for a small company in the following ways: The acquisition cost per policy has gone from $70 to $350 for the $350,000 policy. For the $,200,000 policy, acquisition costs have gone from $240 to $,200 per policy. These costs are based on 206 GRET (Generally Recognized Expense Table), which is a proxy for fully allocated expenses and may not be indicative of actual pricing assumptions. Lower credibility and shorter SDP mean the small company must grade into an industry table by the seventh policy year and use industry margins on the industry rates. At 28% credibility, margins on company experience will increase from Phase levels. These changes are applicable for the inner loop mortality, the mortality on which the DR calculation is based. The outer loop mortality remains unchanged from baseline. For this case study, the small company s selection of industry mortality table assignments for the inner loop mortality are assumed to be the following: Nonsmoker class N: RR60 Nonsmoker class N2: RR80 Nonsmoker class N3: RR0 Nonsmoker class N4: RR25 Smoker class S: RR75 Smoker class S2 RR25 Starting with the Situation 5 pricing results from Phase, Figures 6 and 7 show the stepwise implementation of each of the characteristics noted above. Each row of the table includes the changes in the preceding steps.

14 4 Figure 6: Pricing Results Small Company 0-Year Term Small Company 0-Year Level Term Pretax Profit Margin After-Tax Profit Margin 2 Adjusted After-Tax Profit Margin 3 Surplus Strain IRR Adjusted After-Tax Low-Band Model Office Phase Situation 5 5.7% 8.8% 2.8% 28% 9.% Step : Increase Per Unit Acquisition to $ % 5.7% 0.3% 47% 4.3% Step 2: Inner Loop Mortality 28% Credibility; Three- Year SDP 0.9% 4.4%.6% 47% 3.7% Step 3: Coinsurance.% 3.7% 7.3% 76% 2.4% High-Band Model Office Phase Situation 5 6.2% 8.8%.7% 2% 7.6% Step : Increase Per Unit Acquisition to $ % 5.% 2.% 34%.8% Step 2: Inner Loop Mortality 28% Credibility; Three- 0.5% 2.5% 4.7% 20% 2.7% Year SDP Step 3: Coinsurance.4% 3.2% 6.7% 57% 2.2% 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. Figure 7: Pricing Results Small Company 20-Year Term Small Company 20-Year Level Term Pretax Profit Margin After-Tax Profit Margin 2 Adjusted After-Tax Profit Margin 3 Surplus Strain IRR Adjusted After-Tax Low-Band Model Office Phase Situation 5 8.4%.% 6.7% 72% 9.9% Step : Increase Per Unit Acquisition to $ % 8.2% 3.8% 200% 7.3% Step 2: Inner Loop Mortality 28% Credibility; Three- 3.9% 4.% 0.5% 36% 4.8% Year SDP Step 3: Coinsurance 3.3% 0.4% 3.0% 03% 3.4% High-Band Model Office Phase Situation 5 9.9%.9% 6.7% 47% 0.4% Step : Increase Per Unit Acquisition to $ % 8.5% 3.3% 78% 7.% Step 2: Inner Loop Mortality 28% Credibility; Three- 4.7%.0% 4.5% 472% 4.2% Year SDP Step 3: Coinsurance 8.%.9% 0.5% 75% 4.5% 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.

15 5 Changes observed in Figures 6 and 7 include the following:. Step drives profitability lower by introducing additional Year expenses. In all four studies, this increases surplus strain, reduces profit margin metrics and reduces IRR. 2. Step 2 changes the level and pattern of VM-20 statutory reserves because the DR is affected by the much lower credibility measurement and shorter SDP of the smaller company sensitivity. The pretax profit margins are unaffected because the pattern of statutory reserves remains $0-to-$0 over the level term period. The impact of the lower credibility and shorter SDP on the after-tax profit measures involves complex interactions between investment income and statutory and tax reserve patterns. In general, tax inefficiency has increased because the DR now exceeds the NPR in more durations than for the prior step. Surplus strain is increased because the statutory reserve requirement now starts out at a higher level than for Step. More tax inefficiency (DR > NPR) means a reduction to after-tax and adjusted after-tax profit metrics. There are two exceptions to these general outcomes: For the 0-year plan low band, the surplus strain has not changed from Step to Step 2. This is because the NPR prevails and remains the statutory reserve requirement in the first year in both Step and Step 2. After the first year, for Step 2, the DR pattern is much higher than for Step. For the 0-year plan high band, the Step 2 IRR is higher than the Step IRR. The IRR depends on the relationship of the change in surplus strain from Step to Step 2 and the change in renewal profit patterns from Step to Step 2. Later in this section, all the reserve graphs for each of the four plan groups are shown and discussed. 3. Step 3 reflects the implementation of a coinsurance agreement that small companies might consider to lower surplus strain. Step 3 assumes 80% coinsurance with a maximum retention of $00,000. The coinsurance expense allowances are 00% in the first year and % in renewal years. Coinsurance changes the shape of the profit pattern by reducing the surplus strain (increasing first year profits) and reducing renewal profits. By implementing coinsurance in Step 3, surplus strain is reduced in all four plan groups. Pretax profit margins are lower for all four plan groups. After-tax profit margins and IRRs are lower for three of the four plan groups. For the 20-year plan $,200,000 policy size, the after-tax profit margins and IRR are higher than for Step 2 because, after coinsurance is implemented, the tax basis reserve is equal to the statutory basis reserve for all but the longest durations, whereas for the Step 2 situation, the statutory basis reserve was considerably higher than the tax basis reserve. Graphs of after-tax profit patterns for all four plan groups for Steps, 2 and 3 are shown in Figures 8, 9, 0 and.

16 6 Figure 8: Profit Pattern Small Company 0-Year Term, Low-Band Year Plan $350k Adjusted After-tax Profit 500 Thousands Step ¹ Step 2² Step 3³ Step : Higher Acquisition Expenses 2 Step 2: Lower Mortality Credibility 3 Step 3: Coinsurance Figure 9: Profit Pattern -Small Company 0-Year Term, High-Band Year Plan $.2MM Adjusted After-tax Profit 500 Thousands Step ¹ Step 2² Step 3³ Step : Higher Acquisition Expenses 2 Step 2: Lower Mortality Credibility 3 Step 3: Coinsurance

17 7 Figure 0: Profit Pattern Small Company 20-Year Term, Low-Band Year Plan $350k Adjusted After-tax Profit Thousands Step ¹ Step 2² Step 3³ Step : Higher Acquisition Expenses 2 Step 2: Lower Mortality Credibility 3 Step 3: Coinsurance Figure : Profit Pattern Small Company 20-Year Term, High-Band Year Plan $.2MM Adjusted After-tax Profit Thousands Step ¹ Step 2² Step 3³ Step : Higher Acquisition Expenses 2 Step 2: Lower Mortality Credibility 3 Step 3: Coinsurance

18 8 In this small company sensitivity, reserve relationships change from the Phase case studies. This section looks at the change in reserves under each of the steps implemented for the small company sensitivity. Step does nothing to change the NPR or DR, because acquisition costs are assumed to be incurred at time of issue and are not included in the cash flows for the DR forecast for the end of the first year. In the graphs that follow, the NPR for Phase (Phase NPR) represents the NPR for Step of the small company sensitivity as well. Step 2 illustrates the impact of lower mortality credibility and shorter SDP. The NPR for Step 2 is the same as the Phase NPR, because mortality credibility and SDP do not impact the determination of the NPR. The characteristic of less credible mortality experience and shorter SDP for the smaller company increase the Step 2 DR as compared to the Phase (and, as noted above, the Step DR) higher credibility DR. In fact, under these conditions, the Step 2 DR is as great as, or greater than, XXX method reserves in many durations for each of the four plan groups. For informational purposes only, the XXX 207 CSO line on each of the four graphs depicts the XXX-method reserve using the 207 CSO valuation mortality table. The XXX-method reserves did not factor into the small company profit studies under VM-20. Step 3 is where 80% coinsurance with $00,000 limit on retention is implemented. The coinsurance expense allowances are 00% in the first year and % in all renewal years. Because the majority of the risk is now ceded away, and a coinsurance expense allowance becomes part of the DR cash flows, the level of the DR changes in a material way. The NPR is affected as well, because the NPR needs to allow for only the insurance amount retained. Graphs of all the reserve streams for each plan group are shown in Figures 2 3 (0-year plan, both sizes) and Figures 4 5 (20-year plan, both sizes). In these graphs, the DR is unfloored, consistent with the graphical presentations of DR in Phase.

19 9 Figure 2: Reserve Levels 0-Year Term, Low-Band Year Plan $350k 000 Thousands Phase DR Phase NPR Step ¹ DR Step 2² DR Step 3³ DR Step 3 NPR XXX 207 CSO Step : Higher Acquisition Expenses 2 Step 2: Lower Mortality Credibility 3 Step 3: Coinsurance Figure 3: Reserve Levels 0-Year Term, High-Band Year Plan $.2MM Thousands Phase DR Phase NPR Step ¹ DR Step 2² DR Step 3³ DR Step 3 NPR XXX 207 CSO Step : Higher Acquisition Expenses 2 Step 2: Lower Mortality Credibility 3 Step 3: Coinsurance

20 20 Figure 4: Reserve Levels 20-Year Term, Low-Band Year Plan $350k Thousands Phase DR Phase NPR Step ¹ DR Step 2² DR Step 3³ DR Step 3 NPR XXX 207 CSO Step : Higher Acquisition Expenses 2 Step 2: Lower Mortality Credibility 3 Step 3: Coinsurance Figure 5: Reserve Levels 20-Year Term, High-Band Thousands Year Plan $.2MM Phase DR Phase NPR Step ¹ DR Step 2² DR Step 3³ DR Step 3 NPR XXX 207 CSO Step : Higher Acquisition Expenses 2 Step 2: Lower Mortality Credibility 3 Step 3: Coinsurance

21 2 ULSG Small Company Case Study Figure 6 outlines the stepwise assumption changes from Phase to the Phase 2 small company sensitivity for ULSG. The small company assumption changes are the same as shown for term except that the acquisition expense step is not shown because its impact was minimal relative to the following two steps. The per unit acquisition cost was increased to 206 GRET direct distribution channel rates of $.00 per unit. YRT reinsurance was changed to coinsurance. Figure 6: Assumption Changes Small Company ULSG Step Acquisition Expense per Unit Mortality Credibility and Sufficient Data Period Reinsurance Phase $ % and 5 years Non-Guaranteed YRT, $,000,000 Retention Step 2 $.00 28% and 3 years Non-Guaranteed YRT, $,000,000 Retention Step 3 80% Coinsurance with $00,000 limit on retention* $.00 28% and 3 years Expense allowances are 00% first year, % renewal years *For the $350,000 policy size, $70,000 is retained while $280,000 (80%) is ceded. *For the $,200,000 policy size, $00,000 is retained while $,00,000 (9.667%) is ceded. The changes described above impact the projections for a small company in the following ways: Acquisition expenses are about 60% higher than in Phase. Lower credibility and shorter SDP mean the company must grade into an industry table by the seventh policy year and use industry margins on the industry rates. At 28% credibility, margins on company experience will increase from Phase levels. These changes are applicable for the inner loop mortality, the mortality on which the DR calculation is based. The outer loop mortality remains unchanged from baseline. For this sensitivity case study, the company s selection of industry mortality table assignments is assumed to be the following: Nonsmoker class N: RR70 Nonsmoker class N2: RR90 Nonsmoker class N3: RR25 Smoker class S: RR75 Smoker class S2 RR00 Starting with the Situation 5 pricing results from Phase, Figure 7 shows the stepwise implementation of each of the characteristics noted above. Each row of the table includes the changes in the preceding steps.

22 22 Figure 7: Pricing Results Small Company ULSG Small Company ULSG PT Profit Margin* AT Profit Margin** Adjusted AT Profit Margin*** Surplus Strain IRR Adjusted After-Tax Low-Band Model Office Phase Pricing Situation % 8.6% 6.9% 96% 7.3% Step 2: Small Company Acquisition and Reserve Assumptions 22.7% 3.%.% 43% 5.5% Step 3: Small Company with Coinsurance 6.3% 2.%.7% 56% 6.9% High-Band Model Office Phase Pricing Situation 5 9.5% 4.4% 2.6% 285% 5.9% Step 2: Small Company Acquisition and Reserve Assumptions 8.5%.% 3.0% 503% 4.9% Step 3: Small Company with Coinsurance 4.9% 2.5% 2.3% 3% 3.4% *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. Changes observed in the projections summarized in Figure 7 include the following: In Phase, the DR or SR was prevailing in all time periods of the projection. This continues to be the case for the small company sensitivity for the low band, but the NPR prevails in some early durations for the higher band cell. Similar to Phase, the SR prevails in early years on the high band, and the amount of the additional SR over the NPR is minimal. Although the acquisition expenses have increased considerably, the change pales in comparison to the overall decrease in initial surplus strain ultimately realized in Step 3. The relative size of the acquisition expense to other income statement items for ULSG means that the acquisition expense change is of little significance. The acquisition cost also does not impact the projected reserve, as it is incurred at the moment of issue and has transpired by the end of the first year when the reserve is first calculated. The coinsurance approach reduces the net reserve of the direct company. Moving from Phase Situation 5 to the Step 2 small company assumptions increases the DR, resulting in considerable additional surplus strain and noticeably lower profit margins. The Step 3 reflection of coinsurance reduces surplus strain considerably. For step 3, the impact to IRR is noticeably different between the low band and high band. The DR per unit of face in the high band is lower than in the low band because the coinsurance allowance is the same, while the high band has a higher ceded percentage but lower expenses to cover (as a percent of premium). As a result, the low band experiences only a modest IRR increase while the high band shows a considerable increase in IRR. The impacts on profit margins in the high band and low band are more similar than the IRR impacts, indicating that the IRR is a more sensitive profit measure at the lower retained amounts in these studies. In this small company sensitivity, reserve relationships change from the Phase case studies. Figures 8 and 9 look at the change in reserve under each of the steps implemented for the small company sensitivity. Because the excess of the SR over the DR is minimal, we focus on the impact to the DR.

23 23 Figure 8: Reserve Levels ULSG, Low-Band 90,000 80,000 70,000 60,000 50,000 40,000 30,000 20,000 0,000 Small Company Reserve Patterns $350k Band Phase Situation 5 DR Step 2¹ DR Step 2 NPR Step 3² DR Step 2: Small Company Acquisition and Reserve Assumptions 2 Step 3: Small Company with Coinsurance

24 24 Figure 9: Reserve Levels ULSG, High-Band 300,000 Small Company Reserve Patterns $.2M Band 250, ,000 50,000 00,000 50, (50,000) Phase Situation 5 DR Step 2¹ DR Step 2 NPR Step 3² DR Step 2: Small Company Acquisition and Reserve Assumptions 2 Step 3: Small Company with Coinsurance Figure 20 shows the Step 3 NPR and DR compared to the projection of the Phase DR using the same coinsurance approach applied to the small company sensitivity in Step 3. Figure 20 demonstrates the additional DR margin due to the small company reserve assumptions by comparing the small company DR to the Phase DR on the same reinsurance basis. It also shows that the small company NPR exceeds the DR for the first several policy years the first time this has been observed in the ULSG case studies.

25 25 Figure 20: Reserve Levels ULSG, High-Band Small Company Reserve Patterns $.2M Band Step 3¹ DR Step 3 NPR Phase with Coin DR Step 3: Small Company with Coinsurance Section 7: Guaranteed YRT Case Studies In the Phase report, the case studies reflect nonguaranteed yearly renewable term (YRT) reinsurance on insurance amounts in excess of a $,000,000 retention limit. As a proxy for reinsurer pricing, YRT premiums were set at 0% of the pricing mortality assumption, and the first-year expense allowance was set equal to 00% of the first-year reinsurance premium. For the modeled VM-20 components (DR and SR), the YRT premiums were treated as a nonguaranteed element. We assumed the reinsurer would raise YRT premium rates to offset the higher mortality assumed in the reserve calculations. Specifically, we countered the impact of mortality margins and omission of mortality improvement required by VM-20 by making the same considerations in the YRT premium rates. For the DR and SR calculations, YRT premiums are 0% of the VM-20 mortality assumption. For the Phase case studies, we did not assume any delay in the reinsurer s premium increase. The purpose of this sensitivity is to examine the potential impact to pricing results should the YRT reinsurance agreement guarantee the YRT premium rates. The change made in this Phase 2 sensitivity is to assume that the agreement has a guaranteed premium provision. To be able to better observe the impact of this change, however, the Phase Situation 5 VM-20 pricing needs to be restated assuming a lower ceding company retained amount. As noted above, in the Phase studies, the retained amount was $,000,000, and the impact of reinsurance on the pricing results was negligible and only impacted the $,200,000 policy size. We ran this Phase 2 case study for high band, and the retained amount is assumed to be $200,000. The final change made within this sensitivity is to test the impact of setting the guaranteed YRT rates at specified levels. For term, we ran sensitivities assuming YRT premiums equal to 5% and 20% of expected mortality. For ULSG, we ran only a sensitivity assuming YRT premiums equal to 20% of expected mortality. These sensitivities assumed no additional increase in YRT premiums associated with the higher VM-20 mortality as a result of the mortality margin. The 5% and 20% of expected mortality are proxies for guaranteed YRT premium rates, but are illustrative only and not indicative of the level of rates that would be available in the market. The case studies do not reflect any reduction in capital requirements that might be considered in response to the decreased volatility of results under guaranteed YRT rates.

26 26 Guaranteed YRT Term Case Study Figure 2 provides the pricing result for this series of runs for term. Figure 2: Pricing Results Guaranteed YRT Term, High-Band Guaranteed YRT Term Pretax Profit Margin After-Tax Profit Margin 2 Adjusted After-Tax Profit Margin 3 Surplus Strain IRR Adjusted After-Tax High-Band Model Office 0-Year Term Situation 5 from Phase Report 6.2% 8.8%.7% 2% 7.6% Revised Baseline with $200,000 Retention.2% 5.6% 3.8% 44% 23.0% YRT Premiums at 5% of Expected Mortality 8.5% 3.9% 2.2% 44% 7.3% YRT Premiums at 20% of Expected Mortality 5.8% 2.0% 0.3% 44% 6.0% High-Band Model Office 20-Year Term Situation 5 from Phase Report 9.9%.9% 6.7% 47% 0.4% Revised Baseline with $200,000 Retention 2.9% 7.% 5.8% 55% 5.0% YRT Premiums at 5% of Expected Mortality 0.% 5.6% 4.4% 55% 23.6% YRT Premiums at 20% of Expected Mortality 7.2% 3.6% 2.4% 55%.7% 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. In moving from Situation 5 from the Phase report to the revised baseline with $200,000 retention: Surplus strain is reduced because first-year loss under Phase the baseline is mitigated by the reinsurance claim reimbursements together with a $0 first-year YRT premium After the first year, reinsurance premiums are nonzero, producing a higher reinsurance cost from the lower retention amount. The lower retention (higher reinsured amount) changes the pattern of profits. For the 20-year plan, this means lower profit margins but improved IRR due to the lower initial investment. For the 0-year plan, profit margins before cost of capital are reduced but increased on the after-cost-of-capital basis. IRR is improved as a result of the lower initial investment. Having reestablished results under a Revised Phase 2 Baseline with $200,000 retention, we move on to the Guaranteed YRT Premium sensitivities. For this sensitivity series, it is helpful to compare and contrast the outer and inner loop assumptions with respect to mortality rates and YRT premiums, because these are directly related. Figure 22 provides this comparison.