U.S. GAAP - Chapter 4 - TRADITIONAL LIFE INSURANCE (SFAS 60 AND SFAS 97)

Overview

non-par trax fixed-premium policies
F60 products need to be classified as short or long duration contracts
short-dur - fixed period of short duration
- insurer can cancel contract or adjust provisions
  - ex. P&C (most) and some term life (like credit life)
long-dur - generally not subject to unilateral changes in provisions
- focus of chapter

Product Features

Normal stuff here WL/Endow/Term

Benefit Reserve Methodology

short-dur - different chapter
long-dur
- prems as revenue when due
- net GAAP reserves accrued when prem revenue is recognized
  - based on assumptions applicable at issue
- unpaid claims and claim adj expesed accrued when insured event occurs
- loading - diff between gross and net prem - portion of gross prem that emerges as profit
- if no loss recognition or loading, net prem a constant percent of gross prem

Expense Recognition

Acquisition costs s/b capitalized and charged to expense in proportion to prem revenue recognition
other expenses charged as incurred
can only defer expenses to the degree they don't create a loss in later years (recoverability)
thorough discussion in chapter 3
DAC - hold as deferred cost on asset side of balance sheet (negative reserve)
using an inflation assumption on maint costs WOULD generate a maint exp reserve
for limited-pay policies, establish reserve for maint expenses incurred after prem pay period

Selection of Assumptions

GAAP Assumption Eras
- era where assumptions are appropriate for new issues
  - sometimes known as a "ratebook"
Provisions for Adverse Deviation (PADs)
- s/b included when setting assumptions
- broad guidance as to level of PADs
- same product @ 2 different cos w/ identical experience
  - ultimate profitability same, but emergence will be split between level % of prem and release of PADs
  - likely different between two companies
- ASP10 provides some guidance
  - two types of assumptions
    - best estimate assumptions - s/b reasonable
    - PADs - the riskier the assumption, the higher the PAD
      - should not raise net prem > gross prem
- 1994 Audit Guide
  - PADS will cause profits to emerge from release of risks
    - in relation to NAR
    - invested funds or investment income
    - w/d in relation to excess of (benefit reserve - unamort acq expense) over CV
    - expenses less than estimated
    - profit in premium
  - PADs should apply to interest, mortality, w/d & settlement expenses
    - "reasonable and realistic"
- Investment Earnings Rate
  - typically assume declining int rate in later policy durations
  - F60 - based on estimates of inv yields expected at issue
    - shoudl be consistent w/ co portfolio
- Mortality and Morbidity Rates
  - PADs typically 5-10% above best estimate
  - expected mortality @ issue + PADs
  - f60 - include risk of anti-selection
  - GAAP actuary need to be aware of projected improvements Pricing Actuary is using
- Lapse Rates
  - be careful of lapse supported policies - PADs are backwards from normal
  - best-estimate w/o PADS may be good enough
    - or PADs added in such a way that % prem profits decrease at all durations (vary PAD by dur)
- Expenses
  - Ch 3 for most expense info
  - No PADs for commissions since a controllable expense - we know the rates
- Taxes
Lock-In
- Assumptions locked at issue
- some co's use factors and others use first-principles
  - results calced from inforce
  - not considered a violation of lock-in concept
Loss Recognition
- Prem deficiency may result if experience emerges diferent from assumed
- prospective loss on a group of contracts = prem deficiency
- F60 - prem deficiency recognized as charge to income
  - reduction of DAC or increase in future policy benefit liab
  - future changes in liab based on revised assumptions
- adjust when first becomes apparent
- ASOP10 - use best estimate assumptions when testing for loss (no PADs)
- based on grouping of policies
- F60 amt of prem def = gross prem reserve - GAAP net reserve
Numerical Examples p. 81

Limited-Payment Contracts

income from limited pay contracts s/b recognized over period benefits are provided, not period payments collected - F97
all other aspects same as F60
F97 Limited Pay - life - ins in force as profit carrier
- annuity - expected future benefit payments
profits emerge as level % of ins in force vs % of prems (f97 vs f60)
Deferred Profit Liability (DPL) established (aka Unearned Revenue Liab/Unearned Profit reserve/unreleased profit reserve)
Limited-Pay numerical example - pp. 95-97

Participating Products

if NOT using contribution principle - use F60 methodology
policyholder dividends a component of GAAP benefit reserve
level and slope of PO divs also affect GAAP benefit NP
divs an expense when incurred
UPPEA - Undistributed Par PO Earning Account
- where profits in excess of what can be dividended to stockholder are put
ASP10 describes distribution of this $
example p. 99

Indeterminate Premium Products

F97 - if policy is not essentiall a UL, treat it as F60
assumptions may be "unlocked" at gross premium change dates - ASP10
- if adjusted, done prospectively, w/o change in liab as of valn date
Indeterminte Premium Method (aka Prospective Unlocking)
- Res(t) = PVB(t) - PVP(t) t-> reporting date
- Res(t) = PVB'(t) - PVP'(t) = PVB'(t) - GP'(t)*level%'*Ann'(t)
- same applies to maint reserves and DAC
- if level% > 100, loss recognition testing s/b performed

Implications of Reserve Formula Selection

Benefit Reserves
- Terminal Benefit Reserve
  - TBR(t) = [(TBR(t-1)+NP(t))*(1+i) - DB(t)*q_d(x)*(1+i)^(1/2) - CV(t)*(1-q_d)*q_w] / [(1-q_d)*(1-q_w)]
  - TBR(0) = 0
- lapses a significant part
  - std practice -> policies only lapse on prem due date
- Final Reserve - reserve the moment before terminal (just before lapses assumed)
- FBR(t) = [(TBR(t-1)+NP(t))*(1+i) - DB(t)*q_d(x)*(1+i)^(1/2)] / (1-q_d)
- Mean Benefit Reserve MBR(t) = 1/2*(TBR(t-1) + NP(t) + TBR(t))
- MidTerminal Reserve midBR(t) = 1/2*(TBR(t-1) + TBR(t))
- sometimes use FBR(t) for end of year in above two formulas
- if MRB used, non-annual polices need a deferred prem assest
- if midBR used, unearned prem liability
Expense Reserves
- same concept as benefit reserves
- Terminal Expense Reserve - TER(0) = 0
  - TER(t) = [(TER(t-1)+Pol(t)+GP(t)*(Comm(t)+PT(t))-NP(t))*(1+i)] / [(1-q_d)*(1-q_w)]
- FER(t) - same at TER(t) but w/o (1-q_w) term - analagous to FBR
- MER(t) = 1/2*(TER(t-1) + Pol(t) + GP(t)*(Comm(t)+PT(t))-NP(t) + TER(t)) - Mean Expense Reserve
- similar to def prem asset, cost of collection liability - typically just the comm and PT payable on gross def prems
- midER(t) = 1/2*(TER(t-1)+Pol(t)+TER(t))
- similar to unearned prem loab, EUP asset - generally comm * PT payable on gross unearned premium

Copyright © 2004 Steve Welander.
Permission is granted to copy, distribute and/or modify this document under the terms of the GNU Free Documentation License, Version 1.2 or any later version published by the Free Software Foundation; with no Invariant Sections, no Front-Cover Texts, and no Back-Cover Texts. A copy of the license is included in the section entitled 'GNU Free Documentation License'.