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© 2016 American Academy of Actuaries. All rights reserved. May not be
reproduced without express permission.
ADDITIONAL LIABILITY ASSUMPTION OVERVIEW
© 2016 American Academy of Actuaries. All rights reserved. May not be reproduced without express permission.
2 PBR Boot Camp: Basic Training and Beyond for PBR Implementation September 21 - 23, 2016
Agenda
Model Validation/Governance of Assumptions General Assumption/Margin Development Expenses and Taxes Term Life Assumptions ULSG Assumptions Case Study
© 2016 American Academy of Actuaries. All rights reserved. May not be reproduced without express permission.
3 PBR Boot Camp: Basic Training and Beyond for PBR Implementation September 21 - 23, 2016
Model Validation/Governance of Assumptions
Key topics to be covered o Why it is important o General areas to consider o Initial baselining and types of deliverables o Continuation of validation controls o Best practices o Typical areas of major findings
© 2016 American Academy of Actuaries. All rights reserved. May not be reproduced without express permission.
4 PBR Boot Camp: Basic Training and Beyond for PBR Implementation September 21 - 23, 2016
Model Validation Can Create Opportunities
Why should companies undertake model validation? Model validation adds credibility in the eyes of senior management
Allows for a thorough understanding of the strengths and limitations of existing processes, and identifies areas of possible remediation (errors, operational risks and/or inefficiencies)
Increases confidence that the results are “right”
A parallel model build in a different platform is a more robust/stronger statement for auditors than simply reviewing a model
© 2016 American Academy of Actuaries. All rights reserved. May not be reproduced without express permission.
5 PBR Boot Camp: Basic Training and Beyond for PBR Implementation September 21 - 23, 2016
An Earnings Argument for Robust Model Validation
Q4 2016 Q1 Q2 Q3 Q4 2017 Q1 Q2 Q3
Without Formal Model Validation and Governance
Earnings without Errors Earnings with Errors Realized over Time
Errors discovered and addressed
in the course of normal operations,
or operational issues discovered later
© 2016 American Academy of Actuaries. All rights reserved. May not be reproduced without express permission.
6 PBR Boot Camp: Basic Training and Beyond for PBR Implementation September 21 - 23, 2016
An Earnings Argument for Robust Model Validation
Q4 2016 Q1 Q2 Q3 Q4 2017 Q1 Q2 Q3
After Formal Model Validation and Governance
Earnings without Errors Earnings with Errors Corrected in Q4 2016
Sum of Errors discovered in advance and addressed via MV
© 2016 American Academy of Actuaries. All rights reserved. May not be reproduced without express permission.
7 PBR Boot Camp: Basic Training and Beyond for PBR Implementation September 21 - 23, 2016
What Do We Mean by Model Validation?
Sensitivity testing
Other types of Model Validation
© 2016 American Academy of Actuaries. All rights reserved. May not be reproduced without express permission.
8 PBR Boot Camp: Basic Training and Beyond for PBR Implementation September 21 - 23, 2016
What Do We Mean by Model Validation?
Micro Validation (Technical review)
Macro Validation
Controls
© 2016 American Academy of Actuaries. All rights reserved. May not be reproduced without express permission.
9 PBR Boot Camp: Basic Training and Beyond for PBR Implementation September 21 - 23, 2016
Baselining
A fundamental first step to ensure ongoing compliance with validation requirements
Requires prioritization Much more time and resource consuming than the typical
model change validation activities Advantages of centralized resources to assist with baselining:
o Independence o Dedicated and scalable resources o Knowledge of typical and best practices o Experienced in developing audit approaches o Broader view model interaction across model owner groups
© 2016 American Academy of Actuaries. All rights reserved. May not be reproduced without express permission.
10 PBR Boot Camp: Basic Training and Beyond for PBR Implementation September 21 - 23, 2016
Types of Deliverables for Validation Effort
Overview of Models Including: Historical use Description of key risks (product, policyholder, market, operational, etc.) Description of methodology and assumptions Data flow and process maps, including data used and labeling of controls at various stages Report on Baselining Review: Justification for plan mapping and model compression (e.g., cell structure) Review of model inputs for product specifications and assumptions Application code review for intended purposes Appropriate use of reporting output Test sample illustrations Continued Monitoring: Model change documentation with reason, impacts, technical review, fit for purpose peer
review, and approvals
© 2016 American Academy of Actuaries. All rights reserved. May not be reproduced without express permission.
11 PBR Boot Camp: Basic Training and Beyond for PBR Implementation September 21 - 23, 2016
Continuation of Validation Controls
A formalized process for continuing validation controls after baselining Conduct in-line with model development lifecycle Examples: Separate testing environment for model changes Roll-forward analysis via a “waterfall” or “ladder” of results Maintenance of documentation suited to each model aspect Archive of current assumptions Model change documentation with levels of peer review and acceptance:
o Development o Technical Review o Testing Documentation o Peer Review o Model owner/management sign-off
Process is much easier to build upon the baseline deliverables
© 2016 American Academy of Actuaries. All rights reserved. May not be reproduced without express permission.
12 PBR Boot Camp: Basic Training and Beyond for PBR Implementation September 21 - 23, 2016
Best Practices
Start with models subject to highest risk o Materiality vs. complexity
Baselining of all inputs, formulas, and reports is more effective than ad hoc review on a narrower scope, which can be biased in terms of focus
The baseline report should stand on its own without the need to access the models (include work papers where needed)
Ensure independence during the review process, but obtain buy-in on findings from model owners
Cover the gaps between: o Initial generation of administration data and assumptions and inputs to the model o Model outputs to final delivery of results to stakeholders
© 2016 American Academy of Actuaries. All rights reserved. May not be reproduced without express permission.
13 PBR Boot Camp: Basic Training and Beyond for PBR Implementation September 21 - 23, 2016
Typical Areas of Major Findings
Misuse of data or results delivered between different areas of the company
Key risks ignored or insufficiently modeled
o Non-modeled business or features
o Lack of economic rate variation
Unexpectedly material simplifications
Model assumptions or approaches applied outside of actuarial guidelines or
recommended practices
Legacy practices or calculations invalidated by new events
Errors in back-end processes used in support of the primary projection model
© 2016 American Academy of Actuaries. All rights reserved. May not be reproduced without express permission.
14 PBR Boot Camp: Basic Training and Beyond for PBR Implementation September 21 - 23, 2016
General Assumption/Margin Development
Prudent estimate assumptions = anticipated experience + margin
Company experience o Relevant o Credible
Industry experience, with adjustments as needed Sensitivity testing Annual review
© 2016 American Academy of Actuaries. All rights reserved. May not be reproduced without express permission.
15 PBR Boot Camp: Basic Training and Beyond for PBR Implementation September 21 - 23, 2016
Expenses and Taxes
Expenses o Valuation Manual guidance o Company/industry experience o Inflation
Taxes o Premium tax o Income taxes
© 2016 American Academy of Actuaries. All rights reserved. May not be reproduced without express permission.
16 PBR Boot Camp: Basic Training and Beyond for PBR Implementation September 21 - 23, 2016
Expense Assumptions: VM Guidance
IT costs/other capital expenditures o VM-20 Section 9.E.1.b: “May spread certain information
technology development costs and other capital expenditures over a reasonable number of years in accordance with accepted SAP . . .”
Expense basis o VM-20 Section 9.E.1.d: “Shall choose an appropriate
expense basis that properly aligns with actual expense” (for example death benefits expenses modeled per death)
© 2016 American Academy of Actuaries. All rights reserved. May not be reproduced without express permission.
17 PBR Boot Camp: Basic Training and Beyond for PBR Implementation September 21 - 23, 2016
Expense Assumptions: VM Guidance
Allocation o VM-20 Section 9.E.1.i: “Use fully allocated expenses”
(direct costs associated with block plus allocated indirect and overhead costs per 9.E.1.l)
o VM-20 Section 9.E.1.j: “. . . Allocation method consistent across company lines of business consistent with ASOPs”
© 2016 American Academy of Actuaries. All rights reserved. May not be reproduced without express permission.
18 PBR Boot Camp: Basic Training and Beyond for PBR Implementation September 21 - 23, 2016
Expense Assumptions: VM Guidance
New Business o VM-20 Section 9.E.1.n: “For policies sold under a new
policy form . . . use expense factors that are consistent with expense factors . . . from an existing block of mature policies . . .)
© 2016 American Academy of Actuaries. All rights reserved. May not be reproduced without express permission.
19 PBR Boot Camp: Basic Training and Beyond for PBR Implementation September 21 - 23, 2016
Expense Assumptions: Company Experience
Typically based on unit cost studies produced by the company – frequently these support AAT expense assumptions
Use industry data (such as SOA studies or GRET) if company experience lacking or outdated
Use fully allocated expenses per VM guidance
© 2016 American Academy of Actuaries. All rights reserved. May not be reproduced without express permission.
20 PBR Boot Camp: Basic Training and Beyond for PBR Implementation September 21 - 23, 2016
Expense Assumptions: Inflation
Typically based on historical national inflation data such as: o Consumer Price Index (CPI) o GDP deflator o Central bank inflation forecasts
Use historical average, consider a “select and ultimate” approach
Increase rate for margin
© 2016 American Academy of Actuaries. All rights reserved. May not be reproduced without express permission.
21 PBR Boot Camp: Basic Training and Beyond for PBR Implementation September 21 - 23, 2016
Tax Assumptions
Premium tax o Typically, the state premium tax rate applicable to the
product (i.e., averages around 2% for life insurance) Income taxes
o Per 9.E.1.n.g, shall NOT include assumptions for federal and foreign income taxes (reserve calculations are pre-tax)
© 2016 American Academy of Actuaries. All rights reserved. May not be reproduced without express permission.
22 PBR Boot Camp: Basic Training and Beyond for PBR Implementation September 21 - 23, 2016
Term Life Assumptions
Lapse rates o Level period o Shock o Post level period
Conversions Post level period profits
© 2016 American Academy of Actuaries. All rights reserved. May not be reproduced without express permission.
23 PBR Boot Camp: Basic Training and Beyond for PBR Implementation September 21 - 23, 2016
Term Life Assumptions: VM Guidance
Lapse rates o VM-20 Section 9.D.3.b: “The company must assume
that policyholders’ efficiency will increase over time unless the company has relevant and credible experience or clear evidence to the contrary.”
© 2016 American Academy of Actuaries. All rights reserved. May not be reproduced without express permission.
24 PBR Boot Camp: Basic Training and Beyond for PBR Implementation September 21 - 23, 2016
Term Life Assumptions: VM Guidance
Conversions o VM-20 Section 9.D.1.e: “Reflect the likelihood that
policyholder behavior will be affected by any significant increase in the value of a product option, such as term conversion privileges or policy loans.”
© 2016 American Academy of Actuaries. All rights reserved. May not be reproduced without express permission.
25 PBR Boot Camp: Basic Training and Beyond for PBR Implementation September 21 - 23, 2016
Term Life Assumptions: VM Guidance
Post-level period profits o VM-20 Section 9.D.6: “For the calculation of the deterministic
reserve, for a term life policy issued 1/1/2017 and later that guarantees level or near level premiums for more than five years until a specified duration followed by a material premium increase, or for a policy for which level or near level premiums are expected for more than five years, followed by a material premium increase, for the period following that premium increase the cash inflows or outflows shall be adjusted such that the present value of cash inflows does not exceed the present value of cash outflows.”
© 2016 American Academy of Actuaries. All rights reserved. May not be reproduced without express permission.
26 PBR Boot Camp: Basic Training and Beyond for PBR Implementation September 21 - 23, 2016
ULSG Liability Cash Flow Assumptions
Company assumptions: o Expenses o Credited rate strategy o Other NGE
© 2016 American Academy of Actuaries. All rights reserved. May not be reproduced without express permission.
27 PBR Boot Camp: Basic Training and Beyond for PBR Implementation September 21 - 23, 2016
ULSG Assumptions
Policyholder behavior: o Premium patterns and persistency o Partial (or full) withdrawals/surrenders o Other benefit utilizations o Lapse (if secondary guarantee not in force)
© 2016 American Academy of Actuaries. All rights reserved. May not be reproduced without express permission.
28 PBR Boot Camp: Basic Training and Beyond for PBR Implementation September 21 - 23, 2016
ULSG Assumptions
Required Sensitivity tests: (Section 9.D.4) i. Minimum premium scenario ii. No further premium scenario iii. Pre-payment of premiums as single premium scenarios iv. Pre-payment of premiums as level premium scenarios
© 2016 American Academy of Actuaries. All rights reserved. May not be reproduced without express permission.
29 PBR Boot Camp: Basic Training and Beyond for PBR Implementation September 21 - 23, 2016
ULSG Assumptions
Considerations: o Section 9.D.1.a. is specifically directed at policyholder
behavior assumptions, and indicates consideration of “expectations regarding variations in anticipated policyholder behavior relative to characteristics that have a material impact on the minimum reserve.”
o Section 9.D.1.e. “Reflect the likelihood that policyholder behavior will be affected by any significant increase in the value of a product option.”
© 2016 American Academy of Actuaries. All rights reserved. May not be reproduced without express permission.
30 PBR Boot Camp: Basic Training and Beyond for PBR Implementation September 21 - 23, 2016
ULSG Assumptions
Review model granularity needs Validation of total terminations Incorporation of prescribed industry lapse rates
from the 2007 CIA study Approaches to setting margins
© 2016 American Academy of Actuaries. All rights reserved. May not be reproduced without express permission.
31 PBR Boot Camp: Basic Training and Beyond for PBR Implementation September 21 - 23, 2016
Additional Liability Assumption Overview
Questions
Break-outs