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Comfortable with your Reserves? Session 9: February 27, 2006 Session Producer: Mark Press, FSA, MAAA Gen Re LifeHealth.

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Presentation on theme: "Comfortable with your Reserves? Session 9: February 27, 2006 Session Producer: Mark Press, FSA, MAAA Gen Re LifeHealth."— Presentation transcript:

1 Comfortable with your Reserves? Session 9: February 27, 2006 Session Producer: Mark Press, FSA, MAAA Gen Re LifeHealth

2 ACTUARIALACTUARIAL ACTUARIALACTUARIAL 2 Panelists Judy Hanna, ASA, MAAA Consulting Actuary, Ernst & Young Allen Schmitz, FSA, MAAA Consulting Actuary, Milliman Mark Press, FSA, MAAA Actuary, Gen Re LifeHealth

3 ACTUARIALACTUARIAL ACTUARIALACTUARIAL 3 Comfortable with your Reserves? Long Term Care Active & Disabled Life GAAP Considerations February 27, 2006 Judith Hanna, ASA, MAAA Ernst & Young, LLP

4 ACTUARIALACTUARIAL ACTUARIALACTUARIAL 4 Agenda Active Life Reserves (“ALR”) and Deferred Acquisition Costs (“DAC”) Recoverability and Loss Recognition Testing Prospective Unlocking Disabled Life Reserves

5 ACTUARIALACTUARIAL ACTUARIALACTUARIAL 5 Active Life Reserves and Deferred Acquisition Costs

6 ACTUARIALACTUARIAL ACTUARIALACTUARIAL 6 LTC Classification: FAS 60 Long Duration Contracts Provides insurance protection over an extended period The contract generally is not subject to unilateral changes by the insurer

7 ACTUARIALACTUARIAL ACTUARIALACTUARIAL 7 ALR & DAC Assumptions Assumptions needed for: morbidity salvage investment earnings termination mortality deferrable and maintenance expenses

8 ACTUARIALACTUARIAL ACTUARIALACTUARIAL 8 ALR & DAC Assumptions Assumptions must be consistent with experience at the time policies are issued* Assumptions must contain mild provision for adverse deviation Assumptions must be “locked-in” at issue* * more on prospective unlocking later

9 ACTUARIALACTUARIAL ACTUARIALACTUARIAL 9 ALR Benefit Reserves Benefit Net Premium = The portion of gross premiums required to provide for all benefits (including inflation options and surrender benefits) and maintenance expenses Year 1Year 5 Gross Premium (annual)1,000 650 PV Benefits & Maintenance Expenses/PV Premiums (at issue) = 4,847 / 6,606 = 73.4% x Gross Premium = Net Premium 734 477

10 ACTUARIALACTUARIAL ACTUARIALACTUARIAL 10 ALR Benefit Reserves Prospective View Year 1Year 5 PV of benefits & maintenance expenses 4,7774,120 - PV of net premiums(4,360)(2,980) = Benefit Reserve4171,140

11 ACTUARIALACTUARIAL ACTUARIALACTUARIAL 11 DAC Represents unamortized balance of deferrable acquisition expenses

12 ACTUARIALACTUARIAL ACTUARIALACTUARIAL 12 DAC DAC Amortization Rate = The percentage of gross premiums (calculated at issue) required to provide for deferred policy acquisition expenses PV of Deferrable Expenses1,300 PV of Gross Premiums6,606 Amortization Rate19.7%

13 ACTUARIALACTUARIAL ACTUARIALACTUARIAL 13 DAC DAC Expense Charge = The portion of gross premiums required to provide for deferrable acquisition expenses Year 1Year 5 DAC Amortization Rate19.7%19.7% x Gross Premium 1,000 650 = Expense charge 197 128

14 ACTUARIALACTUARIAL ACTUARIALACTUARIAL 14 DAC Rollforward View Year 1Year 5 Beginning DAC 0 882 + Deferrable expense1,300 0 - DAC expense charge (197) (128) + Interest accrual66 45 = Ending DAC1,169 799

15 ACTUARIALACTUARIAL ACTUARIALACTUARIAL 15 Recoverability and Loss Recognition Testing

16 ACTUARIALACTUARIAL ACTUARIALACTUARIAL 16 Recoverability Testing Testing is performed on current year’s issues Is the block of business profitable enough to recover deferrable expenses? Deferrable costs are limited by – PV of premiums less benefits and maintenance expenses Non-recoverable costs may not be deferred, even if product eventually becomes more profitable

17 ACTUARIALACTUARIAL ACTUARIALACTUARIAL 17 Loss Recognition Testing Can think of it as recoverability testing after issue Basic principle: probable future losses must be anticipated – PV future GAAP profits may not be negative Need to decide on what defines a block of business to be tested. Multiple years’ issues, products, etc. can be aggregated

18 ACTUARIALACTUARIAL ACTUARIALACTUARIAL 18 Loss Recognition and Recoverability Assumptions Best estimate assumptions w/o PADs Do not include overhead expenses Once in loss recognition, these new best estimate assumptions are locked in Consider consistency with Statutory Asset Adequacy Testing

19 ACTUARIALACTUARIAL ACTUARIALACTUARIAL 19 Shadow Loss Recognition Testing EITF D-41 Adjust certain balance sheet items assuming that unrealized gains and losses on Available for Sale (AFS) securities are realized Generates consistency in the balance sheet Cushions the impact of movements in valuations caused by interest rate movements Only occurs in declining interest rate environments


21 ACTUARIALACTUARIAL ACTUARIALACTUARIAL 21 FAS 60 Prospective Unlocking Exceptions to “lock-in” principle are rare: Guaranteed renewable A&H, Indeterminate premium non-par life Method for Unlocking: – Lock-in current benefit reserve, DAC – Recalculate net premiums prospectively – Considers actual or expected increases Supporting References – Cloninger, TSA 1981 Vol.33 – Ernst & Ernst GAAP Stock Life Companies, Chapter 19 Individual Health Insurance, Guaranteed Renewable Business – ASOP 10, Paragraph 3.7.2 – US GAAP, SOA, 2006, Chapter 10 Individual Health Insurance, Section 10.7



24 ACTUARIALACTUARIAL ACTUARIALACTUARIAL 24 DLR Assumptions FAS 60 guidance for termination rates: FAS 60, paragraph 18, states “Changes in estimates of claim costs resulting from the continuous review process and differences between estimates and payments for claims shall be recognized in income of the period in which the estimates are changed or payments are made.” SEC guidance for interest rates for certain types of P&C coverages: SAB 62, Section N interpretative response references rates that are used “…for reporting to statutory authorities” or rates that are “…reasonable on the facts and circumstances applicable to the registrant at the time the claims are settled.”

25 ACTUARIALACTUARIAL ACTUARIALACTUARIAL 25 Comfortable with your Reserves? Allen J. Schmitz, F.S.A. Milliman Inc.

26 ACTUARIALACTUARIAL ACTUARIALACTUARIAL 26 Reserve Testing Active Life Reserves Disabled Life Reserves

27 ACTUARIALACTUARIAL ACTUARIALACTUARIAL 27 Discuss One Approach… Why is this one Approach Important?

28 ACTUARIALACTUARIAL ACTUARIALACTUARIAL 28 You Have To Do It ! Part of the New LTC Experience Forms

29 ACTUARIALACTUARIAL ACTUARIALACTUARIAL 29 LTC Experience Forms What is Changing? Why / When Change? Form I, II, III Implications and Uses

30 ACTUARIALACTUARIAL ACTUARIALACTUARIAL 30 What is Changing? Current: Form A – Claim Experience by Calendar Duration Form B – Cumulative Claim Experience Form C – State Specific Form B New: Form I – Actual Claims and Persistency Against Expected Form II – Ratio of Experience Reserve to Reported Reserve Form III – Claim Runout

31 ACTUARIALACTUARIAL ACTUARIALACTUARIAL 31 What is Changing? (continued) Current Forms: Form A – Claim Experience by Calendar Duration Form B – Cumulative Claim Experience Form C – State Specific Form B Pricing Basis Loss Ratio Focus “Expected” Based on Original Pricing – Distribution of Business – Persistency

32 ACTUARIALACTUARIAL ACTUARIALACTUARIAL 32 What is Changing? (continued) New Forms: Form I – Actual Claims and Persistency Against Expected Form II – Ratio of Experience Reserve to Reported Reserve Form III – Claim Runout Valuation Basis Pricing and Reserve Adequacy Focus “Expected” Based on Actual – Distribution of Business – Persistency Sample Calculations

33 ACTUARIALACTUARIAL ACTUARIALACTUARIAL 33 Why / When Change? Why? New Model Regulation – No longer Loss Ratio Focus Regulatory Request AAA When? 2007 Experience Year

34 ACTUARIALACTUARIAL ACTUARIALACTUARIAL 34 Form I Purpose / Description: Track Claims and Persistency Against Expected Group Separate from Individual Three Policy Form Categories: – Comprehensive – Institutional – Non-institutional Policy Form Level Information Should be Kept Direct Basis Accelerated Benefits


36 ACTUARIALACTUARIAL ACTUARIALACTUARIAL 36 Form I Collected Premiums +Change in Due Premiums –Change in Advanced Premiums –Change in Unearned Premium Reserves =Earned Premiums Column 1 – Earned Premiums


38 ACTUARIALACTUARIAL ACTUARIALACTUARIAL 38 Form I Valuation Expected Incurred Claims – Exposure Adjustment: [Actual Number of Lives Inforce at Beginning of Year – (Expected Deaths + Expected Lapses) ÷ 2] ÷ Actual Number of Lives Inforce at Beginning of Year

39 ACTUARIALACTUARIAL ACTUARIALACTUARIAL 39 Form II Purpose / Description Calculate Ratio of Experience Reserve to Reported Reserve Experience Reserve Developed from: 1)The experience reserve at the end of the prior reporting year (E-1) 2)Valuation net premiums and interest rates, and 3)Experience incurred claims, earned premiums, and actual persistency.

40 ACTUARIALACTUARIAL ACTUARIALACTUARIAL 40 Form II Experience Reserve to Reported Reserve


42 ACTUARIALACTUARIAL ACTUARIALACTUARIAL 42 Form II Column 13 – Experience Policy Reserves

43 ACTUARIALACTUARIAL ACTUARIALACTUARIAL 43 Form III Claim Reserve Adequacy Similar to Schedule O – But LTCI Only Track Development for 8 Incurred Years Split Between Individual and Group Require Individual Claim Data

44 ACTUARIALACTUARIAL ACTUARIALACTUARIAL 44 Parts of Form III Part 1 Paid Part 2 Cumulative Paid & Claim Reserves Part 3 Transferred Reserves Part 4 PV of Incurred Claims Direct Only (Including Purchased Business)

45 ACTUARIALACTUARIAL ACTUARIALACTUARIAL 45 Part 1 Payment Triangle Total (Direct and Transferred) Amount Paid Policyholders Incurred Year 20012002200320042005200620072008 Prior 2001 2002xxx 2003xxx $23,93 3 $414 2004xxx $6,44 0 $41,73 0 $11,28 0 2005xxx $517$10,08 0 $12,56 4 $11,345 2006xxx 2007xxx $12,74 0 $24,480 2008xxx $13,608

46 ACTUARIALACTUARIAL ACTUARIALACTUARIAL 46 Part 2 Cumulative Claim Triangle Incurred Year20012002200320042005200620072008 Paid 2004xxx $6,440$41,730$11,280 Cumulative Paid 2004xxx $6,440$48,170$59,450 + Claim Reserves 2004xxx $43,097$95,678 = Cumulative Paid Plus Reserves 2004xxx $49,537$143,848$59,450

47 ACTUARIALACTUARIAL ACTUARIALACTUARIAL 47 Part 2 Cumulative Claim Triangle Sum of Total Amount Paid Policyholders and Claim Liability and Reserve Outstanding at End of Year Incurre d Year20012002200320042005200620072008 2001$3,427$ 0 2002xxx4,958000000 2003xxx 131,327118,95824,347 2004xxx 49,537143,84859,450 2005xxx 40,46131,96332,39135,026 2006xxx 9,52100 2007xxx 93,641129,110 2008xxx 93,051

48 ACTUARIALACTUARIAL ACTUARIALACTUARIAL 48 Part 4 Interest Adjusted Development Interest Adjusted Development of Incurred Claims - Assume No Transfers Incurred Year20012002200320042005200620072008 2001$3,3 52 $ 0 $3,352 2002xxx4,851000000 2003xxxXxx128,727112,63424,067 104,660 2004xxx 48,529135,86756,632 (8,104) 2005xxx 39,58630,15829,93132,0507,536 2006xxx 9,31400 2007xxx 81,958122,045(40,087) 2008xxx 93,051

49 ACTUARIALACTUARIAL ACTUARIALACTUARIAL 49 Implications / Uses Form I Review Actual vs. Valuation Expected Claims Review Open and New Claims Review Actual vs. Expected Persistency

50 ACTUARIALACTUARIAL ACTUARIALACTUARIAL 50 Form II Review Experience Reserve vs. Reported Reserve Experience Reserve Formula: Implications and Uses

51 ACTUARIALACTUARIAL ACTUARIALACTUARIAL 51 Form II Experience Reserve Formula: If claims lower than expected Reported Reserve < Experience Reserve Conclusion? Implications and Uses

52 ACTUARIALACTUARIAL ACTUARIALACTUARIAL 52 Form III Claim Reserve Adequacy More Frequent Adjustments of Claim Reserves Ranking of Companies Implications and Uses

53 ACTUARIALACTUARIAL ACTUARIALACTUARIAL 53 Monitoring Tool Effort / Work – Learning Curve Transparency – Claim Reserves – Contract Reserves – Ranking of Companies Implications and Uses

54 Comfortable with your Reserves? Miscellaneous Topics and Observations With Respect to Analyzing Reserve Adequacy Mark H. Press, FSA, MAAA GenRe LifeHealth February 27, 2006

55 ACTUARIALACTUARIAL ACTUARIALACTUARIAL 55 Considerations at the Outset A.How do you define reserve adequacy? B.What tests are you performing and how often are they being performed? C.What level of margins are in your reserves? D.Are you perhaps ignoring critical Information or “shooting yourself in the foot” when setting reserves? E.If you find yourself potentially under reserved how do you manage to the theoretically correct level?

56 ACTUARIALACTUARIAL ACTUARIALACTUARIAL 56 Surprise, Surprise, Surprise A.Claim Reserves: May appear adequate in the aggregate but upon closer inspection there may be underlying issues that warrant additional analyses. B.IBNR Reserves: Various techniques are used but ultimately may misstate what’s really happening and result in additional margins being held. C.Active Life Reserves: Possible “black-box” effect with regard to a vendor’s actuarial system which can lead to additional margins and / or deficiencies.

57 ACTUARIALACTUARIAL ACTUARIALACTUARIAL 57 Claim Reserve Adequacy Unpleasant Surprises Abound Analysis of a closed cohort projected out x months and compared to a current listing may very well determine how well your continuance assumptions are holding up in general. But…

58 ACTUARIALACTUARIAL ACTUARIALACTUARIAL 58 Claim Reserve Adequacy Unpleasant Surprises Abound A distinction of claims open less than 1 year and those open greater than 1 year may lead to disturbing results on longer term claims. Rate of payment per unit of exposure: Affects how long a pool of money might be available if current benefit levels are and have been something less than the daily benefit amount. Claim experience for stand alone plans may vary significantly in comparison to integrated products.

59 ACTUARIALACTUARIAL ACTUARIALACTUARIAL 59 Claim Reserve Adequacy Unpleasant Surprises Abound

60 ACTUARIALACTUARIAL ACTUARIALACTUARIAL 60 Claim Reserve Adequacy Unpleasant Surprises Abound Claim management practices / programs recently implemented may allow for reserve adjustment on new claims but may not for claims already open. Potential changes in care path need to be considered when setting these reserves but are they? Claims that do change status may be viewed as new when they are really continuing. The definition of your incurral date needs to be consistent with your actuarial assumptions. Policies written without “hard edges” may be prone to additional and longer durational claims.

61 ACTUARIALACTUARIAL ACTUARIALACTUARIAL 61 IBNR Adequacy Are You “Shooting Yourself in the Foot?” Reported amounts typically a function of either a durational loss ratio factor times earned premium or some other plug number. But…

62 ACTUARIALACTUARIAL ACTUARIALACTUARIAL 62 IBNR Adequacy Are You “Shooting Yourself in the Foot?” Periodic look backs to measure actual to reported IBNR claims may yield few unreported claims and may result in additional margins. Consistency within the claims department as to when a claim is considered IBNR and when it is considered DLR critical for future A/E studies. Some actuarial projection systems may not be measuring IBNR at the start of the projection appropriately. This in turn may unnecessarily cause the actuary concern if future PVANYD amounts appear inadequate when compared to actual amounts at a later valuation date.

63 ACTUARIALACTUARIAL ACTUARIALACTUARIAL 63 IBNR Adequacy Are You “Shooting Yourself in the Foot?”

64 ACTUARIALACTUARIAL ACTUARIALACTUARIAL 64 ALR Adequacy The Potential “Black Box” While licensed actuarial systems develop factors at the cell level do you know what’s happening “behind the scenes” and how these factors make things appear at the cohort level? For instance…

65 ACTUARIALACTUARIAL ACTUARIALACTUARIAL 65 ALR Adequacy The Potential “Black Box” Affect Some projection systems don’t explicitly adjust exposure for lives going on claim and, therefore, project additional incurrals in the future which would lead to holding ALRs higher than necessary.

66 ACTUARIALACTUARIAL ACTUARIALACTUARIAL 66 ALR Adequacy The Potential “Black Box” Affect An example to illustrate reserve levels with and without an implicit adjustment to exposure or claims costs Assumptions – Female aged 52 – Plan Type: LTC, 0-day EP, Lifetime, No Inflation – Mortality: 1994 GAM w/ improvement – Lapse: 1.0% ultimate – Morbidity: 3 rd party claims costs – Interest: 4.5% – No PADs


68 ACTUARIALACTUARIAL ACTUARIALACTUARIAL 68 ALR Adequacy The Potential “Black Box” Affect GAAP Issue – Although a system will levelize a model cell from issue, a projection of a closed block will show continued deterioration when examining the interest adjusted benefit loss ratio due to unisex pricing as the subsidization of women by men wears off. – Even if all assumptions are accurate, it will appear to management that results are deteriorating as additions to the GAAP ALR increase as a percentage of earned premium in each duration.

69 ACTUARIALACTUARIAL ACTUARIALACTUARIAL 69 ALR Adequacy The Potential “Black Box” Affect Assumptions for Sample Cohort 2 cell cohort: 1 Male aged 72 and 1 Female aged 62 Plan Type: LTC, 0 day EP, Lifetime, No inflation Mortality: 1994 GAM w/ improvement Lapse: 1.0% ultimate Morbidity: 3 rd party claims costs Interest: 4.5% No PADs Interest Adjusted Benefit Loss Ratio: The ratio of incurred claims plus change in reserve divided by earned premium adjusted for interest earned on the reserves being held.


71 ACTUARIALACTUARIAL ACTUARIALACTUARIAL 71 Final Thoughts 1.Reports. It’s a good idea to have several types of reports to help keep you on track. a.Reported vs. Plan: YTD, QTD and Month. A-to-E progression of reserve and other items will give you a birds-eye view of how your blocks are performing in comparison to your models. b.Inforce Statistics Report: Periodic review of persistency. If lives are persisting longer than projected, all else being equal, your reserves may be in trouble. c.[GAAP Val Prem ] / GP should be a good bogey as to what your interest adjusted loss ratios should be on a block of policies. 2.Data. Make sure you can get the data you need in a timely manner to prepare your analysis. If there are changes to the data process make certain you’re comfortable with them before moving forward with your valuation work. 3.“Granularity”. Try and analyze your plans by as many characteristics as possible as some plan types will drive your reserve levels (and bottom line results) more so than others.

72 ACTUARIALACTUARIAL ACTUARIALACTUARIAL 72 Final Thoughts 4.Valuation Models: Revisit, Refine, Re-Test. The reserves you develop are a function of your models. Take time to revisit, refine and re-test to make sure your projected results are consistent with your expectations. 5.Documentation. Recording your process will help expedite the next iteration and give your auditors an additional level of comfort when they come to visit.


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