Session 21 PD, A Pricing Actuary's Perspective on PBR, 2017 CSO and Profit

Moderator:

William Gus Mehilos, FSA, MAAA

Presenters: Genevieve D. Knight, FSA, MAAA

Gerald Nicholas Sontheimer III, FSA, MAAA Andrew G. Steenman, FSA, MAAA

SOA Antitrust Disclaimer SOA Presentation Disclaimer

MAY 7, 2018

Andrew Steenman, FSA, MAAA2018 Life & Annuity Symposium: Session 21

A Pricing Actuary's Perspective on PBR, 2017 CSO, and Profit

LimitationsThe content of this presentation represents the views of the presenter and not those of Milliman.These slides have been prepared for the educational use of meeting participants. There are no intended

beneficiaries of this work. This presentation may not be distributed, disclosed, copied or otherwise furnished to any additional party

without our prior written consent. Any distribution of this presentation must be in its entirety.The presented information is intended to be valid as of the date it has been prepared. Its future validity

depends on the further development of market events, regulations, and standards of practice.This presentation is not intended to contain material that represents an actuarial opinion. The

professionals responsible for preparing this report are members of the American Academy of Actuaries and meet the Qualification Standards of the American Academy of Actuaries.

VM-20 and 2017 CSOIntroduction

VM-20 and 2017 CSO are here!!!Effective January 1, 20173 year transition period (January 1, 2020)

Principle-based reserves2017 CSO Table

References Valuation Manual (NAIC adoptions through 8/29/2016)

http://www.naic.org/documents/committees_a_latf_related_valuation_manual_noapf_160829.pdf AG-48:

http://www.naic.org/documents/committees_ex_pbr_implementation_tf_related_actuarial_guideline_ag48.pdf 2017 CSO Tableshttps://www.soa.org/experience-studies/2015/2017-cso-tables/

2017 CSO Tables14 sets of tables (94 unique tables) on SOA websiteLoaded vs UnloadedComposite vs Smoker-DistinctGender-Blended vs Gender-DistinctPreferred StructureSelect and UltimateAge Nearest Birthday and Age Last Birthday table versions

SOA Website for 2017 CSO

14 Excel FilesFrom:

https://www.soa.org/experience-studies/2015/2017-cso-tables/

SOA Website for 2017 CSO

Unloaded (2015 VBT Rolled Forward)3 Excel Files

SOA Website for 2017 CSO

Loaded11 Excel Files

SOA Website for 2017 CSO

Smoker-Distinct9 Excel Files

SOA Website for 2017 CSO

Composite5 Excel Files

SOA Website for 2017 CSO

Gender-Distinct8 Excel Files

SOA Website for 2017 CSO

Gender-Blended6 Excel Files

SOA Website for 2017 CSO

Tables Likely of Interest Loaded Smoker-Distinct Loaded Preferred Structure

High Level Comparison to 2001 CSO

High Level Comparison to 2001 CSO – Early Ages

High Level Comparison to 2001 CSO – Ratios

2017 CSOPricing Considerations

2017 CSO Pricing ConsiderationsTraditional Products: Premium RatesUniversal Life: COI RatesReservesSNFLIRS Section 7702Filings:ContractActuarial MemorandumVariability MemorandumRates

IRS Section 7702 – Mortality AssumptionHow does 2017 CSO impact 7702?7702(c)(3)(B)(i):

“reasonable mortality charges that meet the requirements (if any) prescribed in regulations and that (except as provided in regulations) do not exceed the mortality charges specified in the prevailing commissioners’ standard tables (as defined by section 807(d)(5)) as of the time the contract is issued”

Subject to company interpretationNext slides provide sample generic calculations based on CSO Ultimate tables without expenses

IRS Section 7702 – CVAT Generic Example

IRS Section 7702 – Guideline Single Premium Example

Standard Non-forfeiture Law - ExamplesNAIC Standard Non-forfeiture Law (SNFL) in 1948Calculation to set minimum cash value for traditional productsNAIC Universal Life Model Regulation in 1994For Universal Life, application of SNFL is to set a maximum surrender charge.For illustrative purposes of Universal Life, we are showing generic calculations based on CSO ultimate tables and assume level charges for the first 20 years so the full expense allowance is amortized.

SNFL Whole Life – Generic Example

SNFL Universal Life – Generic Example

ConclusionsConsider all the aspects of 2017 CSOSample test key cells or issue age ranges where possibleAdjust product rates or structure to measure impactsOutcomes may vary by cellPossible outcomes that effect pricing and profitability:Higher minimum cash valuesLarger corridor factors – affecting cash value to death benefit ratioLower GLP, GSP, and MEC premiums

VM-20Some Considerations

NPR for ULSGNPR for ULSG is greater of* reserve under Section 3.B.5 and reserve under Section 3.B.6Section 3.B.5Ignores secondary guaranteeReserve = Funding Ratio * [ PV(Ben) – PV(NP) – UnamortEA ]

Section 3.B.6Focuses secondary guaranteeReserve = Funding Ratio * PV(Ben) – UnamortEA

*floored at max of cash value and amount to cover charges until next period

ULSG NPR Funding Ratio under Section 3.B.6Funding Ratio= Actual Secondary Guar / Fully Funded Secondary GuarSpecified Premium designsActual Secondary GuaranteeFully Funded GuaranteeVM20 funding ratio is based on cumulative premiumAG38 funding ratio is based on excess premiumsCauses Funding Ratio under VM-20 to be higher than under AG38NAIC working group (is?) was reviewing (no APF at slide due date)

ULSG NPR Funding Ratio: Specified Premium ExampleGeneric Policy with Hypothetical Unitized ValuesIssued as 65 year-old female, currently in policy year 10

Funding RatiosAG38 200 / 350 = 57.1%VM-20 450 / 600 = 75.0%

Actuals at t=10Accumulated Premium: $450Accumulated Excess Premium: $450 - $250 = $200

Accumulated Minimum Required Premium at t=10: $250Fully Funded basis at t=10

Required Premium: $600Excess Premium: $600 - $250 = $350

Example: ULSG NPR under Section 3.B.6

Deterministic Reserve Analysis

Other PBR ConsiderationsReinsurancePotential SimplificationsSensitivitySmall Company ExemptionImpact on Tax Reserves

Andrew Steenman

Thank you

andrew.steenman@milliman.com

2018 SOA Life & Annuity SymposiumGENNI KNIGHT, FSA, MAAASession 21, A Pricing Actuary's Perspective on PBR, 2017 CSO and Profit May 7, 2018

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Presentations are intended for educational purposes only and do not replace independent professional judgment. Statements of fact and opinions expressed are those of the participants individually and, unless expressly stated to the contrary, are not the opinion or position of the Society of Actuaries, its cosponsors or its committees. The Society of Actuaries does not endorse or approve, and assumes no responsibility for, the content, accuracy or completeness of the information presented. Attendees should note that the sessions are audio-recorded and may be published in various media, including print, audio and video formats without further notice.

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ProductsSingle Premium Whole LifeFinal Expense Whole LifeTerm (5-yr level, to age 90)Fixed Rate Worksite ULEquity Indexed UL

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Where to Start

Simplest ProductsUse existing model – add PBR codingAdapt PBR coding to other products

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Challenges – PBR New softwarePBR set-up may coincide with conversionLearning software and PBR simultaneously

Entirely new reserving methodLearning ins & outs is time intensiveNot conducive to quick check

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Challenges – PBR (cont’d)Uncertainty surrounding assumptionsMargins (lapses, expenses)Valuation mortality table (industry – SI)Mortality credibility/gradingDR discount ratesExclusion tests – scenariosAsset set-up

Staying grounded

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Results/Observations – PBRWhole LifePassed SET and DET => hold NPRSimilar profitability metrics

TermVM20 NPR favorable compared to XXX DR was negative

ULDR has substantial negative impact on

profitabilityDiscount rates, expenses are drivers

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Challenges – 2017 CSOSI table – indefinite timelineTimeline for filing/implementationWait until SI table available?Proceed with fully U/W 2017 CSO table, re-file when SI table adopted?

2017 CSO does not track with 2001 CSOGCOI’s, nonforfeiture values, reserves

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Lessons LearnedStart earlyCoordination between pricing/valuationDriven/sponsored at senior mgmt level

Document!Educating non-actuarial areas about impact

of requirements

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A Pricing Actuary’s Perspective on PBR, 2017 CSO and Profit

Financial Reinsurance Considerations

SOA 2018 Life & Annuity SymposiumMay 7, 2018

Gerald “Nick” Sontheimer FSA, MAAAActuary, PricingGlobal Financial SolutionsRGA

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Presentation Disclaimer The content of this presentation represents the views of the presenter and

not those of RGA. This material has been prepared for general informational purposes only and is not intended to be relied upon as accounting, legal, tax, or other professional advice, nor is it an Actuarial Opinion.

This presentation may not be distributed, disclosed, copied or otherwise furnished to any additional party without prior written consent from RGA. Any distribution of this presentation must be in its entirety.

The presented information is intended to be valid as of the date it has been prepared. Its future validity depends on the further development of market events, regulations, and standards of practice.

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Overview

“How do PBR and 2017 CSO affect the way actuaries will view financial reinsurance as a tool in product pricing and development?”

Common types of financial reinsurance structures and uses in product development and management

What are the key impacts of 2017 CSO, and especially of PBR

PBR and Financial Reinsurance

Adapting to a changing environment

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Definition

Financial reinsurance refers to reinsurance arrangements where the primary purpose is the achievement of a specific business objective such as increasing statutory surplus, reducing taxes, or acquiring blocks of business.1

1. John E. Tiller, Life, Health, & Annuity Reinsurance, Third Edition

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Financial Reinsurance Overview

Some rules-based formulas can be excessively redundant• XXX, AXXX, deficiency reserves• Capital factors (ex. C-4 RBC on single premium)

Financing method affects profit• Internal – opportunity cost of capital• External – market price for financing

Demand Drivers for Financial Reinsurance

Redundant reserves and capital are costly

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Financial Reinsurance OverviewPotential Benefits

Better pricing returns on new business1

More competitive premium rates2

Reduced new business strain 3

Greater capital efficiency on in-force business4

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Financial Reinsurance Overview

Third-party Reinsurance• Business ceded to an unaffiliated reinsurer• Typically use an authorized or certified reinsurer• Utilizes the reinsurers balance sheet to provide reserve and/or capital relief

Affiliated (Captive-based) Reinsurance• Reinsurer is an affiliate of the ceding company• Typically not accredited – reserve credit often comes from permitted practice• Subject to special regulations such as Actuarial Guideline 48 (AG48)• Primary used for financing redundant XXX/AXXX reserves

Two Common Structures

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Third-party Financial Reinsurance

Common Features

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Financial Reinsurance Structures

For life products, typically use coinsurance treaties• Pass statutory risk transfer• Provide reserve credit

Usual features• Initial ceding commission commensurate with desired reserve relief or new business strain• Modified Coinsurance (ModCo) reserve or Funds Withheld (FWH) • Experience refund of profits for some period of time

o Net of profits used to amortize reliefo Net of a risk fee passed to reinsurer

• Option to recapture by ceding companyo After relief is amortizedo If experience refunds are withheld by reinsurer

• Net cash settlements collapse to risk fee

Third-party Reinsurance Description

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Financial Reinsurance Structures

• Time 0 Net Product Cash Flows (a) 15k initial premium net of 5k commission• ModCo Adjustment is ModCo interest credit less the increase in the ModCo reserve• Relief amortizes by EOY 5, and net settlement is just risk fees paid to reinsurer

Third-party Reinsurance Simplified Example (Co/ModCo)

TimeTotal Stat

ReserveModCoReserve

Coins Reserve (“Relief”)

Net Product Cash Flows

(a)

ModCoAdjustment

(b)

Experience Refunds

(c)

Net Settlements(a) + (b) – (c)

0 15,000 10,000 5,000 10,000 -10,000 0 0

1 15,000 11,000 4,000 1,000 -500 450 50

2 15,000 12,000 3,000 1,000 -450 510 40

3 15,000 13,000 2,000 900 -400 470 30

4 15,000 14,000 1,000 900 -350 530 20

5 15,000 15,000 0 800 -300 490 10

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Third-party Financial Reinsurance

Impacts of 2017 CSO and PBR

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Impacts to Financial Reinsurance

No material change to third-party reinsurance structure

Reserve impact• Typically reduce reserve, redundancy• Tax impact

Other impacts• COI charges on UL• Guaranteed rates on YRT

2017 CSO Third-party Reinsurance

Similar impacts as when previous CSO tables released

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Impacts to Financial Reinsurance

Statutory reserve is now max of:• Net Premium Reserve (NPR)• Deterministic Reserve (DR)• Stochastic Reserve (SR)

Exclusion tests for DR and SR

Each reserve calculated pre-reinsurance and post-reinsurance• Pre-reinsurance winning method not necessarily post-reinsurance winner• Consider ways financial reinsurance can impact each reserve

PBR VM-20 Overview

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Impacts to Financial Reinsurance

NPR is rules-based• For most life products, NPR is based on previous CRVM• New formula for term & ULSG, but still rules-based

Reinsurance reserve credit still applies as before PBR – SSAP No. 61R• Pass “risk transfer” rules to allow reserve credit• Reserve credit is reinsurance quota share of pre-reinsurance NPR

Reinsurance structures that were effective before PBR will generally still be effective with the NPR

PBR VM-20 Net Premium Reserve

Many familiar concepts carried over

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Impacts to Financial Reinsurance

DR & SR are principle-based• Calculated based on modeled cash flows (“modeled reserves”)• Prudent estimate assumptions determine cash flows

Reinsurance reserve credit also principle-based• Still need to pass “risk transfer” rules to be eligible for reserve credit• Reserve credit NOT necessarily reinsurance quota share of pre-reinsurance reserve

Effectiveness of financial reinsurance depends on many variables

PBR VM-20 Modeled Reserves

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Impacts to Financial Reinsurance

Modeling of reinsurance cash flows1

• Must model all treaty cash flows between ceding company and reinsurer• Assume counterparties are knowledgeable about contingencies in the treaty and will take

actions to their advantage (ex. recapture)

Assumptions and margins1

• Reinsurance cash flows should be consistent with the assumptions and margins used in calculating the underlying cash flows

• Ceding company and reinsurer can and will have different assumptions and margins

To generate modeled reserve credit, PV of future cash flows to ceding company needs to exceed PV of future cash flows to reinsurer• Future cash “in” lowers the reserve• Future cash “out” increases the reserve

PBR VM-20 Modeled Reserves Key Considerations

1. VM-20 Section 8.C

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Impacts to Financial Reinsurance

Case 1: Valuation cash flows are materially different than expected• Ceding company opts not to recapture in valuation path• Assume reinsurer eventually makes net cash payments to ceding company• Reserve credit generated by reinsurance treaty

Case 2: Valuation cash flows are not sufficiently different than expected• In valuation path, reinsurance cash flows are just risk fees• Ceding company assumes it has sufficient incentive to recapture• Post-reinsurance reserve will be higher than pre-reinsurance for ceding company

o Underlying product cash flows haven’t changedo Reinsurance has just added risk fees to reserve cash flows

PBR VM-20 Modeled Reserve Impacts

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Impacts to Financial Reinsurance

Financial Reinsurance – Ceding Company Perspective

Case 2 Example - Single Premium UL Co/FWH

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Third-party Financial Reinsurance

Looking Forward

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Financial Reinsurance Looking Forward

Example 1 – Capital Relief Only• No reserve relief needed• RBC is still factor-based for life products

Example 2 – Relief on NPR• Modeled reserves exclusion tests are passed, or• NPR is winning reserve

o Redundancy in CRVM• Expense allowance limit on 10 Pay Whole Life• CSV minimum on front-loaded UL plans with ROP

o High credibility/low margins on modeled reserveso Goal to finance excess of NPR over modeled reserves

Uses for Third-party Reinsurance after PBR

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Financial Reinsurance Looking Forward

Example 3 – Relief on modeled reserves• Modeled Reserve is winning reserve

o Low credibility/high marginso Inefficient expense or asset allocations

• Cede to reinsurer with highly credible and efficient modeled reserve assumptionso Ceding company and reinsurer use different valuation paths

• Relief would “amortize” as ceding company’s experience becomes more credible

Uses for Third-party Reinsurance after PBR

Leverage data and expertise of reinsurer

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Financial Reinsurance After PBR

Modeling considerations• Including financial reinsurance structure• Stress scenarios• Simplifications are allowed, if justifiable

Treaty development becomes iterative process• Changes to reinsurance structure may impact reserves• Changes to reserves may impact structure• Increase collaboration between pricing actuaries at ceding company and reinsurer

PBR & Third-party Reinsurance Challenges

Robust and flexible modeling capabilities are key

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Financial Reinsurance After PBR

“So how will pricing actuaries view financial reinsurance in light of 2017 CSO and PBR?”

Non-issue to some• When NPR is the main reserve, use for financial reinsurance may not be materially impacted

Challenge to others• Providing relief on PBR modeled reserve is complicated by traditional third-party reinsurance

methods• Modeling requirements are more rigorous

Opportunity• Demand will still exist to improve pricing by more efficiently financing reserves & capital• Modeling tools and techniques are more powerful than ever, and getting better• Solutions of the past can be leveraged to shape the successes of tomorrow

Final Thoughts

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