Product Matter Issue 86, June 2013 - Society of Actuaries

ISSUE 86 | JUnE 2013

COnTInUED On PAGE 4

Design Thinking: This Will Change EverythingBy Lance Poole

E rnest Hemingway was once challenged to see if he could write a very short story that carried the emotion and power of some of his longer works. He came up with one that contained just six words. My guess is that the challenger was thinking they

would at least get a few paragraphs. So what were those six words?

For sale: Baby shoes, never worn.

Read the sentence out loud and reflect upon the meaning, and you’ll feel how potent this short sentence is.

Just as Hemingway’s short sentence packs a lot of meaning into just a few words, Stanford’s Design Thinking Boot Camp is a three-day introduction to Design Thinking that provides the knowledge, insight, and experience of a semester-long class. In fact, I was asked to craft my own six-word sentence about my experience at the d.School and it was this: “Life will never be the same.” I won’t try and unpack everything that sentence represents, but as you will hopefully see, Design Thinking is a game changer and I now have a new set of tools to apply to any problem. How can life be the same after you experience something like this?

One of the principles of Design Thinking is “Show...Don’t Tell.” You learn Design Think-ing by doing, not reading. So rather than writing a long article on Design Thinking, I want to introduce you to the steps of the process, and some ways that these steps can be applied to insurance product development. If you really want to “do” Design Thinking, I’d highly recommend you speak to the fine folks at the d.School.

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Product Development Section

1 Design Thinking: This Will Change Everything

By Lance Poole

3 Chairperson’s Corner Hats off to Our Volunteers! By Paula Hodges

7 Life Insurance Acceleration Riders By Jim Filmore

11 Longevity Insurance: Defining your own defined

benefit By Harrison Weaver

14 Then and Now By Paula Hodges

18 Relationship of IRR to ROI on a Level Term Life Insurance Policy

By Wayne Stuenkel

21 Co-Editor Commentary on “Relationship of IRR to ROI on a Level Term Life Insurance Policy”

By Kurt Guske

22 Alzheimer’s Mortality By Dave Moran

24 On the Research Front

2013 SECTION LEADERSHIP

OfficersPaula Hodges, ChairpersonTim Rozar, Vice ChairpersonRhonda Elming, Secretary/Treasurer

Council MembersRhonda ElmingJim FilmoreKurt GuskePaula HodgesJoe KordoviVera LjucovicDave MoranStephen PeeplesTim Rozar

Board Partner Jerry Brown

Web Liason (including PodCasts and LinkedIn)Vera Ljucovic

Other Representatives Jim Filmore, 2013 Life & Annuity SymposiumPaula Hodges, 2013 Annual MeetingMitchell Katcher, 2013 Life & Annuity SymposiumKurt Guske, 2013 Life & Annuity SymposiumJoe Kordovi, 2013 Life & Annuity Symposium

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ISSUE 86 | JUnE 2013

Published by the Product Development Section Council of the Society of Actuaries

This newsletter is free to section members. Current issues are available on the SOA website (www.soa.org).

To join the section, SOA members and non-members can locate a membership form on the Product Development Section Web page at www.soa.org/ product-development. This publication is provided for informational and educational purposes only. The Society of Actuaries makes no endorsement, representation or guarantee with regard to any content, and disclaims any liability in connection with the use or misuse of any information provided herein. This publication should not be construed as professional or financial advice. Statements of fact and opinions expressed herein are those of the individual authors and are not necessarily those of the Society of Actuaries.

© 2013 Society of Actuaries. All rights reserved.

2 | June 2013 | Product Matters!

Donna Megregian, 2013 Life & Annuity SymposiumDoug Robbins, Post 2013 Life & Annuity Symposium SeminarTim Rozar, 2013 Life & Annuity SymposiumRob Stone, 2013 Life & Annuity Symposium

Newsletter Editors Jim Filmore, Co-Editor e: [email protected] Guske, Co-Editor e: [email protected] Peeples, Co-Editore: [email protected]

SOA StaffKathryn Baker, Staff Editore: [email protected]

Jim Miles, Staff Partnere: [email protected]

Ronora Stryker, Staff Research Actuarye: [email protected]

Christy Cook, Lead Section Specialiste: [email protected]

Erin Pierce, Graphic Designere: [email protected]

Articles needed for the next Issue of Product Matters!While all articles are welcome, we would especially like to receive articles on topics that would be of interest to Product Development Section members based outside of the United States.

Please email your articles to Jim Filmore, Kurt Guske or Stephen Peeples by July 15, 2013.

Product Matters! | June 2013 | 3

T he more time I spend involved in SOA activities, the more amazed I become at the proportion that is com-pleted through the efforts of its numerous and talented volunteers. Currently serving in my third year on the Product Development Section Council, I am very grateful to be part of such a great organization.

Much of the activity you see being done by the Society of Actuaries would be impossible without the involvement and generous contributions of its member volunteers. The following is just a small snapshot of examples where members, just like you contribute their ideas, knowledge and expertise. Not to mention their valuable time:

• Research projects. Volunteers are responsible for selecting research topics, determining how much section funding to make available for each topic, serving as members of the Project Over-sight Group (POG) which is responsible for reviewing research results, and following through to ensure that research results are communicated to section membership.

• The Life and Annuity Symposium. Did you know that volunteers create the agenda, write the

session descriptions, and recruit the speakers for the sessions—and many speakers are volunteers as well?

• Our upcoming Preferred Underwriting Seminar, which will be held in August. The idea for

this was conceived by one of our very active Friends of the Council, Al Klein, and, as with the Life and Annuity Symposium, the entire agenda and speaker recruiting is done by volunteer efforts.

• Product Matters! We publish this newsletter three times per year, with articles recruited, written

and edited by volunteers. • Webcasts are like single-session meetings and are scheduled to communicate important informa-

tion to our membership and others in a manner that reaches more people than those who attend the other meetings. Like sessions at the meetings, they are choreographed and recruited by volunteers.

• The SOA Annual Meeting. While the Life and Annuity Symposium is focused more directly on

the subject matter that is the heart of our section, the Annual Meeting hosts about a dozen sessions that are sponsored by the Product Development Section, which means that the volunteer members of this section are responsible for the content and delivery.

Your membership in our section helps to fund many of these activities, and we constantly seek to provide more value to you. If it weren’t for the tireless contributions of our volunteers, the cost of these offerings would be prohibitively higher.

I would be remiss if I didn’t mention the support of the SOA staff in delivering these as well. They provide ex-ceptional organization, structure and continuity to the volunteers. So thank you to the staff of the SOA as well.

When the section council election ballot is delivered to your inbox in a few weeks, please understand the role that will be undertaken by those who choose to enter their names on that ballot. Make your vote count, and thank those who are willing to take on the challenge of maintaining the quality programs that the SOA provides.

Chairperson’s Corner

Hats off to Our Volunteers! By Paula Hodges

Paula Hodges,FSA, MAAA, is 2nd vice president and associate actuary with Ameritas Life Insurance Corp., responsible for Corporate Actuarial Operations. She can be contacted at phodges@ ameritas.com.

Design Thinking … | from page 1

Background and OverviewLet’s try a quick exercise. Think of someone you know that is creative. Who did you come up with? My guess is that 90 percent of people think of someone who is a painter, musician, or writer. Design Thinking rejects the relationship of “creative” equaling “artistic.” Any-one can be creative: an actuary, an accountant, a lawyer. Children are by default creative, making a safari adven-ture out of a sheet and two chairs or a spaceship out of a refrigerator box. We start out imaginative, but some-where along the way, we lose touch with our creative side. Design Thinking seeks to unleash the creative po-tential that lies latent inside of each of us.

Honestly, it’s only been in the last couple of years that I viewed myself as creative. Things that others may see as boring and not allowing for creativity, I see as my craft—an artistic endeavor. Design thinking will allow you to approach your work with the same mindset and look for ways to creatively solve problems.

With that said, let’s dive into the Design Thinking pro-cess. The five parts of the process are Empathy, Define, Ideate, Prototype, and Test. As I mentioned above, I’ll interject examples of how this can be applied to insur-ance product development.

EmpathyWhen most of us think about design, we think about aesthetics—making products that are appealing to the eye. While aesthetics are an important part of design, Design Thinking always starts with the human element. Therefore empathy is essential to solving a problem with Design Thinking. What are some ways to gain in-sight? You need to spend lots of time talking and lis-tening to your user (the person for whom you are de-

signing a solution). Ask lots of open-ended questions. Ask “why” often. Try to evoke stories and emotions. As you’ll see later in the process, stories are an important foundation for the other steps in the Design Thinking Process.

So how do you increase empathy among members of your team, or others in the company? You have to talk with people. Here are some ideas.

Example 1If you were questioning, “How do we improve the cus-tomers’ experience with our company?” a great place to start would be watching what customers do when they open statements/prospectus/bills from your company (or any company for that matter). Give a customer a stack of mail and have them open it. Watch how the expres-sion on their face changes when they open a handwritten letter, versus junk mail, versus a two-pound prospectus packet. Ask the customer to talk about companies they love interacting with—what is it about these companies that delight them? What products do they adore?

Example 2If you were questioning, “How do we help people save for retirement?” you could start by conducting inter-views. Go to a place where people are (obvious, yes?). I have found that it helps to get the conversation started by offering a gift card (of a small monetary value). Ask them questions about retirement. Are they ready? How are they saving? What worries them? I’ve also found it’s helpful to ask lots of “why” questions, such as, “Why is that?”

Now you may be saying, “I can get all of this data from quantitative studies that have a larger and more reliable sample size than five.” And you are right; data can give you a sense of people’s worries, problems, concerns, etc. But data cannot provide stories and a human connection. For someone like me who has spent my career focused on quantitative analysis, the qualitative focus of Design Thinking felt like California feel-good nonsense! But af-ter having experienced it first hand and seeing how com-panies like IDEO have used it to deliver groundbreaking innovation, it’s hard to argue with the results.

Design Thinking rejects the relationship of “creative” equaling “artistic.” Anyone can be creative: an actuary, an accountant, a lawyer.


As I mentioned earlier, we are solution agnostic. Ask a Design Thinker for help designing a bridge to go over a canyon and her first response will be, “Are you sure it needs to be a bridge?”

At this point, some of you will think, “If I work for an insurance company, why should I brainstorm solu-tions that I know I can’t create?” The answer is that your “wild” solution may provide insight that leads to a product you can create or a solution you can manage. Here’s an example using the point-of-view statement: An independent and energetic retiree needs to feel se-cure about not outliving her assets because her biggest fear is being a burden to her children later in life and not being able to buy birthday and Christmas gifts for her grandchildren.

One wild idea is that we create a magic jacket that al-ways has money in the pocket if she needs it to buy gifts for her grandchildren. If she takes her grandchildren to the mall and she doesn’t have money for the gift, the magic jacket will supply a crisp twenty dollar bill in the pocket.

Clearly, this solution epitomizes a wild idea, but it’s an idea into which you can delve deeper. How would it feel

DefineThe definition portion of the process helps create a user point-of-view statement. The point-of-view statement is like a problem statement, but with feeling and emo-tion. This provides a great platform for ideation (brain-storming). Always start the creation of this problem statement with thinking about needs—“needs” as verbs, not nouns. Examples of needs, by this definition: to feel responsible, to show love, to enjoy time with a spouse, to provide for our kids college education. The follow-ing are not needs: security, a second home, replacement income.

After exploring needs, you craft the point-of-view statement. It’s similar to those “Mad-Libs” you played as a kid. Here’s the format: “USER” needs to “NEED STATEMENT” because “INSIGHT.” So let’s look at an example of a problem statement using this format:

An independent and energetic retiree needs to feel secure about not outliving her assets because her biggest fear is being a burden to her children later in life.

This statement is packed with emotion and compels us to want to come up with a solution. Also, we are not solution biased. At this point it may not even need to be an insurance product to solve the problem. This allows us to do what is called “ideate” without con-straints (more to come on that). I’ve also selected what Design Thinkers call an “extreme user.” Identifying and empathizing extreme users allows us to come up with solutions and insights that often apply to a broader user group. Having a powerful point-of-view statement will allow us to come up with great ideas as we move to ideation.

IdeationIdeation is what most of us usually think of as brain-storming. It’s a little embarrassing to think of what I’ve called “brainstorming” in the past. There were no em-pathy insights and I didn’t clearly have a user point of view. Hopefully it is starting to become clear how im-portant these steps in the process are.

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to wear and know that this jacket is in the closet? Can we do anything that would provide the same feeling or meet these needs?

Since this is an intro into the process, I’ll leave the ground rules for ideation to the “Resources” section.

Prototype and TestPrototyping is the stage in the process in which you create something with which the user can interact. This goes back to the Design Thinking principal of “Show...Not Tell.” A prototype can be a skit that shows the ex-perience, sticky notes that show an interface, or con-struction paper and post-its to show the layout of a call center.

The key to prototyping is that it needs to be low resolu-tion / low fidelity (say low-res or lo-fi if you want to sound like a practitioner!). It’s important to construct a low-fi model because:

1) You want to get feedback from your tester as quickly as possible so you improve.2) Testers are more willing to give feedback if the model is less refined.

Think about point #2—if someone on your team brings a PowerPoint presentation he has spent months of his life working on, missed his kid’s soccer games for, and has lost a couple of years of life expectancy because of, wouldn’t it be difficult to tell your team member that his presentation was completely off the mark? Now imag-ine the same presentation: It has headings, but the body is a mixture of sticky notes and drawings of graphs. At this point, it’s much easier to lend feedback and make changes.

Building a low-resolution prototype is essential to be-ing able to quickly gather honest feedback and continue working toward solution. And that’s all that testing is—having the user (or a user) interact with your prototype and receiving feedback. As with all of the steps of the process, this is another opportunity to gain empathy for your user. As the user interacts with your prototype, what problems does he have? What emotions does he feel? This empathy learning can lead to improvements as you further iterate on solutions.

ConclusionMy hope is that this brief intro into Design Thinking has given you an idea how the process can be applied in a wide variety of settings to solve problems. The best way to learn Design Thinking is by experiencing it yourself. If you are interested, contact me, the d.School, or any practitioner of Design Thinking. But before starting, take note: Life will never be the same!

Design Thinking … | from page 5

Lance Poole, FSA, MAAA, is VP, Annuity

Product Development for Protective Life Corp. He can be

contacted at [email protected]. Lance can be followed

on Twitter at @lance-poole.


Chronic Illness Benefit DesignsChronic illness riders are typically designed so that the rider benefit qualifies for favorable tax treatment under section 101(g) of the Internal Revenue Code. The most common chronic illness designs are the following:

(i) Actuarial discounting of the face amount that is being accelerated. For example, $100,000 of the face amount may be accelerated in a par-ticular year resulting in a payment of $80,000 to the policyholder. The other $20,000 is the actuarial discount that reflects the time value of money for the benefit being paid early along with the premiums associated with the acceler-ated amount that would have been required to keep the policy inforce until the projected date of death. The assumptions and methodology used in the actuarial discounting is the one of the keys to a well designed chronic illness rider.

(ii) Acceleration benefit is done by holding a lien

against the death benefit of the policy in the amount of the cumulative accelerated death benefit plus interest. In this design, the poli-cyholder is still paying the premium for the portion of the face amount that is accelerated. Thus, the cost is the interest associated with the lien. The outstanding lien balance reduces the amount of cash value available for surrender or loan. The death benefit paid is reduced by any outstanding lien balance. This design is primar-ily utilized when the base policy is a whole life policy.

(iii) A chronic illness acceleration rider which charges

the policyholder an explicit additional premium at the time the rider is attached to the life insur-ance policy.

Risk Control Measures on Chronic Illness Acceleration RidersCommon risk control measures applied to chronic ill-ness riders include the following:

• Use of a supplemental underwriting application for any acceleration riders. The supplemental

H istorically, life insurance companies in the United States have given the policyholder the option to accelerate a portion of their death

benefit in the case of terminal illness. In those circum-stances, terminal illness was typically defined to be where a physician certified that the applicant has a life expectancy of less than 12 months (24 months is used in some states).

In recent years, life insurance companies have started offering acceleration of a portion of the face amount of the life insurance policy to those who are chronically ill or critically ill. This article discusses the more com-mon form of the chronic illness riders found in the U.S. marketplace today as well as considerations to control the risks under that rider.

DefinitionsFor the purpose of this article, we will be using the fol-lowing definitions:

1. A terminal illness rider is one that allows the policyholder to accelerate a portion of their face amount when they have a life expectancy of less than X months. X is typically 12, but is 24 months in some states.

2. A chronic illness rider is one that allows the

policyholder to accelerate a portion of their face amount in the case of severe cognitive impair-ment or when they are unable to perform 2 or more activities of daily living (ADL) without as-sistance from another person. Activities of daily living are bathing, continence, dressing, eating, toileting, and transferring.

3. A critical illness rider is one that allows the

policyholder to accelerate a portion of their face amount when meeting the criteria for one or more of the listed critical illnesses. An example of a critical illness is a heart attack or a stroke.

There are other related offerings such as life/LTC combi-nation products and Long-Term Care (LTC) acceleration riders that allow the policyholder to accelerate more than the face amount of the policy when meeting certain Ac-tivities of Daily Living (ADL) triggers and/or when stay-ing in a qualified LTC facility. However, those products and riders are beyond the scope of this article.

Jim Filmore, FSA, MAAA, is a vice president and actu-ary responsible for Munich Re’s U.S. individual life pricing teams. He can be reached at [email protected].

Life Insurance Acceleration Riders By Jim Filmore

COnTInUED On PAGE 8


underwriting typically consists of questions related to the applicant’s medical history with respect to the triggers that are used for the ac-celeration benefit. For example, it will focus on conditions that may result in morbidity associ-ated with ADL loss that may not be included in a typical life insurance application. It may also probe regarding ADL losses or currently dis-abilities. The supplemental application may also ask questions related to other living benefit cov-erage inforce (such as long-term care or other chronic illness or terminal illness acceleration riders). Those coverage questions are intended to determine if it appears that the individual is over insured for these benefits (over insurance may imply that the applicant is intending to anti-select against the writing company).

• Limiting the issue ages at which the chronic ill-

ness rider can be added and/or incorporation of cognitive testing at particular issue ages.

• Holding the accelerated amount as a lien against

the death benefit and charging interest against that lien OR payment of a discounted amount relative to the face amount that is being accelerated. The discounted amount is the actuarial present value

of the amount being accelerated taking into ac-count interest and premium payments based upon a life expectancy assumed for a chronically ill in-dividual at that gender and attained age.

• Limiting both the annual and the maximum

acceleration amount to some specific dollar amount. The annual benefit amount is also often limited to ensure that the benefit receives favor-able tax treatment under section 101(g) of the tax code. Often the policyholder is encouraged to consult their personal tax advisor in advance of making the decision regarding the acceler-ated death benefit payment so they can review the policyholder’s personal circumstances to determine whether the payments qualify for tax free treatment.

• Requiring that an approved Licensed Health

Care Practitioner certifies that the policyholder is unable to perform the ADL which are the trig-gering events for the benefit payment. The writ-ing company often reserves the right to pay for an independent examination of the insured by a Licensed Health Care Practitioner to confirm the validity of the claim. The typical chronic illness acceleration rider trigger requires permanent loss of two or more ADL. Chronic illness riders typically also include a benefit trigger related to severe cognitive impairment.

• Defining the loss of ADL as expected to be

permanent can be an important risk control. In the absence of such as definition an otherwise healthy individual could claim under the rider when there is a situation that involves a tempo-rary loss of ADL. Such claims are typically not consistent with the reduced life expectancy that is assumed in the discounted face amount or the additional premium payment forms of chronic illness acceleration riders.

• The rider form may have certain exclusions

such as some mental or nervous disorders, al-coholism, drug addition, act of war (declared or undeclared), suicide or intentional self afflicted injury. These exclusions must mirror the base policy language in most states.


Life Insurance … | from page 7

• The rider is typically only available on poli-cies that are issued up to some maximum rat-ing (such as Standard or Table D).

• The contestability rights for the writing compa-

ny with respect to the rider typically follow that of the base policy.

• Limiting the maximum benefit to be less than

100 percent of the death benefit on the life insur-ance policy.

Reinsurance Participation on Chronic Illness Acceleration RidersReinsurance participation of acceleration riders can take different forms. Terminal illness acceleration riders are often considered to be standard in the United States individual life insurance marketplace. Thus, most rein-surers participate on those riders in proportion to their participation on the base policy. There is typically no additional charge for this rider and the only cost to the policyholder is a small discounting to account for loss of interest between the date of the accelerated payment and the anticipated date of death. It is common for ter-minal illness acceleration riders to have some cap on the overall face amount that can be accelerated.

Reinsurance participation of chronic illness accelera-tion riders is more varied. The first question is the product to which the rider is attached. If it is attached to a permanent policy, then one could argue that the policy is likely to ultimately result in a claim if the insured has met the triggers for the acceleration ben-efit. While that may not be an accurate assumption with all acceleration claims (as one could have a heart attack or stroke and survive for many years), it is not unrealistic to assume the lapse rate on the permanent policy would be at or near zero for those individuals. Thus, the question is whether the dis-counting used in the payment calculation appropri-ately takes into account the loss of premiums and in-terest to the direct writing company and the reinsurer based upon a reasonable life expectancy for a chroni-cally ill individual of that gender and attained age. Reinsurers in the U.S. market today often participate on the acceleration rider if they are able to get com-fortable with both the risk control measures used by the writing company at the time the rider is offered

and the discounting on the back end at the time the benefit is utilized. Not all reinsurers are comfortable participating on the stream of benefit payments made to the policyholder (if that is an option to the policy-holder). Consequently, a reinsurer may approve rider participation subject to a one-time payment either upon death or upon lapse of the policy. Reinsurance participation upon lapse of the policy essentially means that their liability has been determined once an accelerated payment has been made (as the rest is simply a timing issue).

If the chronic illness acceleration rider is attached to a term policy, then the calculations are very similar to when it is attached to a permanent policy. However, the percentage of term policies that ultimately result in a claim is significantly lower than the percentage of per-manent policies that ultimately result in a claim. Thus, the cost of offering such a rider is greater on a term policy as compared to a permanent policy. In addition, the considerations in the actuarial present value calcula-tion can be more challenging as the life expectancy for the policyholder may extend past the end of the level term period. Consequently, offering such a rider on a term policy involves greater uncertainly and potentially higher cost than offering such a rider on a permanent policy. A similar argument holds true when contemplat-ing whether or not to allow such a rider to be included upon conversion of a term policy to a permanent policy. In that situation, a possible risk control measure is to require completion of the rider application if the policy-holder wants to convert from a term policy without the rider to a permanent policy with the rider. To date, the majority of chronic illness acceleration riders have been offered on permanent forms of life insurance. Market pressures are likely going to encourage expansion of these chronic illness acceleration riders onto term prod-ucts. Market pressure may also exist to discourage use of risk control measures that may be viewed as intru-sive to the applicant. As an industry, we should be care-ful not to offer such a benefit option without careful thought as one does not need to go back far in the his-tory of insurance to see examples of how such product creep can be risky.

COnTInUED On PAGE 10


who purchased a life insurance policy in the past four years)? If so, then what underwriting should be done to control the risk of anti-selection?

ConclusionAcceleration riders attached to life insurance poli-cies are getting a lot of attention today. However, one should not be too quick to add such a rider without carefully thinking through the pricing implications. Underwriting and risk control features on most life insurance products today are focused on mortality. A shift to include living benefits requires additional analysis and risk control measures as otherwise the ex-pected profitability the product may not be realized.

Other questions to take into consideration with respect to chronic illness acceleration riders include the following:

• If the writing company charges for the rider, then how is the reinsurer compensated? Not all reinsurers have living benefits experience that would allow them to appropriately evaluate and price these risks.

• Should the reinsurer on a YRT basis wait until death to pay their portion of the NAR? If so, then what happens to a policy that accelerates a portion of the death benefit and then lapses (that may be a rare situation)?

• Should the rider be offered to all or a certain class of existing policyholders (such as those

Life Insurance … | from page 9


Longevity Insurance: Defining your own defined benefitBy Harrison Weaver, FSA, MAAA

receive the benefit. If the annuitant does not, no benefits are paid and the premium is forfeited. As a result of the deferral period and mortality leverage, payouts for this product may be very high: a $100,000 single pre-mium could buy as much as $60,000 of annual income, depending on age and deferral period. This product is typically marketed to those near retirement age as a way to eliminate the tail risk of outliving their retirement income. Because customers receive no benefits in the event of an early death, the product has been viewed as a gamble, and the high payouts have not been enough incentive to create strong demand.

The second form of longevity insurance is a pension replacement vehicle and represents the majority of poli-cies that have been placed in the market to date. With the decline in the prevalence of defined benefit pension plans, a need exists for middle-aged employees to fund their retirement in a more accessible way than simply accumulating vast amounts of money. This product can be positioned as a personal pension funded through weekly payroll contributions. The main difference be-tween this product and pure longevity insurance is the presence of a death benefit (typically a return of pre-miums paid) during the deferral period. From a con-sumer standpoint, the death benefit lowers the product risk (and thus payout), but this design has seen market appeal due to customers’ aversion to losing all their money in the case of an early death.

Product Design IssuesWhile the basic design of most longevity insurance products is very similar, and the market has developed to compete directly on price quotes, there are still a number of design issues that companies have handled in different ways.

Income benefits – The Interstate Compact requires that all income streams on longevity products contain some life dependency, eliminating the option for a deferred period certain annuity. There has been some desire for period certain options as a way for customer’s to bridge the gap between retirement and Social Security, and as

I f the media is to be believed, most retirement aged individuals are either sitting around their kitchen table worriedly discussing their retirement plans or

walking around with a confident smile knowing the ex-act dollar amount of savings they require. Those I know who fit this demographic do neither of these things, but perhaps it is because they spend their time riding tan-dem bicycles and sailing in other commercials.

For the purposes of this article, I set out to paint a more realistic picture of retirement through an informal sur-vey of friends, family, and colleagues. I had three very simple questions:

1. How much money do you need to have saved in order to retire?

2. How much monthly income do you need in re-tirement?

3. What do you know about longevity insurance?

Answers to the first question were large and round, such as $1 million or $500,000, and typically based on ad-vice from a financial advisor years ago or an equally outdated newspaper article. Answers to the second question were much more suited to their own lifestyles: take current expenses, factor in increased medical bills, consider your hobbies, and arrive at $2,000 - $3,000 per month.

The third question was answered with “nothing,” which is discouraging but not surprising. By the time you fin-ish reading this, I hope your response would be different.

Product OverviewLongevity insurance, often referred to as a Deferred Income Annuity (DIA), comes in two basic forms: (1) “pure” longevity insurance and (2) pension replacement vehicles. Though both rely on the same principle—pro-viding guaranteed income streams for the life of an an-nuitant beginning at some point in the future—the two forms are quite distinct.

The first form, pure longevity insurance, is the most commonly considered product from an actuary’s point of view. A customer pays a premium to purchase a fu-ture income stream and must survive to the start date to COnTInUED On PAGE 12

Harrison Weaver, FSA, MAAA, is a consulting actuary with Oliver Wyman in Atlanta. The views expressed are his own and not representative of Oliver Wyman’s. He can be reached at [email protected].


a way to defer the start date of Social Security payments for a higher benefit. Note that this may be possible in most states, if filed individually.

The product may be sold with single or joint life income streams. Period certain with life thereafter payouts are still possible, and most products sold do contain some amount of guaranteed payments. Increasing Payment Options (IPOs) are also prevalent as inflation protection, and may range from 1-5 percent increases annually.

Commutation and accelerated payouts – One of the major sticking points for consumers is an inability to re-move what they view as their own money from the prod-uct. No partial withdrawals are allowed during the deferral period. Historically, many products allowed full commuta-tion of the income stream once the deferral period ended. The exposure to mortality anti-selection, and the Interstate Compact prohibiting commutation features on new filings, has made this feature much rarer today. Note that Cash Refund and Installment Refund payout types do not count as commutation benefits and are still allowed.

While the Compact prohibits full commutation, it has approved products that feature payment acceleration. As an example, customers may receive six months of payments in a lump sum, with the next five payments skipped. This may be marketed as an emergency meth-od to tap into your savings for medical bills or other un-expected costs. One design issue to consider is whether life contingent payments may be accelerated, and if so, whether they may be recaptured in the event of a death before the lump sum has been fully earned.

Death benefit – The most common form of death benefit for the pension replacement variation is a re-

turn of premiums paid, though other payouts are pos-sible. These include an accumulation of premiums at a defined interest rate or receiving only a portion of premiums paid. Note that potential death benefits af-fect the pricing of the income benefit amount to vary-ing degrees, depending on the age of the annuitant. The richer the death benefit feature, the lower the income payout.

Beyond the amount of the payout, one of the major de-sign issues for this product involves the death of an an-nuitant during the deferral period for a joint life policy. Current tax rules require payouts of a death benefit to begin within five years of a death, even if the second annuitant is still living, which conflicts with the purpose of most longevity products. Joint annuitants must be structured as married, opposite-sex spouses with each spouse being the sole beneficiary of the other in order for the product to continue as planned under spousal continuation after a death.

Payout start date – Most products offer deferral pe-riods of between 2-40 years, with minimum purchase ages and maximum annuitization ages. The income start date is chosen when the product is issued, but most contracts allow some amount of flexibility to change the commencement date. Any date change is accompanied by a corresponding change in payout amount, based on the new age and typically an adjust-ment for interest rate differences.

Anti-selection can occur from customers extending their deferral period (and thus increasing their payout) with knowledge of their health and an expectation of living longer than average. As a result, most companies place limits on the extra deferral allowed. Accelerating the start date is generally allowed with more freedom, under the assumption that the customer choice is driven by poor health and thus the company will profit.

Tax-qualified contracts must still comply with Re-quired Minimum Distribution (RMD) rules, which generally limits the deferral by forcing payments to begin at age 70 ½. However, while an RMD must be calculated on each contract, the actual distribution in total may be withdrawn from any combination of ac-


One of the major sticking points for consumers is an inability to remove what they view as their own money from the product.

counts. With the right disclosures and enough other as-sets from which to withdraw funds, deferral need not be limited by this age.

Update from the HillIn February 2012, the Treasury Department released a set of proposals designed to ease reliance on Social Security, which triggered a flurry of activity in the lon-gevity insurance world. These regulations would theo-retically open up the market for longevity products to tax-qualified money in a number of ways:

1. Simplifying partial annuity options in 401(k) ac-counts, making it easier for retirees to split their account between annuities and a lump sum

2. Eliminating RMDs on Qualifying Longevity

Annuity Contracts (QLACs), which facilitates deferrals beyond age 70

3. Easing the administrative requirements on plan sponsors of offering annuities in their 401(k) plans

To be considered a QLAC, the longevity contract must be purchased with the lesser of $100,000 or 25 percent of the retirement account’s value and commence pay-ments by age 85. No commutation or lump sum death benefits are permitted. The majority of products on

the market should satisfy the requirements with minor changes and limitations.

While the Treasury’s proposals are attractive on an indi-vidual customer level, they also hint at institutional pos-sibilities. A partnership between insurance companies and retirement plan sponsors to offer longevity products through 401(k) plans could dramatically increase cus-tomer knowledge and exposure with limited marketing costs. At the time of writing, these proposals have not been finalized or approved.

ConclusionThe first two questions in my informal survey focus on what I consider to be a silently significant problem with retirement services: too much emphasis on accumulat-ing wealth without a plan for decumulation. It is both unintuitive and intimidating to target a generic savings amount most middle class people are unable to achieve. By concentrating on paycheck contributions, with a specific benefit in mind, retirement goals become more definitive and attainable.

Longevity insurance is perfectly positioned to lead this pivot in retirement understanding, and we as actuar-ies are perfectly positioned to give it the right push. With Social Security’s uncertain future, arming cus-tomers with the knowledge and products to take con-trol of their own retirement should be a top priority.


Then and NowBy Paula Hodges

Where were you 30 years ago? The Product Develop-ment Section of the SOA was formed in 1982, and its first newsletter was printed a year later, in October of 1983. As we approach this anniversary, I thought it would be fun to ask “What were we thinking?” when that first newsletter was printed back then. The follow-ing is a reprint of an article from the very first edition of the “News from the Individual Life Insurance and Annuity Product Development Section.” I requested some assistance from the Taxation Section Council and Friends of that Council to decipher the changes between the life insurance tax environment back in the 1980s compared to today.

Then: Major changes in the IRS tax code in the 1980s dramatically impacted pricing of life insurance and an-nuity products. The 1980s tax code is the framework for determining what qualifies as life insurance for U.S. tax purposes . The Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA) dramatically impacted pricing of life insurance and annuity products. Some components of the vast amount of tax regulation that came about in the early 1980s:

• Special tax rules recognize the nature of life in-surance, including federally prescribed tax re-serves

• Product development reflected new company

and policyholder tax limitations • Definition of life insurance contract in Section

7702 applicable to all life insurance contracts • Special life insurance company deduction (25

percent) • Section 809 limiting deduction of mutual com-

pany dividends (“mutual company equity tax”)

• Section 815 continuation of 1959 Act Phase III (PSA) tax on stock companies

• Section 845 expanded the authority of Treasury

to examine and make adjustments to taxable in-come related to reinsurance contracts

Since Then: The tax code continues to be the frame-work for determining what qualifies as life insurance for U.S. tax purposes. New regulations have been layered on:

• Tax Reform Act of 1986 and Revenue Act of 1987

• Eliminated special life insurance company

deduction • Eliminated deduction of policy loan interest

for individuals and limited for corporations • Technical and Miscellaneous Revenue Act of

1988

• Enacted Section 7702A creating modified endowment contracts

• Introduced reasonable mortality and expense

charges for 7702 and 7702A

• Revenue Reconciliation Act of 1990

• Enacted Section 848 (the “DAC tax”) • Imposed 20 percent haircut on UPR relating

to cancellable A&H contracts • Revenue Reconciliation Act of 1993

• Enacted Section 197 (15-yr amortization of ceding commission)

• 1996 Tax Legislation: Small Business Job Pro-

tection Act, Health Insurance Portability and Ac-countability Act

• Accelerated Death Benefits, Long-Term Care, Modified Guaranteed Annuities

• Eliminated deduction of policy loan interest for corporations (with limited “grandfather”)

• Pension Funding Equity Act of 2004

Paula Hodges,FSA, MAAA, is 2nd vice president and

associate actuary with Ameritas Life

Insurance Corp., responsible for

Corporate Actuarial Operations. She can

be contacted at phodges@

ameritas.com.


Now: Paula Hodges – Chair of the Product Develop-ment Section

Paula in 1980s:

Paula now:

Then: The only sure thing in life was death and taxes.

Now: The only sure thing in life is death and taxes.

The more things change, the more they stay the same.

• Repeal of 809 which had limited deduction of mutual company dividends (“mutual company equity tax”)

• American Jobs Creation Act of 2004

• “Suspension” of 1959 Act Phase III (PSA) tax on stock companies

• Pension Protection Act of 2006

• LTC-annuity combination contracts, subject to life DAC rate of 7.7 percent

• Enacted Section 101(j), which provides re-quirements for corporate owned life insurance

• Principle-Based Reserves, Notices 2008-18 and

2010-29 • Statutory deferred tax assets

• Codification first permitted limited admis-sibility in 2001 – SSAP 10

• This limited admissibility was expanded

• Temporarily – SSAP 10R • Permanently – SSAP 101 – effective

2012 and later

Then: Our Product Development Section, and its newsletter, focused its research and com-munications primarily on the U.S. tax code, as that was the key dynamic at that time.

Now: With many more multi-national firms and juris-dictions, we need to concern ourselves with IFRS, Sol-vency II, ORSA, PBR, and a host of other issues. Taxes continue to be such an important topic that we now have an SOA Taxation Section devoted to that topic. The Taxation Section is seven years old and is about 850 members strong.

Then: Richard Kling – Chair of the Individual Life In-surance and Annuity Product Development Section



House Ways & Means Passes Tax Bill

H.R. 4065, The Life Insurance Tax Act of 1983, was approved by the House Ways and Means Com-mittee on October 5. Action by the full House was expected the week of October 24.

H.R. 4065 is designed to raise $3 billion of annual tax revenue, 55% of mutual companies and 45% from stock companies. This compares to an estimated $1.9 billion of annual revenue expected under the 1982-1983 law.

Taxable income is computed in a manner consistent with the determination of the statutory gain from operation, with a number of adjustments. The policy reserves used to determine taxable income are CRVM reserves using the highest interest rate permitted in 26 states at the time the policy is issued. The mortality basis would be the most recent table adopted by 26 states at the time of policy issue, with a three-year grace period to phase in new tables. If the cash value of the policy exceeds this reserve, the cash value is to be used.

The deduction for policyholder dividends for mutual companies is limited. The amount of the limitation is determined by an involved process that essentially increases taxable income by a percentage of a company’s surplus. The amount of the percentage used is designed to represent the difference in the averages of the ratios of gain from operations to surplus for stock and mutual companies.

The company’s share of tax-exempt investment income is excluded from taxable income in a manner similar to the 1982-3 tax law, except that all amounts credited to policyholders, including dividends, are included in the policyholder’ share. This may make investment in tax-exempt securities less attractive for life insurance companies.

A “taxable income adjustment” reduces taxable income by 25% of the amount otherwise. Thus, the marginal tax rate for most companies will be 75% of the corporate tax rate.

Companies with less than $500 million of assets receive a small business deduction of 60% of the first $3 million of taxable income, phased out at $15 million of taxable income.

The difference between the reserves under 1982-3 tax law and reserves under the proposed law, which would include any adjustment to net level reserves under Section 818©, would not be considered a reserve strengthening. Rather, a company would calculate the 1984 reserve increase under the assumption that reserves at the start of the year were computed as pre-scribed by the proposed law. Any difference between this reserve and the tax reserve held at the end of 1983 would be ignored.

Amounts held in the policyholder surplus account as of the end of 1983 would continue in

Then and now … | from page 15


The following is from the October 21, 1983 newsletter of the “Individual Life Insurance and Annuity Product Development Section.”

that account in accordance with the provisions of the 1959-1983 laws and would not be taxed unless withdrawn from that account.

H.R. 4065 also addresses a number of issues relating to policyholder taxation. The rules de-fining life insurance applicable to flexible premium contracts under the 1982-3 law were modified in certain minor respects and the modified rules would apply to all life insurance contracts issued before the end of 1984.

Interest on policy loans of more than $500,000 would not be deductible. Proposals in earlier versions of the bill to include in the taxable income of a taxpayer surrendering a contract the value fo the death protection received under the contract were dropped from the current version of the bill.

H.R. 4065 would extend the limit on the amount of group life insurance which may be provided tax free to employees, to retired employees, thereby limiting the market for “retired life reserves” products. It also changes the basis for taxing holders of non-qualified annuities. The requirement that annuity payments begin before age 70 ½ would be dropped, but gains under annuities where the contractholder dies prior to annuitization would be included in the decedent’s tax return rather than be taxable to the beneficiary. The exemption from the 5% penalty tax for contractholders who hold the annuity for ten years or more would be repealed.

The bill also provides for certain studies to be made. The studies will examine the level of revenue produced by the 1982-3 bill, the operation of H.R. 4065 during its first three years, the relative tax burdens on stock and mutual companies, and the effect of the tax legisla-tion on the ability of life insurance companies to attract investment capital.

At this point, the bill is supported by the Treasury and by most stock and mutual life insurance companies. It is expected that the bill will pass the House without significant opposition. While no significant opposition is expected in the Senate, Senator Robert Dole, Chairman of the Senate Finance Committee, has indicated that he expects to hold hearings on the bill and that he plans to consider possible changes in property-casualty company taxa-tion at the time life insurance taxation is considered. Life insurance company managements are hopeful that, in consideration of the need for timely action on life insurance taxation, Senator Dole can be persuaded to consider the two issues separately.

A more detailed summary of the proposed legislation is available. Anybody interested should write the Editor at the address listed on Page 2. The Editor is also willing to provide copies of the Bill on request, provided the number of such requests is within reason.


Wayne Stuenkel, FSA, CERA, MAAA, is senior vice president

& chief actuary at Protective Life Corp in Birmingham, Ala. He can be reached

at [email protected].

Relationship of IRR to ROI on a Level Term Life Insurance Policy By Wayne Stuenkel

premium rate. There are no cash values or dividends. This product is generally consistent with products that are currently being sold; however, it is constructed for the purpose of demonstrating the relationship of IRR and ROI, and does not duplicate the products sold by our company or any other company.

The product was constructed in a spreadsheet for ease of manipulation, and therefore includes several simpli-fying assumptions (annual premiums and expenses at the start of the policy year, death claims and lapses at the end of the policy year, etc.) The spreadsheet was used to calculate the lifetime statutory IRR and the an-nual GAAP ROI assuming that all experience emerges exactly as expected.

We found that it is possible to construct a hypothetical product such that expected annual GAAP ROIs are lev-el and equal to the lifetime statutory IRR. The assump-tions and methodologies for this product are shown in Appendix A.

However, some of the assumptions and methodolo-gies that are necessary to produce expected level

O ne of the primary pricing measures for indi-vidual life insurance products is the internal rate of return on a statutory basis. The inter-

nal rate of return (IRR) for a policy is a single interest rate that discounts all policy cash flows back to the is-sue date of the policy, such that the sum of discounted cash flows equals zero. “Cash flows” include statutory income, taxes, required capital, and imputed interest on required capital. An insurer will often require that products be priced to achieve a certain minimum IRR threshold.

Additionally, many companies report annual earnings on a GAAP basis. As a by-product of preparation of GAAP income, an annual return on GAAP investment (ROI) at the line of business level or the product level can be calculated. A GAAP ROI calculation typically includes GAAP income plus imputed interest on re-quired capital in the numerator, and required capital plus stat/GAAP differences (DAC, reserves, taxes) in the denominator.

A recurring question from those who look at product profitability concerns the relationship of lifetime IRR to annual ROI. Some observers (often including insurance company CEOs) expect that the annual ROI for a prod-uct should be equal in all years to the lifetime IRR for the product, assuming that product assumptions (lapse, mortality, interest rate, etc.) are met. However, in prac-tice, annual ROI never seems to be equal to lifetime IRR, even if product assumptions are met.

Several excellent papers have been written which ex-amine the relationship between lifetime statutory IRR and annual GAAP ROI. Especially notable in this re-gard are papers written by Brad Smith (TSA 39, pp. 257-293) and Bob Beal (NAAJ Volume 4, Number 4, pp. 1-11). However, neither of these papers specifically identified those product variables that cause annual ROI to vary from the lifetime IRR.

So that we could more fully understand the relationship between IRR and ROI, we constructed a term life insur-ance product. The product provides a level amount of insurance for 20 years, in exchange for equal annual premium payments for 20 years. At the end of 20 years, all policies lapse without value, while the product con-tinues as a whole life product with a high guaranteed


annual ROIs equal to lifetime IRR are either actuarially unsound or outside of statutory and GAAP accounting conventions. The assumptions and methodologies that are necessary to produce level annual ROIs equal to lifetime IRR include:

• DAC interest rate equal to IRR rate• No required capital based on assets, reserves, or

insurance inforce net of reserves• No DAC tax• Statutory reserves equal to GAAP reserves• GAAP reserve mortality equal to pricing mortality• GAAP reserve interest rate equal to pricing

earned interest rate• Lapse rate for GAAP reserves and DAC amorti-

zation equal to pricing lapse rate

In this article, we will refer to the variables above as the “slope-introducing variables,” or SIVs.

It was interesting to observe which of the assumptions and methodologies, while changing the level of ROI and IRR, did not affect the relationship of ROI to IRR. These assumptions included:

• Premium rate per thousand and policy size• Slope and level of mortality rates• Lapse rates—both absolute level and pattern (so

long as GAAP = pricing)• Earned interest rate on required capital• Tax rate• Reinsurance (if the form is coinsurance)• Commissions and expenses (both direct and

ceded)• Required capital based on direct premiums

To examine the effect of the SIVs, we constructed a hypothetical product that had a level ROI that was equal to IRR. (To produce a level ROI that was equal to IRR, the SIVs were set at a level which was either actuarially unsound or outside of accounting conven-tions.) We then changed each SIV individually to a set-ting that is typically found in practice, and observed the effect of the change in the SIV on the relationship of ROI to IRR.

The different patterns of ROI that we observed when the SIVs were changed to more typical settings were as follows:

• “Positive sloping ROI,” defined as ROIs that are lower than IRR in the early durations, then rise to be greater than IRR in later durations, was ob-served when (a) the DAC interest rate was set lower than the IRR rate, (b) GAAP reserve mor-tality was higher than pricing mortality, or (c) GAAP reserve interest rate was less than pricing earned interest rate.

Variable Setting for “Level ROI=IRR” * “Typical” Setting

Premium rate $0.80/M/year Same

Earned interest rate 7.00% Same

Tax rate 35.00% Same

Lapse rate (pricing, GAAP) 12, 11, 10, 9, 8, 7, 6…… Same

DAC tax rate 0.00% 7.70% of net consideration

Pricing mortality 45% of 1975-80 S&U Same

Direct commission + expense 190% (1), 10% (2-10), 4% (11+) Same

Reinsurance percentage 90% Same

Reinsurance method Coinsurance Same

Reinsurance allowance 100% (1), 50% (2-10), 12% (11+) Same

GAAP reserve interest rate Same as earned rate 95% of earned rate

GAAP reserve mortality Same as pricing mortality 105% of pricing mortality

GAAP reserve method Net level Same

Statutory reserve interest rate Same as GAAP rate 4.00%

Statutory reserve mortality Same as GAAP mortality 100% of 1980 CSO

Statutory reserve method Same as GAAP method CRVM – segmented or unitary

(minimum ½ cx mean reserve)

RBC - % of direct premium 3.40% Same

RBC - % of net reserves 0.00% 2.76%

RBC - % of net inforce 0.000% 0.136%

DAC interest rate Equal to IRR rate 7.00%

*Variables that are not “slope-introducing variables” can be set at any level. Setting at a level different

than shown will change the level of ROI and IRR, but not the relationship between ROI and IRR.

Appendix A

Illustrative Assumptions for Level Term Product“Slope-Introducing Variables” are those Italicized Assumptions for which “Typical” Setting is

Different from “Level ROI” Setting



• “Negative sloping ROI,” defined as ROIs that are greater than IRR in the early durations, then decline to be less than IRR in later durations, was observed when (a) DAC tax was used or (b) required capital based on reserves, assets, or in-force net of reserves and reinsurance was used.

• The effect of statutory reserves on the slope of ROI depended on the statutory reserving meth-od. Using reserves that are typical of XXX prod-uct designs (segmented reserves, no deficien-cies) produces a negatively sloping ROI. Using reserves that were typical of unitary product de-signs (single-segment reserves, no deficiencies) produces a positively sloping ROI.

The largest effects on ROI slope arose from the DAC interest rate (positive slope), DAC tax (negative slope), and statutory reserve (both slopes) variables. When we combined all of the assumptions, we found that the product ROI had a generally positive slope for unitary products, and a generally negative slope for XXX products. The slopes of both types of prod-ucts would become more positive if the loading of GAAP reserve mortality over pricing mortality were increased, or if the reduction in the GAAP reserve in-terest rate from the pricing earned interest rate were increased. The IRRs and ROIs for the tested variables are displayed in Appendix B.

Based on our work, we believe that it is impossible for the annual GAAP ROI for level term life insurance pol-icies to be level and equal to IRR. Even if a company perfectly met all of its pricing assumptions, we believe that certain assumptions and methodologies that are required either by accounting convention or by sound actuarial practice introduce a slope to the pattern of annual GAAP ROIs.

We would be interested to know whether other actuar-ies have performed similar calculations on other types of business.

“Level ROI = IRR” setting “Typical” setting (stat

reserves = segmented)

“Typical” setting (stat

reserves = unitary)

19.1% 11.4% 15.3%

(2) Annual GAAP Return on Investment

Duration “Level ROI = IRR”

setting

“Typical” setting

(stat reserves =

segmented)

“Typical” setting (stat

reserves = unitary)

1 19.1% 13.1% 13.1%

2 19.1% 13.2% 13.2%

3 19.1% 12.1% 13.6%

4 19.1% 11.3% 14.0%

5 19.1% 10.8% 14.7%

6 19.1% 10.5% 16.1%

7 19.1% 10.3% 19.0%

8 19.1% 10.3% 26.4%

9 19.1% 10.3% 75.2%

10 19.1% 10.5% Undefined

11 19.1% 10.3% Undefined

12 19.1% 10.3% Undefined

13 19.1% 10.2% Undefined

14 19.1% 10.2% Undefined

15 19.1% 10.3% Undefined

16 19.1% 10.3% Undefined

17 19.1% 10.4% Undefined

18 19.1% 10.6% 60.2%

19 19.1% 10.9% 24.9%

20 19.1% 11.4% 16.2%

*“Undefined” means that numerator of ROI calculation is positive, but denominator is negative

Appendix B

Illustrative Results for Level Term Product

(1) Statutory Lifetime Internal Rate of Return


Relationship of IRR to ROI … | from page 19

Co-Editor Commentary on “Relationship of IRR to ROI on a Level Term Life Insurance Policy”By Kurt Guske

If aligning the relationship of IRR to ROI is impor-tant to you, design thinking might be a great way to “d-think” your business model and product strategy.

“Relationship of IRR to ROI on a Level Term Life Insurance Policy” was first introduced in the Au-gust 2002 issue of Product Matters! (no. 53). The article was also published in September of the same year in The Financial Reporter (issue no. 50).

The divergence between the pattern of year-by-year GAAP ROI (or RoE) and the statutory IRR measure is at least as meaningful a topic today

as it was in 2002 when Wayne Stuenkel first published this vintage article. While the two measures equate over the long haul, recent developments such as the introduction of FASB rule ASU 2010-26 put pressure on new business first year ROI. This naturally tilts the ROI scale more to the favor of later years. The new DAC rule applies especially to more traditional product, distribution, issue and underwriting models whose expense deferability depends on things like high placement rates.


Kurt Guske, FSA, MAAA, is vice president and life product manager at Protective Life Insurance Co in Birmingham, Ala. He can be reached at [email protected].

Alzheimer’s MortalityBy Dave Moran

A lzheimer’s disease is the sixth leading cause of death in the United States, affecting an esti-mated 5.2 million Americans of all ages. Over

the next 40 years, that number is expected to grow to approximately 14 million. Although it can be difficult to peg Alzheimer’s as the primary cause of death, one in every three seniors dies with Alzheimer’s or some other form of dementia. When I was in high school, that number for me was one in four, as I lost my maternal grandfather to Alzheimer’s.

The CDC recently released a report discussing the in-creased rate of death occurring from Alzheimer’s dis-ease in the United States. According to the report, there was a 39 percent increase in Alzheimer’s related deaths from 2000 to 2010. As an actuary who often utilizes mortality improvement as a part of the assumption set-ting process, I was intrigued by the fact that the death

rate for Alzheimer’s is getting worse, so I set out to look a bit more closely at the data.

Before jumping into the results, allow me to clarify a few important points. Although I initially set out to uti-lize actual-to-expected ratios in my analysis, it quickly became clear that attempting to identify an appropriate table for the expected portion would be prohibitively difficult given the time that I had. As a result, the data I examined was total population data for the United States. All of the mortality data was sourced from the CDC’s Underlying Cause of Death database.

For the purposes of comparison, I examined all causes of death combined as well as deaths wherein the main cause identified belonged to the following list: Al-zheimer’s disease, cancer, cardiovascular disease, HIV, diabetes, and influenza/pneumonia. Quinquennial age bands for ages 50 to 84 were examined in order to com-bine enough data points together so as to be somewhat credible, although the incidence of death for some of the diseases in question is so low at some ages that it is hard to attach much credibility to the data. The two charts below show average annual rates of mortality improvement by age and gender for the period 2000 to 2010. As you can easily see, overall population mortal-ity has been decreasing by between 1 percent and 3 per-cent for the ages in question. There are plenty of other observations to be made about the differences in rate of improvement between different age/gender/disease combinations, but that is beyond the scope of this brief article. Suffice it to say that for the conditions that were examined, the improvement in mortality is, for the most part, expected due to advances in prevention and treat-ment.

Because the impetus for my inquiry was the CDC’s re-port on the degradation of Alzheimer’s mortality rates, I was not surprised at the shape of the graph for that disease. However, I was somewhat intrigued by the similar change in mortality for HIV. Call me naïve, but we often hear about new drugs and treatments; and I was expecting to see improvement in the HIV mortality rate that mirrored that of the other conditions. However, the more I thought about it, the more it made sense that both HIV and Alzheimer’s are progressing in a similar fashion.

Dave Moran, ASA, MAAA, is a director with FTI Consulting.

He can be reached at dave.moran@

fticonsulting.com or found on Twitter at

@TattedActuary.


degradation at higher age bands, it appears that treat-ments for Alzheimer’s disease are simply delaying the inevitable.

There is a good chance that you know someone who has been affected by Alzheimer’s disease, either direct-ly or indirectly. Although there is currently no cure for Alzheimer’s, research is ongoing. If you want to learn more, I would encourage you to visit the Alzheimer’s Association website at www.alz.org.

Liz Olson, FSA, MAAA, is AVP, Actuarial Product Support at Nationwide Financial in Columbus, Ohio. She can be reached at [email protected].

New treatments for cancer allow patients to live longer and, in some cases, can completely remove the cancer from the body. Increased awareness about influenza and basic preventive measures have reduced deaths from the virus. Although diabetes cannot technically be cured, new techniques for managing the disease have allowed individuals to control it to such a point that they are no longer dying as a direct result of this condition. However, with Alzheimer’s (and HIV) there is no cure and no treatment as effective as what we have for some of these other conditions. Based on the greater mortality

Assumption Development and Governance Discussion GroupBy Liz Olson

I t is no surprise that companies are devoting more and more resources to assumptions as models be-come complex and bottom-line results are assump-

tion-driven. Best practices around experience studies, assumption approvals and documentation, and monitor-ing are demanding a much higher level of attention in many companies, whether they have had formal sys-tems in place for years or are just starting to develop them.

A number of actuaries across the industry have met a few times via conference call to discuss assumption

practices, and now, with the endorsement of the Product Development and Financial Reporting Sections of the SOA, we’re looking for broader participation. Our calls consist of introductions and brief updates on company initiatives, followed by a discussion around a topic of interest.

If you are interested in joining our conversations, please contact me at [email protected] or 614-249-0605. I can field your questions and add you to our group. Also, look for announcements around our calls in the SOA updates.


On the Research Front

The following is a list of current research studies that will pique your interest and keep you informed.

2007-09 U.S. INDIVIDUAL LIFE PERSISTENCY UPDATE This report presents the results of the most recent study of individual life insurance lapse experience in the United States conducted jointly by LIMRA Internation-al and the SOA. The observation period for the study is calendar years 2007-09. The study is based on data provided by 27 individual life insurance writers and presents lapse experience for whole life, term life, uni-versal life and variable universal life plans issued be-tween 1910 and 2009. An Excel spreadsheet is available which contains supporting source lapse rates for fi gures within the U.S. Individual Life Insurance Persistency report. http://www.soa.org/Research/Experience-Study/Ind-Life/Persistency/2007-09-US-Individual-Life-Per-sistency-Update.aspx

ACTUARIAL MODELING CONTROLS REPORT POSTED ON WEBSITE As the life insurance and annuity industries move to-ward model-based approaches to reserve and capital valuation (MBV), actuarial models are increasing in complexity and sophistication, while the imperative to avoid modeling errors is also increasing. In a new study sponsored by the Financial Reporting Section, Com-mittee on Life Insurance Research, and Committee on Finance Research, actuarial modeling control practices are examined. Authored by Sara Kaufman, Jeff Lortie and Jason Morton of Deloitte, the report summarizes the results of an online survey and follow-up discus-sions with survey respondents on the control systems U.S. and Canadian life insurance and annuity compa-nies have currently implemented. The report then eval-uates the current state against the controls expected to be in place upon adoption of MBV approaches and in-creased external scrutiny, and proposes considerations for enhancing the current state to get to the necessary controls within a more highly controlled model frame-work. http://www.soa.org/Research/Research-Proj-ects/Life-Insurance/Actuarial-Modeling-Control.aspx


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SOA COMMITTEES, SECTION RELEASE LIVING TO 100 MORTALITY OVERVIEW REPORT Get a good overview and analysis of the mortality mod-els, theories and trends contained in the papers presented at the past four international Living to 100 symposia by reviewing a new report sponsored by the Society of Actuaries’ Committee on Life Insurance Research, the Committee on Knowledge Extension Research and the Product Development Section. Authored by Jennifer Haid, Michael Chan and Christopher Raham of Ernst & Young, this paper offers an overview of the technical ma-terials related to data sources, validation techniques and methodologies used by practitioners to develop mortal-ity estimates for present and future periods. A summary of discussions regarding business, policy and social im-plications of increased longevity is also included. http://www.soa.org/Research/Research-Projects/Life-Insur-ance/soa-living-100.aspx

NEW REPORT, “RECOGNIZING WHEN BLACK SWANS AREN’T” JUST RELEASED Read this new research report, sponsored by the Rein-surance and Joint Risk Management Sections and Com-mittee on Life Insurance Research, to better recognize, assess and respond to emerging events. Authored by Guntram Werther of Temple University with the assis-tance of Thomas Herget, this paper provides a holis-tic framework for foreseeing large scale, large impact rare events (LSLIREs). The report covers, among other topics, the defi nition of a black swan vs. LSLIRE; why current recognition methods for these extreme events fail; potential solutions for better foreseeing emerging LSLIREs; and how to improve timing and recognition of the trigger points within an LSLIRE. http://www.soa.org/research/research-projects/life-insurance/re-search-2013-black-swan.aspx

NEW REPORT JUST RELEASED ON LIFE REINSURANCE TREATY CONSTRUCTION Reinsurance treaty negotiations can be a long process that may lead to lengthy, unwieldy documents and

negative experiences for the direct writer and/or rein-surer. The SOA’s Reinsurance Section and the Com-mittee on Life Insurance Research have just released a new report on Life Reinsurance Treaty Construction. Authored by Steve Stockman and Tim Cardinal of Ac-tuarial Compass, this report discusses the importance of many reinsurance treaty terms/provisions, identifi es common treaty structures, practices, and/or solutions in reinsurance treaty construction and negotiation and il-lustrates how treaty terms have evolved over time. The knowledge from this research will assist individuals in-volved in reinsurance treaty negotiations to optimize re-sources and success in future reinsurance treaty devel-opment potentially leading to enhancements in current processes and treaty language, as well as a reduction in the length of time needed to complete negotiations. http://www.soa.org/Research/Research-Projects/Life-Insurance/Life-Reinsurance-Treaty-Construction.aspx

REPORT COMPLETE: COMPARATIVE FAILURE EXPERIENCES OF BANKS AND INSURERS Much has been written about the underlying causes and effects of the most recent fi nancial crisis. The effects of this crisis on fi nancial institutions have certainly differed in the United States, compared to Canada. A new study, sponsored by the Financial Re-porting Section and Joint Risk Management Section Research Committee, and authored by Stephen Robb, Paul Della Penna, and Alicia Robb, examines what factors account for these differences; how the recent events differ from previous fi nancial crises; and how their effects differ among the various types of fi nan-cial institutions. The research uncovered limitations in the available data for the number of failures. The research also indicates that without good data, setting public policy or solving the problems that led to the fi nancial crisis might be diffi cult. http://www.soa.org/Research/Research-Projects/Life-Insurance/research-2013-comparative-failure-exp.aspx


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Product Matter Issue 86, June 2013 - Society of Actuaries

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Transcript of Product Matter Issue 86, June 2013 - Society of Actuaries