Copyright © 2008 by the American Academy of Actuaries CAS Spring Meeting June 16, 2008 Dave Sandberg, Chair American Academy of Actuaries Solvency and Risk Management Committee June 18, CAS Quebec City Introduction to PBA: An Overview of a Principle-Based Approach to Life Reserves and Capital

Copyright © 2008 by the American Academy of Actuaries CAS Spring Meeting June 16, 2008 Outline US History & Current Status Compare & Contrast US & Solvency 2 Concluding Observations on ERM & Regulation of Solvency

Copyright © 2008 by the American Academy of Actuaries CAS Spring Meeting June 16, 2008 History of Valuation 1858 Massachusetts Legislation Commissioner to calculate reserves on all policies of all licensed Companies Actuary Elizur Wright appointed commissioner Wright selected Net Level Premium Reserve Method and Combined Experience (1843 British) Mortality Table and 4% Interest Rate Controversial decision of immense importance

Copyright © 2008 by the American Academy of Actuaries CAS Spring Meeting June 16, 2008 While Risk-Focused Exams are effective January 1, 2010 in US there is no requirement for life risk focused financial reporting. Standard Valuation Law State Statute & Regulations plus Actuarial Guidelines Risk-Based Capital Statute: References NAIC RBC Instructions Regulations Financial Statement Filing Statute: References NAIC Accounting Practices and Procedures & NAIC Blanks Regulations Examination of Financial Condition Statute: References NAIC Examiners Handbook Regulations: Annual Examination by Independent CPA

Copyright © 2008 by the American Academy of Actuaries CAS Spring Meeting June 16, 2008 Definition of Principle-based Approach Captures all of the identifiable, quantifiable and material risks, benefits, and guarantees associated with the contracts 2. Utilizes risk analysis and risk management techniques to quantify the risks; this may include stochastic models 3. Allows the use of company experience to establish assumptions for risks over which the company has some degree of control or influence 4. Uses assumptions and methods that are consistent with, but not necessarily identical to, those utilized within the company’s overall risk assessment process

Copyright © 2008 by the American Academy of Actuaries CAS Spring Meeting June 16, 2008 Evolution of PBA Asset Adequacy Testing Equity Indexed Annuity Regulation RBC C-3 Phase I RBC C-3 Phase II Proposed Actuarial Guideline VACARVM Proposed Valuation Manual Proposed RBC C-3 Phase III

Copyright © 2008 by the American Academy of Actuaries CAS Spring Meeting June 16, 2008 Needed Regulatory Changes For PBA Reserve requirements, two changes are needed: 1. Update the current Standard Valuation Law (and the respective valuation laws of each state) to enable principle- based reserves (PBR) 2.Create a new Valuation Manual to define the detailed PBR requirements For PBA Capital requirements, changes can be made through the existing process to update the RBC requirements

Copyright © 2008 by the American Academy of Actuaries CAS Spring Meeting June 16, 2008 Changes to Standard Valuation Law Major Challenges to proposed SVL Changes 1. Will state insurance departments be willing to give up some of their control in order to achieve uniformity? 2. Will state legislatures be willing to delegate to the NAIC the authority to make future changes to reserve requirements? 3. Will the industry support the experience reporting and independent review process?

Copyright © 2008 by the American Academy of Actuaries CAS Spring Meeting June 16, 2008 Valuation Manual Objectives  Implement principle-based reserves (PBR)  Provide reserve requirements in one place (both PBR and non-PBR valuations)  Provide reporting requirements in one place  Construct Valuation Manual so that the APPM can use the same requirements  Enhance uniformity and efficiency by coordinating with APPM to achieve one exposure and one adoption process

Copyright © 2008 by the American Academy of Actuaries CAS Spring Meeting June 16, 2008 Valuation Manual The Manual will also include: Definition of principle-based reserves The process to update the manual PBA reserve disclosure and reporting requirements PBA experience reporting requirements Coordination with APPM (Accounting Practices and Procedures Manual)

Copyright © 2008 by the American Academy of Actuaries CAS Spring Meeting June 16, 2008 Possible NAIC Timeline By June/Sept 2008 NAIC meeting: NAIC Plenary Adoption of Amended SVL NAIC Plenary Adoption of Valuation Manual 2009 State Legislative Sessions: Introduce Amended SVL and Valuation Manual

Copyright © 2008 by the American Academy of Actuaries CAS Spring Meeting June 16, 2008 Overall Possible NAIC Timeline By December 2010 NAIC meeting: NAIC Plenary Adoption of Revised Valuation Manual NAIC Plenary Adoption of Accounting and Blank Changes NAIC Plenary Adoption of Examination Changes NAIC Plenary Adoption of Financial Analysis Changes NAIC Plenary Adoption of Corporate Governance NAIC Plenary Adoption of RBC Changes

Copyright © 2008 by the American Academy of Actuaries CAS Spring Meeting June 16, 2008 US vs. EU

Copyright © 2008 by the American Academy of Actuaries CAS Spring Meeting June 16, 2008 Objectives ' The solvency system should be designed in such a way that it gives incentive to the supervised institutions to measure and properly manage their risks'' EU Commission - Framework for consultation, June Develop a reserve methodology for life insurance products that results in a reserve that is closer to economic reality. 2. Have an approach that allows the company to develop a reserve that matches its risk, thus reducing the need to game the system. 3. Have a method that results in more comparability with financials in other countries. Commissioner Hampton to ACLI Board – Oct. 2007

Copyright © 2008 by the American Academy of Actuaries CAS Spring Meeting June 16, 2008 Similarity of U.S. and International Frameworks Report true risk Blend of company and market experience Auditable and verifiable Uniformity Establishment of control levels Practical Options Disclosure of margin in assumptions

Copyright © 2008 by the American Academy of Actuaries CAS Spring Meeting June 16, 2008 Differences between U.S. and International Frameworks Scope U.S. framework is more product & risk specific Time Horizon International looks at both long-term and short term U.S. looks long-term, using greatest present value Basis U.S. is book-value based (similar to asset valuation) International is market-value based

Copyright © 2008 by the American Academy of Actuaries CAS Spring Meeting June 16, 2008 Difference between U.S. and International Frameworks (cont.) Governance Neither jurisdiction has decided how to “recognize” other regulatory jurisdictions, nor finalized its own governance requirements International recognizes governance may be country-specific U.S. is considering a centralized approach that is integrated with the financial examination process Regulatory tool/safeguard Means to develop consistent use of assumptions Measurement Metrics U.S. is fairly consistent – e.g., CTE(90) for TAR over life of Business and only for Life business 99+% for one year time horizon for all insurance lines

Copyright © 2008 by the American Academy of Actuaries CAS Spring Meeting June 16, 2008 What is Still to be Resolved for Solvency II? Passage by European Parliament Prior consultation to understand impact Regulators - Legal jurisdictional rights related to Group lead supervisors Less country specific guidance - leave uniform at CEIOPS level Specific Incentives for use of internal models When to use capital add-ons and how much to require? Credit for geographic diversification Implications on Taxation Issue of small companies & use of standard formulas

Copyright © 2008 by the American Academy of Actuaries CAS Spring Meeting June 16, 2008 US Key Issues (per Commissioner Hammond to ACLI Board Fall 2007) 1. Adoption by States & Uniformity 2. Phase-in Process –New Products Only 3. Governance 4. Coordination with Capital Requirements 5. Analysis & Examinations –more like P&C 6. Training of Personnel 7. Data Collection 8. Federal Taxes 9. Small Company Issues

Copyright © 2008 by the American Academy of Actuaries CAS Spring Meeting June 16, 2008 Structure of Pillar 2 & 3 Requirements for Insurance Regulation Still a New Topic 1. Banking Community has spend last 10 years on this topic. 2. Insurance Solution should not copy the banks, but we will need to go through a similar process to get to what works best for insurance. 3. FSA report on 2006 Principle Based Self Reporting

Copyright © 2008 by the American Academy of Actuaries CAS Spring Meeting June 16, 2008 Implications 1. ERM – Is it just diversification? (Bigger is Better) Or is it creating a learning based reporting and management culture? 2. Can ERM be used to manage the regulatory process as well?