Principles Based Reserving

Oct 9th, 08
The progress and potential impact of this new reserving method for life products.

The Principles Based Reserving (PBR) concept gained steam several years ago as regulators and actuaries were seeking a better way to match the liabilities to the products life insurance companies were writing.  It is a fundamentally different process for calculating reserves for life contracts as opposed to the current methodology that utilizes standard mortality tables and conservative interest rates.  It includes the use of multiple company-specific assumptions relating to mortality, persistency, lapse rates, interest rates, and expense experience.  In most cases, PBR will result in lower reserves than the traditional table-driven methods that by their very nature have built-in conservative assumptions.

 

The PBR process will likely create a fair amount of additional expense for companies because of the numerous scenarios that will be required to be developed.  The PBR approach will be much more like the cash flow testing process actuaries now employ but with many additional scenarios.  The additional costs will come in the form of requirements to determine and document a company’s own experience relating to mortality, morbidity, policyholder behavior, expenses, asset purchases and sales, and investment earnings.   

 

PBR has continued to progress through the NAIC channels in recent months.  While initially an industry (primarily the American Academy of Actuaries) driven issue, the NAIC has fully embraced PBR.  The implementation has been the purview of the Life and Health Actuarial Task Force, which tackled another aggressive agenda at the Fall 2008 NAIC meeting in Washington, DC.  The Task Force has spent much of its time with revisions to the Standard Valuation Law and the Valuation Manual, with a good portion of these revisions relating to PBR issues. 

 

The PBR topic also arose at the NAIC/AICPA Task Force as that group was exploring how auditors would address this new reserving concept in their external audits.  The summarized answer to the question was that initially, the reserves calculated under PBR would likely be immaterial, as it is being applied on a prospective basis to new products only.  Once it becomes material though, the AICPA responded that under GAAS, auditors would consider the many audit procedures identified in the Life and Health Audit Guide.  

 

Finally, PBR is still mired in the middle chapters of the book that is full adoption.  The IRS has yet to weigh in fully on how PBR will be treated for tax purposes.  And, the NAIC will need to spend significant time in the coming years to refine the process.  So, stay tuned for the final chapter.