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