8I-U - Product Development

Life and Health Marketing (LOMA) - Chapter 11 - PRODUCT DEVELOPMENT

Product Innovations

Major Innovations - new prduct that meets needs not addressed before by other products
Start-up Businesses - new product for a mkt served by a similar product
New Prroducts for Currently Served mkts - new product for co, but product avail from other cos
Prodcut Line Extensions - new product forms adn items to existing product line to give customers wider choice
Product Modifications - characteristic changed ot allow competitive advantage over similar prod
Style Changes - alter appearances or tangible aspects (ie logo change)

Product Development Process

5 basic steps - after first 3 steps (each one) decide continue/abandon/refine
Product Planning/Business Analysis/Tech Design/Implementation/Monitor & Review
Product Planning
- Idea generation
- Screening
  - two potential screening errors
    - - potential of a good idea underestimated and idea rejected
    - - poor idea looks deceptively attractive and pursuded, wasting resources
  - may use a screening critera checklist to help objectively screen
    - - compatible w/ corp goals and strategic inititiatives
    - - will prodcut enhance copr image
    - - does a need exist in target market
    - - can current prodcut be modified to meet this need
    - - will product generate new sales or shift sales
    - - mkt potential large enough to generate enough business to make product profitable
    - - can product be mkted through existing methods
    - - support a level of commissions that will motivate slaes force
    - - can current systems handle the product
    - - will target mkts understand the product
    - - would it be more attractive if offerred thorugh a sub
  - Concept Testing - measures acceptability w/o actually producing items
    - - helps determine how customers would compare product ot existing products
    - - what sets of benefits/attributes customers like most
    - - which ideas are unacceptable in the mktplace
    - - which target mkt to taimfor
  - Field Advisory Council - group of agents to test new ideas on for feedback
Comprehensive Business Analysis
- Mkt Analysis - study of environmental factors that might affect sales
  - - potential value of product ot customers
  - - nature adn size of target mkt
  - - potential value of product to company
  - - nature of products competition inthe mkt
  - - customer appeal of product
  - - appeal of product to distributors
  - - products relationship to other products offered by co
  - - potential legal/regulatory problems w/ product
  - - special tax considerations
  - - economic considerations
  - - product/company fit
- Product Design Objectives - products basic characteristics/features/benefits/issue lmits/u/w classes/etc
- Feasibility Study - operational & technical viability of producing/offering/admin of product
- Mktg Plan - outlined in C 5
- Prelim Sales & Fin Forcasts
- If analysis indicates good potential, product proposal prepared for mgmt
- Product proposal typically details
  - - product objectives - product description
  - - mktg strategy - mktg fit
  - - fin fit - inv fit
  - - systems fit - scope of product implementation
  - - legal/regulatory
Techical Design
- writing contract/actuarial assumptions/rate structure/benefit levels/issue u/w standards
- usually several revisions utnil compromise reached
- prod dev process flow/timeline/budget assembled
- all put together and presented to management
- areas involved
  - Mkts/Distributors/IS/Actuarial/Investments/Admin/Acctg/Legal-Compliance
Implementation
- establishing admin structure adn processes necessary to take product to market
- 3 concurrent activities
  - - obtain necessary legal approvals
  - - design promo & training materials
  - - develop IS systems/procedure to mkt & admin product
- Policy filing - dynamic process b/c state variations
- Design of Promotion and Training Materials - product naem, sales lit
  - need to get approval from legal on most materials
  - some might need state approvals
- Systems Activities
  - IS might need to buy/develop new systems to support product
  - usually takes greatest amount of time in process
- Product Introduction
  - offering new product for sale and having mktg and product support in place
  - Intro sales kit
    - - outline of product features and how they work
    - - desc adn sample of policy and fin statement insured will get each year
    - - table of issue and u/w limits
    - - commission scales
    - - table of premium rates
    - - list of possible mkts
    - - sample illustrations
    - - saels presentations
    - - suggested sales solutions for diff mkt situations
    - - samples of local and national advertising to intor product to public
    - - sample pre-approach letter adn/or postcards
    - - booklet about product for producer
    - - brocure about product to give to prospects
    - - prospectus (if req'd)
    - - sample app
    - - details on promo campaign
    - - privace disclosures
    - - instructions on how to access website for more info
  - Training classes
  - Incentive prizes/awards
Sales Monitoring and Review
- review PD cycle to see if time/budget met
- review sales to see if matching forecast - if not, attempt to determin why
- check fin results to see if goals met
- Product Modification
  - - s/b systematic as development for new products
  - - changes might occurr because of actual sales/profit experience
- Product Withdrawal
  - sometimes necessary b/c of legal regs
  - sometimes end of lifecycle or unprofitable
  - may meet resistance from agents
  - good to have an acceptable replacement product
  - review portfolio periodically to see if anything should go

Reinsurance - Tiller and Tiller - Chapter 4 - TRADITIONAL REINSURANCE

Yearly Renewable Term (YRT)

NAR Calc
- Level Term Policies
- Decreasing Term Policies
- Permanent Policies
- Universal Life
Retention Determination
- Pro Rata
- Level or Constant Retention
- Formula Retention
Premium Scales
- Normally Select and Ultimate
- often no first year premium (assists with surplus strain)
- can have negative first year premium to further offset production bonuses and the like
- reins prems often stated as percanetage of basic plan premium (or COI if IS)
- used to be experience rated
- normally policy year (vs calendar year) rate scales
- many UL on MRT basis
Premium Calculation
- YRT rate per thousand * reinsured NAR + substd + cession fee (rare)
- normally paid on an annual basis
- substandard normally a multiple
- tmep or flat extras normally coinsured
- ancillary benefits (WVR, GIO, Payor) typically coinsurance
- ADB usually YRT (rarely by age/duration) often on a bulk basis
Uses of YRT
- Trad Whole Life
- IS products (usually with no dur 1 premium and rates as pct of COI)
- custom scales often developed to match slope of term premium scale
- some DI benefits
Other Considerations
- Used to transfer only Mortality or Morbidity risks
- Typically lower profit objective since limited risk, therefore obtainable at lower cost than co or mod-co
- admin is fairly straightforward fo rfixed benefit products
- YRT does not provide relief from def reserves
- YRT premiums must be paid even if base policy goes under nonforfeiture (but amount may be adjusted)
See book (p75) for illustration

Coinsurance

coverage is same form as individual policy
reinsurer establishes proportionate share of policy reserves
- shares proportionately to excess mortality or morbidity, lapses, surrenders, etc.
Coinsurance Premiums and Allowances
- premium usually proportionate to gross premium
- for banded policies, can
  - - reins premium based on banded gross premium, then common set of allowances for all bands
    - most common and easiest to understand
  - - vary allowances by band
    - complicates admin but allows consistent margins by band
  - - reins prem and allowance for all bands is equal
    - simplifies admin, increases margin for ceding co on smaller band sales
- ceding co typically retains 100% of policy fee
- coins typically follows u/w (S/NS etc)
- sometimes allowances vary by age and/or sex
- can be experience rating
- sometimes first year allowance > 100%
Coinsurance Premium and Allowance Calculations
- allocances typically determined unique for each policy (product)
- typically paid on annual basis
- substd more complicated - vary by type of extra and length they apply
- WVR/GIO/Payor usually consured w/ generic allowances 75-85% 1st year, 10-15% renewal
- ADB usually flat rate YRT
Uses of Coinsurance
- can be used on anything
- for life, common on Term where very little CV buildup, therefore minimal investment risk
- used w/ CV products to pass strain or investment risk to reinsurer
Policyholder Dividends
- < 1990s, uncommon for reinsurer to share in PO divs
- may be a problem if big block w/ large portion ceded as co doesn't control those assets
- currently reinsurers SOMETIMES participate, but only in illustrated scale, not in up or down changes
- NY Reg 102 says reinsurer must participate in divs, including scale changes if ceding co wants reserve credit
Other Considerations
- reinsurers rarely participate in policy loans
- reinsurer typically remburses for premium taxes on ceded portion
- RPU - reins is adjusted and no further premiums paid
- ETI - no more prems, but coverage for appropriate duration
- sometime at ETI/RPU, reinsurer will pay CSV to ceded co and terminate reins
- reserve credits if reins is admitted/accredited
- will pass deficiency reserve as well as std reserves
- admin is relatively complex since need to calc prem, pay db, calc expense allowance, reserves and apyments of cash surrenders
Illustrations - p 89

Modified Coinsurance - ModCo

diff from coinsurance is stat vx on ceded portion is obligation of and held by ceding co
reinsurer has to fund reserve increases (less credit for investment income)
Origins - Unknown
ModCo Prems and Allowances
- similar to coins
ModCo Prem and Allowance Calculations
- similar to coins
- WVR/GIO/Payor typically coins even if base is ModCo
- ADB typically flat YRT rate
ModCo Reserve Adjustment
- Ening Policy Reserves - Beginning Policy Reserves - Interest on Beg Pol Vx
- if >0 reinsurer pays ceding co. If < 0, other way
- historically an annual calc
- currently (typically) quarterly
- ModCo Int rate is defined in treaty
  - - historically could be defined in terms of ceding co portfolio rate, rate of return on reinsured blocks assets, new money rate of return, or outside index
  - - sometimes a fixed rate
  - - if ModCo rate = ceding co rate of return, result to ceding co is same as if they used coins
  - - if ModCo rate = reins co rate of return, result to reins is same as if they used coins
  - cap g/l not shared w/ reinsurer
    - - NAIC model reg changes that since ALL significant risk must be transfered
Uses of ModCo
- primarily for products that develop CV - especially par
- in 80s, used to reduce FIT (transfered investment income to u/w income)
  - - tax law changes stopped that
Other Considerations
- Eliminates some problems w/ coins
  - - no Vx credit questions since ceding co maintains policy Vx
  - - eliminates problem of policy loan participation as well (same reason)
  - - ceded co has more control over investments
- Main drawback
  - more difficult to admin because of Reserve Adjustment Calculation
Illustrations - p 100

Reinsurance - Tiller and Tiller - Chapter 5 - FINANCIAL REINSURANCE

Uses of Financial Reinsurance

based on diffences in timing for stat of tax earnings and on stat Vx redundancy
usually structured so only cash that changes hands is for fees or risk charges
Surplus Relief
- most common
- to improve current stat earnings and surplus position
- creates an increase in stat surplus for ceding co in year relief is given
- repayment of relief tied to future cash flow or stat earnings on reinsured block, therefore not guaranteed
- since risk is less than if trad reinsurance, less risk charge
Tax Plannings
- not as much as before
- company cedes, creates a taxable gain, used to offset taxable loss
  - - useful if company hasexpiring tax loss carryforwards
- translates more commonly permanent than with surplus relief
- gain to ceding co is loss to reinsurer
- company might also assume reins to create a loss to offset a gain
- ceding co can usually terminate reins once inital gain repaid
- comany may ced/assume life/health to change co status to/from life/non-life company
Strategic Business Planning
- may wish to acquire reinsurance to
  - - increase future profits
  - - utilize excess admin capacity
  - - assist co in entering a new market
- may cede to
  - - exit a certain market
  - - financing in a LBO
- typically permanent in nature
- recapture typically not a provision
- normally assumption reinsurance

Terminology

Initial Reinsurance Premium
- typically = policy reserve
Allowances
- used to adjust effective amount of renewal premium
- initial allowance provides first year gain
- stated as % of initial premium, amt/unit coverage, or flat amt/trx
- renewal allowances may provide for ceding co commission/maint and adjust expected results to agreed upon level
- higher allowances => longer for reinsurer to recover intial strain
Risk Charge
- portion of reins premium retained (by reinsurer) for providing reins
- normally stated in terms of amt outstanding surplus/gain
- amt depends on
  - - nature of risks assumed
  - - size of trx
  - - reinsurer's profit objective
  - - mkt conditions at time of trx
  - - ceding co's stability
  - - tax considerations
  - - company relationships
  - - reinsurers expenses for analysis, administration, or intermediaries
- historically between 1 and 5% of outstanding surplus relief each year
Experience Refund
- mechanism to identify and return a portion of stat earnings on rens business to ceding co
- typically not paid until inital allowance is recovered (for fin reins)
- negative experience refunds are uncommon
  - - if part of treaty - usually disqualifies stat Vx credits
- loss deficit carryforwards (or similar provisions) OK as long as reinsurer can't terminate treaty to force ceding co into loss position
Outstanding Surplus Account
- used to track the defined portion of stat gains on business reinsured
  - - portion after risk charge, experience refund, and int accumulated on outstanding amount
- usually can't terminate treaty while this is in a deficit position (treaty says)
- ceding co can usually terminate treaty after deficit eliminated

Comparative Model - see book beginning p 112
Plans of Financial Reinsurance

YRT
- Vx is relatively small, therefore doesn't provide significant relief unless reinsured product also YRT
Uses of YRT
- most common: I/S Life product where reinsurer doesn't want to be involved in accum element
- if on YRT, typically create special YRT scale as % of policy prem rates
- if on YRT, little difference from coinsurance
- for surplus relief, most effective if reins prem scale has 0 1st yr prem
  - - chargebacks for lapses may be appropriate
- could be used where ceding co wants to minimize asset transfer
- OK for health policies, NOT annuities
Advantages
- limits reinsurer investment and lapse risk (no Vx or CV build-up)
- possibly lower ongoing cost than coins if risks limited to mort or morbid
Disadvantages
- low cash limits amout of possible future profits (therefore limits allowance/bonuses reinsurer can offer)
- allowance limits limit financial reins applications
- relatively difficult to admin IN FIN REINS situations (fin reins commonly admin on simplified basis & YRT does not work well w/ this type of admin)
- rarely used in financial reins applications

Coinsurance

Typical arrangement: inforce block, intial reins prem = Vx, reinsurer pays allowance which provides initial gain
- future years - allowance covers ceding co maint and commission expenses
Alt Arrangement: initial prem = initial Vx - desired gain
- renewal premiums defined w/o reference to policcy gross prem or specific expense allowance
- same effect as typical arrangement, just stated differently
Subsequest years - reins prems (net of allowances) used to
- pay claims
- fund Vx increases
- cover admin costs
- PADs
- included a charge to reimburse for year 1 investment
pricing done same as a product actuary used to develop product
current mkt highly competitive, therefore little PADs in pricing
larger allowances preferrable to experience refunds for most companies
in financial reins mkts, pricing not so precise
in fin reins - usually has exp refund feature
in fin reins - uses outstanding surplus account
Advantages
- simplest to admin on a quota share method
- regulators like because no question of risk transfer
Disadvantages
- primary - need to transfer assets
  - can be significant if large inforce block
  - if IS or Par, reinsurer has control over part of the div or int rate determination
- requires reinsurer to manage the assets, subject to additional investment risk
- if reins is terminated, reinsurer must transfer assets back and could generate g/l that could have a negative impact on financials
- loss of Vx credit if reinsurer not admitted
- additional insolvency risk to ceding co (ceding co responsible for claims even if reins is insolvent)
Coins Illustrations - text p. 122

ModCo

popular for fin reins since ceding co keeps reserve adn assets supporting reserves
typical arrangement: inforce block, prem = Vx on portion reinsured, ren prems = portion of gross prems, reinsurer pays allowance
anticipated gain at end of each accounting period
Advantages
- applicable to all plans of ins
- avoids need to transfer assets
- ceding co retains control of investment policy
- eliminated Vx credit problem
- reinsurer may deduct entire Vx increase for FIT even if Vx not otherwise qualified as tax deduction
- reinsurer avoids necessity of managing assets
Disadvantages
- more complicated to admin than coins because of mod-co adjustment
- special transactions for surrenders and death
- transfer of assets back to reinsurer @ treaty termination can create capital g/l for ceding co
Mod-Co Illustrations - text p 131

Funds Withheld Coins

looks like trad coins in many ways
impossible to tell difference when looking at intial stat gain
only difference in initial tranaction - reins retain allowance and ceding co retains intial prem
if allowance exceeds initial premium, reinsurer sets up an accounts payable item adn ceding co sets up accounts recievable asset
if initial premium exceeds allowance, reverse is true
in subsequent periods, account balance increase/decrease as profit emerges, surplus repaid, & reserves increase/decrease
no cash will change hands until initial account balance reaches zero
ceded co maintains assets underlying reserves, reinsurer holds reserves on fin stmt, therefore int adjustment like mod-co adjustment is made
Advantages
- no cash changes hands initially
- cash flow minimized throughout life of treaty
- lessens ceding co insolvency risk
- if reinsurer is non-admitted, ceding co can still take Vx credit up to amount of funds it is holding
Disadvantages
- more complicated than regular coins
- receivables and payables must be tracked carefully
- int adjustment for net account receivable (foregone int income)
- may still result in Vx credit problem if reins is non-admitted (but somewhat alleviate by amount of funds held)
Illustrations - text p 140

Funds Withheld ModCo

looks like ModCo in initial transaction
reinsurer retains initial allowance and creates payable item
ceding co sets up corresponding receivable item
Advantages
- reins retains initial allowance, therefore no need to liquidate assets to pay allowance
- reinsurer has lessened risk in event of ceding co insolvency
Disadvantages
- one more layer of complexity to admin of treaty
- mod-co adjustment further complicate b/c ceding co doesn't get cash
- special adjustment b/c interest not earned by ceding co on the allowance
- may be viewed as violation of Model Reg
Illustration - text p 148

Partially Modified Coins (PartCo)

Initial Coinsurance Vx = initial reinsurance allowance
remaining reserve liablities reinsured on mod-co basis
no cash transfer at treaty inception
renewal years: proportions of co and mod-co are adjusted
adjustment may be scheduled of may float w/ increase in coins Vx
Advantages
- no inital cash transaction
- eliminates need to create paper a/l (necessary in funds withheld)
Disadvantages
- main: very complicated to comprehend and to admin
- if coins reserves float w/ outstanding surplus, 2 stat gain from operatoins calcs necessary
  - 1) premlim stat gain from operations needed to calc surplus repaid
  - 2) final to show change in Vx from co->mod-co (or vice versa)
Illustrations - text p. 157

Regulation and Taxation

< 1984, very little (effective) legislation on financial reins
- used often to reclassify components of taxable income & significant reductions in taxes
TRA84 - Sectoin 845 - IRS can change an individual tax return if signifianct tax avoidance found
reins transactions were used to mask true financial condition of company
- therefore State DOI now looks at treaties for significant risk transfer
treaty terms that concern
- - schedule gains to reinsurer, regardless of actual experience of block
- - reinsurer never having to pay out benefits, just building up a payment due liability
- - reinsurer has right to terminate or automatic termination if
  - + reinsured becomes insolvent
  - + reinsured has mgmt change
  - + business reinsured proves unprofitable
some states challenge ALL "cashless" reinsurance
conditions to include to keep regulators happy
- - reinsurer must pay benfits at certain experience level
- - gains to reinsrer based on actual experience of reinsurance
- - no event (insolvency/mgmt changes) can automatically terminate reins (may be terminated after certain level of earnings attained or warranty voided)
- - inforce reins cannot be unilateraly terminated by reinsurer - except for premium non-pmt
- - int paid/credited s/b reasonable w/r to invemenst mkts/assets involved
- - relevant significant risks s/b transferred to reins - including capital loss, disintermediation, and asset default risks (if relevant)
- - ceding co shoudl not be forced to pay back losses except for voluntary termination
- regulators object to Vx credits or receivable credits wehre risk transferred is disproportionate to reserve credit

Security Considerations

"cashless" reins transactions under criticism
led to use of trusts, escrow accounts and letters of credit
also helps protect assets, preserve Vx credits, minimizes currency fluctuations and protects other party in insolvency
Trusts and Escrow Accounts
- trusts used to secure amounts owed from co that secureds trust to co that is benef
- equitable title to the assets is in the trustee
- commoonly used to segregate assets related to Vx of an inforce block
- most common as alternative to funds withheld trx
- escrow accounts earmark assets w/o actually transferring ownership
  - typically used to support funds withheld trx
- if certain stipulated events happen, assets held in escrow are transferred
- possible events include
  - surplus dropping below agreed upon level
  - change in mgmt
  - financial performance of reins below expected levels
- if used to secure reserve credits, Trusts subject to Model Law on Credit for Reins
- Advantages
  - - assets separate and identifiable
  - - investment income can be limited to performance of specific assets
  - - ceding co can still take Vx credit if reinsurer not admitted
  - - if recaptured, assets of trust/escrow can be used to effect payment, reducing dispute over mkt values
  - - trust is true transfer of ownership -> less suspect to IRS and state regulators
  - - on default, benef has right to w/d assets as a secured creditor
- Disadvantages
  - - creates additional expense
  - - can result in restriction on investment mgmt
  - - transfer of assets to trust may necessitate recognition of cap g/l for tax purposes or current mkt values for stat stmt purposes (agreement should state which party takes the cap g/l)
  - - if trust, company giving up assets will see reduction in magnitude of assets it reports
  - - if an asset transfer reversal occurs, depreciation in mkt values could create surplus straing
Letters of Credit
- most states will allow Vx credits from non-admitted reinsurer if reinsurer provides a letter of credit for the amt of the reserves
- requires very little admin
- disadvantage (from Reins view) - ceding co and draw down on a letter of credit w/o warning

Study Notes and Published References - Note ASP 1 - REDETERMINATION OF NON-GUARANTEED CHARGES AND/OR BENEFITS FOR LIFE INS AND ANNUITY CONSIDERATIONS

Background

std related to advice actuary gives to client co in connection with (re)determination of non-guar charges and for benefits for life and annuity contracts
std applies to inforce and NB
does not apply to PO divs
use of non-guar elements grown dramatcially, but little standardizatoin in benefit design, pricing structure, mktg practices and inv philosophies
Emphasis of Std
- set forth areas of inquiry and analysis the actuary should cover in developing advice
- outline areas wehre actuary should describe main elements of advice and reasons therefore
need a redetermination policy for block fo business
- this polcy (an selection of mktg and financial objectives associated w/ it) is a company mgmt decision that provides framework within which the actuary must operate
actuarial report should include
- recommended info to enable mgmt to make informed decision
- description of framework advice developed within
- description of co's redetermination policy
- description of facts, methods, procedures, assumptions upon which advice based
- description of ony special operating practices that affect/could affect repricing actions

Current Practices and Alternatives

An evolving type of business
- for some I/S products, int rate guarantees must be subject to review weekly
  - unless co's relevant policy changed, actuary would not be asked to formally advise in redetermination process
- whenever redetermination process is changed, expected that actuarial advise sought adn report made
  - buy could be shorter report w/ lots of references to prev report
Client's Policy - redetermination policy and the selectoin of solvency margins, mktg, and potential profit objectives assoc w/ policy are co mgmt decisions

Standard of Practice

Analysis of Issues and Recommended Practices
- Company's Policy Taken Into Acct - integral element in developing advice
  - if co has incomplete policy, actuary should describe addition assumptions necessary to develop advice
- Accumulated Losses or Gains - the extent to which accum g/l will be allowed to affect teh redetermination
  - specific provision for recover of past losses or distribution of past gains is a possible element of co's policy
  - recovery of acq expense through annual amortization is not considered recovery of past losses
  - be aware of any regulatory restrictions
- Special Operating Practices - description of variations
  - ex. special u/w rules and an indication if mort exp for this block s/b analysed separately
  - any restriction by type of investment and/or A/L matching standards s/b applied
  - if investments supporting this block are
    - segmented w/in general acct
    - combined w/ other assets but w/ sep ID by year of investment
    - comingled on a portfolio basis
  - include risks involved w/ deviations from these special factors
- Contract Classes
  - a contrac class should remain intact until all contracts matured
  - assignment to a class s/not be based on (non)occurrence of a claim on that contract
  - class consists of contracts that are
    - of a similar type
    - same structre of guar/nonguar charges/benefits
    - based on same anticipated experience factors
    - issued over continuous time period
    - similar mktg objectives
- Contract Factors and Anticipated Experience Factors
  - Contract Factors - valued defined in teh contract or values emerging from the operation of its terms
  - Anticipated Experience Factors - elements in the redetermination of non-guarcharges and benefits that reflect expected future experience
  - "expected/anticipated" - as determined by actuary through application of sound professional judgement
  - s/b based on recent expereince and expected trends in experience for
    - factor clas
    - similar classes of business
      - same co
      - other co
      - other sources
      - in this order of preference
- Modeling adn Averaging
  - possible that signficantly diff levels and incidence of prem payments will emerge w/in class
  - there s/b reflected in redetermining charges/benefits - by modeling or appropriate averaging of classification of contracts
- Impact of Life Deviations from Anticipated Experience
  - actuary should furnish ifo as to impact of likely deviations in experience from that anticipated
  - cover degree of variation that migh reasonably occur
    - effect these variation would have on likely attainment of co's several goals
  - if any variations could have sizable impact, actuary should include a report any changes in operating practices or product design which might alleviate or obviate these potential effects
- Sensitivity Testing
  - on potential impact o flikely deviations in expereince that may have material effect
- Application of Regulations
  - take into account jurisdictional regulations when developing advice
Communications and Disclosures
- Actuarial Report - should include
  - Description of Clients Policy
    - disclose area in which policy is judged incomplete and describe any additional assumptions made
  - Description of Special Operating Practices
  - Description of Contract Classes
    - if any changes in assignment of contracts to these contract classes, report should indentify how assignment changed and reasons for change
  - Identification of Contract Factors
    - if approximations or projected measures of contract factors used, describe basis of measures used
  - Description of Experience Factors
    - all changes in teh values of anticipated experience factors from loast redetermination
  - Descriptoin of Processes adn Methods
    - significant modeling or averaging used
    - manner contract factors and anticipated experience factors used
  - Reporting on Specific Charges or Benfits for the Period
    - present advised non-guar charges/benefits
    - if changed
      - identify
      - indicate amt of change
      - describe reasons
  - Stating Degree of Conformity w/ Co's Policy
    - and degree which actuary expects them to meed co's solvency, profits, and mktg objectives
  - Disclosures on Sensitivity Tests
    - descriptoin of any tests
    - summary of results
    - advice re: changes in operating practices or product design to avoid/minimize impact of any likely variations that have materially adverse consequences
    - if no testing, reasons why
  - Description of Regulatory Requirements and Interpolations
    - any applicable reg requirements
      - incl any explicit approvals necessary
    - if any significant interpretive questions,
      - decribe these adn actuary's interpretation and conclusions
Deviation From Std
- statement w/r to nature, rationale, and effect of deviating from ASP

Study Notes and Published References - Note CIA Recommendations - DIVIDEND DETERMINATION AND ILLUSTRATION

Section 1 - General

describe baseic responsibilities of actuary in application of sound actuarial principlas adn practices to determination adn illustration of divs under par pols
Contribution Principle cannot be applied over longer term to stock companies unless
- possible to determine the surplus earnings of par business
- limitation on amount that may be transferred from part business and surplus to the shareholders acct
Section 83 requires par and non-par blocks be maintained separately
Section 84 limits distribution of par profits to shareholders
general practice: maintain sep accts for par, non-par and suplus
- significantly restrict transfers from par surplus to shareholders acct
report should describe method of determining surplus earning of par block and if stock, limitation on distribution of par profits to stockholders
Recommendation does not address determination of divisible surplus
Does Address
- determination of currently payable divs for pols inforce
- determining illustrated future divs for both inforce and NB
Consider in Report
- an actuarial report is a statement of actuarial findings, conclusion, or recommendations
- any manner of transmittal of an actuarl report which involves teh risk that the underlying facts adn assumptions and limitations resulting from their use are not fully commented to teh client involves a corresponding risk that the conclusions or recommendation may be misinterpreted or misapplied
- the client is the co, its policy-making executives and in some situations its board of directors, whether or not he is an employee fo the ins co
- actuarial report should include such underlying data as are essential to findings or conclusions reported
Recommendation 1
- Whenever an actuary advises an ins co on divs, either illustrated or current, he should prepare a written report which documents the advise
"Sound Actuarial Principles" - generally accepted actuarial principles adn practices whiich emerge from utilization and adaptation of concepts described in actuarial literature

Section 2: The Contribution Principle

Basic principle is to distribute teh aggregate divisible surplus among policies in the same proportion as teh policies are considered to ahve contributed to divisible suplus
Recommendation 2
- use of Contribution Principle is generally accepted practice in Canada
- Actuary's report shoudl state if priciple followed
- if not followed, state deviations and rationale

Section 3: The Process of Dividend Determination

application of Contribution Principle requires two basic types of elements
- policy factors - elemetns which reflect assumptions inherent in std against which experience is measured
- expereince factors - elements which reflect actual experience
Methods of Div determination described in actuarial literature
- source of earnings method (contribution method)
- asset share method
- fund method
- experience prem method
- percentage of prem method
- reversionary bonus method
- other methods, including combos, mods to above, also describe in lit
Recommendation 3
- Actuary's report shoudl include description of precess used to determine divs as well ans manner in which policy and exerience factors are flected in that process
  - also describe the formulations used to calc divs
Recommendation 4
- if impractical to apply Recommendations directly to all pols/benefits, may continue a div scale or use approximations or similar processes and formulations
  - rationale and impact s/b disclosed in report

Section 4: Policy Factors

elements based on guarnatees or underlying actuarial structure of policy
Recommendation 5
- use of actual or approx policy factors is generally accepted practice
  - describe policy factors and of any changes in practice w/r to determination for period covered by report

Section 5: Experience Factors

actual experience - experience and trends to extent they are determinable, available, adn statistically credibe.
- if not available, interpret w/ sound professional judgement based on similar classes fo business from same co/other co/other sources
if a trend is projected for one class, s/b make uniformly for all classes
Recommendation 6
- report should describe experience factor values used
  - if projection used, type and extent of usage s/b stated
Recommendation 7
- if multiple factor classes, differences in factors between classes need to be based on differences in actual experience between teh two classes
  - identify differneces and be prepared to provide a demonstration necessary to support such differences
Recommendation 8
- report changes in experience factors and changes in practice w/r to determination of exp factor classes or placement of policies w/in them

Section 6: Claims Factors

Recommendation 9
- if multiple claims factor classes, disctinction can be made on basis of
  - risk selectin class
  - selection process
  - mktg method
  - policy provisions
  - plan
  - prem rate
  - geographic location
  - size of policy
  - date of policy issue
- variations s/b reported along w/ explanation of rationale and effect of basis

Section 7: Investment Income Factors

includes int earnings reduced by investment expense, capital g/l
effect of taxation may be reflected as reduction of before tax inv income
investment income for a group of policies may be directly affected by pol loans
Recommendation 10
- Generally accepted practice to reflect the effect of policy loans in inv income factors
inv income, excluding policy loans, directly affected by
- amt and timeing of investable CF generated by ins operations of the group of pols
- inv income rates initally and subsequently applicable to CF due to investments actually made
- rate or follover of those investments, which affect investable CF insubsequent periods
Recommendation 11
- use of either portfolio average approach or investment generation approach is considered generally acceptable practice
  - report should state menthod used
  - if method changed, or net method for new group of pols, describe nature, rationale adn effect

Section 8: Termination Factors

terminations for reasons other than claims
organized set of internally consisten experience factors corresponding to () will be considered one factor in defining a termination rate factor class
- () - IA,sex, prem mode, plan, size of pol

Section 9: Expense Factors

mktg, u/w and other acq cost may be allocated to all pols or recognized specifically as non-level costs to be charged to a policy and amortized
Recommendation 12
- direct costs s/b charged to group generating costs and indirect costs allocated
  - amortization s/b based on realistic int and termination rates appropriate for group of pols
considerable latitude in possible approaches for allocating indirect costs w/in various groups of pols
amort periods and matters may also vary widely
Recommendation 13
- minimum test of consistency between two expese factor classes is that any difference in total expense charged to each class s/b justifiable and in accordance w/ sound principles of expense analysis

Section 10: Tax and Other Factors

tax factors may be incorporated into div determination
Recommendation 14
- variation in tax factor should reflect corresponding variatino inherent in applicable law/regs imposing that tax
stock co - charge for stockholder retention
- can be reflected at an aggregate level in determining divisible surplus
- can be separate factor in formula for div scale or implicitly included as part of one or more expense factors
Recommendation 15
- Describe method used by co for shareholder retention charges
  - if div scale contains specific expense factor for such charges, describe and detail and changes
reasons for adjustments to divs
- reflect unusual g/l on certain supplemental benfit riders
- reflect losses arising from presence of settlement option guarantees
- smooth transition from one div scale to another
- provide consistency in quantity discounts made to varying degrees in GP structure
- serve as balancing item so aggregate divs = aggregate divisible surplus
- distribute gains from extraneous sources, such as non-par benefits or LOBs
- smooth incidence of divs w/in div scale by policy dur
Recommendation 16
- specifically state any special adjustments made to divs
  - be prepared to provide demonstrations which support existency adn magnitude of such adjustments

Section 11: Terminal Dividends

generally reflect a POs share of surplus which has not been distributed through annual div
terminal divs program may be part of recurring process or may be one time distribution for a limited period
Recommendation 17
- state whether terminal divs equitably reflect incidence, size and growth of the policy's share of amts previously accumulated on behalf of policies on which such divs payable
  - whether diffs in terminal divs among diff poliices reflect differences in corresponding amts accumulated
  - whether terminal divs expected to be recurring and/or for temporary period
  - describe proscess used to determine
  - source of funds or types of inv gains used to support div
  - changes in practice w/r to determination of terminal divs

Section 12: Determination of Participating Earnings Limitations on Amts Transferred Among Accts

if separation of accounts not used, mvoing an amt from experience of par line to another line or to shareholders acct = transfer
if contribution principle to be followed, transfers from one par line to antoher as important as transfers to shareholder's acct
- describe any such transfers
Recommendation 18
- report if separation of accts maintained and if so, on Stat or GAAP basis
Recommendation 19
- state if current limit exists on amts transferred from par to non-par/shareholder's acct
Recommendation 20
- report (or incorporate by reference) current earnings and PO surplus of each par acct and amts proposed to be transferred to toher accts and distributed to PO
  - state why transfers are reasonable/unreasonable
  - whether (in actuary's judgement) transfers migh impair co's ability to maintain current div scale

Section 13: Illustrated Dividends

methods intended to apply equally to currently payable divs adn illustrated future divs for inforce and NB
may be desirable to assume a conservative position in determining experience factors applicable to only new or recent issues
circumstances can arise wehn there is substantial probability that an illustrated div scale will not be maintained in near future
may be appropriate to illustrate a reduced scale
Recommendation 21
- actuary should conduct tests of illustrated divs to judge if these illustrated divs could be paid in teh near future
  - if substantial probability that illustrated divs not supportable in near future, report should state such
Recommendation 22
- report should identify time period used to determine portfolio inv generation rate of return for policies to which illustrated divs apply
Recommendation 23
- primary responsibility w/r to illustrated divs - ensure divs appropriately reflect current financial results of co adn related to paid divs in an equitable, justifiable manner

Study Notes and Published References - Note SN 8I-100-00 - PRODUCT DEVELOPMENT TRENDS

Overview of Product Development Process

Product Design
- prelim decisions - target mkts, perceived needs/wants of consumers, competitor peer group, perceived needs/wants of destributors
- prelim objectives set for prem rates, nonf values, divs, comm rates, u/w stds
- task force containg freps from most HO funtions, most importantly: Executive, Actuarial adn Mktg
  - Actuarial - primarily repsonsible for fin soundness of product
    - should have (or develop) experience assumptions
  - Mktg - responsible for evaluatigin anc characterizing the mkt place
  - Exec Mgmt - direction to initial conceptual decision and the design process
- Planning Process - begins w/ clear def of life co's goals adn strategies
  - key part of corp strategy - mktg plan
  - to select mkt, co will review
    - size and character of targeted mkts
    - ability of co to effectivley reach mkt
    - nature of perceived copmetition in teh mkts
    - dist channel that most effectivley serves mkts
  - concepts futher refined after initial planning
    - general benefit characteristics defined
    - decisions as to premium structure
      - range ultimate prem structure must fall w/in
      - what funing scenarios included in profit test
      - fixed or flex prems
        
        ren term - agg or S&U
      - how to grade if not level
      - "high" or "low" prems
      - guar or adjustable prems
    - mktg costs must be determined (comm, mktg OH, adv, etc)
    - risk parameters (mort/morb, inv, legal/regulatory, fni, tax, inflation)
    - clarify u/w stds
    - int, persistency, and exp assumptions taht reflect product risk characteristics and target mktplace
    - other reqs
      - reins
      - policy and app forms design
      - computer and admin systems
      - distributor education and training
      - staffing needs (additions?)
      - investment philosophy
    - consumerism adn company solidity
Product Implementation
- Princing - before pricing you need
  - experience assumptions - adjustments may be necessary for target mkt/dist channel/sales scenarios/u/w changes/environ factor/expected/recent changes in environmental circumstances
  - profit or surplus standards
  - competitive standards
  - valuation standards
  - mktg costs
  - FIT
- Policy Values
  - must relate to mktg plan strategy
  - adhere to legal requirements (SNL)
- Forms - drafted,printed & filed for approval
- Mktg support - materials developed ads/ratebooks/etc
- Systems
- Reinsurance
- Add'l Benefits
- Product Release
Process Contraints
- Environmental Constraints
  - legal
  - economic
  - taxation
  - competition
- Organizational Constraints
  - surplus
  - systems
  - expertise
  - tradition
- Critical Product Success Factors
  - competitive prices
  - valuable benefits
  - flexibility
  - harmonious w/ co strategy
  - complements other portfolio products
  - satisfies teh distributor
  - ability to admin and u/w (at reasonable cost)
  - profitable
  - equitable (classes and generations fo PO)
  - managable tax status
  - Important part of prod dev process - continuous re-evaluation of product and performance
  - Evaluation criteria
    - sales success
    - actual vs expected
    - dist receptiveness
    - cost of dist
    - admin effectiveness
Conclusion
- Two distinct levels : Product design and product implementation
- product dev must clearly relect interests of potential consumers, POs, potential distributors, co EEs, shareholders, regulators, general public

Product Trends in the US

Overview
- 3 components of prod dev paradigm: mkt-driven strategies/consumer-oriented/capital focused
- catalysts for development of products
  - consumer needs
  - shift in mkt awareness
  - regulatory issues
  - increased flexibility (benefits and funding)
  - exonomicn and/or inv conditions
  - changes in taxation
- special pricing considerations
  - characteristics of newer products - degree of PO flexibility adn non-guar elements
    - therefore imperative to perform profit analysis using several diff scenarios
    - sensititive tesing w/r to mort/lapse/expenses/int earned/spread/prem pay pattern/etc
  - most require comlicated admin systems
  - admin systems may limit # bands, commission structures, # inv avail, # lives, type of joint age calc
  - costs of new admin systems - developmental adn ongoing
Indeterminite Premium Life
- Product design
  - dual prem structure - guar adn curr
  - guar max is stated in policy form, insured pays lower current prem
  - purpose - avoid def reserves
  - lower prems typically guar first few years
- Pricing Considerations
  - prem structure - during guar peroid, def res may be req'd adn s/b consisdered
    - low curr prem and guar period - primary features for competitiveness therefore critical assumptions
  - regulatory concerns - many states have limitations on prem adj for indet prem products
    - prem changes must be on a class-wide basis, justifiable in light of current and anticipated future exp adn not recover prior losses
    - many states req notification adn justification prior to implementing change
- Pricing Methodology
  - priced using trad techniques to current premium produces proper profit objectives
  - consider
    - filing req gor a prem change
    - def reserves
    - FIT
    - add'l admin system expense
  - consider guar max prem adn analyze profits under a "worst case" scenario where max prms req'd
Multiple Life Products - Last Survivor
- Product Design
  - mainly sold in estate planning mkt - some applications for business ins
  - important product features
    - premium flexibity - focus on DB/$
      - either low AP or limited pay prems
      - CV buildup not as improtant since proceeds usually to pay taxes
    - automatic increase in DB - to cover inflation or increased value of estate/business
      - consider increases when u/w oringal policy
      - consider likelihood of anit-selection
    - policy split option - some allow policy split into two parts if certain events occur
      - sum of new pols = orig face
      - may charge processing fee
      - some cos req evidence of insurability
      - other cos charge extra (like a GIO benefit) but don't require evidence
    - estate preservation - additional coverage for 4 years to cover extra taxes if "gift" to trust brought back into estate
    - first-to-die benefit - small benfit to pay for final expenses
      - sometimes policy becomes "paid up"
- Pricing Considerations
  - Product approach - 2 different comman approaches: dual or single status
    - dual status - PVFB incr dramatically after first death
      - admin systemn need to track sets of pol values for 3 states, x alive, y alive, both alive
    - single status - "Frasierized" method
      - single life decrement developed from teh joint lives
      - a blend of 1 and 2 alive statuses
  - Method of Calculating Multiple Life Status - 3 common methods to combine age/risk classes for pricing multiple whole life products
    - admin systems may dictate method used
    - exact age - everythign calced from first principles based on each life to be insured
    - joint equal age - exact age calcs done, bot only at equal ages
      - "equal age rules" used to calc JEA based on actual ages
    - equivalent single age - rates and values equated to a single age
      - admin as a single life product therefore simplest to admin
      - wide fluctuation in mortality from exact age
  - Mortality - assume independence of lives in formulas
    - consider "lonely-heart syndrome"
    - single life experience probably not appropriate for pricing a new joint product since more older individuals
    - since pays on second death, if one life is "std", second life can be substd ans still get std coverage
    - more u/w concessions since competitive mkt
  - Persistency - much higher than for single life policies
    - bought for a specific need - to pay estate taxes
    - owned by trust
  - Claims - be concerned w/ steep claim costs in advanced years (long dur product)
  - Expenses
    - since face amts usually very large, common to have u/w adn per policy overhead as an amt/policy (vs per $1m)
    - u/w costs are to u/w 2 people and higher med reqs b/c of age
    - maint costs higher b/c dealig w/ lawyers, acctnts, etc
    - "not taken" cost higher b/c of "shopping"
    - admin and illustration systems might need upgrade
  - Cash Values adn Reserves
    - b/c of low lapse assumptions, profit results might be counter-intuitive
    - CV not the concern of the insureds. 0 CV term would be optimal plan
  - Retention:
    - some co's beleive higher retention is appropriate (up to 2x single life)
    - argument can be made for lower retention (low prems, high face, low claim prob)
  - Reinsurance:
    - key to mktg sucess many co'w will have w/ last surv products
    - help w/ u/w
    - reinsurers have difficulty pricing @ attractive rates for ceding co
      - YRT rates sometimes exceed those charged by ceding co
- Pricing Methodology
  - profit tested similar to trad/UL products
  - modifications
    - joint age calc methodology
    - inclusino of contagion mort factor
    - revised to retention limit
    - reins costs
    - provisions for auto increase/policy split/estate preservation if applicable
    - requires select mort charge structure
    - each cell needs to be price separately, paying attention to slope of mort
    - contagion factor can be incorp into Frasier calc of underlying last surv mort experience and provision for substd risks
    - add'l sensitivity tests on varying expenses, persistency and likelihood at least one life substd
    - cells w/ wide variation in age of two insureds s/b tested to ensure consistency and reasonableness of results
Multiple Life Products - First-To-Die
- Product Design
  - insures multiple lives (typically 2) and pays on first death
  - primary mkts
    - business mkt
      - fund buy/sell agreements in event of partner death
      - multiple key person needs w/ cost-efficient split dollar programs
    - family ins mkt
      - provide replacement income on first death in two-income family
      - pay final expenses/taxes as part of family estate planning
  - Important Features
    - survivorship purchase option - allows continuation of coverage for suvivors w/o evidence of insurability
      - potential for anti-select on surv purch option
      - reduced w/ limitations on age/years option is available
    - unequal DB - varying face amt on each insured
    - automatic increase in DB (COLA) - may be max allowed increase
      - must factor in add'l lcost and likelihood of antiselection
    - addition/deletion of insureds - for business
    - simultaneous death - w/o this option, no benfit payable on simultaneous death
      - prob is relatively small and often provided at no extra charge
      - thought enough margin in mort to accomodate this
    - policy split option
      - sum of new pols cannot exceed existing face
      - new pols based on orig IA and u/w class
      - subject to anti-selection in new pols not subject to u/w
- Pricing Considerations
  - product approach - primary approach to build multiple life products is true joint life approach
  - method of calculating Multiple life status - same 3 as last-to-die
  - Number of lives - typically 2. 4-6 for business products but up to 10
  - Mortality - assume independence
    - s/b similar to other single life products
    - substd rates easier on a formula-driven UL product, more complicated on fixed prem products
  - Persistency - generally same as single life products associated w/ family or business mkt
    - potentially lower laspse rate on pols that have prem savings vs sep pols
  - Expenses
    - overhead s/b same as for a single policy. This is the biggest expense
    - economy - 2 lives-> 1 expense
    - u/w expenses higher since need to u/w multiple lifes
    - increased admin & illus styem expenses possible if not already able to handle
  - CV adn Expense Allowance Limitations
    - expense allowance defined as an absolute max, regardless of # lives covered
      - therefore first-to-die generate higher CV that sum of single life pols
  - Reinsurance
    - reinsurers often add single life rates to get joint first-to-die rate
    - possible product charges (add/drop/split) need to be considered by pricing actuary
- Pricing Methodology
  - same techniques as trad/UL products
  - Mods to input parm
    - joint age calc methodology
    - expense allocations
    - cash value and expense allowance limitations
    - rein costs
    - surv purchases/auto increase/change of insured/simultaneous death/policy split benefits if applicable
  - add'l sensitivity analysis - varying # lives covered w/in one policy
Variable UL Products
- Product Design
  - DB adn CV vary according to investment experience of investment accts underlying the policy
  - common features
    - flexible prems payable
    - DB not req'd to vary w/ inv performance
    - expense and mort loads deducted from acct values
    - net prems invested in underlying general acct or sep accts
    - mort and expense asset risk charges assessed against acct value
      - also deduction for COI and admin charges
    - SC (10-15 years)
  - most important feature - fund approach - outside funds or own funds
    - outside funds - instant fund recognition
    - own funds - fund startup costs, no track record and no name recognition
  - common investment options
    - equity - aggressive growth, growth, small-cap, mid-cap, growth and income, blue chip
    - fixed income - med term, long term, high yield, govt
    - managed - asset allocation, balanced
    - international
    - money market
    - fixed (general) account
- Pricing Considerations
  - Regulatory Restrictions
    - under SEC regs
      - must be registered w/ SEC
      - Prospectus delivered to potential investors
      - selling agent must be registered to sell securities w/ SEC
      - selling co must be licensed as a B/D
    - sales load limits
      - max sales load is limited on premiums up to SEC GAP
      - max slaes load from prems in excess of SEC GAP limited
      - sales load percentages cannot increase
      - sales load essentially limited to a % of SEC GAP
        
        actual loads may exceed, but excess must be refunded if surrendered in 1st 24 mo
    - admin loads, prem tax and DAC tax loads must be reasonable
    - M&E (Maint and exp) risk charge must alos be reasonable
  - Admin System
    - usually requires sep admin systems b/c unit values need to be calced daily
    - SEC reg controls require
      - admin procedures consistent w/ prospectus
      - annual prospectus updating and mailing to investors
      - mandatory record keeping
      - processing transactions @ today's price
      - seven days to confirm prems and transfers
      - payment of benefits w/in 7 days
    - Other admin considerations
      - integration w/ other systems
      - telephone transfers
      - atuomated voice response
      - maintaining up-to-date mktg info
      - trakcing distribution systems licensing
      - portfolio rebalancing
      - providing dollar-cost averaging capabilities
    - Build vs Buy
      - considerable investment of time/people/expenses assoc w/ entract to variable marketplace
        
        co could market other co's product in return for compensation
        "private label" another co's product
        manufacture product but outsource admin to TPA adn use outside funds
        keep all processes inside
    - SEC regs make it hard to develop VUL products w/ real differentiation
- Pricing Methodology
  - vastly different from trad and UL pricing
  - lack of mgmt discretion in determining credited rates and margins as a source of profit
  - high degree of regulation, esp in expense load area
  - analyze sources of income and cash outflow
    - front end premium loads
    - issue and maint charges
    - mort charges - can't exceed 80 CSO mort
      - current COI < max for competitive reasons
    - asset charges - % of avg daily net asset bal
      - m&E charge compensate for mort adn expense risks and inv advisory fee
    - surrender charges - generally level 1-7 grade to 0 @ 15
    - transaction charges - charges assoc w/ partial surr and fund transfers
      - usually 12 free per year
  - from these sources of income, need to
    - cover DB payments
    - mktg dist compensation (siimilar to UL usually)
    - expenses (remember extra licensing costs and maint of several funds)
    - profits
  - potential loss from early surrenders
    - important to study profitability under several diff lapse scenarios
    - lapse scenarios ~ assumed inv performance
Market-Value Adjusted Annuity Products
- Product Design
  - SPDA or FPDA w/ int and book value guaranteed @ end of specified period
  - early w/d subject to MVA & SC
  - for buyers, MVAs offer
    - longer guar periods
    - higher int guarantees
    - opportunity for capital gain
  - for ins cos
    - lower cost of PO disintermediation since MVA protects co from mkt loss on surrender
    - lower surplus strain through higher reserve valn int rates
    - potential for better persistency through attracting buyers w/ more of a saver's mentality rather than investor's mentality
- Pricing Considerations
  - MVA formulas - usually not applied on death/annuitizations
    - formula must recognize both up and down adjustments
    - may ignor minor (< 25bps) int rate changes
    - degree of downward MVA permitted
      - some limit adjustment to excess int only
      - some restric MVA to all credited int
      - some have no limit
    - degree of MVA - tradeoff between int rate risk and SEC reg and distribution access
  - Valuation Basis - CARVM
    - MVA = type B annuity
    - allows co to choose between iss year valn basis and change in fund basis
    - MVAs rec more favorable valn treatment than fixed annuities b/c of MVA
    - most co's choose change in fund basis b/c practically all funds usually rec'd irst year
    - pricing actuary shoudl take into consideration impact of reserving methodology choice when pricing MVA product
  - Number of Guar Periods
    - compete against CDs and gov't issued obligations
    - 2,3,4,7,10 yrs most popular
    - @ end of guar period, PO can roll into new guarantee
    - sometimes 30 day free w/d at end of guar
      - if so, shock lapses will be quite large
  - Marketing Dist Compensation
    - 1st year commission and trail (either increases or total asset value)
    - reduced 1st year if rolled into new guarantee
  - Admin System - must handle regular SPDA plus
    - multiple guarantee periods adn resseting acct val as prem
    - MVA formula
    - MVA limitations
    - indiv products and/or group trust
    - sep accts adn acct procedures
    - compliance w/ SEC regs if registered
- Pricing Methodology
  - profit tested like SPDA except each guar period presents unique situations for evaluation
  - MVA adjustment formula determined first
  - valn methodology evaluated as part of pricing process
    - test various combinations
  - each guar period is a subset of overall MVA rpduct
  - primary annuity profit source - spread between earned and credited
  - determine appropriate spread reqs for each guar period, taking into account
    - SC
    - "shock" lapse
    - penalty free surrenders
    - mktg dist compensation
    - renewal resetting
    - early annuitization
  - intial profit tests using "static" inv environment
  - then add'l scenario profit analysis
  - persistency ~ credited rate
  - dynamic pricing to supplement static analysis, consider
    - excess lapse
    - varying re-investment strategy
    - renewal interest creditig strategy
Two-Tiered Annuity Products
- Product Design
  - diff accum values @ mat depending on if annuitized or surrendered
  - AV - Annuitizaton value = accum gross prems @ specified credited rates
  - SV - surrender value = accum(gross prems - loads)@ lower specified credited rates - SC
  - both AV and SV adj for prior partial w/d/annuitizatoins
  - higher AV justified b/c profitability maintained w/ lower int margins b/c annuitization rates incorporate (potentially) two profit sources - int and mortality
  - payments based on guar settlement rates or current SPIA rates, whichever gives highest payment
  - most co's require payout to be >= 5 years to qualify for AV
  - AV usually payable on death
- Pricing Considerations
  - Credited int rates
    - differences between AV adn SV crediting rates is to provide equitable dist of earnings between those who annuitize and those who surrender
    - spread between AV adn SV usually 100-300 bps
    - some cos may guar these spreads
  - Reserve Determination
    - reserve calced under CARVM
    - calc both AV and SV
      - greater is reserve for valn
    - pattern will follow value between SV adn SV-SC @ early durs and approx AV @ later durs
  - Persistency
    - higher than comparable single tier DA products
    - biggest diff @ end of SC when normally a shock lapse
  - Admin Systems
    - systems need to accomodate two accum values adn dual reserve calcs
- Pricing Methodology
  - similar to regular DA, esp the SV
  - AV priced sep assuming higher persistency and conversion to produce payments @ annuitization
  - combine the accum adn payout phase to determine overall profitablity (optional)
  - perform dynamic pricing tests under various int rate scenarios
Varaible Annuity Products - GMDB
- Product Design
  - similar to VUL
    - GMDB evolution
      - DB = acct value (SC waived)
      - DB = ROP (net of loads) - partial w/d
      - DB = ratcheted or stepped-up value (resets to current AV @ certain points)
      - DB = net prems paid accumulated at annual fixed rate (usually 5-7%) aka rollup
- Pricing Considerations
  - formula approach
    - inherent cost to provide GMDB increases as benefit become more generous
    - keep limits in mid (200% or age 75)
  - variable account performance
    - cost of GMDB varys widely depending on performance of sep accts
    - different mixes of assets will give significnatly different benefit amts
  - issue age
    - shoudl consider various combinations of IA and acct performance in pricing
  - mortality
    - projected GMDB costs ~ mort assumption
    - actual mortality might deteriorate if
      - GMDB provisions become critical mktg factors
      - lapse anti-selection occurs
  - persistency
    - higher levels of persistency will result in larger aggregate amts of benfits
  - reinsurance
    - due to volatility and unpredictability of underlying factors, many cos cede total GMDB risk
    - still need to be aware of GMDB consequencesto evaluate reins cost structure
- Pricing Methodologies
  - two methods of estimated cost of GMDB provisions
    - GMDB as series of put options exercisable @ death of PO
      - valued using B-S option pricing formula
      - effect of fund diversification s/b considered
      - B-S is limited in its ability to analyze these issues
    - Monte-Carlo Simulation
      - more generalized approach
      - project multiple future paths of returns for each of underlying funds offering a GMDB
      - @ each point, (GMDB-SV)*qx, then disocunted and summed to estimate cost of GMDB
      - taking diversification into account - consider correlation between inv funds
    - imperative for pricing actuary to perform scenario sensitivity profit tests to gauge importance of changes in assumptions and parameters

Product Trends In Canada

Annuities
- consumer shoing increased sophistication
- demanding more guarantees adn more control over investments - conflicting goals (potentially)
- inc co's in competition w/ banks
  - very thin profit margins
- even though profit/policy is shrinking, mkt is expanding
Deferred Annuities
- series of deposits, @ ret, converted to immediate annuity or RRIF
- mostly registered funds (tax deferred)
- gov't limits amt you can contribute to RRSP
  - contribution limit offset by pension adjustment
- non-registered are non-exempt
  - accrued int is taxable
- range of inv vehicles is increasing
- Var Def Ann guaranteed to be at least 75% of prems paid (less w/d)
  - 75% req'd by law
  - some cos up to 100%
  - advantage since other fin institutions don't have guarantee
Immediate Annuities
- singel life, joint life, term certain along w/ various guarantees
- if term certian purchased w/ registered funds, certain can't go beyond age 90
  - non-reg funds min(40yrs, AA100) for certain
- new risk exposure due to back-to-back market
  - life annuity - annuity mort
  - term to 100 - life mort
  - life mort <> term mort
    - life is u/w therefore annuity mort is taking anti-selection risk
RRIF (reg ret income fund)
- allows more flexibility w/ payout pattern than w/ annuity
- can only be purchased w/ funds from RRSP
- invested in segregated fund or guar fund
- w/d chosen by PO, subject to legislated mins
- no max w/d amt
- payment pattern can be modified annually
LIF (Life Income Fund)
- allo more flexibilty in payout of locked-in pension funds
- goal - extend RRIF options to locked-in pension funds
- prior - could only receive funds when converted to annuity
- increase flexibility by allowing deferral of annuity purchase to age 80
  - prior to annuitization, w/d subject to same mins as RRIF
- RRIF and LIF allowed PO to reduce exposure to int rates
Interest Senstitive Products
- 1st generation - 5 yr adj products
  - db/prem/scv guar 5 years
  - redetermination every 5th year
  - PO could increase prem if DB decreases
  - eventually guarantees introduced as to maximums for mort and expensed, int rates linked to external index
- 2nd generation - removed guar csv adn substituted ETI/RPU amts
  - guaranteed for each 5 yr period
  - generally lower premiums than 1st gen products
  - competition led to aggressive int rate projections and poor (none) disclosures
  - led to significant prem increases at redetermination time
- 3rd generation - 5 yr adj face, prems and non-guar CV
  - new money int rates used for setting prems/face amts
  - @ redetermination, prems recalced based on new money rate and accum cv
  - very similar to UL except prems fixed
- 4th generation - UL w/ very explicit charges - true unbundled ins products
  - 2nd generation UL - dropped explicit expense charges
    - hidden in higher COI charges
    - increase SC (amt and/or dur)
    - SC based on target prem
    - inv options varied (true new money inv accounts), but no equity options or VUL due to tax reasons
  - current genration UL - decreased unbundling
    - COI from YRT to level to age 100
    - substantially lapse supported
    - subject ot same risks as Term-to-100
    - single inv accts linked to moving avg of some outside index
    - rise in popularity of equity or segmented fund inv options
    - int earnings subject to annual taxation
    - still popular despite adverse tax treatment
Lapse Supported Products (Term-to-100 aka T-100)
- T-100 - NP WL w/ little to no CV
  - no SNL in Canada
- provides pure death protection @ affordable cost since no need to fund CV
- prems often guaranteed
- popular in capital gains situations
  - used to fund tax liab on inherited property
  - used w/ immed annuity for back-ot-backs
  - since guar, price is critical
    - no adjustment mech to reflect actual exp
    - 3 assumptions of chief concern (in increasing order of sensitivity)
      - mortality - quite popular at ages 60+
      - inv rates - represents very long implicit int rate guarantee
        
        use of asset strategies will have direct effect on rate used in pricing
      - lapses - most critical pricing assumption
        
        nonf benefits < natural reserve, therefore excessive lapses inprove profitability
        higher assumed lapse rate would result in lower premium
        first valn tech paper suggested rarely appropriate for rate > 3%
        considerations
        
        mkt sophistication - if PO knows that value enhanced by keeping in force, they will tend to not lapse
        
        if insurer works in sophisticated mkt, expect better persistency on avg
        absence of CV s/b strong disincentive to lapse
        
        issue ages and lifestyles
        
        lapse rates should vary by age due to dinstince differences in lifestyle
        
        insured annuities (back-to-backs)
        
        T-100 prems funded by immediate annuity
        
        lapses s/b close to 0
        
        persistency is better on quality sales
        levelized commissions
        
        stronger incentive for agent to maintain coverage
        
        presence of viatical cos willing to buy policies for cash
Miscellaneous
- Cross-Selling (back-to-backs)
  - may provide some tax relief
    - under a prescribed annuity, taxable int income spread evenly over life of annuity
  - used w/ estate planning to preserve capital
- Segregated Funds
  - don't get favorable tax treatment, but increasingly popular w/ consumers
- Compensation
  - more consumer-oriented marketplace
    - trend towards more levelized compensation
  - pros and cons to levelized comm
    - + PO receives better and longer service from agent
    - + long term relationshiop -> additional sales as needs mature
    - + increased persistency of inforce block
    - + less 1st yr surplus strain
    - + better persistency leads to smaller unit costs
    - - insufficient income for new agents
    - - less incentive for an agent w/ big block to pursue NB

Product Trends In Other Countries

Europe
- was either largely deregulated or highly regulated tariff markets
- EU caused most to move to deregulated system
- UK
  - traditionally endowment policies
    - popular unti mid 80s
    - featured
      - smooth investment return to PO
      - guar DB
      - terminal bonuses payable upon death or maturity
      - guar endowment benefit
      - annual bonuses dependent on co results
  - Unit-linked w/ further guarantees in early 90s
    - tied to index fund w/ guarantee that a certain min benfit paid if index isn't to a certain amount over guar period (5 yrs)
    - derivatives to provide maturity guarantee
  - Dread disease products in 80s - lump sum upon diagnosis of speficied disease
Latin America
- changes effect teh ability of ins cos to do business
  - democratization is taking hold
  - market based capitalism on the rise
  - state industries are being privatized
  - inflation is down and becoming more stable
- Argentina - pirvatizatoin of SS system
  - ER & EE contribute a percentage of salary to either state or private pension fund manager (AFJP)
  - if in AFJP, contributions accumulate in indiv pension accts
  - AFJP - sole objective - manage funds
    - contributors free to choose fund managers and can change 2x/year
    - funds segregated and strict restrictions and limits to what fund manager can invest in
  - At retirement, a monthly benfit from state
    - if funds to state, then add'l benefit = % 10yr avg salary
    - if funds to AFJP, annuity based on fund balance
  - Death/Dis benefits also provided
    - outsourced as group ins through public bidding
  - Ins Co opportunities
    - pension fund manager by participating in AFJP
    - opportunity to provide death/dis group ins
    - opportunity to provide retirement annuities to those who contribute to AFJP
Asia
- mkts in different states of maturity
  - mature adn competitive mkts - substantial % of population insured
    - Hong Kong/Singapore/Japan/Korea
  - strong growth mkts - very strong growth last 10-15 years
    - Malaysia/Taiwan
  - rapidly emerging markets - recent new entrants or country changed regulatory environment such that there will be many new entrants
    - Philippines/Indonesia/Thailand
  - immature mkts - mkt exists, but small % of populatoin insured and few products exist
    - China
  - mkts to emerge - concept of insurance doesn't exist
    - Vietnam/Cambodia/Laos
- basic product development considerations for co's looking to enter these mkts
  - regulation
    - waht is regulatory environ an din what direction is it heading
    - often not a level playing field w/ discrimination againt foreign companies
  - distribution
    - agency distribution is waning (used to dominate)
      - direct mktg, bank dist, and EE dist products gaining attention
  - Admin capabilities
    - policy sized may be small, but volume may be huge
  - Cultural Environ
    - must balance co's internal culture w/ culture of country
    - products offered should not challenge basic beliefs of target audience
    - products should fit customers values and needs
    - mkt research - don't just expect to sell what works elsewhere

Study Notes and Published References - Note SN 81-101-00 - LIFE INSURANCE AND ANNUITY NONFORFEITURE PRACTICES

Overview

w/r nonforfeiture - how to treat terminating PO in relatoin to policy is same cohort who hasn't terminated
min nonf law is almost all US states
Canada - no min nonf law
many forms of health ins (including DI) normally do NOT provide nonf benefits
what forms to offer on voluntary termination adn which s/b automatic optoin
- ETI/RPU/APL
nonf values must be determined for a broad range of life and annuity products
level premium plans -> nonf logic
- "overpays" premium in early years for right to "underpay" in later years
- nonf benefit avail on surrender restores PO equity
  - chooing to surrender policy instead of paying prems adn forgo the "right" to "underpay" later yers premiums
- prospective and retrospective values can be quite different on a level prem plan
questions regarding parity among differnt PO
- satisfied by nonf value that reflects teh past
  - or should it consider the future value of the policy
- different methods of determining amounts grow from these answers

Methods of Determing Amounts of Nonf Benefits

Retrospective Method
- based on fund or account value
- SC may be deducted
- currently used for variable products in US
- fairly easy for PO and sales reps to understand, but limits product design
- "no lapse guarantee" requires taht accum value fo actual prems paid >= amt which specified prems would ahve accumulated to under same set of rates
  - or coudl require >= specified prem paid each period
Prospective Method
- present value of future benefits plus PV of co expenses plus contribution to profit less PV future gross prems
- present values may reflect future rates of mort, morb, int yeilds, premium patterns adn lapse/surrenders
- calc may refledct probabilities at various dates of options avialable
- "natural reserve"
- assumptions may or may not be specified by gov't regulation
- changes in these assumptions after issue change resulting nonf values
- not as easily understood by public
- expected future experience w/in class is likely to be less homogenouus thatn overall experience
  - resulting nonf values may not be truely represetnative
- for UL adn other flex prem products, assumptions must be made concerning payment of future premiums
- nonf value avail to terminatoirs reflect FV of ins protection to peristing PO
  - parity between terminators and persistors is maintained
- deterioration in co experience can lead to decreases in nonf value that may lead to misunderstandings
Net Premium Method
- method req'd for Trad Wl adn soem term life in US
- subset of general prospective method
- PV future guar benefits - PV future net prems
- @ issue PV net prems = PV guar benefits + PV "acq expenses"
  - acq expenses defined by law/regulation
  - based on pattern and PV of DB and other policy specs
  - mort talbes prescribed and range of allowed int rates
- for flex prem pols, asumptions must be made concerning paymetn of future prems
  - US SNL not set up for non-req'd prems
    - depending on circumstances, assume no future prems paid
    - actuary may taek a constant % of assume future prems adn adjust in the future if necessary
  - alternative calcs may be available for flex prem UL
    - payment of prem may affect DB, which needs to be relected in calc
    - if policy guarantees w/in range of permissible under US SNL, then CSV is kosher w/ req
Single Premium Method
- Life ins is paid up policy w/ single prem mostly borrowed from ins co
  - like a mortgage where prem payments are mortgage payments
- CV (nonf benefit) = paid up value of policy less "principal" outstanding on "mortgage"
- not used

Nonforfeiture Practices Operative in Selected Countries

Canada
- no min nonf law
- "group equity" concept used
  - value from terminating policies may be used to reduce prems or raise level of benefit for all policyholders
South Africa
- small policies require reduced paid-up nonf benefits
  - otherwise no mins
- co must file plan that states ruls that apply to nonf benefits adn rules must be approved
Scandinavia
- no min amts req'd
- PO s/b informed about surrender terms adn how calculated if available
UK
- no mins req'd
- strong disclosure reg
- typical product is variable life and nonf values function of MV of sep accts
Austrailia
- no mins req'd
- looking into nonf & disclosure rules
US
- NF Laws adn regs specific and prescriptive
- SOA Unruh Report - 1976
  - discussed equity
  - PO, Co, agent & regulator and 4 different views of equity
  - equity is not an absolute but relative truth
- in the long run, costs of early terminations will be paid by continuing PO
- in short run, if co cannot fully pass on these costs, it will reflect them in reduced profits, PO divs, or agent comp

The Nonf Calculational Plan

if formula not mandatory, co may wish (or be req'd) to use written nonf calc plan for each block of business
specify method for determining amts at all policy durations
specify relevant non-guar elements
specify methodologies for determing policy experience assumptions to be used to calc nonf benefits
specify extent to which these amts have been Guaranteed
use of calculational plan permits flexibility in design adn management of diff blocks of ins policies
may be based on retrospective or prospective
calc may assume no future voluntary terminations or it may reflect all available options
hoped that large portion of US regulatory nonf framework could be replaced by
- regulation of nonf calculational plan
- reliance on professional actuarial statements of opinion
- enhanced regulation of disclosure

Misc Practical Nonf Issues

if nonf amts calced retrospective - adjustements for mort anti-selection may be inappropriate
ETI as automatic option can reduce mortality anti-selection (b/c not in force as long)
- can use more liberal reinstatement rules (b/c no reduction in face while under ETI)
RPU advantage - original form and expiry continued
- very little mort anti-selection s/b expected
APL - reinstatement not necessary
- however may provide incentive to discontinue payment of prem
- tends to increase co maint expenses
companies varied in practice re: substd lives
- some increase CV, most don't

Permanent Products w/ Little or no Nonf Values

T-100 - lapse supported non-par WL w/ no nonf values (or values well below natural reserve)
positive profit realized when policy surrendered prior to death
particularly sensitive to LT pricing assumptions for lapses, inv yields and mort rates

Study Notes and Published References - Note SN 81-102-00 - LIFE AND ANNUITY PRODUCTS AND FEATURES

Term Insurance

Characteristics of Term Ins
- coverage periods adn face amt patterns
  - level term - 10,20 yrs or to a given age (65/95/100)
  - decr term - usually follow a patter such as mort amort
    - in theory, s/b monthly decline, but most annual
    - often level off at some point
  - incr term - scheduled increases of face amt or x% or related to outside index
- prem patterns and prem guarantees
  - level term
    - level over entire term period (usually)
    - modified (1 or 2 increases during cov period)
    - increasing every "x" years
    - prem schedule - AA, select, S&U
    - S&U challenges
      - lower renewal discourages re-entry but fear mortality results will deteriorate the further from orig u/w
  - decr term - level prem may eventually be very large compared to DB
    - partial solutions:
      - limited pay
      - decr prem scales
      - level db @ later years
      - ann incr prem (ART rate * DB)
  - incr term - usually incr prem
  - coverage guarnteed, sometimes prem not guar
  - trad non-par term - prems guar
  - trad par term - not very popular
    - mod prem - low early year, higher later years w/ divs
    - ann incr prems w/ divs @ higher durs
    - adv of par term
      - high GP -> no def resv
      - cushion against adverse deviations
      - net outlay may decrease in later years -> better persistency
      - slope can lower costs by minimizing CV
  - Indeterminate Premium Plans
    - current and guar prem scale
    - if need to adjust prems
      - must be done as a class
      - must be done prospectively
      - cannot be used to recoup past losses or distribute past gains
    - allows aggressive approach to term pricing
  - Re-entry Term
    - co can charge higher rates if insured fails evidence of insurabillity every x years
      - u/w reqs and stds not guaranteed
    - anti-selection on those that don't lapse, if not requalified
      - premium spiral may develop
Premium Differences by Size of Policy and by Underwriting Class
- bands very common in competitive ART mkt
- based on size of policy at issue
- Term usually has higher mins for face adn prem b/c need to spread fixed expenses
  - higher per $1/prem b/c of lower term prems vs WL
- Lapse experience probabily much diff between term & WL
- Higher pol fees b/c of higher lapses adn not as much inv income to offset inflation
- reinsurance consideration more important for high face amt policies
- pref rates for better u/w risks
Term Riders
- usually same prem rates as term base plans
  - only diff is absence of pol fee on rider
- another term rider is divs to purchase 1 yr ART
  - this option may reg add'l u/w and maybe reinsurance
- spousal - usually w/ conversion priv and payor
- kid riders - usually coverage to age 21/25 (or insured age 65)
  - w/ conv priv - usually 5x face
Other Types of Term Products
- joint life products - good fro mortgages or two-income families
- hybrid term products
  - level prem term to 65 w/ decrease in DB after x years
    - projected divs by YRT adn PUA to keep DB level
    - @ 65, PUA balance approx 1/2 issue face
- Deposit Term
  - extra high 1st yr prem
    - part is "deposit" that provides PE @ EOY 10
      - early lapse, "deposit" is forfeit
      - theory - encourages persistency
Policyholder Options in Term Products
- Conversion Priv - most common option
  - ability to "trade-in" for perm policy w/o evidence of insurability
  - entire face on level benefit plans
  - on decr term, usually 80% of orig face
    - option usually expires 5 years before end of period
  - some pols have automatic conversion
    - if dis and have waiver, then conversion is automatic
  - some co's allow terminal reserves as premium credits on new pol
  - some co's allow 1st yr discounts
  - generally felt perm more profitable than term
- GIO may also exist - incre decr term to orig face amt
Pricing Considerations for Term Ins
- Mortality
  - usually significant factor for term ins pricing
  - NAR usually greater for Term vs Perm for same face
  - A/E mort lower for term than perm
    - term face amts higher and large face mort better than overall
    - poorer persistency of term tend to weight more of its exposure to earlier policy years
    - as less healthy lives convert (or other options), remove themselves from NB term exposure
  - recent trends
    - large face mort better than overall
    - female large face worse than overall
    - term large amt experience significantly less favorable than perm large face
    - experience varied by band
      - > $1mill had best ratios (and better u/w)
  - slope of expected mort by dur a concern
    - renewal mort influenced by
      - extent coverage (intended to be s/t) is continued by unhealthy lives
      - ability of healthy lives to rewrite coverage at lower rates
  - no best solution to choosing appropriate mortality assumptions
  - design of product and how marketed will have substantial effect
- Persistency
  - higher early lapses can make it very difficult to recover u/w and issue costs
  - high lapses in later policy years may erode expected profits
  - dangerous to assume overly optimistic lapse rates
    - too many incentives to rewrite business
  - product design features which encourage lapses s/b taken into account
  - term lapses more serious problem in renewal than FY
  - FY term lapses slightly lower than perm
  - renewal term lapses > FY term and renewal perm
- U/W
  - similar to perm U/W
  - may U/W for larger face depending on GIo or auto-increase options
  - substd not as available adn w/ more restrictions
- Field Compensation
  - varies substantially
  - rates may be higher than perm, but smaller prems
  - competition has driven comm and prems very low, esp 1st yr
  - comm rates may recycle (each tiem a 5 yr renewable renews)
  - renewals typically around 5% adn may be limited # years
  - reduced comm for exercise of policy options
  - renewal lapses tend to be higher on business written by agents w/ brokerage agreements w/ serveral cos
    - esp ART plans w/ S&U pricing
- Other Expenses and Inflation
  - U/W & issue expense large share of term prem
  - renewal expenses often greater % prem than perm
  - term very sensitive to way overhead is allocated
  - inflation can cause serious problems b/c minimal investment income to cover
- Pricing Options
  - 3 approaches
    - costs borne by those who exercise
    - costs borne by equally by all willing to pay to have option available
    - costs borne by all
  - pricing for coversion credits
    - form of terminal dividend
    - incorporate a specific charge based on the expected conversions @ each dur
  - develop appropriate pricing factors
  - difficult to estimate proportion of insureds who will elect
  - conservative to assume that options will be elected
  - assumptions as to % of coverage opted
  - lapses generally low for option issued policies
  - mortality generally higher on option elected policies
  - since no u/w, issue expenses lower and lower lapse rates -> can be quite profitable
Profit Objectives
- common methods
  - profit margin measures - PV fut profits as % PV future prems
  - IRR - int rate where PV profits = 0
  - IRR w/ target surplus objectives
  - BE analysis - year accum assets cover reserves
- usually combine a couple of these
- impact of options on profitability depends on how priced
- pricing and profitability can be very sensitive to variations in expected mort/lapse/exp experience
- greater the uncertainty about future profits, higher profit measures s/b targeted
Legal and Regulatory Issues
- special regs in some states
- many state have detailed rules for indeterminate prem term
  - affects advertising, disclosure adn mkting practices
- a few states require certifications at policy filing and prem redetermination
- contestability - two years from orig u/w
  - re-entry term - handle like age misstatement
    - what DB would be if they used old scale prems w/ what they actually paid

Appendix 1-I

Experience under Term Conversions and GIO
- Conversion at end of a Specific Year
  - A(x,m,r) = [r]p(x,m)*e(x,m,r)*k(x,m,r)*v^r - PV of extra mort due to conversion
  - k(x,m,r) = sum{[t-1][p((y,m,r)+t-1)-q([y]+r-1)]*NAR([y]+t)*v^t} across t
- Special Case
- Total of Extra Mort Costs for the Special Case

Appendix 1-II

Term Conversion Experience
- Conversion Rates
  - tend to increase by attained age
- Lapse Experience
  - tend to show decreasing pattern of lapses by incr age at conversion
    - during 15 year select period after conversion
    - female lapses higher than male
    - lapse rates for paramed higher than non-med, med lowest
- Mortality Experience
  - generally more favorable for policies converted prior to end of conversion period vs last chance conversions
    - automatic conv and renewable term - favorable
    - decr term - significantly higher
    - female ratios (by amt) lower than males
    - select period rates lowest for paramed, highest for nonmed
    - overall higher ratios for conversions from term policies than from term riders

Appendix 1-III

Option Pricing Mathematics
- one technique for charging each year's cost of option to term policies eligible for the options
- recognizes optoin losses in policy year they are assumed to occur
- determination of cost of options
  - CR(x,t) + [option handling expense / avg size of pols in radix] * [Optoins(x,t,i) / radix]

Universal Life (UL)

Characteristics of UL
- Development of Cash Values
  - prem paid, load deducted, net credited to fund
  - fund accumlated w/ interest, deductions for COI, rider, expense charges
  - min guar int, but usually credit higher
  - max guar COI, but usually charges lower
  - SC
- Death Benefit
  - two options: 1) specified amount 2) specified amt + CV
  - minimum corridor - necessary to retain favorable tax status
  - specified amt can be increased (subject to eligibility) decreased (mins may apply) or DB option changed
- Prem Flexibility
  - usually pay whatever whenever
  - may have req'd first yr prem or a min prem for a few years
- Partial W/D
  - may involve admin fee
  - both CV and DB reduced
- Policy Loans
  - credits below policy loan int rate or guar rate
  - loan taken from general acct assets if variable products
- Riders
  - WVR, ABB, GIO, spouse, kids, payor
  - wvr - waiver of COI or waiver of stipulated prem
- Nonf Options
  - no traditional options, but acts like ETI
  - COIs paid from fund value as long as it lasts
  - can resume payments anytime (if still inforce) w/o evidence
- Int Rates
  - usually 1 year guarantees but may declare monthly
  - some tied to external index
  - portfolio vs new money
- Mortality Charges
  - guar COi - AA scales = nonf mort basis for product
  - sometimes guar rates > nonf mort (simplified issue or smokers)
    - some states won't allow
  - current COI may be AA or S&U
  - S&U used when sold as alternative to term
  - reverse S&U - helps recover acq costs
- Expense and Surr Charges
  - SC - to help recover acq costs
  - FEL - less common now
  - more expenses recovered from int and mort margins
  - currently, usually a % prem charge & per policy annual charge
- Persistency Bonuses
  - means of enhancing long dur CV on UL and ISWL pols
  - guar persistency bonuses have reserve and nonf implications
  - some states don't allow persistency bonuses b/c of tontine-like nature
  - some cos don't pay non-guar bonuses when due
  - soem cos hold voluntary reserves for non-guar persistency bonuses
Other UL Products
- Fixed Prem UL (FPUL)
  - aka ISWL, EIWL, current assumption WL
  - typical characteristics
    - fixed prem req (may be waived under VP concept)
    - accumulation acct (just like UL)
    - min guar set of benfits/values regardless of actual performance (secondary guar)
      - low prem version has reduction in guar Db at some point in time
    - csv = max(min guar cv, accum acct - SC)
  - vanishing premium version most populr
  - consideration on vanishing premium
    - commissions paid on "vanished" prem?
      - If so, only limited time
    - what happens to modal loadings after vanish?
      - switch to annual mode
  - typical low prem plan has drop in DB after 5-10 years (on guar basis)
    - methods for overriding drop in DB
      - if orig prem still deemed sufficient to produce WL benefits, orig DB extended for another period
        
        PO given option fo paying higher prem if orig prem not sufficient
      - orig db continue if actual csv > min guar csv
  - Advantages vs flex prem UL
    - contract is more similar to trad than UL
    - FPUL pays comm to agent on a high prem/$1m
    - fixed nature of prems may enhance persistency in some mkts
  - Disadvantages
    - no prem flexibility (except vanishing prem)
    - additional prems can significantly complicate product and admin reqs
    - VP dependent on level of int rates
- Single Premium UL (SPUL)
  - flex prem can be sold as single prem
  - loads, comm, and other parameters can be tailored for SP inv-oriented sale
  - tax advantages elimnated w/ 88 Tax Act (some of them)
  - still sold for estate preservation purposes
  - popular feature - preferred loans
- Group UL (GUL)
  - most active mkt - salary deduction basis at large employers
  - advantages over indiv UL
    - contracts charge expense loads on a group by group basis (in many states)
    - MET files product in 1 state, offer coverage in 30+ states w/o add'l filings
    - tendency to include experience rating, mort charges based on historic experience
      - guar iss u/w techniques
Pricing Considerations for UL
- Pricing Different Scenarios
  - assume premium pattern will vary
  - benfit pattern will vary
  - w/d & policy loans from client investment anti-selection
  - changing interest margins
  - inflation adn other economic factors in indefinite flux
  - only more realistec scenarios can be reasonably examined
  - important to determine sensitivity of profit studies to deviation in assumptions
  - important to monitor actual experience compared to expected results
- Source fo Profit Analysis
  - important to balance sources of margin so that most scenarios of prems and persistency result in OK profits
  - sources of profit
    - interest earned - interest credited
    - COI charges - DB paid
    - Expense Charges - expenses adn commissions
    - surrender charges
- Asset/Liability Analysis
  - risk of int rate anit-selection
  - if assets held have reduced mkt value, capital losses result if assets ahve to be sold
  - UL subject to this mor than other life products b/c mkts focus on credited int rate
  - important to test various investment and int crediting strategies under different int rate scenarios

Variable Life Insurance

Characteristics of Variable Life Ins
- CV matched by assets in sep acct
- PO can (usually) transfer assets among accts w/o imposition of charges
- sep acct assets immunized from liab of rest of ins co
- min cv not guar for variable life products
- unlike most insurance, variable life regulated by SEC (in addition to state regs)
- VUL - "hybrid" product
  - similarities to fixed prem variable life
    - sep accts
    - several inv options
    - sales loads may be limited by regs
    - other charges may be limited (mort and exp charges, inv advisory fee, policy fee all years (some disagree))
    - sales illustrations need to consider approp rate
    - margins between policy loan int rate charged and credited
  - similarities to UL
    - flexible prem payments
    - DB types 1 & 2
    - changed in DB allowed
    - monthly charges
      - FY per pol loads
      - FY month per $1m loads
      - COI (current and max)
    - charges for riders deducted from fund
    - combination FEL and BEL
    - commissions based on multiple factors (sometimes)
    - polcy loan int margin ofther larger than fixed prev VLI, often charged "in advance"
  - VUL usually designed to look like a UL (where permitted)
  - no guar w/r to CV
  - GMDB good mktg tool, bot don't offer w/o analysis fo risks involved
- Fixed Prem Variable Life
  - similar to trad WL
    - prems guar and level by dur and min DB guar fo rlife
    - CV varies and guar DB varies by intervals
  - 3 basic types fo fixed prem designs
    - Dutch Design
      - DB and prem constant in # shares, share price is variable
      - DB = DB(-1)*inv adj factor
      - prem varies by same %
      - inv adj factor reflects relationshiop between
        
        actual net inv eprforamcne of sep acct and
        assumed int rate (AIR) used for calcing NP and reserves
    - NY Life Design - 1969 SOA paper
      - DB = orig face * actual cv / tabular CV
      - more closely resemble fixed-benefit policy
      - adjustments to DB conceptually simpler than other designs
      - buys prem-paying additions (on orig age basis)
        
        since GP is fixed, continued favorable performance needed to keep additional Db
      - DB more responsive to current inv performance
      - cost of GMDB higher than Equitable design
    - Equitable Design
      - used by virtually all US cos offering fixed prem VLI
      - purchase positive or negative PUA from excess net inv performance (>AIR)
      - DB can't drop below guar
      - Ins co allowed to levy risk charge for GMDB
      - adv: DB will increase as long as inv performance > AIR (NY Life design, had to be > than prev period inv performance)

Survivorship Insurance

pays on second death
considerably cheaper than two pols for half the face
attractive in situations where $ needed to pay estate taxes
can be structured so benefits not subject to estate taxes
Characteristics of Survivorship Ins
- UL/Trad WL/EIWL very littel term, except as riders w/ trad ins
- PAR WL
  - preferred product form - used w/ term riders and divs to PUA to keep DB level
- UL adn I/S products
  - potential disadvantage - excess performance to increase CV, not DB
    - mkt values DB over CV
    - mkt responded w/ variations that work more like Par WL
  - UL offers prem flexibility - important to this mkt
    - goal lowest possible prem to fund benfits over life of contract @ current assumptions
- Single vs Dual Status
  - single status - looks like single life policy - frasier
    - smoother cash values
  - dual status - x or y or both alive
    - in theory, PVFB increases dramatically at first death
  - single/dual decision issues
    - perceived marketability of approach
    - admin feasibility
    - ins regulator attitude
    - percieved risk profile
    - implications of income in term rider costs for dual status policies
  - admin - burden of keeping 3 sets of CV/Vx/div factors for 3 states
  - single status approach more popular
- Joint Equal vs Exact Ages
  - 3 approaches - exact age, joint equal age, equivalent single age
  - Exact Age: determined from first principles based on exact age and risk class of each life
    - some cos calc for all permutations and store in file - huge file
    - some cos calc factors for each policy as issued and store
    - soem cos calc on fly - probably most economical
  - Joint Equal Ages: each combo of lives based on roughly equivalent ages
    - some jurisdictions need add'l certification, if this method used, that JEA results >= exact age results
  - Equivalent Single Age: attempt to equate joint life to single life
    - results in serious overcharging in early years and undercharging in later years
  - Substd and Uninsurable
    - very improtant to survivorship mkt
    - increase in cost relatively trivial if only 1 life substd (compared to single life coverages)
    - b/c high face - rigorous u/w stds, but often make small concessions b/c highly competitive mkt
  - Rating Methods
    - Age rateup - if impaired, assigned a high age w/ approx same life expectency
      - many insurers don't like age rateups b/c IRS def of life rules
    - Extra prem - more difficult w/ substd
      - some cos price on a case by case basis using formulas to develop extra prem
    - for UL plans, age rateups can determine COI charges or multiples applied to std COI rates
  - Uninsurable Lives
    - many will still issue if one life uninsurable
    - still more attractive than single life policy on healthy life
    - important to distinguish between uninsurable and terminal
    - other reqs
      - uninsurable life must undergo normal u/w and have life expectancy of one or two years
      - uninsuralbe must not increase contagion factors due to contagious disease or alcohol misuse w/ adverse MVR
      - insurable life u/w as if single life policy
      - insurable life must not be highly rated (table D max)
- Mortality Assessment
  - critical to understand extremely competitive nature of this mkt
    - mkt will react quickly to any pricing mistakes made
    - very efficient mkt
- Flexibility adn Competitive Concerns
  - product that can respond w/ flexibility are more likely to suceed in this mkt
  - funding requirements vary
    - some want low levels that fall below gift tax levels
    - some want to fund immediately
- Competitive Measures
  - rate of return on death at specified duration or life expectancy
  - min prem payable over max benefit period req'd to fund benefit on current assumptions
  - min prem to vanish in specified # years
  - min cash value to vanish
- Riders
  - Policy Split Rider
    - very few sold, but availability can be deal breaker
    - no charge but evidence req'd or
    - charge GIO prem and n/c for split (and no evidence)
    - only split on specified events (divorce, tax law change, etc)
  - Estate Preservation Rider - specifically developed for US tax environment
  - First-to-Die Term Rider
    - used to
      - rollout split dollar policies
      - fund policy after 1st death
      - pay some estate taxes
      - split dollar prem recovery
  - riders included in basic prem (no charge) or specified charge
  - specified charge preferred
    - valuation questions w/ free term ins
    - sophisticated mkt knows nothing is free
    - if needed, cost realtively small and insureds willing to pay for it
Pricing Considerations for Survivorship Insurance
- mortality assumptions
  - factors to consider
    - anticipated level of single life mortality for class of PO being targeted usually considerably different from regular single life business
    - degree of u/w concession provided
    - contagion - in form of joint accident risk
    - "broken heart" syndrome
  - additional factors
    - impact from almost all being medically u/w
    - socio-economic class of lives insured
    - impact of very low lapses on long-term mortality
    - implications of all issued policies covering "married" individuals
  - cos often lack credible basis for estimating female mort at very advanced ages
- Persistency
  - initial results very good
  - lapse-supported products potentially dangerous
- Expenses
  - often expressed as amt/policy for this mkt
  - expenses should reflect u/w two lives usually w/ multiple APS
  - per pol maint exp assumed higher as well
- Reinsurance
  - high face amts -> reins vital role in pricing
  - some cos increased retention
    - logic - if took out sep policies, but under retention, we'd pay out 2x DB on them
- PO Taxation
  - low lapse rates can produce counter-intuitive results w/r to cv scales

Appendix 4-III

Contagion Risk
- normally assume death of individual is independent event
- to exent not true, exists a risk to insurer (contagion risk)
- heartbreak (or lonely-heart syndrome)
- joint accident risk
- problem compounded by lower lapse rates after first death

Extra Premiums for Substandard Life Ins Risks

Substd risks -
- varying patterns of level and incidence of extra mortality
  - level # deaths (independent of age)
  - level % of extra mortality
  - increasing %
  - decreasing %
  - slowly decreasing 5
- theoretically, sep mort table for each impairment
- most impairments, difficult to obtain sufficient data to define precise patterns
- most cos - 2 systems to classify extra mort
  - multiple table classes
  - flat extra - good for consistent extra # deaths/thousand
    - used for s/t impairments and hazardous avocations
- numerical rating - debits (unfavorable) adn credits (favorable)
  - final results consistent w/ good judgement
  - criticized as too arbitrary
- other methods (rarely used)
  - advance in age (age rate-up)
  - return of prem - in lieu of DB for first n years
  - Lien method - reduced fact amount grading to full DB in a few years
  - different prems for each subst class, diff NF values and divs to reflect actual experience
    - few cos ahve sufficient experience to justify
- if extra hazard too difficult to classify, exclusion clause may be used
  - exclusions limited in some jurisdictions
- most substd business written on a multiple table extra basis
Substd Rating Classes
- decide on # of substd classes and mort range for each class
- consider broad or narrow classifications
- if smaller amts adn/or simplified u/w, usually higher limit for std class and few broad substd classes
Gross Extra Prems
- Mortality
  - std mort table should not have any margins so margins aren't distorted when table multiples applied
  - some co's adjust table so an absolute differnece in mortaltiy beyond a certain point
  - multiple s/b aruond midpoint of rating range for each class
- Subdivision into M/F adn S/N
  - substd usually around 4-8% of business
  - splitting substd into M/F S/N may not be worth effort
  - if only using 1 set of extra prems, may use age setback
    - some indication that relative diff is less for substd than std
  - for nonsmokers, if slightly substd, might issue as std smoker vs substd nonsmoker
- Subdivisions by Plan
  - Term w/ IA/Dur substd can generate prems higher than substd perm
    - causes higher not-takens and lapses on term
  - UL - either extra charge for mortality element
    - or amt of coverage w/r to "investment" element decreased
  - VLI - for simplicity, often same extra prem as trad plan of same face
  - single prem - wider classes to absorb more of substd as std
    - reduce amt of coverage
    - NAR smaller for single prem plans & potential anti-selection reduced
  - can always limit certain plans to only std risks
- Expenses
  - consideration for expenses properly chargable to substd pols only
    - not spread across all pols
  - two extremes
    - business of taking risks, so expenses, regardless of source, s/b shared across all business
    - substd shoudl stand on its own AND contribute to surplus
  - usually reqs more u/w (and more experiended U/W), but often expenses not split
  - maint expenses generally same, except for requests for rating reduction/removal
- Not Taken & Lapse Rates
  - higher and increase as ratings increase
  - not takens > 50% in highest rating classes
    - vs 10-15% for std
  - lapse rates higher too which drives up substd costs adn fewer pols to amortize initial expense
- Extra Cost of ETI & RPU for Trad Risks
  - usually provide ETI/RPU at std mortality
    - ETI not available for higher substd classes
  - extra cost is single prem to provide benefit at substd mort - single prem to provide benefit at std mort
- Prem Paying Period
  - theoretically correct to charge for whole premium period
  - can cause prems to exceed face
  - some cos limit WL extra prems to max (AA65, 20yrs)
  - common to remove hazardous avocations prems after max(AA65, 10yrs)
- Gross Extra Prem Calc
  - expereince gross extra prem = experience substd total gross prem - experience std gross prem
  - GP_R = NP_R(1+c) + I_R / adue_R(x:n) + k_R + Z_R*GP_R
  - GP = NP(1+c) + I / adue(x:n) + k + Z*GP
  - wehre R - Rating Class GP - Gross Prem/amt GEP - gross extra prem/unit
  - NP - net AP/unit c - per policy claim cost/avg size pol
  - I = acq exp per pol / avg size pol
  - k - other constant expense incl maint exp/unit, level ann acq extra cost for substd ETI/RPU
  - Z - level ann equiv expenses as % prems
  - GEP_R = (NP_R - NP)*(1+c) + (I_R/adur_R(x:n) - I/adue(x:n)) + (k_R - k) + GP*(Z_R - Z)/(1-Z_R)
  - another method - use asset shares at key ages to determine extra prem that meets targeted surplus
- Cash Values
  - since co's usally use std cash values, may want to reduce scale of gross extra prems
    - in theory, substd CV would be higher
- Asset Share Tests
  - adequacy of substd experience prems s/b tested by asset shares
    - select mortality and lapse rates introduced
    - should give effect of using std CV, std divs adn extra cost of nonf benefits
  - should serve as a check on level exp prems and give basis for making final adjustments to gross extra level prems
- Temporary or Permanent Flat Extra Premiums
  - principles same for temp and perm
  - reverse of table extra
    - prems set first & class rating set afterwards
  - provision for extra expenses likely to be less
    - expenses usually less
    - commissions usually not payable on flat extras
    - addition of substd expenses makes intial prems too high
  - take prem/$ (usually 2.50, 5.00,7.50, 10.00)
    - subtract out expenses
    - remainder is annual # extra deaths/thou covered by flat extra prem
- Supplementary Benefits
  - same theries apply to subb ben (wvr, ADB, etc)
  - as practical matter, most co's charge a multiple fo basic charge
  - if rated too high, not available
- Reduction adn Removal of Ratings
  - in theory, pricing should reflect removal of ratings from those who later become eligible (via re-u/w) to have ratings removed

Fixed Deferred Annuities

SPDA
- sold both qual and non-qual mkts
- min size usually $5,000-10,000 - some qual IRAs $2000
- FEL or periodic fees - may charge explicit FE loads or periodic fees
- SC - % of acct value
  - % declines over time
  - purpose: recover acq costs
- Int rate and int guar period - min guar rate
  - usually initial guar rate > min for x years
  - renewal rates - generally blend between supportable rate adn competitor rates
    - usually guar for 1 policy year
FPDA
- FE loads adn periodic fees
  - may charge FE load
  - many have annual charge for periodic policy maint
- SC - % of total annuity acct value
  - % grades off
  - sometime big drops (plateus and cliffs)
  - sometimes:
    - SC associated w/ each prem payment (as % prem)
    - level % of sum prems paid over previuos x months
    - level % of min(acct value, last x years' premiums)
- Int Rates and Intr guar periods
  - generally slightly lower rates than SPDAs
  - initial rate typically guar 1 year
Variations in Design
- CD annuities
  - SC period adn int rate guarnatees coterminus
  - @ end fo guar, 30-60 day window to surr w/o penalty
  - SC designed to mimic CD
    - loss 6 mo's excess or total interest
    - loss of all excess int credited since beg of guar peroid
    - level % of acct value - usually 1/2 current int rate
  - at end of guar, can renew for same or diff guar period @ then current rates
    - deault is usually same renewal period
  - initial comm vary by length of guar
    - renewal comm usually paid as full first year w/ each renewal
- MVA annuities
  - interim contract values based on both SC adn MVA formula
  - MVA formula reflects chagnes in current rates since beg of int rate guar period
  - typically longer int rate guar than SPDAs
  - no MVA @ end of guar period, but may still be SC
  - normally MVA is opposite directoin of mkt int rate movement
  - intended to reduce disintermediation risk - enables crediting higher rates
  - typical formula [(1+a)/(a+b+c)]^(n-t)
    - n - lenght of current int rate guar period
    - t - period (dur) since beg of current guar period
    - a - current guar
    - b - current rate
    - c - constant factor (0-50 bps)
    - "c" constant factor used ot force at last that amt of mkt change before any impact
      - some cos don't use factor
      - some say MVA formula only applicable if rates changed more than x bps
    - reduction in int rate risk results in more favorable stat reserve adn req capital provisions
- Two-Tiered Annuities
  - commonly sold in tax qual mkt
  - accumlates two values, one fo rannuitization, one for surrender
  - some products cap differences between two balances
  - designed to encourange PO to keep money w/ co and maintain equity between terminating and persisting PO
  - criticism - customers don't understand difference between tiers and illustrations confusing
- Non-Surrenderable Annuities
  - surrenders not allowed, except at specified times - typically end of guar periods
  - might be limited penalty free w/d provision
  - might have loan provisions
  - generally no SC
  - insurers hestitant to offer since percieved as less mktable than MVAs due to reduced liquidity
Other Product Features
- Bailout Provisions - waive SC if declared renewal rate drops below defined bailout rate
  - may have window period to exercise bailout
  - may be permanent waiver
  - may be in effect until renew > bailout declared
  - once triggered, if PO doesn't exercise rate
    - provisions continue as is
    - provisoin continues, but bailout reset
    - provisoin is terminated
- Medical Bailouts
  - when confined to a nursing home or LTC facility
  - if conditions trigger non-subjective, easily administered adn not easily abuse, cost is relatively low (< 10 bps)
- Penalty-Free Partial W/D provisions
  - cann surrender a portion of acct value w/o SC
  - typically avail on full surrender also
    - reduces effective SC%
  - variation - allow unused portion of penalty free w/d to be carried forward
  - subject to min w/d amt adn min remaining acct balance
- Return of Principle Guarantee - SV >= prems paid (adj for prior partial w/d)
  - stat reserves need to be higher w/ this secondary guar
  - if no comm chargeback, beware of churning
- Death Benefits
  - normally = acct value
  - some = CSV
  - some (if allowed by law) - No DB
- Waiver of SC upon Annuitization - may req additional reserve
- Guaranteed Settlement rates
  - generally conservative but may impact reserve calculations
- Acct Value Enhancement (bonus)
  - annuitization bonus - most common - encourages funds to remain w/ co
  - persistency bonus - encourage LT persistency
  - bonuses on large acct values
  - first year int bonus - designed to attract new funds
    - may be vesting schedule for bonus amt
Princing Considerations for Def Annuities
- C-3 risk - assets arising from a product will be insufficient to fund products liabs due to chagnes in interest rate environment
- DA PO has option of selecting against co
- Interest Spread
  - goal of princing exercise - determination of targeted int spread req'd to meed profit objective
  - used periodically to set current int rate on NB and renewal rate on EB
  - affected by competitive considerations (both other carriers and other (bank cds))
  - targeted spreads generally 125-200 bps
  - actually usually less due to competitive pressures
  - components of spread (what it has to cover)
    - spread req'd for inv, acq, maint and commission expenses
    - spread req'd for freatures like bailout
    - spread req'd for risk cahrges for assuming asset risks
    - spread req'd fro expected profit margin
  - Pricing must use
    - realistic provisions for costs fo features like bailout
    - realistic provisions for cost of the int rate risks assumed
    - realistic assumptions for w/d, expense, mortality
- Crediting Strategy
  - int spread is principal source of revenue available
  - consideration of most effective ongoing crediting strategies for realizing targeted spread over princing horizon
  - in general, excess laspes -> profit margin not being met
  - if still in SC period, "real" int rate = credited rate and decline in SC
  - to understand optimal crediting strategy, product design may be evaluated under various crediting strategies by use of int rate scenario pricing
  - potential crediting strategies
    - net protfolio yield less targeted spread
    - net protfolio yiled less targeted spread, but never above competitors rate + x% adn never more than y% below competitors rate
    - z% of (net portfolio yield less targeted spread) + (100-z)% of competitors rate
  - w/d rates need to reflrect competitiveness of credited rates and magnitude of SC
    - examples: a*(j-i-b)*SV/AV + c
      - a*(j-i)^b - c*SC + d
      - a,b,c,d constants, i- our rate, j - competitors rate
- Withdrawal
  - one of most significant pricing assumptions for DAs
  - affected by
    - SC - incidence and magniture
    - credited int rate - level and competitiveness
    - distribution system
    - int guarantee periods - length and expiration
    - age and economic status of PO
    - size of contract
    - perceived fin strenght of ins carrier
- Partial W/D Provisions
  - need assumptions as to amt of CV w/d under provision
  - impact of penalty-free w/d on stat reserves s/b incorporated ito profit test
- Mortality
  - genearlly not a significant factor
    - an annuity mortality table is not appropriate for DA DBs
    - S&U life experience not appropriate sicne annuitants do not undergo u/w selection process
    - very little guidance as to what table is appropriate
    - important consideration at older issue ages (75-85 when mort rate approx 5-8% decrement to inforce
      - either restrict issues beyond those ages or reduce commissions
      - more difficult to fully amortize comm and acq expenses
    - mort also important if DB is excess of CV paid on both death of annuitant and death of non-annuitant owner
- Commissions and other Mktg Expenses
  - SPDAs - 3-8%
    - some cos use tails
  - FPDAs - typically 7% 1st yr, 3% ren
    - some cos use levelized for FPDAs
  - CD annuities typically pay renewal at end of guarantee on those that renew
- Expenses
  - acq expenses relatively low
    - no u/w
    - just mktg adn policy issue
  - maint expenses relatively low
- Effect of Competition of Expenses adn Compensation Levels
  - significant non-ins competitors for DA $
    - money mkt, mutal funds, CDs
  - underlying asset portfolio of other mkt entities may be significantly diff from ins co in terms of dur and quality
  - to compete sucessully, need to admin business adn compensate field force w/in mkt pressure constraints
  - restraint in product design to eliminate aspects which increase admin cost w/o increase in competitive advantage
- Surplus Strain
  - potential to deplete surplus if significant volumes written
  - sources
    - first year comm
    - reserve increases
  - "avg" strain - 4-5% of premium
  - additional surplus needed for both solvency purposes and to maintain adequate ratings
    - 3.6% of reserves depending on product design and investment strategy
  - since surplus limiting resource, distributable profits is profit measure in pricing
- Bailout Pricing
  - possible additional surplus strain assoc w/ product design due to stat reserve reqs
  - value of option itself, cost of excess lapses adn lost SC if triggered
    - cost of artificially supporting renewal rate to not trigger bailout
  - estimated cost of bailout provision - avg lost SC * assumed excess lapser rate * probability of trigger
  - actual cost - add'l spread req'd to force media profit test from dynamic scenarios to equial profit objectives vs traditional deterministic profit test
  - cost of option iself and cost of additional suplus req'd by option presence (in bps) represents total cost of provision
  - s/b able to pass entire cost on to PO, but competition forces gap between actual and charged cost
- Pricing CD annuities
  - two specific items to consider
    - w/d rates @ end of int guar period (can be very high)
    - if renewal comm paid if contract renews
      - if so, what level
      - comm usually paid since proceeds very liquid adn easily movable by agent w/o penalty
- Int Scenario Pricing
  - deterministic profit test typically has more favorable results then median results under int scenario pricing
  - allows costs associated w/ assumptions of int rate risk to be quantified
  - objective - quantify risk vs return trade-offs adn decide on optimal strategies
  - a co that does not understand who inv and crediting strategies they've adopted affect CF patterns is at serious financial risk
- Profit Objectives
  - profit margin - PV stat book profits (dist profits if include TS) as % of PV prems - either pre/post tax
  - internal rate of return - int rate PV stat book profits = 0
  - BE year w/r to reserves
  - even if objective is only one of these, monitor all 3 as they provide valuable insight
  - most cos use a combo
  - BE-year more important w/ annuities than life
    - target: BE yb end of SC period (or first window w/ CD annuities)
- Pricing Horizons
  - generally much shorter than life ins
  - 10-20 yrs
  - shorter for SPDAs adn non-qual FPDAs
  - longer for tax-qual FPDAs

Variable Deferred Annuities

Overview
- provides benefits which vary according to inv experienc of supportin gassets
- does not have int guarantees like a fixed annuity
- PO bears inv risk and receives inv return actually earned, less charges assessed by co
- general acct may be restricted (by law) as to type and quality of investments it may hold
- sep acct - few (if any) restrictions
- historical rationale for VA - protection of retirement income from inflation
- protection of retirement income from inflatoin - crucial goal of ret savings program
- VAs eliminate C-3 risk found in fixed DAs
Characteristics of VAs
- often "combination" contracts - offer both fixed and variable adn may allow PO to have funds in each
- may allow transfers between accts
- allowing transfers out of fixed exposes co to risk of anti-selection in timing
- product differences reflect differences in expense levels for mktg, agent comp or admin
- Product Guarantees
  - full acct value @ death w/ no SC
  - may have GMDB
    - ins co bearing inv risk for contingency of death
  - assessed charges guaranteed to remain level or below stated max
  - contract stipulates annuity purchase rate used to determine initial annuity payment
- Product Charges
  - FEL
  - rear-end load or SC
    - 3-12% of prems or accum value
    - decr often to zero
  - % of asset charges
    - .5 - 1.75% per year
    - extra charges for optional guaratnees
  - other fees - may be assessed a periodic fixed fee
    - annually $10-30 common
- Admin Considerations
  - much more complex than for fixed annuities
  - calculation of unit values on daily basis
  - timely processing essential
    - SEC requires all disbursements made w/in certain period after request rec'd
    - all trx processed effective as of date paperwork rec'd
    - SEC req most trx confirmed to PO w/in certain period
      - significant mailing expense
Pricing Considerations for Variable Deferred Annuities
- b/c guarantees limited, pricing consists of selecting product charge structure which will provide adequate profit after recovering sales, admin, adn inv expenses (w/in competitive constraints)
- Lapse
  - key factor impacting profitability of BEL products
  - b/c primary souce of income is asset charge, brings in more income in later years since expenses don't grow significantly w/ asset growth
- Premium Persistency
  - difficult to anticipate VA premium persistency
  - limited historical experience
  - dependent upon mkt sold in adn feature and economic conditions
- Avg Size
  - single prem if SPDA
  - anticipated amt of recurring prem on an FPDA
  - admin expenses relatively consistent for each contract
    - greater prem flow/contract -> greater profit
- Expenses
  - regulatory requirements & UV calcs -> high admin expenses
  - agent comm substantially less as % prem vs Life Ins
Pricing Minimum Death Benefit Reserves for VAs
- need to anticipate
  - allocation of assets among funds & fixed acct
  - mean and variance of total returns for each class
  - age/sex distribution of PO cohort for mortality
  - sep models for FPDA adn SPDAs
  - dur or inforce policies
- consolidate info into one formula where asset charges (equal to expected claim costs) added each month
  - actual claim costs deducted
  - int on reserve accrues
Investment Options
- most VAs offer 2 or more types of inv funds
- prospectus states investment objectives of fund and investment policy used to carry out objective
- investment options available in payout period may be more limited then during accum phase

Appendix 7-I: Variable Product Mechanics

Units
- variable equivalent to dollars
- each contract has x "units" of participatoin in fund
Accumulation Phase
- account maintained for each contractholder
  - sep record for each fund
- account has balance of x units
- acct value = units * unit value
Calc of Accumulation Unit Values
- at fund inception, unit is assigned an arbitrary unit value
- Sep acct Alone - assume 1 day valn period
  - NIF(t) = 1 + [II(t) + UCG(t) + RCG(t-1) - EXP(t)] / R(t-1) - Daily Asset Charges
  - AUV9t) = AUV(t-1) * NIF(t)
  - II - Inv Income => divs + accrued int
  - R - reserve
  - EXp - any Inv Exp & deducted directly from II
  - RCG/UCG - realize/unrealize cap gains
  - NIF - Net inv factor
  - AUV - accum unit value
Unit Investment Trust
- net asset share for each valn period = mkt value of assets / # fund shares held
- NIF(t) = 1 + a/b
  - a - value of fund shares held by SA @ EOP less value fo fund share held by SA @ EOP(-1)
  - b - total accumation acct values plus annuity reserves @ EOP(-1)
Annuity (Payout) Phase
- initial VA payout payment based upon AIR
- subsequent payments incr or decr depending on relationship between AIR adn actual inv performance
- unit values supply mechanical method used to determine payments
- each annuity payment = prev payment * UV(t) / UV(t-1)
  - Annuity Unit Value - UV(t) = UV(t-1) + (1+NIF(t))/(1+AIR)^(x/365)
  - this is different UV than before
  - usually assign a # annuity units to payout annuity
  - # annuity units = initial payment / ann.uv
  - # annuity units * ann.uv(t) = payment(t)
- AIR methodology - at each pmt date, annuity value reflects actual perforamnce to date, but AIR for remainder of annuity period

Income Annuities

Overview
- guarantee periodic income for a certain period of time, life of annuitant, or both
- pmts usually begin immediately
- rarely - has deferral period => deferred income annuities
- refund options - introduce a DB reature to income annuity which reduces living benefits
- income escalation options - hedge against inflation
- payment-certain annuities for a special set of products - used to provide guar income for limited period, fund an endowment program or as a gift annuity
- specialty mkts
  - structured settlements (most significant)
  - state lotteries by bid
  - gift annuities through charitable institutions
  - reverse mortgages
Characteristics of Income Annuities
- Life Only
- Life w/ n years certain
- Unit refund
- joint and survivor
- payments for a specified period
- tax-qual plans have maximums for certain periods
- Choice of AIR - variable vs Fixed annuity payout
  - higher AIR -> higher initial payment
    - but relation to actual, pmts could go down for a higher AIR
    - lower AIR could have higher ultimate payments
Pricing Considerations for Income Annuities
- virtually all are single premium products
- assumptions needed for
  - projected benefit flows
  - prem taxes
  - commissions
  - admin expenses
- FIT, cost of cap, etc may be part of formula or part of profitability analysis
- for trad ret annuities, most of CF concentrated in early durations and quickly trail off
- structured settlement annuities - cash flows spread into later years
  - often substd mort. If u/w, could have large loss if life was std
- int rate should reflect current rates available, adjusted to produce targeted levels of profit
  - traditionally used a LT rate for all durations
  - current trend, use spot rates at each dur adn LT rate for durations beyond last spot rate
- Mortality
  - selection of appropriate mort assumptions for CF made based on know (or assumed) characteristics of annuitant population
  - sex distinct rates used, except when unisex required by regulation
  - should reflect realistic death rates w/ margins added for conservatism and future potential improvements in mortality
  - future mort improvement for potential medical advances reflected through sue of projection scale factors
    - vary by AA and sex
  - substd mortality reflected where life expectancy projected by u/w/medical director is materially different than std mortality table
    - constant multiple mort - determine m% constant cultiple such that resultant qxs generate a life expectancy of n years
    - rated age mortality - adjust IA so life expectancy @ adjusted age is n years
    - constatn extra deaths mortality - add contant k deaths/M to std qxs to get life expentancy of n years
  - rated age is most common
  - constant multiple and rated age produce similar actuarail values
    - rate age - reserves fall off too quickly
    - both maintain extra mortality in all durations
    - many impairments - expected mortality improves w/ time
- Premium Taxes, Commissions adn Admin Expenses
  - prem taxes usually assessed as charges up front
  - comm - 2-4% of gross prem payable at issue
    - FEl appropriate
  - admin charges included in pricing formula to cover future servicing costs
  - asset charges for variables - major source of income
    - often same as during accum phase
  - policy fee - permits explicit recovery of 1st yr acq costs
- Statutory Surplus Strain
  - important to consider as part of pricing & PD process
  - solvency based reservs (US Stat) calc using int and mort
    - that combines to produce conservative reserves (compared to pricing generally)
    - reserve at issue typically exceeds premium charged for annuity benefits
      - often > gross (fully loaded) considerations as well

Study Notes and Published References - Note SN 8I-103-01 - POLICYHOLDER DIVIDENDS

Introduction

Dividend scale need only provide broad based equity between different classes of policies w/in LOB

Backgorund

NY has set lots of div rules
- most mutuals domiciled in NY
NY rules have been considered good actuarial practice

Participating Policies

What is a par policy?
- a policy which is part of a dividend calss that has very high probability that the class will be self supporting over the long run, even if very adverse experience occurs
What are the legal rights of the PO in a mutual ins co?
- any favorable experience retained as increased surplus or paid as PO divs
- very limited rights as owners
  - right to receive fair (equitable) share of surplus from their block of business
- co cannot take larger charge for contributions to retained surplus in mutual co than what is needed to assure co's financial ability to meet its obligations, including reasonable rates of growth
- if mutual co were to cease doing business, non-distributed surplus would be claimed by co's state of domicile
- if co is becoming smaller, Actuary should try to avoid creating a tontine for last few PO
- in mutual, each block of business s/b self sustaining over its lifetime
  - block is obligated to repay any surplus strain w/ int at fair rate of return that must be higher than expected LT growth of CO
- inforce div scales protected (or smoothed) against large sudden fluctuations due to unforseen future losses by co's total surplus
  - all inforce should contribute towards building up Co's total retained surplus
  - these contributions considered a true risk premium
- dividends must include charge for expected LT growth rate of co
  - charge established to maintain cos TS and limited to stat after0tax ROI (incl provision for TS)
  - regardless of ROI, each generation of PO should contribute a reasonable minimum amt to retained surplus
- if mutual uses capital to finance accelerated growth, any additional costs in excess of internally generated capital s/b charged to NB
  - a charge could be made to EB, but only if assumed or rationalized that EB benefits from ths growth
Participating Lines of a Stock Co
- compnay must not take an unfair charge for profits to be paid to stockholders
How are Par Policies Different from Non-Par policies?
- Par policies w/ other non-guar elements
  - mutual may issue par policy that may adjust for future experience using non-guar elements other than divs
  - non-guar elements other than divs must be based on future expected experience and not actual past results
  - often classified as "par, but not expected to pay divs" and policy must state the same
    - should have prems reviewed periodically to see if ad-hoc div necessary
- Policies described as Par, but where div scale fixed at issue
  - fixed divs or coupons - used to avoid def reserves
  - technically not guaranteed, cos had no intention of varying and do not stat that they share in any excess earnings
  - cannot legally be sold in all states
  - since technically labeled as par, actuary needs to disclose that does not follow contributory principle
  - if policy states these policies will share in future excess earnings, not varying div creates professional prob for actuary and legal prob for co and board
  - if contract states PO will participate, excess gains should increase divs

Dividend Actuary

Who is the Dividend Actuary?
- MAAA who recommends a scale of PO divs to Board that follows contributory principle and equitable to PO w/in LOB
- Also responsible for AS disclosures
- different actuary could be responsible for each LOB
- few cos have a title "Dividend Actuary"
- CV ind life generates majority of annual divs payable for most mutuals
- Actuary should know how theory applies to other lines and how they interrelate
- critical for actuary to ahve understanding of historical treatment of block, including pricing
  - sometimes this info isn't well documented and passed on via discussion
- company history is very important
What are the Dividend Actuary's responsibilities?
- Ask "who is my client adn to whom and I responsible"
- Ins Co is employer, but responsibilities to PO, Board, possibly others and professional responsibilities
- legal responsibility of Board to set aggregate amt of divs
  - Div Actuary w/ Sr Mgmt should advise
  - Div Actuary responsible for establishing formula that will distribute aggregate amt in an equitable manner in proportion to major sources of past and current (but not future) earnings
- if Board chooses not to distribute divs in a manner recommend by Div Actuary and action not consistent w/ AAA ASOP, actuary must clearly disclose on annual statement

Sources of Earnings that Drive a Dividend Scale

annual div scale should vary in proportion to how major sources of earnings vary
Investment Earnings (Interest)
- largest single source of excess earnings for most CV products
- Div Actuary must bridge diff between Stat accts and how inv income tracked for div purposes
- Cap gains is an inter-generational equity issue
- Div Actuary must also decide whether changes in unrealized cap gains s/b included in distribution
- IMR and AVR capture capital gains before releasing into surplus so Div Actuary hsa to consider whether capital gains s/b paid out faster than the spreading provided by these reserves
- since cap gains need to be smoothed, spreading must be over reasonable period
- cap gains on bonds/mort - IMR does spreading automatically - no futher adjustments needed, except for increasing inv returns by gains released from IMR
Investment Crediting Methods: Portfolio/IYM
- during periods of high inv returns, cos pressured to consider adopting IYM
- if IYM being used, inequitable to merge an old block w/ new block if new money rates lower than earnings on existing business
- method of allocating inv earnings to a block of EB is not normally changed
Special Concerns for IYM: Defining new classes
- actuary may need ot decide whether forming a new portfolio rate was appropriate and not harmful to older policies
Policy Loans: Fixed or Variable Loan Rates & Direct recognition of Loans
- Fixed load rate w/o direct recognition of loans
  - historically, policy loan int and balances included in determining portfolio rate for all policies
  - if policy loan rate < rate co currently earning on other investments, then an incr in loans can have effect of lowering divs on all pols
  - cos worked w/ regulators to allow variable loan int rates and/or direct recognition
- Fixed Loan Rate w/ Direct Recognition of Loans:
  - each policy receives a dividend that reflects earnings on loaned and non-loaned portions of CV
    - have to track loan rate, amt of loan, fraction of year loan outstanding
  - Div Actuary should set loan spread at a level where co makes similar contribution to suprlus, expenses adn taxes from earnings on loanded and non-loaned CV
  - some cos have loaned adn non-loaned div scales and interpolate
  - Alternate: calc non-loaned div and adjust based on avg loan in policy year * (non-loaned - loaned int rate)
    - method is self-adjusting and equitable
  - "conditional recognition" limits divs paid on loaned pols to not more than that paid on non-loaned pols
    - rarely used
- Variable Loan Rate w/o direct recognition of loans
  - divs on loaned pols do not reflect their own loan activity
  - div rate reglects int on loans and loan balances of all PO in block
  - can produce distortions on illustrations for portfolio based div scales if new money rates drop rapidly
  - generally equitable, but borrowing still affects divs for non-loanded pols
- Variable Loan Rate w/ Direct Recognition of Loans
  - maintains equity between loaned and non-loaned portions of policy values
  - some states have caps on loan int rate
    - variation in div adjustments for loans by state may be additional admin problem
- Update Programs
  - most companies elected to update business on PO election basis, to the new method used by the co
What Assets Back the Div Int Rate?
- only actively invested assets shoudl back the dividend scale
- a company can use a segmented method between lines of business
  - in can use IYM for some blocks and portfolio for others
  - this will influence what assets are chosen to back the div scale
Mortality Experience
- normally block by block, if experience is credible
- traditional div method
  - use ultimate mort in divs scale
  - use select mort gains to offset u/w and acq expense
Expense Experience
- often the catchall and called "loading"
- can include items other than direct expesnes such as taxes not included elsewhere
- expense allocation should not favor NB at cost of older policies
- old business should reflect any increased costs of handling these pols
- inflation can cause rapid increase in unit costs, if co not growing faster than rate of inflation
- differences between actual and pricing s/b resolved
Persistency
- lapse can be directly or indirectly reflected
- depends on how co sets annual div scale
- initial div scale has lapse assumption based on recent or expected experience
- expense charge includes amount of intial expenses
- assuming policy not lapse supported, expense charges can be lowered if lapse rates decline
- lapses can also affect mortality => high lapse rates can lead to adverse mortality
Other Issues
- Taxes
  - taxes which affect other components s/b reflected in component that generates income to be taxed
  - using marginal or actual tax rates by the tax law drivers can be used
  - actuary must understand current and prior tax laws
  - special tax items - Dac tax, equity based tax adn tax vs stat reserves need to be considered and vary by block
- Mergers
  - experience of both cos must be combined over time in such a way as to maintain equity for PO of either co, relative to what they had prior
  - merger should lower total expenses
    - savings s/b allocated to all blocks
  - expenses incurred in merger s/b charged against future expense savings
  - important that divs on one block not reduced in order to increase divs to merged block
  - in defining equity - must look at past separately, but must merge into future experience
- Reinsurance
  - risk reinsurance s/b reflected in proper div componenet as expense of that block
  - financial reins (used to manage total surp) generally not reflected ina give block, even if that block is reinsured
    - can increase cost of capital

Changing Dividend Scales

scales will be changed periodically, particularly when changes in experience are material
consider admin cost of changing div scale
normally advisable to avoid minor temporary declines in payable divs
Pegging is a smoothing or transitional method used if current dividend to be paid is lower than prior year's div
- trys to pay div at least as large as they rec'd previous year
- only peg non-loaned div if direct recognition
- if future divs on current scale higher than amt paid last year, part (or all) of current reduction eliminated
- usually only look 2-3 years ahead when pegging
Substitution - replaces current formula div that would be paid with a previous formula scale
- best used for recent issues only and only for first few divs
- usually only used for annual premium business since little or no early CV exist
Pegging and Substitution slightly improve persistency which may offest part of extra cost
modified pegging method - experience premium method
- stopped divs from declining in $ terms, but carried cost into future policy years

Adjusting for Experience Changes: Block vs Average

credible experience - to avoid random variations
if block too small, blend experience w/ overall co experience
avg several years to stabilize as well
can use co avgs instead of tracking each block if no reason to assume a difference
mortality and morbidity (in general) all that needs averaging
cost of rein and reinsured claims can be handled several ways
- eliminate claims paid by reinsurer and reflect cost of rein net of claims
expenses normally stable
- one time exceptional costs can be spread over several years
- change in persistency can effect initial expense recovery speed
- do not overallocate to old blocks of business
- policy fees s/b refelcted per policy
- direct expenses => block incurred

Illustrations vs Payable Scales

illustrated scale should not exceed actual factors underlying payable scale (NB)
illustrated scale should not contain pegged or substitued divs (NB)
inforce illustrations can reflect pegging that is expected to accur assuming practice will continue
illustration shoul not exceed payable scale, but can be lower if justified
exceptional one-teim div payments should not be illustrated
illustrate current div assumptions only if based on actual recent past experience
IYM divs s/b illustrated using currently available new money rates, rather than overall inv earnings of co

Public Statements of the Dividend Actuary

statements s/b checked for completeness to assure that they provide comprehensive, important information adn are not misleading

Forming New Classes for New Business

Mortality Classes
- if new block of business formed, but u/w stds not changed, a new class need not be formed
- for material change in u/w rules or policy rating classification, a new mort class s/b established when material difference in experience are expected or actually emerge
IYM
- form a new class whenever new money rates have changed by a material amt (1/2%) over a reasonable period of time (6-12 mo)

Retained Surplus

What is a Reasonable Retained Surplus?
- very complex and needs to be looked at from both co-wide and block basis
- more than amt needed to meet current guarantees - also need to consider suplus needs of future co growth
Terminal Divs
- paid at death or surr
- some cos believe par block should return most of surplus block produced before last policy terminates
- other cos pay as release of risk - in that needed surplus of co is reduced if pol not inforce
- Stat only allows terminal divs expected to be paid in the next year
- most terminal divs set at issue and rarely changed
Entity (permanently retained) Surplus
- larger initial strain or smaller the margins, larger expected permanent annual contribution to surplus to reflect risk
- what is a reasonable amt for annual permanent contribution to surplus?
  - the amt req'd that will
    - allow co to grow at targeted rate
    - avoid increasing unit expense costs
    - maintain total surplus over long periods at leaste at a minimum level related to future risk
- annual contribution should not be varied by rate of growth of new sales or changes in NB strain
- Week's Axioms - "if a company experiences each year uniform rates of intial expense, renewal expense, mortality and interest, then the divs ought not to change merely b/c of changes in either the volume or NB or in its distribution by plan or age"
- special considerations if co fails to grow and surplus is accumulating
- excess accumulation of entity surplus s/b used to restart growth of co
Limitations on Aggregate Retained Surplus
- most states do not limit amt of retained stat surplus for a mutual
- NY does limit - max(10% stat reserves and liabs,sqrt(7% stat policy reserves^2 + 35% health prems^2))
  - net of reinsurance
Expense Allocation by Block
- complex since individual judgement as to allocation of overhead
- NY Reg 33 and Holding Co Act give guidance in allocations by line
- once split by line, Actuary as to allocate by Block w/in line
  - normally consistent w/ how expenses allocated in Co's acctg systems
- important that co keep growing to prevent overhead cost/unit from increasing too rapidly
- cost of exceptional expansion should not be allocated to inforce, unless inforce will also benefit from earnings or renewal expense reductions from expanding the co
- single reasonableness test
  - if allocation needs only minor adjustments when applying to different years, probably OK

Effect of Tax Law or Other One Time Changes

effect of FIT in co earning has real impact on distributable profits
- div changes can be favorable and/or unfavorable
Handling FIT Law Changes
- taxes need to be viewd on both a co-wide and per policy basis
- handling transition between laws can be complex
- Div Actuary needs to know corp tax plan and how/if these actions should affect divs
Past Law Changes
- 1959 Act - used a long time and worked well w/ low int rates
  - "arithmetic Menge" formula resulted in increasing marginal tax rate on inv income
    - > 100% on investment income
    - excess int paid to stock co PO were 100% deductible as int payments
  - some cos reduced taxes by raising guar int rate of policy
  - mutuals used ModCo 820 to reduce taxes by converting highly taxed inv income to u/w gains which not taxed (or taxed at much lower rate)
- TEFRA 1982 (aka StopGap)
  - continued to allow deduction of expenses and NL reserves
  - varied deductibility of divs between stock (77.5%) and mutual (85%)
  - divs for qual pension plans 100% deductible
  - most favorable to mutuals
- DEFRA 1984
  - 100% deductiblity of divs
  - eliminated immediate deductions for acq expenses by moving from NL to CRVM
  - increased divs that could be credited
  - increased after-tax expense strain for NB
  - law contained fresh start reserve calculation
  - divs changed from incurred to cash basis for tax purposes
    - in year of change, 50% of divs deducted twice
  - ModCo 820 benefit gone, but grandfathered
  - stocks and mutuals taxed the same and additional tax for mutuals
  - tax reserves redefined
  - w/ double deduction for 83 policies, question: should 83 pols get better divs
    - conclusion: tax law affects all policies adn transitional g/l s/b considered company-wide
  - equity tax - based on difference in earning rates of stock and mutals * tax equity
    - tax equity includes AVR/MSVR, adjusted tax reserves adn 50% of div liablilty
- TRA 1986
  - changed primary rate from 36.8% to 34%
  - forgave ModCo 820 elections
  - changed int rate to AFIR (reduced tax reserves and increased taxes where V_t(x)<>CV(x)
    - higher taxes reduced early divs for pols w/ CV
  - mutuals suggested DAC tax and elimination of Equity Tax
    - got DAC tax w/o elim of equity tax
  - Div Actuary has to be able to adjust divs to reflect changes as they occur
- How Does Actuary Reflect Equity Tax
  - unique tax not related to earnings
  - some methods
    - charging tax as it is incurred
      - may result in large variations in annual div scale
      - averaging may be needed
      - can produce odd result -> higher surplus = smaller divs
    - best estimate of difference averaged over a period of time
    - increasing the annual contribution to surplus
      - problem: deciding how much is s/b increased
    - use target surplus formula and considering any left over tax as belonging to equity surplus
    - use TS formula for each block, rather than actual surplus, and charge avg equity tax rate on this amt of surplus to that block
      - any extra tax charged to retained surplus
    - charge the equity tax on teh actual surplus of a given block of business
      - not used by many cos
- What about Allocation of this Tax under the 1984 Act
  - equity tax must be viewed on a company wide basis w/ all policies paying a fair share
  - cannot be based on current amt of tax or surplus that currently exists
- How does teh Actuary Reflect teh DAC Tax
  - effectively an interest-free loan to the gov't
  - stat effect is an additional large up-front strain
  - affects both old and new business and cuold be assessed in a couple ways
    - as it is incurred for each block of business
      - would result in large immediate reduction in divs following credits in the following years
      - if used for NB, divs in early years would be 0 for many years
    - as flat % of premium charge
      - viewed as premium tax or as PV of a positive expense followed by a credit
  - DAC tax reduced profits on certain classes of in-force business that could not adjust
    - particularly a problem for indiv health ins
  - Actuary must consider how to handle limited pay policies, RPU and older issues
    - not a problem if using flat % method

Riders to Policies

CV riders should have own separate div formula
low prem riders pirced not to pay divs can have excess gains allocated to total block of business

Subsidiaries, other Lines of Business and New Ventures

most cos have multiple LOBs
not acceptable to take excess profits from Par lines to finance other co activities, if such actions will not benefit current PO before most of them terminate
mutual co may look at non-par lines (which do not present unreasonable risks) as a possible good investment of surplus or as an asset backing a par block
Sr Mgmt of mutual may be constrained w/r to what LOBs it may enter to avoid risk/profit margin not commesurate w/ risk of loss
Par PO should not have divs reduced to fund growth of new LOB, if expected return too far into future to benefit current PO
One of main reasons mutuals would like to enter capital mkts

Non-Life Product Lines: Annuities, Health, Disability

earnings from these lines do not contribute much to annual PO divs (in general)
main concerns in setting these divs is taking a reasonable profit charge
health may be regulated by loss ratio
- div on one form may go to zero, have to pay on another form and by LOB, not making adequate profit
possible b/c of min loss ratio tests, may need to distribute more divs than you or Board would prefer to distribute
most DAs pay excess int instead of divs
- excess int can also be paid as part of a div
Par Immediate Annuities (rare) - cash dividend would decline by duration

Non-Par Lines of Business

most mutuals only sell par policies
main adv of non-par line to a mutual
- generate add'l income beneficial to whole co
non-par lines that generate pos stat earnings
- good means for mutual to grow faster than supported by ROI of par lines
- avoid costs of finding sources of outside funds
if mutual add non-par line - must decide how g/l from these lines affect div paying par policies
many mutuals place non-par lines in subs and view subs as an investment of the par POs
if sub used co may not be able to pay stockholder divs to parent on regular basis
- this is why many cos treat these subs as owned by entity surplus
- therefore excluded from calc of investment returns for div purposes

Demutualization

allowed by most states
critical that best interests of PAR PO be maintained
should not receive less that what they would receive if co remained a mutual
ensure that any existing surplus that remains w/ par blocks is distributed quickly enough to avoid producing a tontine

Schedule NP: Stock Co Earnings

some states require certain pages of AS to be filed separately for par and other lines
Schedule NP - req'd in NY - designed to apply to stock cos w/ par business
- separates lines into Par, Non-Par w/o non-guar elements, non-par w/ non-guar elements other than divs
distributed earnings from a par sector to stockholder is only a stockholder concept
annual transfer from par sectors for a stock co limited in some states
stock co's not req's to annually remove surplus from Par lines
co can not transfer amounts over the limit b/c tehy transferred less in previous years
mutual can transfer non-par earnings and surplus to a par line at any time
- if transferred, must decide how/if they are to be distributed to Par PO

Study Notes and Published References - Note SN 81-104-03 - NAIC STANDARD NONFORFEITURE LAW FOR LIFE INSURANCE

Section 2 - Nonforfeiture Benefits

within 60 days of due date, nonf benefit kicks in
table and rate used must be specified in policy
statement that values >= min req'd values must be in policy
company can reserve right to defer payment up to 6 months

Section 3 - Computation of CSV

PVFB - PV Adj Prems - indebtedness + CV PUA
excludes rider/supp benefit prems when calcing

Section 4 - Computation of Paid-Up Nonf benefits

PV nonf benefits = CSV @ lapse

Section 5c - Calculations of Ajd Prems by nonf NLP method

80 CSO/CET or 1961 Std Industrial Mort Table
Jan 1, 1989
PV adj prem = PVFB = 1% ELA + min(1.25*nonf NLP, 0.04 ELA)
ELA = ten year BOY avg DB
nonf NLP = PVFB / adue(x) where adue is for prem period of policy
for non-guar pols - calc assuming no changes
- if changes - recalc adj prems
  - PV future adj prems = PVFB (as of reval date) + add'l expense allowance - CSV
Add'l expense allowance at time of change
- .01*max(0,ELA_new - ELA_old) + 1.25*max(adj prem_new - adjprem_old)
recalced nonf NLP (NFF)
- NFF_old*adue(x+t) + PVFB_new - PVFB_old) / adue(x+t)
80 COS w/ or w/o select factor
nonf int rate = 125% of cal year SVL rate rounded to nearest quarter of 1%

Section 6 - Nonf Benefits for Indeterminate Prem Plans

if min vals cannot be determined by other outlined methods
- commissioner must be satisfied that benefits provided are at least as good as min benefits otherwise req'd
- not misleading to PO
any policy must be approved by commissioner before it can be used

Section 7 - Proration of Values; Net Value of Paid Up Additions

pro-rata between anniversary
can ignore:
- ADB
- wvr
- reversionary or deferred reversionary annuity
- term riders (if rider would not qualify if stand alone)
- CTR
- other non-DB/Endow benefits

Section 8 - Consistency of Progression of Cash Surrender Values w/ increasing Policy Duration

CSV shan't vary by more than 0.2%*ELA from max(0,basic cv) + PUACV - loan
basic CV = PVFB min(PV NFF, PV future adj prems)

Section 9 - Exceptions

Does not apply to:
- Reinsurance
- Group INs
- PE
- Annuity or Reversionary Annuity
- 20 YR (or less) LT w/ expiry prior to age 71
- 20 YR (or less) DT w/ expiry prior to age 71
- Policies where no CVs exceed 2.5% of BOY Ins amt

Study Notes and Published References - Note SN 8I-105-03 - NAIC UNIVERSAL LIFE INSURANCE MODEL REGULATION

Section 2 - Purpose

supplement existing regs to accomodate UL

Section 3 - Definitions
Section 6 - Nonforfeiture

Minimum CSV for Flex Prem UL
- accumulations of
  - + prems paid
  - - benefit charges
  - - avged admin expense charges for first policy year and any ins increase years
  - - actual admin expense charges for other years
  - - initial and add'l expense charges (subject to limits)
  - - deduction for partial w/d
  - - service charges actually made
  - - unamortized unused initial and additional expense allowance
- admin expense charges include charges per prem payment, per $ prem paid, periodic charges per $1m insurance, periodic per policy charges and other contractual charges
- averaged admin expense charges - charge rates based on avg or rates policy states will be imposed in years 2-20
- initial acq expense - excess of non service expense charges actually made in first policy year over adg'd admin expense charges for year
- add'l acq expense charge similar to initial acq expense but made in ins increase year
- ins increase year - PO initiated increase
- initial expense allowance - same as SNFL for fixed face/prem endowment of same intial DB
- unamortized unused initial expense allowance = unused intial expense allowance * adue(x+t) / adue(x)
Min CSV for Fixed Prem UL
- min CSV = A - B - C - D
  - A = PVFB
  - B = PV future adj prems - calced from SNFL
  - C - PV NFF from post-issue guarantees
  - D - sum of (B) like items from post-issue structural changes
- future guaranteed benefits determined by
  - projecting policy value taking into account future prems and using guarantees of int, mot, expense dedcutinos, etc
  - taking into account any guaranteed benefits which do not depend on policy value
Minimum Paid Up Nonf Benefits

Study Notes and Published References - Note SN 8I-106-03 - NAIC STANDARD NONFORFIETURE LAW FOR INDIVIDUAL DEF ANNUITIES

Section 2 - Applicability

N/A to
- reinsurance
- group annuity purchased under ret plan
- qualified deferred comp (except IRAs)
- prem deposit fund
- VA
- investment annuity
- immediate annuity
- DA after payments commence
- reversionary annuity

Section 3 - Nonf Requirements

paid up annuity or lump sum payment upon payment stoppage
lists mortality table and int rate for calcing annuity benefits
if PV < $20 @ laps, can cash out instead of setting up pd up annuity

Section 4 - Minimum Values

Min Nonf amt =
- + accumulation of net considerations
- - prior w/d
- - annual $50 contact charge, accumulated at int
- - prem tax paid by co, accum at int
- - loan
net considerations = 87.5% gross considerations
int rate = min(3%, a)
- a = 5 yr Constant Maturity Treasury Rate rounded to nearest 1/20th of 1% - 125 bps
  - not less than 1%
- can be redetermined - redetermination period must be stated in contract
- 125 bps reduction can be increased by up to 100bps if equity indexed
  - commissioner must be satisfied that extra bps don't harm SV

Section 5 - Computation of Present Value

computed using mortality table (if any) and int rates specified in contract for determining minimum paid-up annuity benefits given in contract

Section 6 - Calculation of CSV

CSV >= nonf amt
int rate can be up to 1% hgiher for CSV than for accum

Section 7 - Calculation of Paid-Up Annuity Benefits

CV of paid up annuity needs to be at least as great as nonf value

Section 8 - Maturity Date

assume latest possible maturity date when calcing CSV or PaidUp Benefits

Section 9 - Disclosure of Limited DB

must disclose if DB not >= min nonf amt

Section 10 - Inclusion of Lapse of Time Consideratoins
Sectoin 11 - Proration of Values; Add'l Benefits

Study Notes and Published References - Note SN 8IU-107-04 - EQUITY INDEXED ANNUITIES: PRODUCT DESIGN AND PRICING CONSIDERATIONS

Introduction

EIA - fixed annuity w non-traditional method of interest crediting
- int credited a function of some well-known index (generally)
- have a guarantee designed to meet DA SNFL to avoid being categorized as a security

EIA Product Design

GMAV - guar min acct val - designed to satisfy SNFL
- GMAV(t) = 90%*single prem *(1.03^t) (essentially old DA SNFL min CV)
Index Acct Value (IAV)
- IAV(t<=index period) = 100%*singleprm*prod(1+indexbasedInterest(i)) from i = 1 to t
- IAV(T') = max(GMAV(T),IAV(T)) where T' is one moment after time T and T is lenght of index period
Components involved in calc of Index-Based Interest
- index
- index period
- index growth%
- participantion rate
- margin
- cap/Floor
Index - equity proxy used to calc level of interest credited to IAV
- S&P 500 most common
- DJIA also used
Index Period - similar to SC period
- usually 7-10 years
- some desings do not continue Index-based int crediting after index period
- some have rolling index periods w/ new SC periods
Index Growth % - two main categories
- point-to-point growth % - uses only 2 close levels
  - IndexGrowth% = (FinalClosingLevel / InitialClosingLevel) - 1
- average Index Growth % - based on average closing level over a peroid of time - typically 1 year
  - IndexGrowth% = ([sum(daily closing levels) / # trading days] / initial closing level) - 1
    - daily averaging has tendency to keep indiv volatility minimized
    - typically will produce 55-60% of unaveraged calc
    - can also do monthly averaging - more volatile than daily, less than annual
      - still provides 55-60% of unaveraged
- can also have ratcheting - means returns locked and connot be countered by poor future indexes
Participation Rate - percentage factor applied to raw index growth %
- early plans had up to 125% participation
- if doing daily averaging, still < 100% of point-to-point growth
Floor Return - usually 0%, can be higher
- floors on index-based int calc guar IAV never lower than SP and IAV will never decrease
Margin - similar to participation rate < 100%, decreases index-based int relative to index growth %
- can be applied before or after participation rate
- cannot reduce int < 0%
Cap - can be applied before or after margin
Margin and Cap - ways to "stunt" growth measurement and allow purchase of less expensive options
high equity volatility can be a problem for insurers funding multi-year guar EIA products
- index-based int in EIA funded by call optoin on the index
- longer period until maturity, more higher volatility affects option prices
another strain on EIA funding when rates are low
- GMAV generally funded w/ fixed income bonds w/ remainder of prem income (after expenses) use to fund index-based int
- w/ lower int rates, not much $ left over after funding GMAV
when int rates low and equity volatility high, if yverything has been adjusted as much as possible (w/in mktg constraints), then participation rate needs to be adjusted

Other EIA Design Features

need to design products that have less restrictive SNFL min requirements
Annual Reset EIAs - resettable components still have min guar attached to them with ability to change index-based int components as often as annually, EIA writers have a way to manage high index volatilities
Flexible Premium EIAs - allows writers to reduce GMAV from 90% of prem @3% to as low as 65% @3%
- common => 75% of initial prem and 87.5% of additional prem
- lowers cost of funding guar, leaving more to spend on int-based index
Lower GMAV Int Rates
- SNFL being updated to allow 1.5% as min int
Index Growth Measurement
- averaging - smooths volatility and dampens return
  - daily averaging not very common in EIA design
  - monthly avg and point-to-point prevalent
- innovative return methods
  - binary returns - if index increases, credit x%, 0% otherwise
    - or might have tiers 0%, 3%, 6% if [0,5%) -> 3% [5%,infinite) ->6%
  - highwater mark - instead of using two end points, use starting point and highest point during period
- Customer Choice
  - index choice - client chooses index to participate in
  - index growth measurement - client chooses avg or point-to-point
  - fixed int - client chooses fixed rate rather than indexed rate
  - fund transfer - client can have several options elected adn move money between them
- Inducements to Purchase
  - premium bonuses, sometimes spread over index period
- GMAV alternatives
  - instead of 90% @ 3%, 100% @ 2% w/ SC
  - designed w/ mktg in mind
  - example w/ SC = 10%-0 over 10 yrs, 100%@2% w/SC >= 90% @ 3% so SNFL not a problem

Pricing and Design Considerations

EIA Funding
- 1st - how will product be funded
- traditional annuity - credited rate = inv earning rate - margins for expenses and profits
- EIA funding - premium = GMAV costs + PV expenses/profits + index-based Int budget
- credited rate - two elements - GMAV adn Index-based int component
- for s/t guarantees, GMAV funding can be rolled into pricing spread
  - rather than managing option program w/ budget determined up-front, application of traditional spread pricing to EIAs is more realistic
  - Net Earned Rate - Pricing spread = hedging budget
    - actual option purchase = notional * option cost
    - notional for 1st year is prem, for future years, IAV
  - several factors can affect ability of hedge budget to fund significant index-based int levels for future years
    - reinvestment rates cound incr/decr teh net earned rate which would change the hedge budget
    - actual Index-based Int credited affects future levels of IAV
      - high int means budget has to cover higher amounts
    - high future equity volatility causes higher option costs
    - high future risk-free rates cause higher option costs
    - high option costs in any year during an index period can strain option budget
Funding Index-Based Interest
- early EIA writers used OTC equity options to exactly match index-based int they were giving to customers
- designs evolved and OTC deals no longer absolutely necessary
- two major forms of hedging - static and dynamic
  - static hedging - synonymous w/ buy and hold and ofter involves OTC options
    - most common static hedge today: purchase of a call spread option on teh index
      - actually 2 trx - puchase plain vanilla call option adn sale of call option w/ strike = cap rate of liability being hedged
    - B/S call option pricing formula: call option price = S(0) - N(d(1))-k*e^(-r(f)*t)*N(d(2))
      - d(1) = (ln(S(0)/k) + (R(f)+ (sd^2)/2)*T) / (sd*sqrt(T))
      - d(2) = d(1) - sd*sqrt(T)
      - S(0) - Initial Security Price
      - k - strike price
      - r(f) - risk free rate
      - sd - volatility
      - N() cumm PDF for std Normal dist
    - decide on funding ratio
      - usually < 100% b/c lapses (assuming not vested @ surr)
      - assume too low a lapse rate, stuck w/ extra options
      - too high - not enough
    - economies of volume necessary on OTC b/c high fixed cost
  - Dynamic (delta) hedging
    - involves monitoring the delta of the liab portfolio and holding a changing position in index via futures or other instruments
    - disadvantages:
      - higher trx costs b/c of frequent position changes
      - no downside protection
- Other EIA pricing Considerations
  - customer choice - might not have enough in each option to offer economies of scale in hedging program
  - index return method complexities
    - no guarantees that any dealers willing to price deals w/ complex return designs
  - policy guarantees - multi-year guarantees currently not attractive
    - might be attractive if future int rates increase and volatility decreases and option dealers willing to sell l/t options
  - GMAV funding
    - necessary to fund GMAV w/ fixed int rate bond fund
      - evaluate risks of default and int rate risk
    - int rate risk important to consider w/r to lapses

Regulatory Considerations

Reserving

Study Notes and Published References - Note PRODUCT MATTERS - REGULATORS RESPOND TO INDUSTRY INNOVATION THROUGH GUIDELINE AXXX

Section 1 - Increase tied to an external trigger

b/c insurer does not have unrestricted right to increase prems
AXXX requires cos reserve these plans as if prems guar for full level prem period

Section 2 - Refund of Prem - Partially Guaranteed

right to increase prem not unrestricted since need to provide additional benefits
must reserve over entire level prem or secondary guarantee preriod

Section 3 - Affiliated Co Guarantee

prem increased protected by second co via reinsurance, second policy, or agreement
AXXX requires that the reserves of these combined coverages/benefits = what direct writer would hold w/o this agreement
reserve credits only allowed if agreement meets reinsurance requirements

Section 4 - Refund of Prem - Fully Guaranteed

high guar GP w/ CV, div or prem refund after period of time
creates low net prem
AXXX requires net prem used in calc
coinsurance allowances for legit reinsurance does not fall into this category

Section 5 - Re-entry Plans

AXXX requires initial re-entry period and prems treated as continuation of initial guarantees

Section 6 - Level Net Reins Prems

additional "expense allowance" has no relationship to actual expenses
initial segment = full level prem period and valn prems s/b level over that period

UL and AXXX

Accum of Prem and Shadow Acct Secondary Guaranteed both fall under AXXX
Accum of Prem already addressed under XXX
No Lapse Guar is Shadow Acct > 0 (even if regular acct < 0)
Shadow Acct grows just like regular acct, but w/ more favorable changes/credits than guar in underlying policy
Catch-Up provisions allow PO to dump money in to reinstate secondary guar

Section 7 - Premium "Catch-Up" Provisions

AXXX provides relief
can reduce basic and def reserve by any "catch-up" amounts (reserve can't drop below 0)

Section 8 - Secondary Guar Requirements

prepaid shadow acct deposits need to be added to reserve
- capped by coveage NSP
argument against: actual prem payment history is modification to XXX and UL Model Reg
- Model Reg call for prems at issue and prepayments not known at issue.

Sections 1-7 retroactive to XXX effective date
Section 8 effective 1/1/2003

Study Notes and Published References - Note PDNEWS - SEAC SECONDARY GUARANTEES DEBATE

Are Secondary Guarantees Good for the Public?

Affirmative:
- Give consumer valuable option w/ no explicit charge
- cost covered by conservatism inherent in contractual guaranteed values
Negative:
- nonforfeiture law
- can lose entire no=lapse protection with a single late payment
- current legislation unable to address complex reserving issues
Affirmative Rebuttal:
- Valn Actuary law assures reserves are adequate
- Secondary Guars are voluntary, not forced
Negative Rebuttal:
- Valn Actuary law won't catch everything or we wouldn't need XXX
- One more confusing option for consumers to deal with

Are Nonf Benefits related to Secondary Guars req'd by law?

Negative:
- yes, both letter and spirit
- Letter - TX and sorta CA
Affirmative:
- SNFL does not require segmentation of policy
- UL Model Reg does not require anything add'l for secondary guars
  - UL nonf benefits based on retrospective accumulation
- if req'd, stopping payments creates a nonf cliff
Rebuttal Negative:
- nonf cliff no diff from losing an int bonus by surrending 1 month early
Rebuttal Affirmative:
- nonf cliffs would not be understood by general public and create new round of litigation nightmare

What Types of Reserves req'd for seconday guars under SAP adn GAAP acctg?

Affirmative:
- Theoretical reserve - PV of expected utilization of benefit
- GAAP - can be incorporated into F97 projections
- Stat - covered under Valn Actuary Law
Negative:
- doesn't care about GAAP
- if commish deems nonf values req'd, must be refelcted in benefit reserve
Rebuttal Affirmative:
- Actuaries need to promote ability to assess risks and establish adequate reserves
- Should not have to have situation clouded by piecemeal regulations
- Sensitivity testing is important part, including mortality if that is the primary risk factor
Rebuttal Negative:
- secondary guaranteed are valuable benefits that create significant liablity

Can we ever ignore letter of law? Can we ever ignore spirit of law?

Negative:
- NO
Affirmative:
- NO, but issue is when commissioners have discretion to "interpret" laws
- Ins laws relating to valn and nonf are out-of-date
  - not designed for modern products
- ins laws applied inconsistently between states (and w/in states sometimes)
- these grey areas will cause letter of law to to pushed to limits
- for spirit of law, take macro view