Transcript CIA Pension Seminar - Canadian Institute of Actuaries

CIA Annual Meeting
Assemblée annuelle de l’ICA
June 29 & 30, 2006  Les 29 et 30 juin 2006
Ottawa, Ontario
Session Val-5 CLIFR Part II
CIA Annual Meeting  Assemblée annuelle de l’ICA
Considerations in the Valuation of Seg. Fund Products
• Sub-Committee of CLIFR formed late in 2005
• Members of Sub-Committee:
– Jacques Boudreau, Byron Corner, Greg Lawrence,
Dale Mathews
• Mandate
– Review areas where additional guidance could be
provided to ensure compliance with standards and
to narrow the range of practice
• Status – early draft
Session Val-5 CLIFR Part II
CIA Annual Meeting  Assemblée annuelle de l’ICA
Considerations in the Valuation of Seg. Fund Products
•Agenda
•Methodology – Bifurcated versus Whole
Contract
•Guarantee Reserve – Discounting and C3
MfAD
•What is a PFAD?
•Term of the Liability – Examples of Issues
•Recoverability Testing for AAE
•Policyholder Behaviour
Session Val-5 CLIFR Part II
CIA Annual Meeting  Assemblée annuelle de l’ICA
Considerations in the Valuation of Seg. Fund Products
•Methodology
•There is currently a range of practice across
the industry
•We’re reviewing the general approaches in
use
•The main differentiation is bifurcated versus
whole contract approaches
Session Val-5 CLIFR Part II
CIA Annual Meeting  Assemblée annuelle de l’ICA
Considerations in the Valuation of Seg. Fund Products
•Methodology – Bifurcated vs. Whole Contract
•Bifurcated
•Revenue is allocated between recoverability
testing of the Allowance for Acquisition Expense
(AAE) and the liability for the guarantee
•Allocation does not change from period to
period
•Policy liability for the guarantee is calculated
separately using revenue based on this allocation
Session Val-5 CLIFR Part II
CIA Annual Meeting  Assemblée annuelle de l’ICA
Considerations in the Valuation of Seg. Fund Products
•Methodology – Bifurcated vs. Whole Contract
•Bifurcated
•Allocation of revenue to the guarantee
would generally be related to the additional
charge priced into the product for the
guarantee
Session Val-5 CLIFR Part II
CIA Annual Meeting  Assemblée annuelle de l’ICA
Considerations in the Valuation of Seg. Fund Products
•Methodology – Bifurcated vs. Whole Contract
•Whole Contract – Approach 1
•Total policy liability is determined using
all net cashflows available
•Deterioration in market conditions could
cause liability to increase and DAC
implicitly written down
Session Val-5 CLIFR Part II
CIA Annual Meeting  Assemblée annuelle de l’ICA
Considerations in the Valuation of Seg. Fund Products
•Methodology – Bifurcated vs. Whole Contract
•Whole Contract – Approach 1
•Future market improvements could result
in reduction of liability and implicit writing
up of AAE which is inconsistent with
standards
•This method should not be used for
Canadian GAAP purposes
Session Val-5 CLIFR Part II
CIA Annual Meeting  Assemblée annuelle de l’ICA
Considerations in the Valuation of Seg. Fund Products
•Methodology – Bifurcated vs. Whole Contract
•Whole Contract Approach 2 – DAC Focus
• AAE is first tested to ensure
recoverability using all fee income
•In order to calculate the liability for the
guarantees, the AAE balance is added to
the stochastic result
•Mathematically equivalent to backing out
a PV of fee income equal to the AAE
balance
Session Val-5 CLIFR Part II
CIA Annual Meeting  Assemblée annuelle de l’ICA
Considerations in the Valuation of Seg. Fund Products
•Methodology – Bifurcated vs. Whole Contract
•Whole Contract – Approach 2
•This method is consistent with Standards
•For the remainder of the presentation we
will simply call this the whole contract
approach
Session Val-5 CLIFR Part II
CIA Annual Meeting  Assemblée annuelle de l’ICA
Considerations in the Valuation of Seg. Fund Products
•Methodology – Bifurcated vs. Whole Contract
•Under both methods
•If the AAE becomes unrecoverable it is
written down to the extent it is recoverable
•Future amortization is reduced
accordingly and locked in consistent with
SOP Section 2320.24
•Once the AAE is written down it may not
be written back up.
Session Val-5 CLIFR Part II
CIA Annual Meeting  Assemblée annuelle de l’ICA
Considerations in the Valuation of Seg. Fund Products
•Methodology – Bifurcated vs. Whole Contract
•Under both methods a zero floor on the
liability is generally applied at some level of
aggregation.
•Reflection of SOP section 2320.25 which
suggests that the term ends at the balance sheet
date unless extending the term increases the
liability
Session Val-5 CLIFR Part II
CIA Annual Meeting  Assemblée annuelle de l’ICA
Considerations in the Valuation of Seg. Fund Products
•Methodology – Examples
• Cohort of variable annuity policies with an initial AAE of
$1000
•Policies priced with 100 basis points of revenue plus
additional charge of 25 basis points for a maturity guarantee
•Bifurcated Method
•Recoverability testing for the AAE is done assuming 100
basis points of revenue. The liability for the guarantee is
calculated assuming 25 basis points of revenue.
•Allocation doe not change period to period.
Session Val-5 CLIFR Part II
CIA Annual Meeting  Assemblée annuelle de l’ICA
Considerations in the Valuation of Seg. Fund Products
•Whole Contract Method
•The entire 125 basis points is first made available to
recover the AAE.
•To the extent it is not entirely required, the excess is
reflected in the liability for the guarantee.
Example 1 – Liability for the guarantee is always positive
Example 2 – Calculated liability for the guarantee is sometimes
negative and zero floor comes into play
Session Val-5 CLIFR Part II
CIA Annual Meeting  Assemblée annuelle de l’ICA
Example 1 – State 1: Initial – 75 basis points
needed to amortize AAE
Bifurcated Whole Contract
AAE
(1000)
(1000)
Basis points allocated to AAE
25
50
Liability for guarantee
25
5
Total Liability
(975)
(995)
Whole Contract method produces a lower liability as
all revenue is reflected.
Session Val-5 CLIFR Part II
CIA Annual Meeting  Assemblée annuelle de l’ICA
Example 1 – State 2: Modest Market Correction
– 90 basis points now needed to amortize AAE
Bifurcated Whole Contract
AAE
(1000)
(1000)
Basis points allocated to AAE
25
35
Liability for guarantee
40
30
Total Liability
(960)
(970)
Change from previous state
15
25
Change in liability is larger under Whole Contract method
as revenue is shifted to recover AAE.
Session Val-5 CLIFR Part II
CIA Annual Meeting  Assemblée annuelle de l’ICA
Example 1 – State 3: Larger Market Correction
– 115 basis points now needed to amortize AAE
Bifurcated Whole Contract
AAE
(870)
(1000)
Basis points allocated to AAE
25
10
Liability for guarantee
60
150
Total Liability
(810)
(850)
Under the Bifurcated method the AAE must now be written
down to a recoverable level. Under the Whole Contract
method the total revenue of 125 basis points is still sufficient
but less is available for the guarantee.
Session Val-5 CLIFR Part II
CIA Annual Meeting  Assemblée annuelle de l’ICA
Example 1 – State 4: Severe Market Correction
– 140 basis points now needed to amortize AAE
Bifurcated Whole Contract
AAE
(714)
(893)
Basis points allocated to AAE
25
0
Liability for guarantee
80
225
Total Liability
(634)
(668)
Total revenue of 125 basis points is now insufficient so
AAE must now be written down under the Whole Contract
method.
Session Val-5 CLIFR Part II
CIA Annual Meeting  Assemblée annuelle de l’ICA
Example 1 – State 5: Market Recovery to State 3
– 115 basis points now needed to amortize AAE
Bifurcated Whole Contract
AAE
(714)
(893)
Basis points allocated to AAE
25
22
Liability for guarantee
60
80
Total Liability
(654)
(813)
Change from previous state
(20)
(145)
AAE may not be written up under either method.
Change in liability is greater under Whole Contract method
reflecting higher revenue allocated to the guarantee.
Session Val-5 CLIFR Part II
CIA Annual Meeting  Assemblée annuelle de l’ICA
Example 2 – State 1: Initial – 75 basis points
needed to amortize AAE but calculated liability
for the guarantee is now negative.
Bifurcated Whole Contract
AAE
(1000)
(1000)
Basis points allocated to AAE
25
50
Liability for guarantee
(50)
(125)
Liability for gtee. after floor
0
0
Total Liability
(1000)
(1000)
Session Val-5 CLIFR Part II
CIA Annual Meeting  Assemblée annuelle de l’ICA
Example 2 – State 2: Modest Market Correction
– 90 basis points now needed to amortize AAE
Bifurcated Whole Contract
AAE
(1000)
(1000)
Basis points allocated to AAE
25
35
Liability for guarantee
(10)
(65)
Liability for gtee. after floor
0
0
Total Liability
(1000)
(1000)
The calculated liability for the guarantee has remained negative
So the two methods produce the same result because of the
zero floor.
Session Val-5 CLIFR Part II
CIA Annual Meeting  Assemblée annuelle de l’ICA
Example 2 – State 3: Larger Market Correction
– 95 basis points now needed to amortize AAE
Bifurcated Whole Contract
AAE
(1000)
(1000)
Basis points allocated to AAE
25
30
Liability for guarantee
15
(40)
Liability for gtee. after floor
150
0
Total Liability
(995)
(1000)
The Whole Contract method provides a more stable liability
as the calculated liability for the guarantee remains negative
for a longer period.
Session Val-5 CLIFR Part II
CIA Annual Meeting  Assemblée annuelle de l’ICA
Considerations in the Valuation of Seg. Fund Products
•Methodology – Considerations
•Total liability under Whole Contract method will be
less than or equal to that under the Bifurcated
method
•Whole Contract method will defer possible writing
down of the AAE as long as possible as the AAE has
first priority on future revenue.
•Once the liability for the guarantee has become
positive the liability may become more volatile
under the Whole Contract method as the allocation
of revenue can change period to period.
Session Val-5 CLIFR Part II
CIA Annual Meeting  Assemblée annuelle de l’ICA
Considerations in the Valuation of Seg. Fund Products
•Methodology – Considerations
•At this time CLIFR is not recommending one
method over the other
•May be reconsidered as the direction of
International Standards becomes clearer.
Session Val-5 CLIFR Part II
CIA Annual Meeting  Assemblée annuelle de l’ICA
Considerations in the Valuation of Seg. Fund Products
• CALM Methodology Issues
•Application of CALM for the general
account liability for the guarantees
•Possible implications of Section 3855
Session Val-5 CLIFR Part II
CIA Annual Meeting  Assemblée annuelle de l’ICA
Considerations in the Valuation of Seg. Fund Products
•Guarantee Reserve - CALM Methodology
•Using the CALM method for guarantee
reserves likely impractical
•Implies using stochastic or deterministic
interest rate scenarios along each stochastic
guarantee test path
•Common approximation method is to use
a discounted cashflow method
Session Val-5 CLIFR Part II
CIA Annual Meeting  Assemblée annuelle de l’ICA
Considerations in the Valuation of Seg. Fund Products
•Guarantee Reserve - CALM Methodology
•Discount rate should be related to current
statement value of supporting assets as
reflected in current book yield
•Under 3855, if assets are designated as Held
for Trading (HFT) yield would be reflective of
fair value and discount rate should be variable
period to period
Session Val-5 CLIFR Part II
CIA Annual Meeting  Assemblée annuelle de l’ICA
Considerations in the Valuation of Seg. Fund Products
•Guarantee Reserve - Testing C3 MfAD
•C3 MfAD is usually estimated as an
adjustment to the Discount Rate
•Theoretically should be calculated or
justified by CALM testing
•reflecting reinvestment or disinvestment
exposure of liabilities and supporting assets
•In practice tested after the fact on
representative cash flows
Session Val-5 CLIFR Part II
CIA Annual Meeting  Assemblée annuelle de l’ICA
Considerations in the Valuation of Seg. Fund Products
•Guarantee Reserve - Testing C3 MfAD
•Cashflows should be chosen carefully to be
representative and appropriate, for example
•Average of period by period cashflows for the
30% of scenarios producing the highest liability if
CTE70 is used
•A representative path chosen as most consistent
with the key drivers of the liability
•E.g. maturity guarantee payments for cohorts
most in the money for a typical maturity
guarantee
Session Val-5 CLIFR Part II
CIA Annual Meeting  Assemblée annuelle de l’ICA
Considerations in the Valuation of Seg. Fund Products
•Guarantee Reserve - Testing C3 MfAD
•Note that this is quite often not a material issue
given the size of the liability for the guarantees
Session Val-5 CLIFR Part II
CIA Annual Meeting  Assemblée annuelle de l’ICA
Considerations in the Valuation of Seg. Fund Products
•What is a PfAD?
•One of the areas in which respondents to the
OSFI survey requested guidance
•Essentially a disclosure issue
SOP Section 1110.39: “Provision for adverse
deviations is the difference between the actual
result of a calculation and the corresponding result
using best estimate assumptions.”
Additional margins could be disclosed separately….
The following examples show how this might work.
Session Val-5 CLIFR Part II
CIA Annual Meeting  Assemblée annuelle de l’ICA
Example 1
Bifurcated Approach
Gtee – CTE0
(27.35)
Gtee CTE80
(16.67)
Amt. Booked 0
Starting Position MV/GV = 100%
Initial AAE = 50
Assume:
Best Estimate = CTE0 without margins
Liability for gtee booked at CTE80
with margins
AAE recoverability testing at CTE60
Session Val-5 CLIFR Part II
Gtee Margin
27.35
AAE CTE0
(67.89)
AAE CTE60
(50.37)
Booked
(50.00)
AAE Margin
17.89
Total Margin
45.24
CIA Annual Meeting  Assemblée annuelle de l’ICA
Example 1 – Bifurcated Approach
Calculation of PfAD
Gtee – CTE0
(27.35)
Gtee CTE80
(16.67)
Amt. Booked 0
Best Estimate Result
Guarantee
0
AAE
(50.00)
Total
(50.00)
Gtee Margin
27.35
AAE CTE0
(67.89)
Guarantee
0
AAE CTE60
(50.37)
AAE
(50.00)
Booked
(50.00)
Total
(50.00)
AAE Margin
17.89
PfAD
0
Total Margin
45.24
Additional Margin
45.24
Session Val-5 CLIFR Part II
Actual Result
CIA Annual Meeting  Assemblée annuelle de l’ICA
Example 1
Whole Contract Approach
Test AAE
MV/GV = 100%
Initial AAE = 50
Assume:
Best Estimate = CTE0 without margins
Liability for gtee booked at CTE80
with margins
AAE recoverability testing at CTE60
Session Val-5 CLIFR Part II
AAE CTE60
(96.18)
Booked
(50.00)
Calculate Liability – total
margins
CTE0
(94.11)
CTE80
(58.07)
Add AAE
50.00
Booked
0
CIA Annual Meeting  Assemblée annuelle de l’ICA
Example 1 – Whole Contract Approach
Calculation of PfAD
Best Estimate Result
Test AAE
Guarantee
0
AAE CTE60
(96.18)
AAE
(50.00)
Booked
(50.00)
Total
(50.00)
Actual Result
Calculate Liability – total
margins
CTE0
(94.11)
CTE80
(58.07)
Add AAE
50.00
Booked
0
Guarantee
0
AAE
(50.00)
Total
(50.00)
PfAD
0
Additional Margin
= 0 – (94.11) - 50.00
44.11
CIA Annual Meeting  Assemblée annuelle de l’ICA
Example 2
Bifurcated Approach
Gtee – CTE0
(18.86)
Gtee CTE80
38.30
Amt. Booked 38.30
MV/GV = 70%
Initial AAE = 50
AAE now written down
Assume:
Best Estimate = CTE0 without margins
Liability for gtee booked at CTE80
with margins
AAE recoverability testing at CTE60
Session Val-5 CLIFR Part II
Gtee Margin
57.16
AAE CTE0
(47.93)
AAE CTE60
(34.88)
Booked
(34.88)
AAE Margin
13.05
Total Margin
70.21
CIA Annual Meeting  Assemblée annuelle de l’ICA
Example 2 – Bifurcated Approach
Calculation of PfAD
Gtee – CTE0
(18.86)
Gtee CTE80
38.30
Amt. Booked 38.30
Best Estimate Result
Guarantee
0
AAE
(47.93)
Total
(47.93)
Gtee Margin
57.16
AAE CTE0
(47.93)
Guarantee
38.30
AAE CTE60
(34.88)
AAE
(34.88)
Booked
(34.88)
Total
3.42
AAE Margin
13.05
PfAD
51.35
Total Margin
70.21
Additional Margin
18.86
Session Val-5 CLIFR Part II
Actual Result
CIA Annual Meeting  Assemblée annuelle de l’ICA
Example 2
Whole Contract Approach
Test AAE
MV/GV = 70%
Initial AAE = 50
AAE now written down
Assume:
Best Estimate = CTE0 without margins
Liability for gtee booked at CTE80
with margins
AAE recoverability testing at CTE60
Session Val-5 CLIFR Part II
AAE CTE60
(49.36)
Booked
(49.36)
Calculate Liability – total
margins
CTE0
(66.64)
CTE80
9.98
Add AAE
49.36
Booked
59.34
CIA Annual Meeting  Assemblée annuelle de l’ICA
Example 2 – Whole Contract Approach
Calculation of PfAD
Best Estimate Result
Test AAE
AAE CTE60
(49.36)
Booked
(49.36)
Guarantee
0
AAE
(50.00)
Total
(50.00)
Actual Result
Calculate Liability – total
margins
Guarantee
59.34
AAE
(49.36)
CTE0
(66.64)
Total
9.98
CTE80
9.98
PfAD
59.98
Add AAE
49.36
16.64
Booked
59.34
Additional Margin
= 0 – (66.64) - 49.36