1. What’s Next in Store for PBR? Dave Neve, FSA, MAAA, CERA Vice President, Capital Management - Aviva USA Chairperson, American Academy of Actuaries Life Financial Soundness / Risk Management Committee

2. Overview 1.Update of Valuation Manual Adoption 2.PBR Review and Updating Process 3.Outstanding VM-20 Issues 4.VM-22 Update 5.Overview NAIC Implementation Plan 6.Implementation Issues and Challenges 7.PBR Implementation Resources

3. Valuation Manual Adoption Process 1.NAIC Adoption Revisions to the Standard Valuation Law (SVL) were completed and adopted by the NAIC in 2009 NAIC adopted the Valuation Manual in December of 2012 Culmination of over 8 years of work on VM-20, the principle-based reserve requirements for life products 2.Next Step: Legislative approval of SVL by states. VM becomes operative January 1 following the first July 1 in which the following occurs: Adoption by 42 states (out of 56 jurisdictions, or 75%) Adoption by enough states that represent at least 75% of industry direct premiums in 2008 3.Work will continue to revise the VM during the legislative approval process 4.Timeline: earliest operative date is probably January 1, 2016

4. PBR Review and Updating Process 1.A well-conceived and designed PBR Review and Updating Process (formerly referred to as a "PBR Feedback Loop") is essential to ensure that there is an ongoing evaluation of the effectiveness of the PBR methodology and prescribed assumptions defined in the Valuation Manual. 2.The Academy developed a proposal that provides a summary of the importance, purpose, and goals of such a process. 3.A key element of the PBR Review and Updating Process is providing support to state insurance regulators regarding the necessary expertise, resources, data, and tools to effectively review PBR models and reporting for products subject to PBR requirements. 4.LATF adopted the Academy proposal (with some modifications) in section VM-00 of the Manual.

5. Process to Update Valuation Manual 1.Changes to the valuation manual shall be effective on January 1 following the date when the changes have been adopted by the NAIC by an affirmative vote representing both of the following. a)At least three-fourths (3/4) of the members of the NAIC voting to approve, but not less than a majority of the total membership, and b)Members of the NAIC representing jurisdictions totaling greater than 75% of the direct premiums written as reported in annual statements that are most recently available prior to the vote. 2.A significant change in the process, since all future reserve changes will be decided by the NAIC, not by states. 3.However, a state still has the authority to impose their own reserve requirements if they don’t support the changes to the Valuation Manual.

6. NAIC Support of Valuation Manual 1.Support of the VM by the NAIC is mixed. NAIC vote to adopt the VM passed by only one vote (43 out of 56). New York has publically stated their opposition to the adoption of the VM. 2.Expect NY to lobby keys states to defeat the proposed SVL revision authorizing the Valuation Manual 3.Concerns with PBR raised in letter from NY Superintendent Lawsky on 11/26/12 –PBR reserving in the banking sector proved disastrous –Under PBR, reserves will decrease, increasing risk of insolvency –It is not clear that a PBR regime will benefit consumers –Regulators are ill-equipped to implement and oversee PBR –Even if rule-based approaches has it shortcomings, does not mean PBR is necessarily the answer.

7. Outstanding VM-20 Issues 1)Aggregate Margin to replace individual margin 2)Investment Return on Starting Assets 3)Credibility Method for Mortality Assumptions 4)98% - 102% collar on starting assets

8. Aggregate Margin VM-20 currently requires a margin on each individual assumption. Due to concerns on the impact of individual margins on the reserve from the NAIC Impact Study, a proposal to permit the use of an aggregate margin was submitted to LATF in early 2012. Due to timing issues, LATF deferred the decision on the use of an aggregate margin until after adoption of the Valuation Manual by the NAIC. LATF has formed a subgroup, chaired by Mark Birdsall of Kansas to study the issue LATF has asked the Academy to develop a recommendation on the use of an aggregate margin. The Academy formed a Task Force, chaired by Patricia Mattson, to make a recommendation. Proposal to determine an aggregate margin using a cost of capital approach was submitted by the Academy several years ago, but rejected by LATF. Goal is to submit recommendation to LATF before the end of 2013.

9. Concerns with Individual Margins 1.Per assumption margins are time-consuming to set and in many cases involve a high degree of judgment. 2.Poses the challenge of how to incorporate correlation between risks. In practice, quantifying such correlation is time consuming, onerous and rarely done or, if done, is performed on a very approximate basis. 3.The cumulative individual margins are likely to produce a distorted picture of the cumulative uncertainty associated with the set of modeling assumptions, thereby producing overly conservative reserves. 4.It is very difficult to determine appropriate margins on certain policyholder behavior assumptions, such as premium pattern assumptions, and allocation between available investment funds. 5.Establishing assumptions for NGEs is problematic under an individual margin approach since the margin in each individual assumption represents adverse experience that the NGE assumptions are designed to mitigate

10. Requires that a “Best Estimate” Reserve be Defined in VM-20 Explicit and implicit margins in VM-20 would need to be removed from the current stochastic and deterministic reserve calculations. These include: 1.Mortality assumption –Eliminate both sets of prescribed margins (the percentages applied to company experience rates and the percentages applied to the industry basic table). –Eliminate the prescribed grading to an industry table –Permit the use of mortality improvement beyond the valuation date, using the company’s anticipated experience assumption for mortality improvement. –Eliminate the required adjustment to modify mortality assumptions for term polices following the end of a level term period. 2.Policyholder behavior assumption –to modify lapse assumptions for term polices following the end of a level term period. Eliminate the explicit margin requirement applied to the anticipated experience assumption. –Eliminate the prescribed use of the Canadian lapse table for ULSG products. –Eliminate the required adjustment

11. Best Estimate” Reserve (cont.) 3.Revenue sharing assumption –Eliminate the explicit margin requirement applied to the anticipated experience assumption. –Eliminate the prescribed caps (i.e. haircuts) on net revenue sharing income. 4.For all other prudent estimate assumptions, eliminate the explicit margin requirement that is applied to the anticipated experience assumption. 5. Asset default assumption –For assets with an NAIC designation: o Modify the baseline annual default cost factors to base the cost factors on historical mean industry experience, rather than basing them on a 70 CTE metric. o Eliminate the maximum net spread adjustment. –For assets without an NAIC designation, eliminate the requirement that the net yield be capped at 104% of the applicable Treasury yield rate,.

12. Best Estimate Reserve (cont.) 6.For reinvestment spread assumptions, eliminate the cap that is based on a 50/50 blend of A2/A and Aa2/AA net asset spreads 7.Interest rate and equity return assumptions –For the deterministic reserve, use Scenario 9 from the set of prescribed scenarios used in the stochastic exclusion test (baseline scenario with no shocks), rather than Scenario 12 (deterministic scenario that assumes one-standard deviation shocks for the first 20 years). –For the stochastic reserve, replace the CTE 70 metric with a CTE O metric, so that the resulting reserve is based on the mean reserve from the distribution of stochastic outcomes, not the amount based on the “worst 30%” stochastic outcomes.

13. Aggregate Margin: Approaches Being Considered 1. Cost of Capital method 2. Confidence Interval method 3. Simple percentage method 4. Stress Testing 5. Pure Exit Value method 6. Adjustment to discount rate

14. Starting Assets 1.New York has expressed concerns over use of low investment grade assets to increase the discount rate and lower reserves in VM-20 PBR calculations. 2.New York is exploring the use of a cap on the return of starting assets –Equal to current “A” market spread for each asset (similar to AG38, section 8D) –Discussions took place with the ACLI and the Academy in late 2012 3.At the December LATF meeting, the American Academy of Actuaries reviewed the requirements in this portion of VM-20 to address these concerns, and the history behind the process to develop the requirements, and areas that provide some address of New York’s concerns. 4.American Council of Life Insurers (ACLI) has prepared proposals to address these concerns. 5.Further discussion and examples of calculations on these proposals will be discussed at April LATF meeting.

15. VM-20 Mortality Calculation 1.Determine mortality segments (Subsection 9.C.1.a). 2.Determine company experience rates (or use applicable industry table) 3.If the company determines company experience mortality rates, determine the applicable industry table for each mortality segment to grade company experience to the industry basic table. 4.Determine the level of credibility of the underlying company experience the credibility maybe at either the mortality segment level or at a more aggregate level 5.Apply prescribed mortality margins. Separate mortality margins are determined for company experience mortality rates and the applicable industry basic tables. 6.Grade company experience to an industry table using a prescribed grading table based on the level of credibility of the data.

16. Credibility Methodology for Mortality 1.VM-20 does not prescribe the credibility method 2.Mortality requirements for the credibility calculation a.For valuations prior to 1/1/2015, the methodology must follow common actuarial practice as published in actuarial literature (for example but not limited to the Limited Fluctuation Method or Panjer method). b.For valuations after 1/1/2015 the level of credibility shall be determined such that the minimum probability is at least 95% with an error margin of no more than 5% (which are parameters use in the Limited Fluctuation Method). 3.The 95% / 5% credibility requirements may need to be revised/redefined to apply to other methods. 4.LATF plans to form a subgroup to study the overall mortality methodology, with an emphasis on credibility requirements.

17. VM-22: PBR for Fixed Annuities LATF has asked the Academy’s Annuity Reserve Work Group (ARWG), chaired by Jim Lamson, to develop an initial draft of the PBR requirements for fixed annuities The ARWG is developing a proposal that will include: A stochastic principle-based component A prescribed deterministic floor based on modifying AG33 An exclusion test for the stochastic component The ARWG has set a target date of delivering a proposed framework to LATF during 2013

18. NAIC Implementation Plan NAIC has prepared a discussion draft (available on NAIC website). Key elements of plan: 1.Regulatory Support for PBA Review –NAIC Actuarial Staff Support –Actuarial Analysis Working Group (AAWG) 2. Defining Statistical Data 3.Standardized Financial Reporting and Analysis Tools 4.PBR Asset Spread Data 5.Training 6.Accreditation

19. NAIC Implementation Plan – ACLI comments Comments from the ACLI: 1.Need to develop a high level outline of the topics, issues and questions that need to be addressed, followed by a series of issue papers that provide additional granularity about each topic. Two draft issues papers were submitted: –State regulatory review process –Process for changes to Valuation Manual 2.Regulator should assume the role of lead state 3.External peer review of reserves should be required. 4.Recommend creation of a new NAIC subgroup, the Valuation Manual Working Group (VMWG) that is charged with maintenance of the Valuation Manual.

20. NAIC Implementation Plan – Academy comments Comments from the Academy 1.Resources are needed to address two concerns: –Support state review of individual company reserves –Evaluate the overall effectiveness of the PBR methodology at large 2.Greater emphasis is needed to evaluate the overall effectiveness of the PBR methodology. Essential elements include: –Sanitization of confidential data –Periodic progress reports –Evaluation of capital requirements –Definition of stakeholder roles

21. PBR Implementation: What Can I do Now? Leverage: Risk Management process to identify and measure material risks in products; Model Audit Rule controls and procedures for assumption setting and model controls Asset Adequacy tools for Stochastic and Deterministic reserves Begin Testing: Impact on reserves by duration, product features. Efficient modeling techniques. Communication & Processes: Actuaries – Pricing and Valuation Management Board External

22. Key Elements Needed to Implement PBR 1.Cash flow liability model 2.Selecting approach to model assets Left up to company to decide what approach to use Company can use actual assets of the company, or simplified proxy assets. 3.Determining assumptions Some set by the company Some prescribed by regulators 4.Deciding whether or not to perform Exclusion Tests (are optional)

23. Impact of PBR on Pricing 1.Currently, total reserves are known up-front & throughout the pricing process. Under PBA, reserves are company specific and dependent on product 2.Need early and ongoing interaction with valuation team 3.Issues to address Include all liability cash flows? Do you have one model for all product features and riders or have separate models been used? Are all material liabilities being modeled? Use prudent estimate assumptions are Subject to individual subjectivity Will likely need to develop a proxy reserve for pricing purposes.

24. Document, Document, Document Documentation is extremely important. Basis for assumptions, especially those that deviate from experience Level of margins in assumptions and methodology for margin development Approach to grouping and segmentation within model Scenario development Exclusion tests Actual to expected relationships for assumptions Controls/governance on models Benchmark modeled results to actual results Independent peer review

25. Resources: Life PBR Practice Note Work Group to prepare a draft PN has been formed, chaired by Todd Erkis, to update initial draft prepared several years ago Q&A format that addresses practical issues on implementation Goal: document industry practice. This is difficult since VM-20 is not in place yet (and may still be changing somewhat). Objective is to put in a range of practice believed to be appropriate Not binding Goal is to complete first draft for comment by mid-2013

26. Resources: Discussion Draft of PBR ASOP An ASB Task Force led by Frank Irish is developing a draft ASOP to provide guidance to actuaries on PBR ASB has authorized the Task Force to distribute a Discussion Draft (not an Exposure Draft) Expect the Discussion Draft to be completed in early 2013 The Task Force expects to create an Exposure Draft after discussions with interested parties.

27. Resources: SOA Research on PBR Implementation New research initiated by SOA Financial Reporting Section Objective: utilize current literature, studies and experience to provide a resource that outlines key considerations for a company implementing PBA Not designed to duplicate practice notes Sample of issues to be addressed (not complete): How large a staff is needed? What system modifications may be needed? What data will be required? What information may be needed by external auditors? What are good control processes ?