Transcript Slide 1

Investment Policy and Asset Liability Management
USA
Larry J. Bruning FSA, MAAA, CLU
International Life Actuary, NAIC USA
7 September 2011
1
Presentation Outline

International Regulatory Developments

Insurance Core Principles related to Investments

Investment Policy Regulation in the United States

Insurance Core Principles related to Asset Liability
Management

Asset Liability Management Regulation in the United
States

Questions
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International Regulatory Developments
International Association of Insurance Supervisors (IAIS)

Established 1994

180 jurisdictions
 100 observers representing industry and professional
associations, insurers, reinsurers, consultants and international
financial institutions

Standard Setting Body issuing global insurance principles,
standards and guidance papers

26 Insurance Core Principles (ICP) drafted
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International Regulatory Developments
Insurance Core Principles
ICP 1 Objectives, powers and responsibilities of the Supervisor
ICP 2 Supervisor
ICP 3 Information Exchange
ICP 4 Licensing
ICP 5 Suitability of Persons
ICP 6 Changes in control and portfolio transfers
ICP 7 Corporate Governance
ICP 8 Risk Management and Internal Controls
ICP 9 Supervisory Review and Reporting
ICP 10 Preventive and Corrective Measures
ICP 11 Enforcement
ICP 12 Winding-up and Exit from the Market
ICP 13 Reinsurance and Other Forms of Risk Transfer
ICP 14 Valuation
ICP 15 Investment
ICP 16 Enterprise Risk Management for Solvency Purposes
ICP 17 Capital Adequacy
ICP 18 Intermediaries
ICP 19 Conduct of Business
ICP 20 Public Disclosure
ICP 21 Countering Fraud in Insurance
ICP 22 Anti-money Laundering and Combating
the Financing of Terrorism
ICP 23 Group-wide Supervision
ICP 24 Macro-prudential Surveillance and Market
Analysis
ICP 25 Supervisory Cooperation and Coordination
ICP 26 Cross-border Cooperation and Coordination
on Crisis Management
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International Regulatory Developments
International Association of Insurance Supervisors (IAIS)

Financial Stability Committee (FSC)
 June 2010 IAIS Position Statement on Key Financial Stability Issues
 January 2011 delivered FSB draft methodology of quantitative and
qualitative indicators to assess the systemic importance of insurers
 Provides guidance on how to identify global and domestic SIFIs

Solvency and Actuarial Issues Subcommittee

Develop Common Framework (ComFrame) for supervision of Internationally
Active Insurance Groups (IAIGs)
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International Regulatory Developments
International Association of Insurance Supervisors (IAIS)

Supervisory Forum
 Promote effective and globally consistent regulation and supervision
 Provide platform for supervisors to share ideas, receive feedback and
develop best practices
 Evaluate potential impact on large and complex insurers from global
macro-economic scenarios
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International Regulatory Developments
International Association of Insurance Supervisors (IAIS)

Macro-prudential Policy and Surveillance Working Group (MPSWG)
 Develop economic expertise within IAIS
 Develop macro-prudential tools to assess the insurance sector
 Identify components of macro-prudential surveillance relative to
supervision
 Identify cross-border and cross-sector issues relative to supervision
 Take measures to mitigate regulatory arbitrage
 Liaise with other regulatory bodies both domestic and international
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Insurance Core Principles Related to Investments

ICP 14 Valuation – The Supervisor establishes
requirements for the valuation of assets and liabilities.
 14.1
The valuation addresses recognition, de-recognition and
measurement of assets and liabilities.
 14.2 The valuation of assets and of liabilities is undertaken on
consistent bases.
 14.3 The valuation of assets and liabilities is undertaken in a
reliable, decision useful and transparent manner.
 14.4 The valuation of assets and liabilities is an economic
valuation.
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Insurance Core Principles Related to Investments

ICP 14 Valuation –
 14.5
An economic valuation of assets and liabilities reflects the
risk-adjusted present values of their cash flows.
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Insurance Core Principles Related to Investments

ICP 15 Investment – The Supervisor establishes
requirements for solvency purposes on the investment
activities of insurers in order to address the risks faced by
insurers.
 15.1
The solvency regime establishes requirements that are
applicable to the investment activities of the insurer.
 15.2 The solvency regime is open and transparent as to the
regulatory investment requirements that apply and is explicit
about the objectives of those requirements.
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Insurance Core Principles Related to Investments

ICP 15 Investment –
 15.3
The regulatory investment requirements address at a
minimum the Security, Liquidity and Diversification of an
insurer’s portfolio of investments as a whole.
 15.4 The solvency regime requires the insurer to invest in a
manner that is appropriate to the nature of its liabilities.
 15.5 The solvency regime requires the insurer to invest only in
assets whose risks it can properly assess and manage.
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Insurance Core Principles Related to Investments

ICP 15 Investment –
 15.6
The solvency regime establishes quantitative and
qualitative requirements, where appropriate, on the use of more
complex and less transparent classes of assets and investment in
markets or instruments that are subject to less governance or
regulation.
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Insurance Core Principles Related to Investments

ICP 16 Enterprise Risk Management for solvency
purposes – The Supervisor establishes enterprise risk
management requirements for solvency purposes that
require insurers to address all relevant and material risks.
 16.6
The supervisor requires the insurer to have a risk
management policy which is reflected in an explicit investment
policy which:
• Specifies the nature, role and extent of the insurer’s
investment activities and how the insurer complies with the
regulatory investment requirements established by the
supervisor.
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Insurance Core Principles Related to Investments

ICP 16 Enterprise Risk Management for solvency
purposes –
 16.6
The supervisor requires the insurer to have a risk
management policy which is reflected in an explicit investment
policy which:
• Establishes explicit risk management procedures within its
investment policy with regard to more complex and less
transparent classes of asset and investment in markets or
instruments that are subject to less governance or regulation.
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Investment Policy Regulation in the United States

Investments of Insurers Model Act (Defined Limits NAIC
Model Law 280)

Investments of Insurers Model Act (Defined Standards
NAIC Model Law 283)

Derivatives Instruments Model Regulation (NAIC Model
Regulation 282)

Disclosure of Material Transactions Model Act (NAIC
Model Law 285)
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Investment Policy Regulation in the United States

Investments of Insurers Model Act (Defined Limits)
 Article
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I General Provisions
Section 1. Purpose and Scope
Section 2. Definitions
Section 3. General Investment Qualifications
Section 4. Authorization of Investments by the Board of
Directors
Section 5. Prohibited Investments
Section 6. Loans to Officers and Directors
Section 7. Valuation of Investments
Section 8. Regulations
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Investment Policy Regulation in the United States

Investments of Insurers Model Act (Defined Limits)
 Article
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II Life and Health Insurers
Section 9. Applicability
Section 10. General Three Percent Diversification, Medium
and Lower Grade Investments and Canadian Investments
Section 11. Rated Credit Instruments
Section 12. Insurer Investment Pools
Section 13. Equity Interests
Section 14. Tangible Personal Property Under Lease
Section 15. Mortgage Loans and Real Estate
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Investment Policy Regulation in the United States

Investments of Insurers Model Act (Defined Limits)
 Article
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II Life and Health Insurers
Section 16. Securities Lending, Repurchase, Reverse
Repurchase and Dollar Roll Transactions
Section 17. Foreign Investments and Foreign Currency
Exposure
Section 18. Derivatives Transactions
Section 19. Policy Loans
Section 20. Additional Investment Authority
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Investment Policy Regulation in the United States

Investments of Insurers Model Act (Defined Limits)
 Article
III Property and Casualty, Financial Guaranty and
Mortgage Guaranty Insurers
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Section 21. Applicability
Section 22. Reserve Requirements
Section 23. General Five Percent Diversification, Medium
and Lower Grade Investments and Canadian Investments
Section 24. Rated Credit Instruments
Section 25. Insurer Investment Pools
Section 26. Equity Interests
Section 27. Tangible Personal Property Under Lease
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Investment Policy Regulation in the United States

Investments of Insurers Model Act (Defined Limits)
 Article
III Property and Casualty, Financial Guaranty and
Mortgage Guaranty Insurers
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Section 28. Mortgage Loans and Real Estate
Section 29. Securities Lending, Repurchase, Reverse
Repurchase and Dollar Roll Transactions
Section 30. Foreign Investments and Foreign Currency
Exposure
Section 31. Derivative Transactions
Section 32. Additional Investment Authority
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Investment Policy Regulation in the United States

Section 5. Prohibited Investments
 An
•
•
•
•
insurer shall not, directly or indirectly:
Invest in an obligation or security or make a guarantee for
the benefit of or in favor of an officer or director of the
insurer.
Invest in an obligation of a business entity in which 10% or
more of the voting interests are owned by officer or director.
Engage on its own behalf or through one or more affiliates in
a transaction designed to evade the prohibitions of this Act.
Invest in or lend its funds upon the security of shares of its
own stock.
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Investment Policy Regulation in the United States

Section 6. Loans to Officers and Directors
 An
insurer shall not, without prior written approval of the
commissioner :
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Make a loan to or other investment in an officer or director of
the insurer.
Enter into an agreement for the purchase or sale of property
from or to an officer or director of the insurer.
Make a guarantee for the benefit of or in favor of an officer
or director of the insurer.
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Investment Policy Regulation in the United States

Section 10. Medium and Lower Grade Investments
 An
insurer shall not acquire, directly or indirectly after giving
effect to the investment:
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The aggregate amount of medium and lower grade investments then held
by the insurer would exceed 20% of its admitted assets.
The aggregate amount of lower grade investments then held by the
insurer would exceed 10% of its admitted assets.
The aggregate amount of investments rated 5 or 6 by the SVO then held
by the insurer would exceed 3% of its admitted assets
The aggregate amount of investments rated 6 by the SVO then held by
the insurer would exceed 1% of its admitted assets.
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Investment Policy Regulation in the United States

Section 16. Mortgage Loans and Real Estate
 The
obligations held by the insurer shall not at the time of
acquisition of the obligation exceed:
•
•
•
90% of the fair market value of the real estate if the mortgage loan is
secured by a purchase money mortgage or like security received by the
insurer upon disposition of the real estate.
80% of the fair market value of the real estate if the mortgage loan
requires immediate scheduled payment in periodic installment of
principal and interest with an amortization period of 30 years or less.
75% of the fair market value of the real estate for mortgage loans that do
not meet the requirements of the above.
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Investment Policy Regulation in the United States

Investments of Insurers Model Act (Defined Standards)
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Section 1. Purpose and Scope
Section 2. Definitions
Section 3. Minimum Financial Security Benchmark
Section 4. Authorized Investments
Section 5. Prudence Evaluation Criteria
Section 6. Insurer Investment Policy
Section 7. Authorized Classes of Investments
Section 8. Limitations Generally Applicable
Section 9. Protection Against Currency Fluctuations
Section 10. Prohibited Investments
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Investment Policy Regulation in the United States

Investments of Insurers Model Act (Defined Standards)
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Section 11.
Section 12.
Section 13.
Section 14.
Section 15.
Section 16.
Section 17.
Section 18.
Section 19.
Effect of Investment Restrictions
Reports and Replies
Retention of Experts
Commissioner’s Orders
Administrative Hearings
Confidentiality of Information
Conflict of Laws and Other Standards
Regulations
Effective Date
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Investment Policy Regulation in the United States

Section 7. Authorized Classes of Investments
 The
following classes of investments may be counted for the
purposes specified in Section 11:
A.
B.
C.
D.
E.
Cash in the direct possession of the insurer or on deposit with a
financial institution regulated by any federal or state agency of the
United States
Bonds, debt-like preferred stock of governments in the US and Canada
or private business domiciled in the US or Canada
Loans secured by mortgages, trust deeds of property located in US and
Canada
Common Stock or equity-like preferred stock of business in US and
Canada
Real property necessary for the convenient transaction of the insurers
business
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Investment Policy Regulation in the United States

Section 7. Authorized Classes of Investments
 The
following classes of investments may be counted for the
purposes specified in Section 11:
F. Real property together with the fixtures, furniture, furnishings and
equipment pertaining thereto in the US or Canada which produces
substantial income
G. Loans, securities or other investments of the types described in
subsections A to F in countries other than the US or Canada.
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Investment Policy Regulation in the United States

Section 8. Limitations Generally Applicable
 Investments
•
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authorized by Section 7B and Section 7G:
The aggregate amount of medium and lower grade investments are
limited to 20% of admitted assets.
The aggregate amount of lower grade investments are limited to 10% of
admitted assets.
The aggregate amount of investments rated 5 or 6 by the SVO are limited
to 5% of admitted assets.
The aggregate amount of investments rated 6 by the SVO are limited to
1% of admitted assets.
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Investment Policy Regulation in the United States

Derivatives Instruments Model Regulation
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Section 1. Authority
Section 2. Purpose
Section 3. Definitions
Section 4. Guidelines and Internal Control Procedures
Section 5. Commissioner Approval
Section 6. Documentation Requirements
Section 7. Trading Requirements
Section 8. Effective Date
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Investment Policy Regulation in the United States

Section 4. Guidelines and Internal Control Procedures
 Before
engaging in a derivative transaction an insurance
company shall establish written guidelines, approved by the
Commissioner, that shall be used for effecting and maintaining
derivative transactions. The guidelines shall:
•
•
•
•
Specify insurance company objectives for engaging in derivative
transactions and derivative strategies and all applicable risk constraints,
including credit risk limits.
Establish counterparty exposure limits and credit quality standards.
Identify permissible derivative transactions and the relationship of those
transactions to insurance company operations e.g. a precise identification
of the risks being hedged by a derivative transaction.
Require compliance with internal control procedures.
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Investment Policy Regulation in the United States

Section 4. Guidelines and Internal Control Procedures
 An
insurance company shall have a written methodology for
determining whether a derivative instrument used for hedging
has been effective.
 An insurance company shall have written policies and
procedures describing the credit risk management process and a
credit risk management system for over-the-counter derivative
transactions that measures credit risk exposure using the
counterparty exposure amount
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Investment Policy Regulation in the United States

Section 4. Guidelines and Internal Control Procedures
 An
insurance company’s board of directors shall in accordance
with this Act:
•
•
•
•
Approve the written guidelines, methodology and policies and procedures
required by this Act.
Determine whether the insurance company has adequate professional
personnel, technical expertise and systems to implement investment
practices involving derivatives.
Review whether derivatives transactions have been made in accordance
with the approved guidelines and consistent with stated objectives.
Take action to correct any deficiencies in internal controls relative to
derivative transactions.
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Investment Policy Regulation in the United States

Disclosure of Material Transactions Model Act
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•
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•
Section 1. Report
Section 2. Acquisitions and Dispositions of Assets
Section 3. Non-renewals, Cancellations or Revisions of
Ceded Reinsurance Agreements
Section 4. Confidentiality
Section 5. Effective Date
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Insurance Core Principles Related to Asset
Liability Management

ICP 16 Enterprise Risk Management for solvency
purposes – The Supervisor establishes enterprise risk
management requirements for solvency purposes that
require insurers to address all relevant and material risks.
 16.2
The supervisor requires the insurer’s measurement of risk
to be supported by accurate documentation providing
appropriately detailed descriptions and explanations of risks, the
measurement approaches used and the key assumptions made.
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Insurance Core Principles Related to Asset
Liability Management

ICP 16 Enterprise Risk Management for solvency
purposes –
 16.5
The supervisor requires the insurer to have a risk
management policy which includes an explicit asset-liability
management (ALM) policy which clearly specifies the nature,
role and extent of ALM activities and their relationship with
product development, pricing functions and investment
management.
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Asset Liability Management Regulation in the United States

Standard Valuation Law (NAIC Model Law 820)

Actuarial Opinion and Memorandum Regulation (NAIC
Model Regulation 822)
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Asset Liability Management Regulation in the United States

Standard Valuation Law Section 3 Actuarial Opinion of
Reserves
 Opinion
required annually (submitted with annual financial
statement)
 Submitted by a Qualified Actuary
 Opinion covers in force business (liabilities)
 Opinion takes into account the assets a company owns
 Opinion must follow actuarial standards of practice adopted
by the Actuarial Standards Board
 Opinion accompanied by an actuarial memorandum
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Asset Liability Management Regulation in the United States

Actuarial Opinion and Memorandum Regulation –
General Requirements
 Company
Board of Directors must appoint a Qualified
Actuary to prepare the Statement of Actuarial Opinion
 Qualified Actuary


Member in good standing of the American Academy of
Actuaries
Qualified to sign statements of actuarial opinion for life and
health insurance company annual statements in accordance
with the American Academy of Actuaries qualification
standards
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Asset Liability Management Regulation in the United States

Actuarial Opinion and Memorandum Regulation –
General Requirements
 If
appointed actuary determines as the result of asset adequacy
analysis that a reserve should be held in addition to the
aggregate reserve held by the company and calculated in
accordance with methods set forth in the Standard Valuation
Law, the company shall establish the additional reserve.
 Any additional reserve established above and deemed not
necessary in subsequent years may be released and any amounts
released shall be disclosed in the actuarial opinion for the
applicable year.
40
Asset Liability Management Regulation in the United States

Opinion should include a statement such as “In my
opinion the reserves and related actuarial values:




Are computed in accordance with presently accepted actuarial standards
consistently applied and are fairly stated in accordance with sound actuarial
principles;
Are based on actuarial assumptions that produce reserves at least as great as
those called for in any contract provision as to reserve basis and method;
Meet the requirements of the Insurance Law and regulation of the state and
are at least as great as the minimum aggregate amounts required by the state;
Are computed on the basis of assumptions consistent with those used in
computing the corresponding items in the annual statement of the preceding
year-end;
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Asset Liability Management Regulation in the United States

Opinion should include a statement such as “In my
opinion the reserves and related actuarial values:



Include provision for all actuarial reserves and related statement items which
ought to be established;
When considered in light of the assets held by the company including, but not
limited to, the investment earnings on the assets, and the considerations
anticipated to be received and retained under the policies and contracts, make
adequate provision, according to presently accepted actuarial standards of
practice, for the anticipated cash flows required by the contractual obligations
and related expenses of the company; and
This opinion is updated annually as required by statute and to the best of my
knowledge, there have been no material changes from the applicable date of
the annual statement to the date of my rendering of this opinion which should
be considered in reviewing this opinion.
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Asset Liability Management Regulation in the United States

Asset Adequacy Analysis involves the following:



Building a financial model of a company’s in force insurance contracts
Building a financial model of a company’s in force assets
Setting liability assumptions such as:
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Premium payment patterns
Lapse Rates (base and excess)
Interest crediting rate strategy
Mortality
Policy owner dividend strategy
Competitor or market interest rate structure
Annuitization rates
Company commissions and expenses
Morbidity
Policy owner utilization
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Asset Liability Management Regulation in the United States

Asset Adequacy Analysis involves the following:

Setting asset assumptions such as:
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
Reinvestment and dis-investment of cash flows
Asset valuation bases for assets held
Default costs
Bond call functions
Mortgage pre-payment functions
Market values for assets sold
Determining yields on asset purchased
Investment expenses
Generating Interest Rate or Market Rate scenarios to test
•
•
Deterministic such as New York 7
Stochastic (American Academy of Actuaries Economic Scenario Generator)
44
Asset Liability Management Regulation in the United States

Asset Adequacy Analysis involves the following:


Running the financial models under each interest rate/market rate scenario
over a period long enough such that no material liability exists
Calculating the metric for each scenario
•
•

Present Value of Ending Market Surplus
Present Value of Ending Book Surplus
Determining the additional reserve, if any, after evaluating the results of each
scenario
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Asset Liability Management Regulation in the United States

New York 7 Interest Rate Scenarios (Stress Tests)
 Level Scenario
 Uniformly increasing over 10 years at 0.50% then level
 Uniformly increasing over 5 years at 1.0% then uniformly
decreasing at 1.0% for 5 years then level
 Immediate increase of 3.0% forever
 Uniformly decreasing over 10 years at 0.50% then level
 Uniformly decreasing over 5 years at 1.0% then uniformly
increasing at 1.0% for 5 years then level
 Immediate decrease of 3.0% forever
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Asset Liability Management Regulation in the United States

In addition to the NY 7 interest rate scenarios, most companies also
run a set of stochastic interest rate scenarios

Cash flow models contain many assumptions so most companies
run additional sensitivity tests on the assumptions such as increased
and decreased lapse rates, mortality rates, expenses, default costs,
pre-payment speeds etc.

Must consider rationale for inclusion or exclusion of different
blocks of business

Must consider impact and treatment of reinsurance

Must consider definition of moderately adverse conditions
47
Asset Liability Management Regulation in the United States

Company must file annually a Regulatory Asset Adequacy Issues
Summary (RAAIS) which:
•
Disclose scenarios tested, sensitivity testing done, scenarios that
generated negative ending surplus, additional reserve needed to
eliminate negative ending surplus.
• Disclose any asset adequacy assumptions that were materially
different from the previous year’s assumptions.
• Disclose the amount of reserves and product lines subjected to asset
adequacy analysis in the prior opinion but not subject to analysis in
the current opinion.
• Disclose any interim results that may be of significant concern to the
appointed actuary.
48
Asset Liability Management Regulation in the United States

Company must file annually a Regulatory Asset Adequacy Issues
Summary (RAAIS) which:
•
Disclose methods used to recognize the impact of reinsurance on
company’s cash flows.
• Disclose whether the actuary is satisfied that all options whether
explicit or embedded in any asset or liability and any equity-like
features in any investments have been appropriately considered in the
asset adequacy analysis.
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Questions
Questions ???
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