Actuarial Standard of Practice No. 54
Pricing of Life Insurance and Annuity Products
STANDARD OF PRACTICE
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: Actuarial Standard of Practice (ASOP) No. 54, Pricing of Life Insurance and Annuity Products
This document is the final version of ASOP No. 54, Pricing of Life Insurance and Annuity Products.
History of the Standard
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. 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.
First 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 were reflected in the second exposure draft.
Second Exposure Draft
In June 2017, the ASB approved a second exposure draft with a comment deadline of October 31, 2017. Six comment letters were received and considered in making changes that are reflected in this final ASOP.
The ASB thanks all those who made comments on each of the exposure drafts.
Notable Changes from the Second Exposure Draft
Notable changes from the second exposure draft in response to the comment letters include the following:
- The fifth paragraph of section 1.2 was clarified by adding the following: “To the extent that a product does not clearly fall into the scope just described, the actuary should use professional judgment to determine whether the product is in scope.”
- An example was added to the sixth paragraph of section 1.2 to clarify that the ASOP would apply in the case of a product written on an individual policy form that offers both a death benefit and a long-term care benefit.
- A seventh paragraph was added to section 1.2 to clarify that the standard “does not apply to actuaries when performing actuarial services with respect to the pricing of reinsurance contracts.”
- The definition of pricing in section 2.2 was revised by adding the phrase “including evaluating the product’s profitability and underlying risks” to the first sentence;
- Section 3.5.1, Cost of Capital, was removed. The concept is now covered in section 3.1.1(c).
- Several clarifying revisions were made to section 3.6, Governance and Controls
- Guidance was added to section 4.1 to state that the actuary should disclose “the material results of any additional profitability analysis that was performed.”
The ASB voted in June 2018 to adopt this standard.
|Life Insurance and Annuity Pricing Task Force|
|David A. Brentlinger, Chairperson|
|Jodi L. Kravitz||Steven L. Putterman|
|Lisa S. Kuklinski||Anthony J. Tokarz|
|Life Committee of the ASB|
|David A. Brentlinger, Chairperson|
|Janice A. Duff||Henry W. Siegel|
|Lisa S. Kuklinski||Anthony J. Tokarz|
|Linda M. Lankowski||Matthew J. Wininger|
|John A. MacBain|
|Actuarial Standards Board|
|Beth E. Fitzgerald, Chairperson|
|Christopher S. Carlson||Darrell D. Knapp|
|Maryellen J. Coggins||Cande J. Olsen|
|Robert M. Damler||Kathleen A. Riley|
|Mita D. Drazilov||Barbara L. Snyder|
The Actuarial Standards Board (ASB) sets standards for appropriate actuarial practice in the United States through the development and promulgation of Actuarial Standards of Practice (ASOPs). These ASOPs describe the procedures an actuary should follow when performing actuarial services and identify what the actuary should disclose when communicating the results of those services.
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 attached to such products. Throughout the remainder of the ASOP, the use of the term “product” includes riders attached to life insurance and annuity products.
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 in-force 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 Nos. 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.
The standard does not include guidance on compliance with federal antitrust laws or the evaluation of other considerations (such as marketing, sales, and competition) that may affect the ultimate price.
The standard applies to actuaries when performing actuarial services related to life insurance and annuity products written on individual policy forms and to group master contracts with individual certificates that are priced in a similar manner to products written on individual life and annuity policy forms.
Products not priced in a similar manner to those written on individual life and annuity policy forms or products that do not have material mortality or morbidity risk are not in scope. Two examples are traditional group term life and certain retirement funding products (for example, synthetic guaranteed interest contracts). To the extent that a product does not clearly fall into the scope just described, the actuary should use professional judgment to determine whether the product is in scope.
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 other ASOPs will govern the pricing of such other specific benefits. For example, the pricing of a product that offers both a death benefit and a long-term care benefit written on an individual policy form would be within the scope of this ASOP. However, to the extent that the guidance in this standard conflicts with guidance in other ASOPs regarding the pricing of the long-term care benefit, the guidance in other ASOPs would govern the pricing of such long-term care benefits.
This standard does not apply to actuaries when performing actuarial services with respect to the pricing of reinsurance contracts.
This standard does not apply to actuaries when performing actuarial 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 December 1, 2018.
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, assumptions, policy provisions, and underwriting class.
The process of determining charges for, and benefits provided by, an insurance policy or annuity contract at issue, including evaluating the product’s profitability and underlying risks. Examples of charges include premiums, cost of insurance charges, separate account charges, surrender charges, and policy fees. Examples of benefits include death benefits, surrender benefits, interest credits, 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
The amount of capital a company chooses to hold to meet a business objective, given its risk profile.
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, which are usually related to profitability and risk, include, but are not limited to, the following:
a. the choice of profitability metrics;
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. Targets often are stated at an aggregate product level and may be stated at other levels as determined by the principal, such as at the modeling cell level;
c. the approach for incorporating the cost of maintaining a defined level of risk capital into the profitability analysis; and
d. how risk management policies of the company relate to product pricing; for example, how tolerant the actuary’s principal is to volatility in earnings and the balance sheet.
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 objectives of the product;
b. the intended market, anticipated sales, 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. potential risk mitigation strategies such as reinsurance and hedging;
f. applicable law (statutes, regulations, and other legally binding authority); and
g. 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 one or more 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 and underlying risks. 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.
The actuary should use discount rates that are appropriate for the selected profitability metric, where applicable.
3.2.2 Considerations When Selecting a Profitability Metric
When selecting a profitability metric, 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, the size and pattern of risk capital); and
c. any other considerations that the actuary determines are relevant (for example, limitations of the profitability metric for the product being priced).
3.3 Developing or Selecting the Model
The actuary should develop or select the model to support pricing in a manner consistent with the criteria of the actuary’s principal. The actuary should develop or select 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 or selecting 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 the model accommodates the necessary detail of model components, such as time intervals, modeling cell structure, and assumptions that vary by modeling cell, to appropriately represent the expected profitability and underlying risk of future sales;
c. Dynamic Assumptions—the degree to which the model accommodates how certain assumptions, such as policy behavior assumptions, may vary based on other factors;
d. Asset Returns—the degree to which the model accommodates 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 accommodates, if appropriate, market consistent or real world scenarios that represent an appropriate range of future economic conditions;
f. Accounting and Actuarial Bases—the degree to which the model accommodates the accounting standards and practices (for example, statutory, GAAP, and tax) and the assumptions and methods used to calculate reserves and other actuarial balances that underlie the profitability metrics to be used in pricing;
g. Risk Capital Framework—the degree to which the model accommodates a risk capital framework that is expected to be used in practice;
h. Taxes—the degree to which the model accommodates 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 Evaluation—the degree to which the model accommodates an appropriate method to evaluate risks, as described in section 3.5;
j. Risk Mitigation—the degree to which the model appropriately accommodates risk mitigation strategies that are expected to be used to support the product;
k. Model Validation—the degree to which the model is sufficiently transparent to support validation, as described in section 3.6; and
l. any other items the actuary determines are significant to the model.
3.4 Pricing Assumptions
The actuary should use professional judgment to set assumptions that are reasonable for the intended purpose and 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 any data deficiencies.
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 assumptions.
3.4.2 Assumption Margins
The actuary should consider the appropriateness of including a margin in the assumptions. When setting a 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;
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 is appropriate for each assumption individually and in aggregate for all assumptions.
3.4.3 Consistency of Assumptions
The actuary should use assumptions that are internally consistent and reflect any interdependencies with each other, consistent with current and anticipated company practices, and, where appropriate, consistent with similar assumptions used for other assignments within the company and its associated entities.
3.4.4 Assumption Setting
When setting assumptions, the actuary should consider 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 risk selection and classification of future applicants, the impact of expected trends on future assumptions, and product features 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 behavior, such as relevant policyholder characteristics (for example, age), policy or rider characteristics (for example, size of policy), tax treatment of the product as it applies to the owner, and 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; and
f. the principal’s capacity and intent with regard to in-force management strategies, including the determination of nonguaranteed elements and dividends.
The actuary should consider the extent to which certain of these assumptions may also be influenced by the following:
1. product design;
2. the intended market and the competitive alternatives to the product; and
3. how the product will be sold, for example, underwriting, distribution, and marketing.
When setting assumptions in areas outside the actuary’s area of expertise, the actuary should consider incorporating the views of experts. However, the actuary should set assumptions that reflect his or her professional judgment.
3.4.5 Capital Market Assumptions
When analyzing the cost of 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 assess how well the results of the analysis align with the profitability goals and risk management policy of the actuary’s principal.
3.4.6 Documentation of Assumptions, 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.
In setting assumptions, the actuary should refer to ASOP No. 25, Credibility Procedures, for guidance.
3.5 Risk Evaluation
The actuary should evaluate the risks in the product when performing a profitability analysis.
3.5.1 Sensitivity Analysis
The actuary should use sensitivity analysis to evaluate the impact of deviations in assumptions on profitability results and should consider performing more analysis for assumptions that have a significant impact on the profitability analysis than for assumptions that have less impact.
3.5.2 Stochastic Analysis
The actuary should consider using stochastic analysis to evaluate the distribution of the results of the profitability analysis from variations in key assumptions, in particular interest rates and equity returns. When performing stochastic analysis, the actuary should evaluate the results of the profitability analysis not only in the aggregate but also for a selection of individual scenarios.
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, may rely on others to use, reasonable governance and controls over the actuarial services provided as part of pricing. Examples of possible governance and controls include the following:
a. effective oversight of methods and assumptions used in pricing;
b. preservation and protection of the model from unintentional or untested changes;
c. validation of the appropriate use of the inputs in model calculations;
d. validation that values from the models are consistent with independent calculations of such values from outside the model;
e. validation that the model reasonably simulates the expected future financial impact of the product; and
f. review of assumptions and other aspects of the model by another knowledgeable person who conducts the review in an objective way.
The actuary should document the governance and controls used by the actuary as part of pricing. The actuary should disclose any reliance on governance and controls used by others.
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. The actuary should disclose the extent of any such reliance.
3.8 Reliance on Assumptions Provided by Others
When relying on assumptions provided by others, the actuary should refer to ASOP No. 41, Actuarial Communications. The actuary should disclose the extent of any such reliance.
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. criteria of the actuary’s principal, as described in section 3.1.1;
b. relevant characteristics of the product, as described in section 3.1.2;
c. the profitability metrics used in the profitability analysis and how these metrics are consistent with the criteria of the actuary’s principal, as described in section 3.2;
d. the considerations used to determine the model, as described in section 3.3;
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;
f. results of risk evaluation, as described in section 3.5;
g. any reliance on governance and controls used by others, as described in section 3.6;
h. any reliance on data or other information supplied by others, as described in section 3.7;
i. any reliance on assumptions provided by others, as described in section 3.8; and
j. results of the profitability analysis, in a format comparable to the profitability metric targets described in section 3.1.1(b), and the material results of any additional profitability analysis that was performed.
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.
Pricing 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. 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 ASOP 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, including riders attached to such 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.
Pricing life insurance and annuity products typically requires developing an actuarial 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 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 Second Exposure Draft and Responses
The second exposure draft of this proposed ASOP, Pricing of Life Insurance and Annuity Products, was issued in June 2017 with a comment deadline of October 31, 2017. Six 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.
Click here for a summary of 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 ASB Life Committee, and the ASB. Also, unless otherwise noted, the section numbers and titles used in appendix 2 refer to those in the second exposure draft.