What implications must life insurers consider related to the effects of principle-based reserving (PBR) on product design?
By Karen K. Rudolph, Principal, FSA, MAAA and Brian Fomby, Relationship Manager, FSA, MAAA.
This is the second of two posts with highlights from the recent study Milliman performed in collaboration with the Society of Actuaries (SOA) on the implications of principle-based reserving (PBR) on life insurance product design. See the first post here.
The study itself runs through a wide range of possible scenarios incorporating many possible combinations of key choices such as mortality tables, reserving methods, and excess reserve financing options. While the products studied are hypothetical and results will vary based on each company’s products, premiums, assumptions, and experience, a few key themes emerged from the work.
Perhaps the simplest change a company can make is moving from the 2001 CSO mortality tables to the 2017 CSO mortality tables. Assuming this is the only change a company makes, the study shows a small increase in the internal rate of return (IRR) for term insurance and no material change for universal life with secondary guarantees (ULSG) insurance. This shows that the 2017 tables are somewhat less conservative than the 2001 tables when it comes to mortality rates.
Next, let’s consider products that do not use excess reserve financing, adopt the 2017 tables, and implement the reserve methods from Chapter 20 of the National Association of Insurance Commissioners Valuation Manual (VM-20). For the hypothetical term products studied, using VM-20 did result in significant increases in IRR. The reason is that VM-20 has a tendency to “right-size” reserves to risk, reducing statutory and tax reserves for these products that otherwise would have to follow more conservative assumptions. Longer level premium periods tend to be associated with greater gains in IRR in this scenario. These writers could have the opportunity to reduce premiums or maintain higher levels of profitability by adopting VM-20 early.
When it comes to non-financed ULSG policies, on the other hand, the IRR for hypothetical products studied was not materially affected by the use of VM-20. While statutory reserve decreases were observed, ULSG policies are subject to lower tax reserve deductions under VM-20 than they were previously, and the two sides more or less cancel each other out. For similar products, writers might want to consider maintaining the status quo and adopting VM-20 at a pace that makes sense given other factors, because early transition to PBR will not necessarily benefit the bottom line.
Turning to business that was financed prior to VM-20, in the case of both ULSG and term policies, removing financing would tend to reduce profitability. Losing the tax benefits of financing for the modeled policies, as would be the case in adopting VM-20, would not be offset by lower reserves. These companies may want to continue to use financing arrangements during the transition period in order to maintain the associated tax benefits. If they don’t, they might have to accept lower profitability or raise premiums.
Of course, once a company adopts VM-20, the picture becomes even murkier, because assumptions are not locked in at issue. Pricing and modeling are complicated due to:
• Emerging experience for mortality, lapse, expenses, and policyholder behavior, including flexible premium payments
• Earnings rates on assets in-force as of future valuation dates, which may include assets backing liabilities issued after the product was priced
• Newly adopted CSO valuation mortality tables
• Revisions to prescribed mortality margins
• Actual Treasury yield rates up to the valuation date that will impact the generation of the VM-20 deterministic and stochastic reserve scenarios
As time goes on, clarity will emerge around product changes brought on by the move to VM-20 reserving methods. In the meantime, we hope to continue providing insights that will help writers and product design actuaries deliver their best efforts to market. Milliman’s Integrate is your tool for rapidly exploring a variety of scenarios using large amounts of data, and for readily handling the complexities of projecting VM-20 reserves as is required for the pricing of new products under the PBR regime. Because it’s based in the cloud, you can scale up computing power to run complex models and examine multiple case studies while paying only for what you use. With robust tools and enterprise-grade security, Integrate is the leading edge technology that helps you navigate the ever-changing landscape of PBR. Contact us to learn more.