Pricing of Life Insurance and Annuity Products
Second Exposure Draft
TO: Members of Actuarial Organizations Governed by the Standards of Practice of the Actuarial Standards Board and Other Persons Interested in the Pricing of Life Insurance and Annuity Products
FROM: Actuarial Standards Board (ASB)
SUBJ: Proposed Actuarial Standard of Practice (ASOP)
This document contains the second exposure draft of a proposed actuarial standard of practice, Pricing of Life Insurance and Annuity Products. Please review this exposure draft and give the ASB the benefit of your comments and suggestions. Each response will be acknowledged, and all responses will receive appropriate consideration by the drafting committee in preparing the final document for approval by the ASB.
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If you wish to use conventional mail, please send comments to the following address:
Pricing of Life Insurance and Annuity Products Second Exposure Draft
Actuarial Standards Board
1850 M St. NW, Suite 300
Washington, DC 20036
The ASB posts all signed comments received to its website to encourage transparency and dialogue. Unsigned or anonymous comments will not be considered by the ASB nor posted to the website. The comments will not be edited, amended, or truncated in any way. Comments will be posted in the order that they are received. Comments will be removed when final action on a proposed standard is taken. The ASB website is a public website, and all comments will be available to the general public. The ASB disclaims any responsibility for the content of the comments, which are solely the responsibility of those who submit them.
Deadline for receipt of comments in the ASB office: October 31, 2017
The ASB periodically reviews the completeness of ASOPs for all practice areas and asked the Life Committee to consider whether an ASOP addressing life insurance and annuity pricing principles would be appropriate. Casualty and Health areas have guidance on ratemaking. In October 2014, the ASB Life Committee distributed a Request for Comments regarding an ASOP focused on life insurance and annuity pricing. Sixteen comment letters were received. Most of the comments supported the drafting of such an ASOP.
The pricing of products is one of the most important functions actuaries perform. Therefore, the ASB Life Committee believes that the profession would be well served by an ASOP providing guidance regarding life insurance and annuity product pricing. The ASB agreed and approved the creation of an exposure draft.
In March 2016, the ASB approved an exposure draft of this proposed ASOP. Seventeen comment letters were received and considered in making changes that are reflected in this second exposure draft.
The ASB thanks all those who made comments on the first exposure draft.
Key changes from the current standard reflected in this exposure draft include the following:
1. Section 1.2, Scope, was redrafted to more clearly define what actuarial services are in scope.
2. The phrase “goals of the actuary’s principal” was changed to “criteria of the actuary’s principal” to more accurately reflect the intent of the drafters. The phrase “criteria of the actuary’s principal” was added to several places within the standard to improve clarity.
3. Internal rate of return was given equal consideration among the various profitability measures listed in section 3.2.1, Profitability Metrics, and not singled out as a preferred profitability metric.
4. Guidance was added to the section titled Assumption Margins. The guidance was also moved from the section on cost of risk (now section 3.5, Risk Evaluation) to section 3.4, Pricing Assumptions.
5. Wording was added to the section on stochastic analysis (now section 3.5.3) to clarify that stochastic analysis is not a requirement.
6. Section 3.6, Pricing Controls, was changed to Governance and Controls and redrafted to more effectively capture the intended guidance.
Request for Comments
The ASB would appreciate comments on the draft ASOP and would draw the reader’s attention to the following areas in particular:
1. Is it clear what actuarial services are covered in section 1.2, Scope? If not, please give an example of an actuarial service or a product whose exclusion is unclear and how to clarify.
2. Throughout the ASOP, there are references to “the criteria of the actuary’s principal.” Are the examples in section 3.1.1, Criteria of the Actuary’s Principal, adequate to apply the guidance included in the draft ASOP?
3. Is the guidance in section 3.6, Governance and Controls, clear?
The ASB voted in June 2017 to approve this exposure draft.
|Life Insurance and Annuity Pricing Task Force|
|David A. Brentlinger, Chairperson|
|Jodi L. Kravitz||Anthony J. Tokarz|
|Lisa S. Kuklinski||Candace J. Woods|
|Steven L. Putterman|
|Life Committee of the ASB|
|David A. Brentlinger, Chairperson|
|Janice A. Duff||Henry W. Siegel|
|Linda M. Lankowski||Anthony J. Tokarz|
|John A. MacBain||Matthew J. Wininger|
|Actuarial Standards Board|
|Maryellen J. Coggins, Chairperson|
|Christopher S. Carlson||Barbara L. Snyder|
|Beth E. Fitzgerald||Kathleen A. Riley|
|Darrell D. Knapp||Frank Todisco|
|Cande J. Olsen||Ross A. Winkelman|
The ASB establishes and improves standards of actuarial practice. These ASOPs identify what the actuary should consider, document, and disclose when performing an actuarial assignment. The ASB’s goal is to set standards for appropriate practice for the U.S.
Section 1. Purpose, Scope, Cross References, and Effective Date
This actuarial standard of practice (ASOP) provides guidance to actuaries when performing actuarial services with respect to the pricing of life insurance and annuity products, including riders. For this ASOP, the term “product” includes “riders.”
This standard applies to actuaries when performing actuarial services with respect to the pricing of life insurance and annuity products when a product is initially developed or when charges or benefits are changed for future sales. This standard does not apply to any changes made on inforce policies. Such resetting of nonguaranteed elements, including dividends, on products in force is outside the scope of this ASOP and is addressed in ASOP No. 2, Nonguaranteed Charges or Benefits for Life Insurance Policies and Annuity Contracts, and No. 15, Dividends for Individual Participating Life Insurance, Annuities, and Disability Insurance. The actuary should also refer to ASOP No. 2 or 15 when determining nonguaranteed elements or dividends when a product is initially developed or when charges or benefits are changed for future sales.
In the context of this ASOP, actuarial services include evaluating the product’s profitability and underlying risks and advising on the product’s rates and benefits. Actuarial services may also include advising on the design of the product. Although the actuary needs to be mindful of all considerations that may affect the ultimate price of the product, the standard addresses only issues related to actuarial services, and therefore does not address other issues that may be important to the pricing exercise, such as marketing, sales, and competition, or compliance with federal antitrust laws.
The standard applies to actuaries when performing actuarial services related to life insurance and annuity products written on individual policy forms. The standard also applies to group master contracts with individual certificates that are priced in a similar manner to products written on individual life and annuity policy forms. Examples of products that are not priced in a similar manner to products written on individual life and annuity policy forms and therefore not in scope include the following:
a. traditional group term life; and
b. investment products that do not have an annuitization component, such as certain types of funds included in a retirement product.
To the extent that the guidance in this standard may conflict with guidance in other ASOPs regarding the pricing of specific benefits other than life and annuity benefits, the guidance in the other standard will govern. This standard does not apply to actuaries when performing professional services with respect to illustrations of nonguaranteed charges or benefits subject to ASOP No. 24, Compliance with the NAIC Life Insurance Illustrations Model Regulation.
If the actuary departs from the guidance set forth in this standard in order to comply with applicable law (statutes, regulations, and other legally binding authority) or for any other reason the actuary deems appropriate, the actuary should refer to section 4.2.
1.3 Cross References
When this standard refers to the provisions of other documents, the reference includes the referenced documents as they may be amended or restated in the future, and any successor to them, by whatever name called. If any amended or restated document differs materially from the originally referenced document, the actuary should consider the guidance in this standard to the extent it is applicable and appropriate.
1.4 Effective Date
This standard will be effective for any actuarial services performed on or after four months after adoption by the ASB.
Section 2. Definitions
The terms below are defined for use in this actuarial standard of practice.
2.1 Modeling Cell
Policies or contracts that are treated in a model as being completely alike with regard to, for example, demographic characteristics, policyholder behavior assumptions, policy provisions, and underwriting class.
The process of setting charges for, and benefits provided by, an insurance policy or annuity contract at issue. Examples of charges include premiums, cost of insurance charges, separate account charges, surrender charges, policy fees, and target interest rate spreads. Examples of benefits include death benefits, surrender benefits, dividends, and income benefits.
2.3 Profitability Analysis
An evaluation of a product’s expected financial results using a set of assumptions, a specified model, and specified profitability metric(s).
2.4 Profitability Metric
A measurement used to assess a product’s expected level of financial results.
2.5 Risk Capital
Amounts to absorb potential unexpected losses resulting from severe events.
2.6 Sensitivity Analysis
Analysis performed by changing an assumption or set of assumptions and comparing the results to those resulting from the baseline assumption(s).
2.7 Stochastic Analysis
Analysis performed using a model that estimates distributions of potential outcomes by allowing random variation in one or more inputs to the model.
Section 3. Analysis of Issues and Recommended Practices
3.1 Initial Pricing Considerations
When preparing for the pricing exercise, the actuary should take into account the criteria of the actuary’s principal and the relevant characteristics of the product.
3.1.1 Criteria of the Actuary’s Principal
Criteria of the actuary’s principal include, but are not limited to, the following:
a. selection of profitability metrics, which often are stated at an aggregate product level over the expected life of the product, as well as at the modeling cell level.
b. targets for profitability metrics, including any special circumstances, such as targets for shorter periods of time or situations where profits are expected to be followed by losses; and
c. risk management policies that are relevant to product pricing; for example, the level of risk contained in the product being priced.
3.1.2 Relevant Characteristics of the Product
Relevant characteristics of the product include, but are not limited to, the following:
a. the intended design objective of the product;
b. the intended market, sales goals, and the competitive alternatives to the product;
c. how the product will be sold, for example, underwriting, distribution, and marketing;
d. how the product will be administered, including any limitations in administrative and valuation systems that could impact product design or operational risks;
e. applicable law (statutes, regulations, and other legally binding authority); and
f. the tax treatment of the product as it applies to both the owner and the insurer.
3.2 Selecting Profitability Metrics
The actuary should select profitability metrics in a manner consistent with the criteria of the actuary’s principal and the underlying design and risks of the product.
3.2.1 Profitability Metrics
The actuary should consider using more than one profitability metric when evaluating the expected profitability. Examples of profitability metrics include, but are not limited to, the following:
a. the expected return on initial invested capital, often referred to as the internal rate of return;
b. the average of expected future periodic returns on capital, often referred to as average return on equity;
c. a measure of profitability expressed as a percentage of premium, often referred to as profit margin;
d. the present value of expected future profits as a percentage of the present value of expected assets, often referred to as return on assets;
e. the present value of expected future profits, often referred to as the value of new business; and
f. the time period when a measure of cumulative profits turns positive, often referred to as break-even year.
3.2.2 Considerations When Selecting Profitability Metrics
When selecting profitability metrics, the actuary should consider the following:
a. the expected pattern of profits over time (for example, the pattern of gains and losses, however measured);
b. the significance of the product’s underlying risks (for example, how capital intensive the product is); and
c. any other considerations that the actuary determines are relevant.
3.3 Developing the Model
The actuary should develop the model to support pricing in a manner consistent with the criteria of the actuary’s principal. The actuary should develop a model that accommodates the design of the product and the selected profitability metrics, and reasonably simulates the future financial impact of the product.
When developing the model, the actuary should consider the following:
a. Time Horizon—the degree to which the model extends over a sufficient time period such that the profitability results and underlying risks of the product are adequately captured;
b. Granularity—the degree to which (1) the number of modeling cells represent the expected profitability and risk evaluation of future sales, and (2) assumptions vary by modeling cell or time interval. For example, the actuary should be able to evaluate the range of profitability across different modeling cells in order to understand the degree to which the profitability metrics could vary based on achieving a different sales mix than anticipated;
c. Dynamic Assumptions—the degree to which the model can accommodate how certain assumptions may vary based on external factors through policyholder behavior and other items described in section 3.4.4(d);
d. Asset Returns—the degree to which the model incorporates asset returns consistent with how returns are expected to be recognized and allocated to the product;
e. Economic Scenarios—the degree to which the model uses, if appropriate, market consistent or real world economic scenarios that represent an appropriate range of future asset returns;
f. Accounting and Actuarial Bases—the degree to which the model uses accounting and actuarial bases relied upon by management to evaluate the product’s profitability and underlying risks;
g. Risk Capital Framework—the degree to which the model uses a risk capital framework that is expected to be used in practice;
h. Taxes—the degree to which the model uses a tax structure that is expected to apply, given the product, the tax position of the company, and the company’s tax allocation practices;
i. Risk Quantification—the degree to which the model uses an appropriate method to quantify risks as described in section 3.5;
j. Risk Mitigation—the degree to which the model appropriately uses risk mitigation strategies that are expected to be used to support the product, such as reinsurance, hedging, dividends, or nonguaranteed elements;
k. Model Validation—the degree to which the model is sufficiently transparent to support validation as described in section 3.6; and
l. Such other items as the actuary determines are significant to the model.
3.4 Pricing Assumptions
The actuary should use professional judgment to set assumptions that reflect expected future experience, based on the following considerations.
3.4.1 Historical Experience Used When Setting Assumptions
The actuary should use professional judgment to ensure that relevant historical experience is reflected when setting assumptions.
188.8.131.52 Assumptions Based on Relevant and Credible Data
The actuary should use assumptions based on relevant and credible data, such as company experience, industry experience, and other relevant experience, which may be modified to reflect the circumstances being modeled. When modifying such experience, the actuary should refer to ASOP No. 25, Credibility Procedures, for guidance.
184.108.40.206 Assumptions Based on Historical Experience
When using historical experience, the actuary should consider whether there are reasons to expect that future experience will differ from past experience.
220.127.116.11 Assumptions When There Is No Relevant Historical Experience
In some instances, no relevant historical experience is available to the actuary. In this situation, the actuary should use professional judgment, considering available sources of data, when setting the assumption.
3.4.2 Assumption Margins
The actuary should consider the appropriateness of including a margin for uncertainty in the assumptions. When setting any margin, the actuary should consider the following:
a. the degree to which there is uncertainty around the assumptions due to lack of relevant, credible company or industry experience data to support the assumptions, such as when a new product is being introduced to the marketplace;
b. whether the degree of uncertainty may vary over different periods of time within the time horizon of the model; and
c. whether the level of margins individually for each assumption and in aggregate for all assumptions is appropriate.
3.4.3 Consistency of Assumptions
The actuary should use assumptions that are internally consistent with other components of the model, consistent with current and anticipated company practices, and, where appropriate, consistent with assumptions used for other assignments within the entity.
3.4.4 Product Design and Assumption Setting
When setting assumptions, the actuary should consider the product design, as well as the following:
a. sales mix assumptions that reflect the anticipated distribution of sales across modeling cells;
b. investment assumptions and economic market assumptions that reflect real world or market consistent theory, where appropriate, and that include assumptions for reinvestment, asset default, and investment expenses;
c. mortality and morbidity assumptions that incorporate the effects of selection and classification of future applicants, where appropriate, the impact of expected trends on future assumptions, and the impact of policy or rider characteristics, such as conversion and level premium periods on term coverage;
d. for experience that is elective in nature, such as the policyholder’s ability to pay or not pay premiums, to receive certain types of benefits, or to terminate the contract, assumptions that consider the causal variables impacting the policyholder’s choice, such as policyholder characteristics (for example, age) and policy or rider characteristics (for example, size of policy), as well as the value of guaranteed benefits driven by external factors (for example, the current interest rate environment and underlying market performance);
e. expense assumptions that reflect anticipated future trends in expenses (for example inflation or expense efficiencies). The actuary should consider the appropriateness of the basis (for example, fully allocated, marginal) when developing expense assumptions;
f. discount rate(s) that are suitable for the selected profitability metric, where applicable; and
g. the principal’s capacity and intent with regard to inforce management strategies, including dividends and nonguaranteed elements.
The actuary should consider the extent to which certain of these assumptions may also be influenced by the distribution channel through which the product will be sold.
The actuary should consider incorporating the views of experts when setting assumptions in areas outside the actuary’s area of expertise. However, the setting of assumptions should reflect the actuary’s professional judgment.
3.4.5 Capital Market Assumptions
If performing stochastic analysis, the actuary should take into account the design of the product when determining whether to use market consistent assumptions or real world assumptions. When analyzing a benefit that can be replicated using liquid capital market instruments, the actuary should consider comparing the cost of the benefit using market consistent assumptions to the price of a comparable investment guarantee observed in capital markets to assure that it aligns with the profitability goals and risk management policy of the actuary’s principal.
3.4.6 Documentation of Assumptions, Their Rationale, and Data Modifications
The actuary should document the assumptions, the rationale behind the assumptions, and any modifications made to data sources. If margins are included in assumptions, the actuary should document the approach used and, where practicable, the margin component of each assumption. The actuary should consider making disclosures of documentation of material assumptions, as appropriate.
3.5 Risk Evaluation
The actuary should evaluate the impact on profitability metrics from deviations in assumptions when performing a profitability analysis.
3.5.1 Cost of Capital
The actuary should consider incorporating the cost of capital into the profitability analysis. Examples of approaches that the actuary can use include, but are not limited to, incorporating risk capital or setting profitablity metrics that are consistent with the underlying risks of the product.
3.5.2 Sensitivity Analysis
The actuary should use sensitivity analysis to evaluate the impact on profitability from future experience being different than assumed and should consider performing more analysis for assumptions that have a significant impact on the profitability analysis than for assumptions that have less impact.
3.5.3 Stochastic Analysis
The actuary should consider whether stochastic analysis should be used to evaluate the distribution of potential profitability metrics from variations in key assumptions. In particular, the actuary should consider performing stochastic analysis for products that are expected to exhibit sensitivity to the level of interest rates or equity returns.
The actuary may consider other risk evaluation techniques as appropriate. The actuary should consider the impact of risk mitigation strategies that are expected to be implemented at the product and company level and the expected effectiveness of those strategies.
3.6 Governance and Controls
The actuary should use, or, if appropriate, rely on others to use, reasonable governance and controls over the actuarial services provided as part of pricing. Examples of governance and controls include, but are not limited to, the following:
a. effective oversight of methods and assumptions used in the pricing exercise;
b. preservation and protection of the model from unintentional or untested changes;
c. separation of duties;
d. validation of the appropriate use of the inputs in model calculations;
e. validation that values from the models are consistent with independent calculations of such values from outside the model;
f. validation that the model reasonably simulates the product’s expected impact on the company’s future financial and risk position; and
g. review of assumptions and other aspects of the model by a knowledgeable person who conducts the review in an objective way.
The actuary should consider documenting the governance and controls used as part of pricing.
3.7 Reliance on Data or Other Information Supplied by Others
When relying on data or other information supplied by others, the actuary should refer to ASOP No. 23, Data Quality, for guidance. When relying on assumptions provided by others, the actuary should refer to ASOP No. 41, Actuarial Communications.
The actuary should prepare and retain documentation in accordance with ASOP No. 41.
Section 4. Communications and Disclosures
4.1 Actuarial Communications
When issuing any actuarial communication relating to this ASOP, the actuary should refer to ASOP No. 41. The actuary should consider the needs of the intended user in communicating the actuarial findings in any actuarial report. In addition, in any actuarial report concerning pricing, the actuary should disclose the following, if practical and relevant:
a. product description including design features and the market to which it will be sold;
b. results of the profitability analysis, including the range of results over modeling cells;
c. the profitability metrics used to evaluate expected profitability and how these metrics are consistent with the criteria of the actuary’s principal as described in section 3.2 of this standard;
d. the considerations used to develop the model as described in section 3.3 of this standard;
e. material pricing assumptions and the manner in which the actuary established these assumptions to reflect expected future experience, adjusted to include any margin, as described in section 3.4 of this standard; and
f. results of risk evaluation as described in section 3.5 of this standard, including the manner in which the actuary has evaluated the product’s underlying risks and how those underlying risks will be managed.
4.2 Additional Disclosures
The actuary should also include the following disclosures, as applicable, in an actuarial communication:
a. the disclosure in ASOP No. 41, section 4.2, if any material assumption or method was prescribed by applicable law (statutes, regulations, and other legally binding authority);
b. the disclosure in ASOP No. 41, section 4.3, if the actuary states reliance on other sources and thereby disclaims responsibility for any material assumption or method selected by a party other than the actuary; and
c. the disclosure in ASOP No. 41, section 4.4, if, in the actuary’s professional judgment, the actuary has otherwise deviated materially from the guidance of this ASOP.
Background and Current Practices
Note: This appendix is provided for informational purposes and is not part of the standard of practice.
The pricing of life insurance and annuity products is a complex process and requires management to make decisions based on a variety of inputs that often include analyses of profitability and risk performed by actuaries. The roles performed by actuaries when pricing are significant and varied. They can range from technical analysis of profitability to the development of marketing strategies for a proposed product. While the final decisions on product design, price, and marketing are the responsibility of management, information necessary for making those decisions is most often provided by actuaries. Management must balance business growth, profitability, and other strategic goals when setting the parameters for a proposed new product. Actuaries are typically asked to evaluate the profitability and risk inherent in those parameters. In this relationship, management relies on actuarial analyses to make decisions that impact the ability of the insurance company to meet its goals in the future.
Several ASOPs currently address various aspects of the pricing of life insurance and annuity products. Examples include the following:
- ASOP No. 2, Nonguaranteed Charges or Benefits for Life Insurance Policies and Annuity Contracts;
- ASOP No. 7, Analysis of Life, Health, or Property/Casualty Insurer Cash Flows;
- ASOP No. 12, Risk Classification (for All Practice Areas); and
- ASOP No. 15, Dividends for Individual Participating Life Insurance, Annuities, and Disability Insurance.
This draft ASOP, when and if adopted by the ASB as a final standard, supplements the guidance provided by existing ASOPs and provides guidance to actuaries providing actuarial services related to the pricing of life insurance and annuity products.
Most life insurance and annuity products provide multi-year guarantees in the form of a fixed premium, guaranteed benefits, or limits on the ability of the company to change future premiums, fees, or benefits. In these situations, the company must commit to the price before the product is sold and may have to honor that commitment for a lifetime. It is critical that the actuarial analyses supporting that commitment meet accepted standards.
Supporting the pricing of life insurance and annuity products typically requires developing a model to apply expected future experience to measure the risks inherent in the product design and the likely future profit. Setting the assumptions for future experience is typically the role of the actuary, although at times either regulation (for example, unisex legislation) or management will mandate the use of a certain assumption.
Developments in consumer preferences and medical science will continue to affect policyholder behavior, future mortality rates, and product profitability. Other examples of existing trends that are expected to affect life insurance and annuity product pricing include the following:
- Principle-based approaches to determining statutory accounting requirements will provide more flexibility and responsibility for actuaries in establishing the assumptions and methods that are used in that context.
- Vendors and other third parties are playing increasingly important roles in the traditional pricing and product distribution functions.
- Risks and opportunities are created by new distribution models, disruptive market entrants, and technology.
Comments on the First Exposure Draft and Responses
The first exposure draft of this proposed ASOP, Pricing of Life Insurance and Annuity Products, was issued in March 2016 with a comment deadline of August 31, 2016. Seventeen comment letters were received, some of which were submitted on behalf of multiple commentators, such as by firms or committees. For purposes of this appendix, the term “commentator” may refer to more than one person associated with a particular comment letter. The Life Insurance and Annuity Pricing Task Force carefully considered all comments received, reviewed the exposure draft, and proposed changes. The Life Committee and the ASB reviewed the proposed changes and made modifications where appropriate.
Summarized below are the significant issues and questions contained in the comment letters and responses.
The term “reviewers” in appendix 2 includes the Life Insurance and Annuity Pricing Task Force, the Life Committee, and the ASB. Also, unless otherwise noted, the section numbers and titles used in appendix 2 refer to those in the first exposure draft.
Click here to view the comments on the first exposure draft in their entirety.
Comments on the Second Exposure Draft
Click here to view the comments on this second exposure draft in their entirety.