The life insurance industry’s shift to principle-based reserving (PBR) is complex with pricing and profitability implications unique to each insurer.
By Karen K. Rudolph, Principal, FSA, MAAA and Brian Fomby, Relationship Manager, FSA, MAAA.
In the life insurance business, the shift to principle-based reserving (PBR) has been long in the making. Set to become the industry standard for new issues by 2020, most insurers and actuaries are well aware of the need to make the shift from the traditional statutory approach. However, the complexity of the changes PBR introduces to the landscape is heightened by the range of products and populations unique to each insurer, which has left many scratching their heads as to what the impact will actually be on pricing and profitability. Given that companies have the option to begin using the new principle-based framework, as defined in Chapter 20 of the National Association of Insurance Commissioners Valuation Manual (VM-20), for new issues starting this year, deciding what to do and when is no longer purely an academic question.
In an effort to shed some light on the issues, Milliman worked with the Society of Actuaries (SOA) to compare the outcomes of specific product strategies when moving from statutory reserving to PBR. The result is titled, “Impact of VM-20 on Life Insurance Product Development.” This first phase of a two-part research effort focuses on modeling the products typical of a large, top-quartile writer. It uses hypothetical case studies for term and universal life with secondary guarantees (ULSG) products to illuminate changes in profitability from statutory reserving methods to PBR methods, with implications for the product development process. (The second phase will focus on smaller insurers, the impact of reinsurance, and the industry’s overall readiness for VM-20.) The full report is worth reading because it goes into individual topics in much greater depth.
The topic of product design changes under VM-20 quickly gets complicated because of the number of key dimensions of reserving that can impact profitability. Some of the important decisions to be made include:
• When to make the move from the 2001 CSO valuation mortality tables to the 2017 CSO valuation mortality tables
• Whether to utilize the full three-year transition period or implement PBR methods earlier
• After implementation of PBR, a VM-20 exclusion test must be selected
Additionally, there are two other factors that can have a significant effect on a company’s assessment of profitability. First, there’s the way in which profitability is measured—profit margins or internal rate of return (IRR). A profit margin is less sensitive to the pattern of profits while IRR is sensitive to the patterns of profits as they emerge over time. Because the build-up and release of reserves contribute to the profit pattern, the method of calculating reserves plays a key role in the profit metric.
Finally, there’s the financing factor. Products with excess reserve financing, in which a third-party carrier or captive company takes on some of the reserve load to support enhanced profitability, will have a different profitability framework against which to assess the move to PBR. The tax benefits enjoyed by these strategies are important to the total profit picture.
With so many issues at play, case studies such as the ones featured in the SOA report can be useful guides. At the same time, organizations will need to model their own products using a tool such as Integrate to truly understand the consequences of their decisions. In our next post, we’ll cover some highlights from the report’s executive summary to show how these different levers of change can affect various types of products.