I have been a consultant for 18 of my31 years as an actuary; I pride myselfon being able to see multiple perspec-

tives on a variety of issues. This enablesme to work in many situations, easily slip-ping between one side of an issue andanother.

Through the years, I’ve heard the occa-sional comment about my lack ofconviction, and unwillingness to take astrong position on the hot insurance andactuarial issue of the day. The most recentexample of my ability to see all sides (orunwillingness to take a position) is withrespect to secondary guarantee universallife insurance.

What an exciting time to be a productdevelopment actuary. We are in the middleof one of the most intricate, exciting andcontentious issues to face the life insur-ance industry in years. This new productoffering allows us to use all the tools in ourarsenal—both technical and business skills.We can design the products, determine prof-itability, interpret complicated reserve rules,communicate effectively within our compa-nies, and discuss passionately within theindustry and profession.

The Product Development Section co-spon-sored a three-session embedded seminarcovering secondary guarantee universal lifeinsurance during the Spring Life Meeting inNew Orleans. The speakers displayed all theskills an effective actuary needs to possess.We listened to passionate, well thought-outpresentations and discussions from leaders of

life insurers representing all sides of theissue. We also heard from an investmentanalyst, a state regulator, the general counselof the American Academy of Actuaries, andthe president of the SOA. I enjoyed thesessions immensely, and achieved a renewedpride in being an actuary.

I also wished we had identified one addi-tional topic to address—responsibility. BeforeI go further, let me pull out my trusty(online) dictionary and quote a couple of thedefinitions:

continued on page 3

Comments from the ChairResponsibility and the Product Development Actuaryby Abraham S. Gootzeit

Product Matters!The newsletter of the Individual Life Insurance and Annuity Product Development Section

Published in Schaumburg, Il l. by the Society of Actuaries August 2005 • Issue No. 62

Published by the Individual Life Insurance and Annuity Product Development Section of the Society of Actuaries475 N. Martingale Road, Suite 600Schaumburg, Ill. 60173-2226

Phone: 847-706-3500 • Fax: 847-706-3599Web: www.soa.org

This newsletter is free to section members. Asubscription is $20.00 for nonmembers. Current-year issues are available from the CommunicationsDepartment. Back issues of section newslettershave been placed in the SOA library and on theSOA Web site: (www.soa.org). Photocopies of backissues may be requested for a nominal fee.

2004-2005 SECTION LEADERSHIPAbraham S. Gootzeit, ChairpersonElinor Friedman, Vice-ChairpersonKelly A. Levy, Secretary/TreasurerJeffrey A. Beckley, Council MemberMary Ann Broesch, Council MemberKeith Dall, Council MemberMichael L. Kaster, Council Member Douglas L. Robbins, Council MemberNancy Westfall Winings, Council Member

Douglas C. Doll, Newsletter EditorTowers PerrinOne Alliance Center3500 Lenox Road, Suite 900Atlanta, Ga. 30326-4238PHONE: (404) 365-1628FAX: (404) 365-1663E-MAIL: doug.doll@towersperrin.com

Michael J. LeBoeuf, Web LiaisonE-MAIL: mike_leboeuf@aoncons.com

Society StaffJoe Adduci, DTP CoordinatorPHONE: (847) 706-3548E-MAIL: jadduci@soa.org

Clay Baznik, Director of PublicationsE-MAIL: cbaznik@soa.org

Facts and opinions contained herein are the soleresponsibility of the persons expressing them andshould not be attributed to the Society of Actuaries,its committees, the Individual Life Insurance andAnnuity Product Development Section or theemployers of the authors. We will promptly correcterrors brought to our attention.

Copyright © 2005 Society of Actuaries.All rights reserved.Printed in the United States of America.

2 August 2005

1 Comments from the ChairResponsibility and the Product Development Actuary- Abraham S. Gootzeit

3 Letter to the Editor- Edward Hui

4 Term Mortality and Lapses- Jeffery T. Dukes

8 Equity Indexed Universal Life“The Devil’s in the Details”- David J. Weinsier

12 NAIC 2005: The Start of a Busy Year- Donna R. Claire

15 Call for Actuarial Pioneers- Jim Brooks

16 Lower Statutory Valuation Interest Rates for Life Insurance- Brian Sprawka

18 Life Settlements—Is There a Cause for Concern?- Michael J. LeBoeuf

20 Insights from the Dark Side—One Actuary’sExperience in Sales and Marketing- An interview with Jon Davis, FSA, by Mike Kaster

22 Is the Timing Right for Equity-Indexed Immediate Annuities?- Susan J. Sell

24 U.S. Population Mortality Improvement- Douglas C. Doll

26 What’s Ahead—2005 SOA Annual Meeting in New York

27 Actuaries Gone MAD- Rob Stone

27 Help Wanted

Contents

Responsibility: the state, quality or fact ofbeing responsible; something for which one isresponsible; a duty, obligation or burden.

Responsible: characterized by trustworthi-ness, integrity, and requisite abilities andresources; able to choose for oneself betweenright and wrong.

To whom are we burdened with the dutyand obligation of responsibility? That wouldseem easy, we are responsible to the princi-pals that hire us; we must be effectiveadvocates for their positions. We must alsobe responsible to ourselves and other publics,choosing between right and wrong, and onlytaking defensible positions.

In complicated insurance issues, it can bedifficult to determine what is right or wrong.In representing our principals, our advocacysometimes means winning at all (or most)costs. Our comments sometimes includephrases like “of course” (indicating, to me,that other perspectives and points of vieware incorrect).

I believe there are additional aspects tobeing responsible. I suggest we give increas-ing attention to being responsible to our

industry and profession. By the time you readthis, a secondary guarantee UL reservingcompromise may be in place. It was (is) a hardfought and emotional battle; I hope the scarsheal quickly, and the next battle is far off.

The life insurance industry and profes-sional actuarial associations are vitallyinterested in our ability to identify andresolve issues professionally, responsibly andefficiently; let’s keep them in mind. Weshould respect and comply with the intentand spirit of regulations and rules. Weshould not assume that older regulations aredesigned to apply in newer, unintended situ-ations—it might be time to begin a freshdialog. Let’s stay open minded, and try toavoid black-and-white perspectives. Mostimportantly, let’s resolve industry andprofessional issues internally, quickly andefficiently; we don’t want our inability tocompromise to invite outside intervention.

I suggest we look for responsible solu-tions—those that satisfy the industry andprofession, as well as ourselves and ouremployers.

You know, seeing various perspectives oncomplicated issues suits me just fine! ¨

In response to recent articles about mortal-ity in this newsletter, particularly aboutmortality at high ages, I have the followingobservation about the 2001 VBT table. Forthe 2001 VBT table, male ultimate agemortality at ages 90-100 is approximately102 percent of the 2001 U.S. Census popula-tion mortality. However, female ultimate agemortality for the same ages is approximately80-95 percent of the 2001 U.S. Census popu-lation mortality. The male data was basedon the Veterans Administration WWIIprogram (NSLI) experience at ultimate ages.Corresponding female data at these ulti-

mate ages, was not available and was basedon extrapolation. Female mortality in theselect period of attained ages 90-100 is alsosignificantly less than the 2001 Census. Asomewhat less pronounced pattern for ulti-mate mortality also exists for the 1975-80and 1990-95 SOA tables. Given that oftengreater than 50 percent of volume for issueages 70+ is female, one conclusion is that itcould make sense to use a different percent-age of the VBT table for males versusfemales at these high ages.¨

– Edward Hui

Product Matters! 3

Chairperson’s Corner • from page 1

Abraham S. Gootzeit, FSA,

MAAA, is with Aon

Consulting in St. Louis,

Mo. He can be reached

at Abe_Gootzeit@

aoncons.com.

Letter to the Editor

I would be surprised if there is a terminsurance market in the world todaymore complex and competitive than the

U.S. market. It was not always this way.Prior to the mid-late 1970s, a new issue

was rated either standard or substandard.There were no smoker/nonsmoker distinc-tions. Super-preferred/preferred/residualclasses did not exist. Term premiums variedonly by gender and attained age—ART, five-and 10-year renewable and convertible.

Term Wars I (TWI) was launched in thelate 1970s with the introduction of select andultimate premium structures. Initially, thesewere select and ultimate ART plans, but theyquickly evolved into what was then a moretax efficient design—increasing (or graded)premium whole life (IPWL or GPWL). IPWLhad S&U ART-type rates for 20 years or sowith a very high level premium for life,thereafter.

TWII started in the late 1980s with prod-ucts similar to today’s—level premiums forn-years, followed by much higher ART rates.A typical early TWII product might have hadone preferred and residual class for non-smokers and one or two smoker classes.

By the mid-1990s some companies hadsplit the nonsmoker or non-tobacco classesinto as many as five super-preferred/preferred classes and one residual class. Thenumber of smoker/tobacco class splits hasbeen more modest—generally no split or justone preferred and one residual class.

Accurately anticipating policyholder lapseand mortality experience has always been keyto pricing or projecting profits for term plans.But past experience provided little or no helpin predicting the future at the outset of eitherTWI or TWII. Even today, it is hard to impossi-ble for most actuaries to find good, credibleexperience data, particularly for mortality.

Credible lapse experience is much easier toobtain than credible mortality experience, butit still takes years for a complete picture toemerge. As expected, companies see a sharpspike in lapse rates when premiums spike upafter the level premium period. At Session 63(Term Mortality and Persistency) of the SOA’sSpring Meeting in New Orleans, GeorgeHrischenko of Transamerica Re said they areseeing total termination rates of about 80percent at the end of 10- or 20-year select peri-ods, with smaller total decrement rates for afive-year term where premium increases afterthe level premium period are less dramatic.Other companies have reportedly seen some-what different lapse patterns, e.g. 60 percentin year 10 and 50 percent in year 11 of a 10-year level premium plan. Persistency duringthe level term period is comparatively muchbetter, with the lowest lapse rates occurringfor the best risk classes, older issue ages andthe longer level term periods.

Developing assumptions for mortality ismuch tougher and currently involves a greatdeal of speculation and professional judg-ment. For example:

• There is no ultimate experience and not much more than about 10 years of select experience consistent with today’s underwriting criteria.

Term Mortality and Lapsesby Jeffery T. Dukes

4 August 2005

Features

• Nobody really knows how preferred/ residual ratios change over time. In fact,we still are not certain how smoker/non-smoker ratios behave over the entire select and ultimate period.

• Related to the prior two points, there is debate among actuaries about how aggregate mortality rates will increase over the select and ultimate period. The most recent SOA mortality study,distributed at the 2004 annual meeting,provided A/Es for both 2001 VBT and 1975-80 expected bases. Each expected basis has its fans and critics as being representative of the slope of aggregate (or, in the case of the 2001 VBT, also smoker/nonsmoker) mortality, and some are not comfortable with either.

• Differences among companies in the number of and/or underwriting criteria for preferred and residual classes create opportunities for policyholder anti-selec-tions that are very difficult to quantify.

• For companies that assume future mortality improvement, is it likely that historical rates of improvement will apply to the future? Even if you think the answer is “yes,” judgment is needed to determine the period over which to measure the historical improvement rates that are supposed to be representa-tive of future rates of improvement.

Measuring historical improvement rates is not so easy either. Given the frequent changes in the companies con-tributing to industry mortality studies and changes in people’s habits (e.g., the decreasing prevalence of smoking), it is a real challenge to find consistent data from either industry studies of insured experi-ence or population tables which can be used to ascertain historical improvement rates. Then there is the issue of how longevity gains from past improvements in medicine and public health measures will compare with the gains that current and future biomedical research might produce.

• Most, and maybe all, actuaries expect substantial mortality anti-selection after the level premium period when gross premiums increase dramatically and most remaining policies lapse. I will elaborate on this issue below, since it

was one of the topics discussed during Session 63 in New Orleans.

The SOA is working to fill in some of thegaps in our knowledge. Tom Rhodes, whochairs the Individual Life InsuranceExperience Committee, said during Session 63that the current data call for the next industrymortality study asks companies to (a) identifytheir multiple preferred and standard classes,and (b) provide additional plan information,including information needed to study lapserates for level premium term business. Tofurther encourage companies to contributedata to the study, Tom also made it clear thatthe MIB, which does the mortality studies forthe SOA, can accept data in almost any format.Longer term, the SOA hopes to get companiesto contribute more detailed underwriting-related data that can be used to define andmeasure mortality for different preferred andstandard classes.

A substantial paper could be writtenabout each of the points listed above, andsome have—e.g., see Steve Cox’s article,“Does Preferred Wear Off?” and Doug Doll’sarticle, “Mortality Table Slope—TheDiscussion Goes On,” both in the July 2004issue of Product Matters! For the remainderof this article, I will provide some additionaldiscussion on the topic of mortality beyondthe level premium period.

I have been told that the three most popularapproaches for setting mortality assump-tions after the level premium period are:

1. SWAG or WAG—(Sophisticated) Wild A__ Guess

2. (B-K) Becker-Kitsos 3. (D-M) Dukes-MacDonald

Since both B-K and D-M involve their ownSWAGish elements, I will skip over the pure(S)WAG approach, although some of myremarks may be of interest to its adherents.

The first point I would like to note is thatthere is not a single D-M or B-K approach.Doug Doll identified three variations of D-Min the July 2003 issue of Product Matters!and I am aware of two variations of B-K. Forboth B-K and D-M:

Product Matters! 5

continued on page 6

• Lapses in excess of some set of baseline rates are assumed to be anti-selective.

• Total deaths for the excess lapse group (“reverters”) and those who do not lapse (“persisters”) must equal expected deaths with baseline lapses (conserva-tion of deaths).

• You need to make an assumption for “reverter” mortality.

• Then you can use conservation of deaths to solve for expected persister mortality.One consequence of conservation of deaths is that the anti-selection will wear off m years after the last excess lapse, where m equals the select period for the base mortality table. It seems to me that this internal consistency with the base mortality table also represents one advantage of B-K and D-M over a pure (S)WAG approach.

For purposes of illustration, let’s supposethat:

• D-M calculations assume that n% of excess lapses at attained age x+s (duration s for issue age x) are fully select and that the remaining (100-n)% percent have mortality equal to what persister mortality would be if there were no excess lapses at ages x+s+t, t = 1, 2, 3, . . . I believe this is what Doug Doll calls “Method 2” in his July 2003 article. The formulas become somewhat involved when excess lapses occur at more than one duration. Formulas for n% = 100% were presented in the original D-M paper in the 1980 TSA.

• B-K calculations assume that reverter mortality for excess lapses at age x+s equals:

qr

[x+s]+t-1 = F(t)* q[x+s]+t-1

F(t) = 1 + G(t)*R*[(q[x]+s/q[x+s]) – 1]

G(t) grades from 1.0 for t=1 to 0 for t=16,the first ultimate duration. For purposes

of the sample calculations, I have assumed that this occurs linearly.R is a parameter that controls the level of reverter mortality—smaller values of R translate into lower levels of reverter and higher levels of persister mortality.

In the original B-K article, they recom-mended that R be between 0.2 and 0.4.

I believe this is the original formulation of B-K, except that I have omitted an accidental death refinement.

• Male, issue age 40• Base lapse rates = 10 percent per year,

annual mode• Base mortality = 1975-80 S&U, ALB• Total lapse rates = base lapse rates,

except for policy years 10-13• Total lapse rates (QW) equal 85% or 90%

in year 10 and 30%, 20% and 15% for years 11, 12 and 13, respectively.

Resulting persister mortality as a multi-ple of base mortality is shown in the table onpage 7 for selected policy years of a 10-yearlevel premium term product and a fewchoices for n%, QW10 and R.

The table gives some indication of thesensitivity of post-level premium periodmortality to the choice of parameters and tothe level of excess lapses. Not surprisingly,decreasing expected reverter mortalityincreases expected persister mortality.

To estimate reverter or persister mortal-ity, it strikes me that it would be very usefulto know:

• The fraction of the in-force at the end of the level premium period that would fall in each underwriting category, including various levels of substandard, if subjected to underwriting at that time.The answer would almost certainly vary by gender, issue age, underwriting class at issue and length of the level term period.

• The relationships between (a) the premi-ums payable by persisters after the level premium period and (b) corresponding new issue ART or level premium term premiums.

6 August 2005

Term Mortality and Lapses • from page 5

If all policyholders could act rationally, thenthe persisters would consist solely of peoplewho (a) still wanted insurance coverage and(b) for whom the very high persister premiumswere lower than they would pay if they wereunderwritten and issued a new policy. Forexample, if persister premiums were roughly500 percent of a new issue residual premium,then you would expect only those who wouldbe rated Table 16 or higher, if re-underwritten,to persist. I would expect that to be a smallpercentage of the in-force at the end of thelevel premium period before the shock lapse,which would imply a very high total lapse andvery high mortality for the few persisters.

Since actual total lapse rates are lowerthan I might expect based on the rationalpolicyholder theory and some of thepremium relationships I have seen, it wouldseem that many of the persisters either donot react immediately to the premiumincrease due to some sort of inertia, do notnotice the premium increase, which seemshard to believe, do not think the increase isexcessive, or are under some constraint (e.g.,subject to the terms of a divorce settlementwhere the policy is in an irrevocable trust)that does not allow them to lapse.

Regardless of the reason(s) for why itoccurs, this better-than-expected persistencymakes it harder to estimate mortality foreither persisters or reverters. Still, it seemshard to believe that there would not be astrong bias toward the healthiest lives termi-nating their coverage, which is implicitlyassumed for both B-K and D-M. But the actu-ary, maybe in collaboration with theunderwriter or medical director, has to exer-cise judgment in setting the parameters sothat the result seems reasonable.

Given the uncertainties, it would seem natu-ral for actuaries to:

• Limit coverage to the level premium period. But the high post-level premium period premiums and potential for addi-tional profit might be enticing.Restricting coverage to the level premium period might also have an unfavorable impact on GAAP income.And, of course, the option of extending coverage beyond the level premium period, even at very high rates, might be a valuable option to policyholders.

• Do sensitivity testing. Some candidates for sensitivity testing might be (a) the level of total and excess lapses and (b) the values of n percent (D-M) or R (B-K),including the possibility of variations by issue age, duration of excess lapse, and the magnitude of current and prior excess lapses and (c) profitability assum-ing no profits beyond the level premium period.

Over the next few years an increasingamount of experience will emerge, whichshould help reduce the magnitude of theuncertainty, at least for companies whichhave access to that experience.¨

REFRENCES

BECKER, DAVID N. (and KITSOS, THEODORE J.).September 1984. Pricing for Profitability in ART.Best’s Review.

COX, STEVE. July 2004. Does Preferred Wear Off?Product Matters!

DOLL, DOUGLAS. July 2003. Mortality Anti-Selection – Different Versions of Dukes-MacDonald.Product Matters!

DOLL, DOUGLAS. July 2004. Mortality Table Slope– The Discussion Goes On. Product Matters!

DUKES, JEFFERY T. and MACDONALD, ANDREWM. 1980. Pricing a Select and Ultimate AnnualRenewable Term Plan. Transactions of the Society ofActuaries XXXII: 547-565.

Product Matters! 7

Term Mortality and Lapses

Jeffery T. Dukes, FSA,

MAAA, is a consulting

actuary with Milliman, Inc.

in Chicago, Ill. He can be

reached at jeff.dukes@

milliman.com.

Comparison of D-M and B-K Anti-Selection Multiples

Dukes-MacDonald Becker-Kitsos

Policy QW10=85% QW10=85% QW10=85% QW10=90% QW10=85% QW10=85% QW10=85% QW10=90%

Years n%=100% n%=90% n%=80% n%=80% R=0.2 R=0.3 R=0.4 R=0.3

1-10 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00

11 3.85 2.71 2.14 2.40 3.28 3.00 2.71 4.19

12 4.20 2.91 2.27 2.53 3.30 2.85 2.40 3.90

13 4.35 2.98 2.31 2.58 3.27 2.74 2.21 3.71

14 4.35 2.97 2.30 2.55 3.18 2.61 2.04 3.51

15 4.12 2.81 2.19 2.43 2.94 2.37 1.82 3.16

20 3.74 2.50 1.95 2.16 2.79 2.36 1.97 3.25

25 2.87 1.95 1.59 1.72 2.46 2.29 2.14 3.26

30 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00

E quity-indexed universal life (EIUL),while having existed since 1997,appears to finally be in a position to

cause a legitimate wave in the marketplace.Carriers looking to capitalize on the recentsurge of equity-indexed annuity sales (EIA)are poised to enter the EIUL market. Lowinterest rates and choppy equity markets,along with consumer jitters that continue tocast a cloud over the variable markets eversince the stock market bubble burst fiveyears ago, make for near-perfect economicconditions for equity-indexed products.

The EIA market has shown that a productfeaturing potential upside accumulationindexed to the equity markets, combined withdownside protection, can carry plenty ofappeal in the eyes of the consumer. Of course,it should be acknowledged that relatively highcompensation has also been a contributingfactor to healthy EIA production figures.

Despite relatively low sales to date (Exhibit1), many believe the EIUL market is well posi-tioned to follow the same upward sales trendexperienced by EIAs, thus increasing market

share amongst current life stalwarts (Exhibit2). Currently the EIUL market is dominatedprimarily by one carrier with several otherstrying gain market share. There is reason tobelieve that several major players will beentering this marketplace by the end of 2005,potentially changing the competitive land-scape of this product. Those poised to enter themarket typically come from one the followingpedigrees.

1. VUL carriers

Some VUL carriers are looking to move intoalternate distribution channels. As EIULproducts are non-registered, they do not typi-cally compete with VUL distribution. A VULcarrier looking to expand sales can enter thisspace while likely avoiding significant chan-nel conflict and taking sales away from their“bread-and-butter” product line. The primaryhurdle to entering the EIUL market may bean administrative system that must be over-hauled to accommodate such a product.

2. EIA players

EIA players wish to leverage their productknowledge and hedging capabilities to gainefficiencies on the life side. While both ofthese factors give them a head start tosuccess, the additional moving parts andrequired capabilities required for a life prod-uct (e.g., need for sales illustrations) can leadto bumps in the road on the way to marketentry. It is also worth noting that annuity-oriented distribution systems havehistorically experienced challenges sellinglife product.

3. UL sellers

Companies that derive most of their salesfrom general account UL, a close cousin toEIUL, may be best positioned in terms ofspeed to market due to many of the required

8 August 2005

Equity-Indexed Universal Life“The Devil’s in the Details”by David J. Weinsier

Features

administrative capabilities already havingbeen set up. Of course, tracking the equitymarkets, setting up hedging capabilities, andtraining agents on a new concept can taketime, effort and care.

When appointed to bring an EIUL productfrom concept phase to market roll-out,several unexpected challenges specific to thisproduct have a tendency to rise up along theway. In this article, we will examine deci-sions that must be made during the designphase, introducing common hurdles thattend to develop, as well as questions thatmust be answered.

The key to product design is to achieve areasonable balance between productcomplexity and the availability of value-added options. Representation from yourproduct implementation team should beinvolved early in the design stage so thatadministrative capabilities are fully under-stood and features aren’t promised which areparticularly troublesome to implement. Thefollowing policy features and methodologiesmust be defined while always keeping theaforementioned balance in mind.

Method of CreditingVirtually all EIUL products available todayuse an annual reset (i.e., ratchet) structure.Index interest can be credited on a point-to-point basis or via an averaging formula. Theformer is simpler to administer and under-stand from an agent/policyholder perspective,but the latter will allow for a higher participa-tion rate or cap.

Participation RateRecently most carriers have moved to offeringa 100 percent guaranteed participation rate.While those involved in product developmentrealize that the participation rate simplyserves as a balancing item between the optionbudget and cost of the comparable indexoption needed to hedge the liability, manyagents and policyholders continue to hold theperception that a participation rate of, say 75percent, implies the carrier retains 25 percentof the index gain as profit. While initial

players in this space made failed attempts toexplain this concept to agents and policyhold-ers, companies today have realized that the100 percent participation rate makes the mostsense, and instead allow an alternativefeature (e.g., the index cap) to change alongwith derivative costs.

Index CapAs mentioned above, the cap has become theprimary “moving part” when pricing EIUL. Aminimum cap is defined in the contract whilethe carrier sets a current cap at issue andreserves the right to reset the cap, typicallyonce per anniversary. While an annual caphas served as the standard to date, a recenttrend in the EIA market is to offer a monthlycap (e.g., 3 percent per month), allowing the(unlikely) possibility of a 36 percent annualreturn, which far exceeds the typical 12 to 15percent annual cap. It also should be notedthat some state regulators have frowned uponpolicy designs featuring both a non-guaran-teed participation rate and cap. Thus mostproducts define one as guaranteed (typicallythe 100 percent participation rate) and allowthemselves to adjust the other to fall in linewith current derivative costs.

Guaranteed RateGuaranteed rates in the marketplace gener-ally range from 1 to 3 percent per annum. Aleading seller of EIUL features a 2 percentcumulative guarantee over a five-year index-ing period. This implies that the index gainswould have to return less than a cumulative10 percent return at the end of five years inorder for the guarantee to be in the money.Such a feature can result in lowering the costof the guarantee, thus providing a largeroption budget than an equivalent productwith an annual guarantee.

Product Matters! 9

The key to product design is

to achieve areasonable

balance betweenproduct

complexity andthe availability of

value-addedoptions.

continued on page 10

10 August 2005

Equity-Indexed Universal Life • from page 9

IndexWhile the S&P 500 has historically been theindex of choice for equity-indexed products(primarily due to the viable option market),some EIA products offer policyholders theoption to participate in alternative indices. Itis expected that EIUL carriers, particularlythose able to leverage off such a feature aspart of their EIA portfolio, will follow suit.

Timing of TransactionsA decision must be made as to how manyindexed buckets will be established. In otherwords, how frequently will a policyholder’spremium be transferred to the indexedaccount? Annually, quarterly, monthly, bi-monthly and daily can all be found in themarketplace. Allowing for frequent transferscan carry more marketing appeal and maykeep you from having to establish a short-term fixed account to hold premium prior tothe next transfer date. Less frequent trans-fers leads to better matched hedging.

Some plans base index segments on policydates (e.g., monthaversaries) while othersare based on calendar dates (e.g., 15th of eachmonth). The former typically favors the poli-cyholder, especially when premium is paid ona consistent date, while the latter allows fora better matched hedge for the carrier, due tothe fact all policies’ premiums can be sweptinto one pool to be hedged.

Fixed AccountDue to its sales appeal, offering the policy-holder the ability to apply a portion of eachpremium into a fixed (i.e., non-indexed)account within an EIUL product has becomea “must-have” feature. Unfortunately for theactuary and product implementation team,this feature does introduce some uniquechallenges, the degree of which depends atleast partially on answers to the followingquestions:

- Will fund transfers be allowed between the fixed and indexed accounts? If so,how frequently (warning: unlimited transfers could lead to anti-selection, as well as leaving you over or under hedged)?

- How will monthly charges be deducted? Will they be taken only from the fixed account or from both the fixed and

indexed account based on fund value? Will charges be deducted from each bucket on a pro rata basis, or LIFO,based on the bucket in which the last premium was applied to?

- Interest on the fixed account is typically credited on a monthly basis. Will interest in the indexed account, which is credited annually based on index gains, be based on average fund value over the indexing period or fund value just prior to the bucket anniversary?

- From which account will loans and with-drawals be deducted?

It is my experience that while the ques-tions above are far from top of mind duringthe initial design stage, many a project planhas experienced significant delays due to theadministrative complexities they can bringabout.

No Lapse GuaranteeDue to the recent surge of sales of generalaccount UL products featuring lifetimeNLGs, some carriers have decided to includesuch a feature on their EIUL products aswell. The upside of additional sales broughton due to the appeal of this feature needs tobe weighed against the following:

- Is this feature appropriate on a product typically used for accumulation, as opposed to protection?

- The cost of the feature attached to an EIUL is higher than a UL product due to the lower guaranteed rate.

- How will index credits be applied when the fund value falls below zero?

- How will reserves be impacted?

Summary

Due to the surge in sales of both EIAs andUL products in recent years, it is anticipatedthat many more companies and products willinfiltrate the EIUL marketplace by the endof 2005. This means we should anticipateinnovative product designs and increasedcompetition in the near future. Those carri-ers that can most quickly answer thequestions and avoid the speed bumps raisedabove will improve their speed to marketand have a leg up on their competition.¨

Product Matters! 11

Equity-Indexed Universal Life

David J. Weinsier, FSA,

MAAA, is a senior

consultant with Towers

Perrin in Atlanta, Ga. He

can be reached at David.

Weinsier@towersperrin.

com.

It appears that 2005 may be the year thatmajor steps are taken toward principle-based as opposed to formula-based

reserves and capital requirements. Therewere several times when regulators askedthe question, “How would this project impactprinciple-based reserves?” A number of regu-lators do not want work being done thatwould distract from an ultimate goal ofreserves and capital that better reflect theactual risks of the company as opposed toonly being based on formulas.

This article summarizes my take on theMarch and June 2005 Life and HealthActuarial Task Force (LHATF) meetings, aswell as some other National Association ofInsurance Commissioners (NAIC) meetings.

C-3 Phase 2 – Risk-Based Capital

A step toward the principle-based system isthe C-3 Phase 2 addition to the risk-basedcapital formula, which was adopted by theNAIC’s Capital Adequacy Task Force at theJune 2005 meeting. (Note that the Executive

and Plenary Committees still have toapprove this document in order for it to beofficially adopted, and this will not takeplace until the September meeting.) TheRBC changes would apply to all variableannuities and are effective for year-end 2005.The C-3 Phase 2 of RBC generally requiresstochastic testing. This stochastic testingwould need to be done calculating a condi-tional tail expectation (CTE90) (averagingthe 10 percent worst results). This givesrecognition to the fact that the risk of theguarantees in variable annuities is in thetail—rates being too high or too low, depend-ing on the type of guarantees. There arealternative minimum factors available forcompanies with simple guarantees who donot want to spend too much time modeling,but the limitations on the use of thesefactors make it unlikely that many compa-nies will use these alternative minimumfactors for long.

Although there are guidelines for thescenarios, most of the assumptions to beused in the testing are left to the actuary’sprudent best estimate. This puts a lot ofresponsibility on the actuary.

The NAIC Capital Adequacy Task Forcealso adopted a “standard scenario” that allcompanies must use as a floor. There were anumber of letters stating that the standardscenario was not a good idea, since a singlescenario cannot capture the risks of a partic-ular company’s product and assets. However,the regulators felt that, at this time, they atleast want to use this one scenario for allcompanies until they get some feel as to howaggressive a company’s own modelingassumptions may be; i.e., they want to makesure this baby can walk before they willallow it to run. In discussions with severalregulators, they expressed the possibilitythat the standard scenario requirement maybe dropped in the future if they believe thatactuaries are doing a proper job.

12 August 2005

Features

NAIC 2005:The Start of a Busy Yearby Donna R. Claire

The American Academy of Actuaries’(AAA) work on this project spanned severalyears, and was spearheaded by Bob Brownand Larry Gorski with significant contribu-tions from many people including GeoffreyHancock, Tom Campbell, Dennis Lauzon,John O’Sullivan and Jim Lamson. The C-3Phase 2 report is available from the AAA atwww.actuary.org.

Reserves for Variable Annuities

There is a proposed actuarial guideline thatwould require reserving to be done on aconsistent basis with the RBC C-3 Phase 2with certain changes to reflect that it is deal-ing with reserves, not capital. Tom Campbellchairs the AAA Variable Annuity ReserveWorking Group. The AAA group hasproduced a report as well as worked on theproposed guideline. The report on this isavailable at www.actuary.org.

One of the differences between thereserves and risk-based capital would be theconditional tail expectation percentage. TheAcademy report currently uses CTE 65(which means that one would average theresults of the worst 35 percent of scenarios).The New York regulators have proposed thatCTE 80 be used instead. Another proposedchange by the New York regulators would beto have a capital markets option value ofliabilities as a floor in addition to a seriatimstandard scenario floor that would be similarto the standard scenario floor for RBC.

LHATF will have a conference call onsome of the details of the guideline. Theguideline is exposed for comment, and theexpectation is that it will be in place for 2006(not 2005). The delay is, in part, becausethere are some outstanding issues, and itwas felt that companies would want to knowwhat the reserve level is at least six monthsbefore the end of the year in order to imple-ment the change in reserves.

Update to Actuarial Guideline 38

The proposed revisions to Actuarial Guideline38 continued to provide passion at LHATFmeetings. At the June NAIC meeting, LHATF

voted to adopt an updated AG38, whichstrengthens the formula for reserves thatmust be established for pre-funding of asecondary guarantee in a universal life prod-uct, effective for policies issued after June2005. It includes the compromise suggestedby an industry group, which sunsets theformula in 2007. LHATF recommended to itsparent committee (the A Committee), thatthey defer adoption of the change until theyhave studied it, so the A Committee receivedthe LHATF report and proposed a publichearing on this subject.

Nonforfeiture for DeferredAnnuities

There have been some interesting discussionson the proposed model regulation to go alongwith the new law change that allows the mini-mum nonforfeiture rate on deferred annuitiesto be adjusted according to the rates onTreasuries. At the June LHATF meeting, aregulator, expressing frustration at the lack ofagreement on certain aspects of the regulationand its complexity, especially as it pertains toequity-indexed annuities that also have fixedbuckets, made a motion to scrap the wholeproject and instead go back to the law andcome up with a single interest rate to be usedas a minimum. After some lively exchanges,this motion was defeated in a close vote (six tofive, with three abstentions).

One suggested alternative to how EIA/fixed bucket policies should determine aminimum is to have separate minimuminterest rate guarantees for the money ineach EIA/fixed bucket. During an earlierconference call some regulators expresseddoubt that this would be allowed under thecurrent law, but subsequent research showedthis may be allowed. A second alternative isto develop a single interest rate for eachpolicy based on the percentage of money ineach EIA/fixed income bucket at the begin-ning of each year. LHATF will have aconference call to work out the details onhow to determine a minimum nonforfeiturerate for combo EIA/fixed bucket products.

Product Matters! 13

...LHATF voted toadopt an updated

AG38, whichstrengthens the

formula forreserves that

must be established forpre-funding of

a secondary guarantee.

continued on page 14

SVL II – Possible Revisions toReserving:

There is an AAA group headed by DaveSandberg that is working on revising theStandard Valuation Law to be more princi-ple-based versus formula-based. Reportswere given at both the March and JuneNAIC meeting on this.

At the June LHATF meeting, Dr. AllanBrender, who is the senior director, actuarialdivision, Office of the Superintendent ofFinancial Institutions in Canada, was aguest speaker. He concentrated on theprocess of independent actuarial peer reviewin Canada. Once every three years, eachcompany in Canada is required to have anindependent actuarial consultant review theassumptions and modeling used to deter-mine the level of reserves and capital. Hebelieves the process is working. The peerreview process is likely a necessity if theUnited States adopts a more principle-basedapproach to reserving.

Update to the StandardNonforfeiture Law

To go along with changes in the reserving,there is also an AAA group that is exploringupdating the nonforfeiture laws to accommo-date more flexible, multi-benefit products.This AAA group has been reporting eachquarter to LHATF. At the June meeting theyreported that they are working with the taxgroup of the AAA to determine the possibletax implications of various proposals. Severalbrief reports from this group are available onthe AAA’s Web site.

UL Working Group

At both the March and June LHATF meet-ings, updates were given of the AAA’sUniversal Life Work Group, that is workingon a principle-based approach for reservingfor certain life products. This group isheaded by Dave Neve.

The revisions to reserving could be madeto accommodate newer UL and term prod-ucts, but could also be used for reserving alllife products. The overall framework is thatreserving would be based on the greater ofthe results of a single deterministic reserve

and a stochastically derived reserve ifneeded. This would be similar to assetadequacy testing, but with greater controlsover the assumptions used. The assumptionsunderlying the deterministic reserve are notlocked. LHATF will have a conference call todiscuss guidance on policyholder behaviorand asset assumptions.

This is a very active group, with sub-groups looking into the methodology,modeling, mortality, economic scenarios, poli-cyholder behavior, expenses and reinsurance.The work of this group got a boost when theACLI voted to support principle-basedreserving. The goal of the AAA group is tohave proposals available by 2007. Reportsfrom this group are available on the AAA’sWeb site, www.actuary.org.

Preferred Mortality

LHATF voted to work on developing apreferred risk mortality table or tables. Thiswill support the work on the principle-basedreserving, because it will give companiesmore information on the industry preferredmortality. There is a possibility that thiswork can be used to support lower reservingfor certain policies under the current AG38also. The project will include substantialassistance from the SOA and the AAA.

The SOA is currently doing a data call.They have some data available from 20companies. They hope to have 50 companiescontributing data. The AAA was asked toassist in developing a basic table, as well asrules as to when the preferred tables can beused. Note: if anyone is interested in workingwith the AAA group, please let AmandaYanek at the AAA know. Her e-mail isYanek@actuary.org.

GRET Table

The SOA has done work on a new GenerallyRecognized Expense Table to potentially beused in life insurance sales illustrations.This report should be available soon from theSOA or NAIC. The factors have large differ-ences from the factors currently being used,so if your company is using the GRETfactors, this new report should be examined.LHATF is expected to vote on approvingthese factors at a later meeting.

14 August 2005

NAIC 2005: The Start of a Busy Year • from page 13

Donna R. Claire, FSA,

MAAA, is president of

Claire Thinking, Inc. in Fort

Salonga, N.Y. She can be

reached at clairethinking@

cs.com.

Summary

As the above shows, there are a number ofprojects LHATF is working on. Virtually allhave the theme of giving companies moreflexibility, which also means much moreresponsibility being given to the actuary. It ishoped that these changes will result in prod-ucts that consumers want, with reserve andcapital requirements at levels that are not

excessive, but that are sufficient, so thatthere can be fair prices for the products,while the companies still maintain a satis-factory level of solvency.¨

Product Matters! 15

NAIC 2005: The Start of a Busy Year • from page 14

T hink of a pioneer as “someone whoopens up new areas of thought,research or development, or one

who ventures into unknown or unclaimedterritory.” (Webster’s Dictionary)

The SOA’s current Image Campaign isbased on the belief that the actuarial skillset has value that extends beyond techni-cal analysis into other operational andstrategic roles. We know there are actuar-ies demonstrating this expanded valuetoday, thereby modeling the dynamic andrelevant image of the profession we areseeking to promote.

Specifically, Actuarial Pioneers are:

– Outside the traditional sectors of insurance companies, reinsurance companies, and consulting firms apply-ing their actuarial skill set to new,non-traditional roles such as chief risk officers, financial planners, entrepre-neurs, personal actuaries, or

– Inside the traditional sectors, applying their actuarial skill set in non-tradi-tional ways to become chief marketing officers, chief risk officers, CEOs, etc.

Pioneers who are identified will inspirethe profession, create practical pathwaysfor career development, and potentiallyserve as spokespersons to business lead-ers. They will be profiled through articles,Web sites and media releases.

The anticipated time commitment for apioneer is small. Minimally, it will involvecommunicating some basic information toSOA staff, and at a maximum involve afew interviews for articles or media events.

Names and contact information are tobe submitted via e-mail to pioneers@soa.org. Individuals are free to nominatethemselves or recommend others. SOAmarketing staff will follow up on eachnomination.¨

Call for Actuarial Pioneers...Are You One?by Jim Brooks, Chair of the Actuary of the Future Section

16 August 2005

T hanks to lower interest rates in thepast year, the maximum statutoryvaluation rate for long duration life

insurance products issued in 2006 will be4.0 percent, marking the first change in 11years. The reduction in the statutory valua-tion interest rate also causes the maximumnonforfeiture interest rate to decrease from5.75 to 5.00 percent. However, there is aone-year grace period before nonforfeitureinterest rate changes are mandatory. Thisarticle provides background information onthe calculation of the interest rates and abrief discussion on the effect that changinginterest rates will have on some typical lifeinsurance products.

Explanation of Interest RateCalculations

Maximum statutory valuation interestrates depend on the values of “referenceinterest rates.” The “reference rate” for thelong duration life insurance rate for 2006 isthe minimum of the 12-month and 36-month arithmetic mean of the Moody’sCorporate Bond Yield Average (MCBYA) forthe period ending June 2005. The current12-month average of the MCBYA is 5.78percent and the 36-month average is 6.25percent. The final “reference rate” isadjusted through a formula (which variesby product guarantee) and is rounded to thenearest multiple of 0.25 percent.

Life insurance rates only change if thenewly calculated rate is at least 0.50percent different from the previous year’srate. This requirement will make it difficultfor the long duration life insurance rate tochange again in the near future. For exam-ple, the long duration life insurancevaluation rate will not change again in 2007as long as the average MCBYA from July2005 to June 2006 is between 4.78 percentand 8.74 percent. Changes in the statutory

valuation interest rate also affect thenonforfeiture interest rate because thenonforfeiture rate is equal 125 percent ofthe valuation interest rate rounded to thenearest multiple of 0.25 percent.

Effects on Typical Life InsuranceProducts

In general, lowering interest rates causereserves, cash values and deficiencyreserves to increase, which in turn lowersprofitability when measured by return oninvestment. While the precise effectsdepend on the product type and the specificdesign features, we can generalize about theeffects on a typical design for three stan-dard life insurance products: term, wholelife and universal life.

For a typical term product, the valuationinterest rate change will only result in aminimal increase in basic reserves. Theeffect on deficiency reserves could be morepronounced because the lower interest rateresults in higher valuation net premiumsand the existing premium deficiencies arediscounted at the lower rate. For typicalwhole life products, the reserves and nonfor-feiture values could increase significantly.

The impact on universal life variessignificantly depending on the design of theproduct. For products with secondary guar-antees, stipulated level premium designshave the highest deficiency reserves andare therefore the most affected while theimpact on shadow fund and ART designsmay be less pronounced. For cash accumula-tion universal life products with surrendercharges, a 4 percent maximum valuationrate may increase the alternative minimumreserves.

The increases in reserves and cashvalues may incent companies to developnew products if profits are affected tooadversely. Furthermore, companies may

Lower Statutory Valuation Interest Rates forLife Insuranceby Brian Sprawka

Features

Brian Sprawka, FSA, is a

consulting actuary with

Towers Perrin in Dallas,

Texas. He can be reached

at brian.sprawka@

towersperrin.com.

need to redraft product forms if the cashvalues change when the nonforfeiture ratedecrease becomes mandatory. It is impor-tant that companies proactively attend to

these issues and the other effects ofdecreasing statutory valuation and nonfor-feiture rates.¨

Product Matters! 17

Lower Statutory Valuation... • from page 16

T wo new exciting research projects arecurrently underway to help meet theeducational needs of product develop-

ment actuaries. The first project examinesthe various product guarantees available intoday’s individual life insurance and annuitymarkets. In addition to the familiar mortal-ity, expense and interest rate guarantees,new features have emerged such as nolapse/secondary guarantees included inuniversal life products and guaranteed mini-mum death benefits found in variableannuity contracts. Understanding these newfeatures and their associated risks is impor-tant for product developers and the riskmanagers with whom they work.

The project, “Analysis of ProductGuarantees,” identifies the life insuranceand annuity product guarantee featurescurrently being sold and provides solutionsto the following questions:

• What methods do product development actuaries use to analyze and quantify these various product designs?

• What are the insurance company risks associated with each of the product guar-antee features?

• How are these risks being managed?• How does each product guarantee

feature impact policyholder behavior?

The Product Development Section hascontracted with Victoria Pickering and JohnGlynn of Carstens, Glynn, and Pickering toperform the research. In addition to anextensive literature search, they surveyed

individual life insurance and annuity compa-nies to understand the pricing techniquesand risk management practices utilized bythe industry. They have compiled the resultsof their research and are finalizing a reportexpected to be available this summer on theSOA Web site.

As a result of a growing interest in offer-ing annuities on an underwritten basis, thesecond project, “Substandard Annuities,”evaluates the current substandard annuitymarket and assesses the likelihood of marketexpansion. Other issues to be researchedinclude, but are not limited to:

• Examining the risks and pricing implica-tions related to offering substandard annuities.

• Identifying implications of an expanding substandard annuity market to current substandard annuity risk management and reserving methods and standards.

• Analyzing substandard annuity under-writing practices and comparing the substandard annuity practices to that of traditional life insurance.

• Identifying possible arbitrage opportuni-ties between substandard annuities and life insurance.

Work is scheduled to begin soon withLIMRA International and Ernst & Youngcarrying out the research.

For more information on these projects,please contact Ronora Stryker, SOA ResearchActuary, at rstryker@soa.org.¨

Product Development Section Sponsored Researchby Ronora Stryker

Ronora Stryker, ASA,

MAAA, is a staff research

actuary with the Society of

Actuaries in Schaumburg,

Ill. She can be reached at

rstryker@soa.org.

18 August 2005

L ife settlements seem to be causingmuch concern in the life insuranceindustry at present. This concern is

especially found among certain actuarieswhose fears over life settlements are result-ing in a loss of sleep, hair and the ability toconcentrate on improving their golf game.Are these concerns valid? This article takes alook into the life settlement business to see ifthe concern is well founded or not. This arti-cle does not address the suitability issue forpolicyholders who are considering settlingtheir contracts. Another area not addressedis investor-originated life insurance prod-ucts, where the policy is applied for with theintention of “settlement.” These are topicsthat would take up whole separate articles.

Life Settlements – Background

First of all, for those less familiar with thistopic, let’s define a life settlement. Accordingto the Viatical and Life SettlementAssociation of America, “A viatical and/or lifesettlement is the sale to a third party of anexisting life insurance policy for more thanits cash surrender value but less than its net

death benefit.”Although not in the definition, the key

condition to a successful life settlementtransaction is that the present value of theexpected death benefit must be higher thanthe expected cost of purchasing and main-taining the policy. Profitability for the lifesettlement investor is linked directly to theinsured’s life expectancy. In general, the lesstime the insured lives following a life settle-ment, the less cost for the life settlementcompany to maintain the policy and thegreater their return. For this reason, suchproducts are usually marketed to older indi-viduals, potentially in impaired health.

These products emerged in the early1990s and have continued to grow over thepast decade and a half. At present, it is esti-mated that there is $13 billion of in-forcesettlement business. Further, optimisticprojections have this business growingrapidly, due to several factors. First, it isfueled by the growth in individuals age 65and older, a group growing three times fasterthan the total population. Second, lowerinterest rates have resulted in lower thanexpected cash values for life insurance prod-ucts, rendering life settlements moreattractive. Finally, the elimination of estatetaxes would reduce the need for deathprotection at the later ages. It is this rapidgrowth expectation that has fueled concernsover this market.

Why the Concern over LifeSettlements?

Why are life insurance companies concernedover life settlements? If a life settlementcompany assumes a life insurance policy, thepolicy continues in force and premiumscontinue to be paid to the life insurancecompany by the life settlement firm. On thesurface, it does not appear that there is anyimpact on the insurance company except for achange in the owner and beneficiary. However,this is not the case. Actuaries are concerned

Life Settlements—Is There a Cause for Concern?by Michael J. LeBoeuf

Features

that rapid growth in the life settlementmarket could have an adverse effect on theexpected experience of a block of policies.Specifically, level premium product designswith low cash values, such as term anduniversal life with or without secondary guar-antee coverage, are examples of products thatmay have profitability issues if long-termlapse rates decline below pricing levels. Theseproducts are also excellent candidates for alife settlement.

Lapse rates are an important variable inpricing life insurance products. The pricingactuary makes an assumption on theexpected lapse experience for a block of busi-ness. Those concerned about the lifesettlement market worry that, given theoption of entering a life settlement for a cashamount greater than the policy cash value,people will cease lapsing their policies.Under this scenario, lapse rates could effec-tively move toward zero, well below pricingassumptions, therefore compromising prof-itability.

Compounding this concern about lapserates is the belief that the reduction in lapserates will be more pronounced for unhealthylives. The effect of this will be deteriorationin the experience of the block of business.This also would undermine product prof-itability.

Are the concerns valid?

While it appears that the life settlementmarket is a growing market, it is uncertainthat it will grow rapidly as anticipated in theoptimistic assumptions discussed above.Even if these optimistic growth assumptionswere realized, life settlements would still bea relatively small percentage in relation tototal life insurance in-force (currently over$9 trillion). Given this small percentage, therisk of life settlements “ruining” the industryis probably not realistic.

Life settlements are a transaction drivenby life settlement brokers and insurance

agents. Generally speaking, these brokersand agents target large policies to maximizetheir own income potential. The average sizeof a policy that is settled is $1 – $1.5 million.This high average policy size is due to ineffi-ciency in the settlement business where onlyaround 20 percent of policies submitted for alife settlement transaction actually close, aswell as agents and brokers desire to satisfytheir own economic needs. This high averagepolicy size should minimize concentration oflife settlement business in most companies,limiting the impact of life settlement busi-ness on emerging experience.

Looking at the impact on pricing assump-tions, the impact on lapses would begenerally limited to large face amount poli-cies and not distributed throughout a blockof business. In addition, the belief that every-one considering a lapse will opt for a lifesettlement is unfounded. Again, it is abroker/agent driven transaction. Life settle-ment companies will not drive thetransaction for all policyholders, only thosepolicies with large face amounts.

Further, the belief that unhealthy peoplewere planning on lapsing their policies, butinstead chose a life settlement, is alsounfounded. It is this belief that fueled theargument that life settlements would resultin the deterioration of mortality experiencefor companies. Companies may need to makeminor pricing adjustments to respond to thechanges in experience from life settlements,however, the impact should not be as signifi-cant as some fear.

Finally, if life settlements become a viablemarket for all consumers and for all sizepolicies, we expect life companies willrespond with product design changes toaddress this demand as was done with accel-erated benefits about 15 years ago. So relax.Don’t lose sleep, don’t pull out your hair, lifesettlements are not coming to destroy theindustry. Oh, and get back to work on thatgolf game.¨

Product Matters! 19

While it appearsthat the life

settlement marketis a growingmarket, it is

uncertain that itwill grow rapidlyas anticipated in

the optimisticassumptions

discussed above.

Michael J. LeBoeuf, FSA,

MAAA, is vice president

and consulting actuary

with Aon Consulting in

Avon, Conn. He can

be reached at mike_

leboeuf@aon.com.

20 August 2005

A long time ago, in a company far, far away…

K ind of cliché, but in this case it is anappropriate analogy. As the finalepisode of the Star Wars saga is now

playing across the country, many people arereflecting on the good and evil conflict thatexists in many aspects of life. Actuaries fordecades have traditionally had naturalconflict with sales and marketing depart-ments. Our training as actuaries haspositioned us as uniquely aware of allaspects of traditional insurance, and as suchwe believe we know how things should workin sales.

When we meet individual sales profession-als, we figure they are out for the wrongaspects of our world. Our intentions are pureand good, not unlike those of the Jediknights. Thus those on the other side, the“Dark Side,” must be evil. We must do asYoda says: “Look inside yourself, you willknow what is right.”

If an actuary is turned to sales and market-ing (or the “dark side”), we say a silentprayer for them and hope that they see thelight some day. This conflict between goodand evil, actuarial and sales, can sometimeslead to angst and anguish for many of us.One of our own “Jedi’s,” Jon Davis, wasconflicted a few years ago and decided to join

the “dark side.” Is this a bad thing, or isthere hope for young Mr. Davis?

I had the opportunity recently to speak toJon on two separate occasions and it appearsthat many of us could learn a great deal fromthose who have made the bold leap to “gowhere no actuary has gone before” (sorry formixing my sci-fi analogies).

Jon started his career as an actuarialstudent working for an insurance company.He soon learned that product developmentwas his forte. “I enjoyed working with allaspects of the company to lead the efforts tobuild profitable products that our agentswould sell,” he recalled.

Sounds like a good actuary, right? He even-tually found himself at Conseco, where Iwork. He rode the wave during the high-flying 1990s, grew to take on bigger andlarger areas of responsibility, and continuedto learn more as he went along. “Manyaspects of what we learn as actuaries canserve us very well in meeting customers’needs,” Jon observed. “We know how todesign products that are good for thecustomer, agent and company.

After having a number of different jobresponsibilities (12 job titles over 10 years),he found himself wondering what he shoulddo next with his career. After considering anumber of alternatives he decided to trulytake a chance and join an independentmarketing company.

Being a good actuary, he weighed the risksinvolved with this decision and the ultimaterewards. In Jon’s case, the risk was nottotally unknown. His family has an insur-ance agency and his desire to take a breakfrom the corporate world was just what hisbrother needed to convince him to join thefamily business. But would Jon be able tomaintain the strong qualities he learnedduring his Jedi training to not be seduced bythe dark side? His entrepreneual spiritcaused him to desire independence and theability to make his own success. “The lack ofsecurity with traditional employers todaymade this decision a little easier,” he

Features

recalled. So Jon made the jump and joinedthe family insurance agency.

Today, Jon is quite certain he made the rightdecision. “Working directly with sales peopleto help them sell quality products tocustomers is not only financially rewarding,but very satisfying,” he observes. Jon nowuses what he learned from his years in ahome office to help his agency add value toagents by navigating through the maze thatmany insurance companies create for salespeople. “Often I can simply explain to theagent the reasons for some of the difficultiesthey face, and they deem that to be a value-added service we can provide,” says Jon.

Jon and his brother are now co-owner opera-tors of the Davis Life Brokerage. Together,they function as an independent marketingorganization (IMO) for several differentcarriers. Because of Jon’s background, manyof these companies have invited him to serveon their product development advisory coun-cils. Companies enjoy working with Jonbecause they don’t need to explain a lotabout the process, they can just get goodmarket feedback from Jon as someone a lotcloser to the customer.

Some additional insights from our Jedi:

On what he’s learned from the independentworld of insurance marketing:“Independent agents can do business withwhomever they like. To be successful, youhave to find a way to stand out and to buildclose relationships with agents. Agents needa lot of support. They know how to close asale, but many need help with their overallbusiness practices. Generating leads, under-standing products, building tools to help thesales process, this is all the stuff that we canprovide to make their job easier.”

On the changing insurance landscape:“Products today are becoming less and lessimportant. Agents are looking for personal-ized care and attention, and addressing theirneeds is the most important priority.”

On the biggest mistake companies aremaking today:“Companies are not following the K.I.S. prin-ciple (keep it simple). Companies today,especially in the annuity arena, are creating

more and more complex product structuresto try to differentiate themselves. This ismaking it more difficult for the agents andcustomers to understand. Companies need tokeep the product simple and make it easy forthe agent to explain to the customer whatthey are buying. The product does not haveto be the most competitive, just reasonable.”

On how his actuarial training and experienceis applicable to his current role:“During my many years working for compa-nies, I learned a great deal about theinternal workings of an insurance company.This has been helpful. I have a good idea ofhow to attack the problems our agents havewith the company. They really seem to valuethat. But more importantly, I gained a broadand holistic view of all aspects of insurance,especially product development. I believethat actuaries are the one unique profes-sional that can have this broadunderstanding.”

On how traditional actuaries can make them-selves more valuable:“Actuaries are often criticized for having nounderstanding of what an agent has to do tomake a living. This is a well-deserved criti-cism. Actuaries need to sit back and look atwhat the agent goes through to sell a policy.And companies today are not doing enoughto make the process easier.”

“We need to listen to agents. They are theones that are sitting down with customers ona daily basis. They know best what they needin order to help the client in a time of need,which after all is the purpose of the productswe sell. The customer isn’t looking for some-thing complicated, they want to understandwhat they are buying. Keeping thingssimple, this can win the day with many ofour agents.”

On the importance of service:“Service is now king with agents. Fewcompanies are giving good or excellent serv-ice. If a company could provide excellentquality service for the agent, they could winmore business and not be forced to focus onoffering the lowest priced, most competitiveproduct in the market.”

Product Matters! 21

continued on page 23

Michael L. Kaster, FSA,

MAAA, is senior vice presi-

dent, actuarial product

management with

Conseco Insurance

Companies in Carmel,

Ind. He can be reached at

mike_kaster@conseco.

com.

T he popularity of equity indexed annu-ities (EIAs) has exploded over thelast few years. According to

Advantage Compendium, EIA sales in calen-dar year 2004 were $23.4 billion, a 64percent increase over 2003 EIA sales. Newcompanies entered the EIA market, bringingthe total number of companies that comprisethe market up to 33. These companies have astrong understanding of how the equityindex component works in a deferred annu-ity product. Systems, hedging and processesare in place to support equity-indexed prod-ucts. Reps and customers have become morecomfortable with EIAs, and their level ofunderstanding has also increased. A logicalprogression in this market may be expansioninto the income side of the business.

Is now the time to consider introducing anequity-indexed immediate annuity (EIIA) tothe market? Currently, many carriers arefocusing on the retirement income market.They are trying to figure out how to addressthe many issues that continue to hauntcurrent payout annuity products. One issue

that the retirement income market faces isthe lack of inflation protection. Singlepremium immediate annuities (SPIAs)generally do not address this issue, unless acostly cost-of-living rider is attached.Variable payout annuities do provide upsidepotential, but at the price of exposure todownside risk. Downside protection is avail-able on variable payout annuities in the formof guaranteed payout annuity floor riders.Such riders may be costly. Further, there canstill exist volatility of the variable payoutannuity benefit from period to period atlevels above the floor. Similar to the deferredEIA, an equity-indexed immediate annuitycan provide upside potential with a guaran-teed floor on the payment amount. EIIAs arenon-registered products under the same coreprinciples as deferred EIAs.

How would an equity-indexed immediateannuity work? One approach is to calculatethe base payment in a manner similar to thecalculation of a SPIA payment, but withrecognition of amounts needed for the EIAhedge budget. One way to reflect this budgetwould be to reduce the interest rate that isused to calculate the payment amount by anamount that represents the hedge budget(e.g. 1 percent). This base payment repre-sents the minimum benefit amount that ispayable for the duration of the benefitoption.

One of the issues to consider in developingan EIIA is how the payment amount reflectsthe gain in the selected index. Severaloptions are available, but the approach islikely dependent on the averaging methodused to determine the gain. Another factor isthe frequency of reflecting the gain in thepayment amount. Payments could vary on amonthly basis (for monthly mode business)or could be held constant for a 12-monthperiod and varied on an annual basis. Thelatter approach is similar to annual benefitstabilization methods used in variable

22 August 2005

Is the Timing Right for Equity-IndexedImmediate Annuities?by Susan J. Sell

Features

income products. The approach used toreflect the change in the index in thepayment amount is not dependent on thefrequency of reflecting the change. If there isno gain in the index, the base payment is notadjusted. This is the downside protectionoffered by the contract. Any index growth inthe contract could be:

a) Amortized over the remaining benefit period using then-current interest rates,or

b) Amortized over the next year or the frequency of reflecting the gain in the payment.

The former approach increases all futurepayments by the same dollar amount. If thegain is not amortized over the remainingbenefit period, there is a risk that paymentscould decline. Similar to variable income

payments, frequent ups and downs in thepayment amount could be unsettling forpayees.

One of the perceived barriers of incomeproducts, in general, is the lack of liquidity.Some level of liquidity should be consideredfor EIIAs to improve their appeal to agentsand policy owners.

In theory, compensation for EIIA productsshould be higher than that paid on SPIAs.The product is somewhat more complicatedthan a fixed payout annuity. Ongoing servicemay be required to explain the changes inthe payout amount.

Carriers have been trying for years toignite the payout annuity market, and themarket seems ripe for this opportunity withthe current focus on retirement income.Perhaps equity indexed immediate annu-ities will be the spark needed to start themomentum.¨

Product Matters! 23

Does an actuary truly need to give up his orher Jedi Knight training received from theSOA to join the “dark side” of sales? Theanswer is clearly no, as Jon Davis has shown.His business today is growing. Success is trulyoccurring for this entrepreneur.

But did Jon truly go to the dark side? I thinknot. We can all learn a great deal from some-one like Jon who can help us see there aremany aspects of the business we don’t trulyunderstand. Listening to the customer,making things simple, adding value, and

doing things right, these are all the attrib-utes that we as actuaries seek to follow. JonDavis is showing that working in sales andmarketing is not at all evil. On the contrary,it is a very noble endeavor. We should allspend a day in the life of an agent; we couldlearn some very invaluable lessons. And wecan become even stronger Jedis.

May the Force (of mortality?) be with us all.The Force is truly with Jon Davis.¨

Insights from the Dark Side... • from page 21

Susan J. Sell, FSA, MAAA,

is a consulting actuary with

Milliman, Inc. in Lake

Forest, Ill. She can be

reached at sue.sell@milli-

man.com.

24 August 2005

Earlier this year the CDC NationalCenter for Health Statistics released“Deaths: Preliminary Data for 2003,”

which received some press coverage becauseit showed new record life expectancies forthe United States. I have summarized someof the death rates from 1987 through 2003(the latest year for which data is available)and calculated mortality improvement ratesfor various periods.

Projection Scale G rates (one-half forfemales) are shown in the far right column as

a basis for comparison. These improvementfactors are commonly used for annuity pricing.They also were used for creating the Annuity2000 valuation table. These appear to beroughly consistent with the experience data,except that the improvement in the pastseveral years has been lower for males ages45-54 and for females ages 35-54. I would beinterested in hearing theories for what ishappening at these ages, especially for males,since I fit within this age category.¨

U.S. Population Mortality Improvementby Douglas C. Doll

Features

Douglas C. Doll, FSA,

MAAA, is a consulting

actuary with Towers Perrin

in Atlanta, Ga. He can be

reached at doug.doll@

towersperrin.com.

TABLE 1.1Annual Mortality Improvement (Males) – U.S. Population

Death Rates per 100,000 Annual Rates of Improvement

Males

Age 1987 1993 1997 2001 2003 1987- 1993- 1997- 2001- Scale

2003 2003 2003 2003 G

25-34 189 212 163 143 140 1.9% 4.1% 2.5% 1.1% 0.5%

35-44 290 329 275 259 252 0.9 2.6 1.4 1.4 2.0

45-54 638 603 548 544 548 0.9 1.0 0.0 -0.4 1.8

55-64 1,626 1,480 1,343 1,192 1,160 2.1 2.4 2.4 1.4 1.5

65-74 3,636 3,411 3,170 2,914 2,771 1.7 2.1 2.2 2.5 1.4

75-84 8,206 7,700 7,055 6,842 6,633 1.3 1.5 1.0 1.5 1.2

Population death rates are from the National Center for Health Statistics.

Product Matters! 25

TABLE 1.2Annual Mortality Improvement (Females) – U.S. Population

Death Rates per 100,000 Annual Rates of Improvement

Females

50%

Age 1987 1993 1997 2001 2003 1987- 1993- 1997- 2001- Scale

2003 2003 2003 2003 G

25-34 74 74 68 68 64 0.9% 1.4% 1.0% 1.5% 0.5%

35-44 135 145 135 148 147 -0.5 -0.1 -1.4 0.3 1.1

45-54 367 334 310 316 317 0.9 0.5 -0.4 -0.2 0.9

55-64 910 868 806 754 731 1.4 1.7 1.6 1.5 0.9

65-74 2,070 2,010 1,937 1,892 1,821 0.8 1.0 1.0 1.9 0.9

75-84 5,102 4,824 4,832 4,764 4,676 0.5 0.3 0.5 0.9 0.8

Population death rates are from the National Center for Health Statistics.

26 August 2005

A s you may now be aware, the dateand location for the SOA Annualmeeting have been changed to Nov.

13–16 in New York City. The ProductDevelopment Section is sponsoring 10sessions and a hot breakfast. Here is a briefdescription of the sponsored sessions.

Alternative Pricing Measures

Exploration of profit measures other thanthe statutory internal rate of return to assistin balancing competitive position and prof-itability in product pricing.

What’s New and Exciting withEquity-Indexed Products?

The value of equity-indexed products in aninsurer’s portfolio, the status of equity-indexed products as securities and marketchanges of equity-indexed products during2005.

Universal Life No-Lapse Guarantee Update

Review of regulatory activity in 2005 regard-ing Actuarial Guideline 38, market activityand progress of the American Academy ofActuaries’ UL Working Group.

Annuity Guarantee Costs: What’sthe Better Measure?

Debate of the techniques for pricing guaran-tees in annuities—real-world evaluation ofcosts as implicitly required under proposed

RBC and reserving standards versus marketconsistent approach.

Mortality at the Older Ages

Considerations for projecting mortality atolder issue ages including the length of selectperiod and the slope of mortality.

Stochastic Pricing

A case study of pricing annuities using astochastic pricing model and how this type ofanalysis relates to principles-based reservingand asset adequacy analysis.

Life and Annuity ProductDevelopment—Year in Review

Recent regulatory actions and initiatives,what’s hot (and what’s not) in product devel-opment, and predictions for the next year.

Product Innovation Around theWorld

Life insurance and annuity products avail-able abroad as sources for creativity andinnovation in United States and Canadianproduct design.

An Inside View of Life Settlements

The role of the actuary in the life settlementindustry.

Reinsurance Market Landscape—From the Perspective of the Direct Writer

Overview of the current reinsurance marketincluding capacity, price satisfaction, reten-tion shifts and alternatives to first dollarreinsurance. Partnering with reinsurers todevelop treat language and procedures forunderwriting exceptions, audits and claimsadjudication.¨

What’s Ahead—2005 SOA Annual Meeting in New York

Announcements

SOA05ANNUAL MEETING & EXHIBIT

W e are looking for one or morevolunteers to help put togetherfuture issues of this newsletter,

with the possibility of taking over one ormore issues. You get a lot of freedom indeciding what goes into the newsletter(except the section chairs, who like to havetheir columns published as written). There isa lot of satisfaction in actually completing anissue, which contrasts with some othercommittee work that I have been involvedwith where the works goes on for years with-out end. If you are interested, please contactme at: doug.doll@towersperrin.com.¨

Product Matters! 27

C ongratulations to the newly renamedMarketing and Distribution (MAD)Section, fresh off it’s Board of

Governor’s approved name change (formerlycalled the Non-traditional Marketing (NTM)Section). What does this change mean? Thinkof it as NTM-Plus. MAD will continue to coverall the topics and distribution channels histor-ically covered by NTM. Its overall focus,however, has expanded to reflect the increas-ing role marketing plays in today's financialservices environment and to underscore theneed for actuaries to be marketers along withthe other valuable roles they already fill. As a

part of the change, the section has adopted thefollowing mission statement:

“The Marketing and Distribution Sectionfosters research and innovation in distribu-tion methods of financial services productsand in the inter-relationship of marketingstrategies with product design, underwritingand operations.”

Be a part of taking this section into thefuture! For further information, please feelfree to contact Rob Stone, Marketing andDistribution Section chair, at rob.stone@oneamerica.com or Section Vice-Chair VanBeach at van.beach@milliman.com.¨

Actuaries Gone MADby Rob Stone

Robert P. Stone, FSA,

MAAA, is AVP of individual

product development with

One America Financial

Partner Companies in

Indianapolis, Ind. He can

be reached at rob.stone@

oneamerica.com.

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