March/April 2017

PBR—Who, What, and How

By Arnold Dicke and Leonard Mangini

Actuaries have several new responsibilities under principle-based reserving, and many resources to draw upon.

In the discussions held by the Life Actuarial Task Force (LATF) of the National Association of Insurance Commissioners (NAIC) last spring and summer to consider the final set of amendments to the Valuation Manual that sets forth the process that will underpin principle-based reserving (PBR) for life insurance, the authors heard a regulatory actuary ask a question that provoked heated discussion: Does a qualified actuary who is assisting or advising a company regarding its responsibility to establish principle-based reserves represent the interest of the company, or that of the state insurance commissioner?

The task force member who raised the question pointed out that, under the revised model Standard Valuation Law (SVL) that has been adopted in 46 states as of year-end 2016, the commissioner has the responsibility for either valuing the company’s insurance liabilities or causing them to be valued. In most cases, the com- missioner in turn requires the company to value its liabilities, but the commissioner has the right to hire an independent actuary to carry out the valuation. If the company has policies that are subject to principle-based valuation, it must in turn assign certain responsibilities to a “qualified” actuary, including the responsibility for overseeing the valuation. Thus, the company must, under the law, assign oversight responsibility to a qualified actuary for a function that it is carrying out on behalf of the commissioner. Moreover, the commissioner could, at his or her discretion, hire a qualified actuary directly. Does this mean that the qualified actuary in some sense represents the interest of the commissioner?

LATF decided to ask for public comment on this question. Before reporting on the responses to this request, we will give some background on what the authors understand to be the responsibilities of the various parties involved in a principle-based valuation of life insurance policies.

As stated above, the SVL approaches the valuation of insurance liabilities by giving that responsibility to the commissioner. Sections 2A (regarding operative date policies) and 2B (regarding post-operative date policies of the SVL) each begin:

The commissioner shall annually value, or cause to be valued, the reserve liabilities (hereinafter called reserves) for all outstanding life insurance . . . [and other specified] contracts of every [life insurance] company…

Thus, the primary responsibility for valuing reserve liabilities belongs to the commissioner, which the commissioner in most cases will “cause to be valued” by the company holding the liabilities.

For policies subject to principle-based valuation (that is, a reserve valuation that uses one or more methods or one or more assumptions determined by the insurer), the company is given specific directives in the SVL. First, in Section 12A:

A company must establish reserves using a principle-based valuation that meets [certain stated] conditions for policies or contracts as specified in the valuation manual.

The stated conditions include quantifying benefits and guarantees at a level of conservatism that reflects “conditions that include unfavorable events that have a reasonable probability of occurring during the lifetime of the contracts” and choosing assumptions, methods, and models that are consistent with company risk management practices, reflect company experience to the extent that it is statistically credible, and provide margins for uncertainty that including adverse deviation and estimation error. The commissioner is given the right, under Section 11G, to require the company to change any assumption or method that the commissioner finds to be not compliant with the Valuation Manual requirements.

Second, under Section 12B, a company having policies subject to a principle-based valuation is itself required to take certain actions, including establishing procedures for corporate governance and oversight of the actuarial valuation function, certifying annually to the commissioner and the company’s board of directors that the controls applied to the principle-based valuation are effective, and developing a report on the principle-based valuation (as specified in chapter VM-31 of the Valuation Manual) that may be requested by the commissioner. While most companies typically have had procedures for governance and oversight and take a great interest in the controls applicable to the valuation process, the requirement for an annual certification to the commissioner is new and defines specific responsibilities (and liabilities) for the company, its senior management, and its board.

Laying Out the Responsibilities

Chapter VM-G of the Valuation Manual gives guidance to the board and to senior management regarding their respective responsibilities with respect to principle-based valuations. VM-G also requires the company to assign specific responsibilities relative to each group of policies subject to PBR to one or more “qualified actuaries.” A qualified actuary is defined to be an individual “qualified to sign the applicable statement of actuarial opinion in accordance with the American Academy of Actuaries qualification standards for actuaries signing such statements and who meets requirements specified in the Valuation Manual.” The company does not have to assign all (or any) policies to its appointed actuary. Different groups of policies (for example, term policies, universal life policies, etc.) may be assigned to different qualified actuaries, or all policies may be assigned to one qualified actuary, who may or may not be the appointed actuary.

The distinction between the qualified actuary assigned responsibility for a group of policies and the company’s appointed actuary is important: The appointed actuary is appointed by the board (the qualified actuary need not be) and opines on the adequacy of the assets backing the company’s life insurance re- serves (the qualified actuary does not). The responsibilities of the appointed actuary are described in chapter VM-30, while the qualified actuary has specific responsibilities that are listed in Section 4A of VM-G. These responsibilities of the qualified actuary include:

  1. The responsibility for overseeing the calculation of principle-based reserves for the assigned group of policies or contracts;
  2. The responsibility for verifying that
    • The assumptions, methods and models used in deter- mining principle-based reserves, and
    • The company’s documented internal standards used in the principle-based reserve valuation processes, the company’s documented internal controls, and documentation used for principle-based reserves appropriately reflect the requirements of the Valuation Manual for the assigned group of policies or contracts;
  3. The responsibility for providing a summary report to the board and to senior management on the valuation processes used to determine and test principle-based reserves, the principle-based reserve valuation results, the general level of conservatism incorporated into the company’s principle-based reserves, the materiality of principle-based reserves in relationship to the overall liabilities of the company, and significant and unusual issues and/or findings;
  4. The responsibility for preparing the PBR Actuarial Report with respect to that group of policies/contracts, as per VM- 31; an
  5. The responsibility for disclosing to the company’s external auditors and regulators any significant unresolved issues regarding the company’s principle-based reserves held with respect to that group of policies or contracts.

This is quite a list of responsibilities. Unlike the sections of VM-G that apply to the board and senior management, these responsibilities are not guidelines, but are legal responsibilities imposed on the qualified actuary. Let’s look at them one by one.

First, the qualified actuary has an oversight responsibility for the group of policies assigned to him or her. What this will mean in detail will no doubt be made clear as experience is gained with the PBR process, but it would seem to imply that, in addition to the other responsibilities in the list, the qualified actuary is responsible for assuring that senior management has the information it needs to fulfill its VM-G responsibilities, including the responsibility stated in Section 3 of VM-G to determine that “resources are adequate to carry out the modeling function with skill and competence.”

The second listed set of responsibilities, in our view, is per- haps the most important. The qualified actuary must verify that the assumptions, methods, and models appropriately reflect the requirements of the Valuation Manual. As was pointed out, the assumptions, methods, and models are chosen by the company, which could (but need not) delegate this responsibility to the qualified actuary. In any case, the actuary must verify the appropriateness of the assumptions in light of the Valuation Manual. This means more than simply ticking a box. In determining appropriateness, we believe that the qualified actuary must be convinced that the assumptions, methods, and models fall within a range that is likely to achieve the purpose of the principle-based valuation—as stated, for example, in Section 12A of the SVL, described above.

Similarly, the qualified actuary is required to verify the appropriateness of the company’s documented internal standards and controls in light of the Valuation Manual requirements. Given this obligation, we believe that a qualified actuary who is not personally qualified to carry out this verification may need to consider whether to establish reliance on an expert who is qualified and, in any case, should retain the appropriate documentation.

The third responsibility involves providing a summary report to the board and senior management. This report need not be part of the PBR Actuarial Report (and so need not be made available to the commissioner), but it may be. In discharging this responsibility, we believe that qualified actuaries may find it valuable to consult with legal advisers about the level of confidentiality provided to an internal report to the board vis-à-vis a report, such as the PBR Actuarial Report, that is covered by the confidentiality provisions of the SVL. The qualified actuary also might consider providing documentation that VM-G responsibilities have been carried out in the PBR Actuarial Report, although this is not required.

The PBR Actuarial Report may consist of sub-reports for groups of policies. This provides an easy way for each qualified actuary to carry out the fourth listed responsibility of preparing the report for the policies assigned to him or her.

The fifth responsibility is significant: The qualified actuary must disclose significant and unresolved issues to the company’s external auditors and regulators. This responsibility, in our view, sheds some light on the question of whose interest the qualified actuary represents. While the qualified actuary works for the company, either as an employee or a consultant, the qualified actuary has a responsibility to disclose unresolved issues to the commissioner’s representatives.

After listing responsibilities in Section 4A, VM-G goes on to provide some limits to qualified actuary responsibilities in Section 4B: Specifically, a qualified actuary assigned responsibilities with respect to a group of policies or contracts may be required to make any certification required by the Valuation Manual (including certification that assumptions are prudent estimates), but is not required (except as regards any responsibilities he or she may have as the appointed actuary under VM-30) to opine upon or certify the adequacy of the aggregate reserve for (1) that group of policies or contracts, (2) the company’s surplus, or (3) the company’s future financial condition.

Whose Interest?

Now that we have reviewed the Standard Valuation Law and the responsibilities assigned to the qualified actuary under VM-G, we are better prepared to understand the discussion of the question, “Whose interest does the qualified actuary represent?” Several comments were received by LATF. The major points were made in two of the submissions, one from the American Council of Life Insurers (ACLI) and the other from the American Academy of Actuaries.

The ACLI contended that case law supports the expectation by the insurer that the actuary, as an employee or retained consultant, will work in the interest of the company. It stated that it does not believe the advent of PBR changes the relationship of the actuary to the company and the regulator. Finally, the ACLI response points to the specific provisions of the Code of Professional Conduct, adopted by the five U.S.-based actuarial associations, which defines the actuary’s Principal as the employer or client and outlines certain responsibilities that the actuary has to the Principal:

  • Under Precept 5, the Principal must be identified in communications;
  • Under Precept 7, the actuary must disclose conflicts of inter- est; and
  • Under Precept 10, the actuary must cooperate with other in the Principal’s interest.

Thus, the ACLI concludes, the Code “clearly provides a primary relationship of an actuary to work in the interest of the company, disclose any conflicts, and cooperate with others, including the Commissioner, in the interest of the company.”

The Academy’s response (submitted by the Academy’s Life Practice Council) pointed out that the request for comment did not define “the interest of the company or the interest of the com- missioner” and thus its response doesn’t address the question of interests of either party directly. However, the Academy also stated that the professional responsibilities of life insurance actuaries with respect to their principals and the principals’ regulators are the same as before the introduction of PBR.

The Academy response then pointed to the Code of Professional Conduct, the U.S. Qualification Standards, and several actuarial standards of practice (ASOPs) that are applicable to regulatory work such as ASOP No. 21, Responding to or Assisting Auditors or Examiner in Connection with Financial Statements for All Practice Areas, and ASOP No. 41, Actuarial Communications. ASOP No. 41 is cited as an example of an ASOP that may serve the interests of any intended user. The commissioner is clearly an intended user of the financial statements and the PBR Actuarial Report, and the ASOP makes clear that any intended user should be able to rely on the reported actuarial findings. The ASOP covers the situation that is actually facing the qualified actuary assigned responsibility for the principle-based valuation of a group of policies by requiring the actuary to disclose whether the assumptions or method conflict significantly with what, in the actuary’s professional judgment, is reasonable. The Academy’s response also pointed to the PBR ASOP, which at the time of the letter (and as of the date of release of this article) was still being finalized. Of course, ASOP No. 1, Introductory Actuarial Standard of Practice, directs that actuaries may look to exposure drafts of an ASOP, at their discretion for advisory guidance, but specifies that they are not binding on actuaries. (The ASOPs identified above, the PBR ASOP exposure draft, and other ASOPs and materials that bear on the responsibilities of the qualified actuary will be discussed in more detail below.)

In the end, LATF accepted the responses and did not take any action regarding the question it had asked. Nevertheless, the dialogue helped bring to the fore some of the issues that face the qualified actuary with responsibility for a group of policies, and also point to important sources of guidance, such as the ASOPs that we will examine in the remainder of this article. It might be useful before we begin to note that the Code of Professional Conduct and the ASOPs apply to any actuary who is a member of one of the five U.S.-based actuarial organizations that have adopted the Code and is assisting or advising a company on principle-based reserves, not just to the qualified actuaries to whom groups of policies have been assigned and the company’s appointed actuary.

Our Functional Approach

The Valuation Manual provides the foundation for our “functional approach.” Specifically, we believe that the second responsibility of the Qualified Actuary listed in Section 4A of VM-G—to verify that the assumptions, methods, and models, as well as the documented internal standards and controls used for principal-based reserves, appropriately reflect the requirements of the Valuation Model—suggests that a fruitful way to approach the question of which of the existing ASOPs might apply is a “functional” one. By that we mean in a principles-based world, one may benefit from considering whether the “activity” that each ASOP governs might be matched up with what an actuary (or other company personnel) is “supposed to be doing” when following the general principles that are laid out in the Valuation Manual.

In our own evaluations of ASOP applicability, we look to two “categories” of ASOPs that might apply and we consider a third type of Actuarial Standards Board work product: longstanding ASOPs; those that have recently, or relatively recently, changed; and ASOP exposure drafts that appear likely to be adopted and effective in the near future. We believe ASOP exposure drafts are very important to be aware of for two reasons. First, the exposure drafts give an idea of what the Actuarial Standards Board is weighing as possibly appropriate actuarial practice, and following appropriate practices—though exposure drafts are indeed exploratory drafts, and clearly not binding guidance—is essential when one is given the latitude that exists under PBR. Second, and perhaps in practice more importantly, we think that taking into consideration likely-to-be-adopted ASOPs allows the Qualified Actuary to proactively establish processes and ade- quate and compliant controls over these processes early in the implementation phase. With that work completed, the Qualified Actuary may need only to re-evaluate and adjust the processes and controls to address any differences between what is stated in the exposure drafts and what is specified in the ASOPs that ultimately issue and become binding guidance.

Before turning our attention to specific ASOPs, exposure drafts, and other relevant material, we provide some cautions and reminders. It is important to recall that ASOP No. 1, Introductory Standard of Practice, applies to actuaries when rendering actuarial services. As directed by ASOP No. 1, each actuary is responsible for determining which ASOPs apply to the actuarial services at hand. The discussion below offers our personal views with respect to which ASOPs are relevant and what these ASOPs require in the context of PBR. Of course, each Actuary performing Actuarial Services that are relied upon by a Principal or other intended user—whether that be a state insurance commissioner or the Actuary’s principal—has a personal professional duty under the Code to familiarize him- or her- self with any ASOP that may apply to his or her work and to use professional judgment as to its specific application when performing Actuarial Services or supervising the work of others working under their direction. (Throughout this article we capitalize terms defined in the Code or Valuation Manual. Note that, when capitalized, “Actuary” refers to a member of one of the actuarial organizations that has adopted the Code; when lowercase, to any practicing actuary. Further, when capitalized, “Qualified Actuary” refers to one of the qualified actuaries who has been assigned responsibility for a group of policies; when lowercase, to any actuary meeting the Valuation Manual definition of qualified actuary.)

ASOP No. 1 also defines how the terms “must,” “should,” and “may” are to be interpreted in all other ASOPs and what to do about deviations from appropriate actuarial practice as set forth in an ASOP. Recall that a “should” indicates what is normally appropriate practice, and that a “may” describes practices that most actuaries would use in many circumstances, but that are not required practices. Furthermore, recall that ASOP No. 1 states that failure to follow a course of action denoted by either the term “must” or “should” constitutes a deviation from the guidance of the ASOP, and directs the actuary to ASOP No. 41 (Section 4.4 of which addresses disclosure in the actuarial communication of material deviation from the guidance set forth in an applicable ASOP).

By the Numbers

Let’s first address existing ASOPs, in a sequential order, outlining our views with respect to those ASOPs that might directly or indirectly address how an assumption or margin is set; how a model is chosen, developed, or used; or how a control is established about the process of doing either of these.

ASOP No. 2, Nonguaranteed Charges or Benefits for Life Insurance Policies and Annuity Contracts, addresses actuarial practices around nonguaranteed elements (NGEs). Section 7 of the Valuation Manual has quite detailed requirements regarding modeled reserves (i.e., the deterministic reserve) or the stochastic reserve and how they should take NGEs into account. Economic variables and product design set up an environmental framework for the policyholder interaction with and reaction to a particular scenario. The PBR cash flow model reflects management actions taken in reaction to the environment and policyholder response. ASOP No. 2 provides guidance on the determination of NGEs and the setting of the policies for such determination. It is clear to us that the Qualified Actuary assigned responsibility for a group of policies with NGEs will typically need to consider ASOP No. 2. Similarly, ASOP No. 15, Dividends for Individual Participating Life Insurance, Annuities, and Disability Insurance, applies to actuaries assisting in setting a dividend framework. We believe that the dividend framework could be an important assumption for principle-based reserves for participating policies.

ASOP No. 7, Analysis of Life, Health, or Property/Casualty Insurer Cash Flows, addresses insurer cash flows; one might jump to the conclusion that this is the purview of the appointed actuary. After all, under VM-30, the appointed actuary retains sole responsibility for testing the adequacy of reserves that are produced, and the Qualified Actuary is just concerned about how they were produced (unless the Qualified Actuary also happens to be the appointed actuary). But we believe that jumping to that conclusion would be incorrect. ASOP No. 7 describes appropriate practice for any actuary who performs professional services involving the analysis of asset or liability cash flows, and Section 7 of the Valuation Manual is devoted to cash flow models used for PBR. These models need not be identical to the models used for asset adequacy analysis; however, in many cases, adding margins to the assumptions used in asset adequacy testing may be an efficient approach for the Qualified Actuary to take and, moreover, Section 6 of the Valuation Manual explicitly permits the use of the asset adequacy testing model, with certain modifications, for the stochastic exclusion ratio test. As a result, we believe that the Qualified Actuary may find it useful to understand the company’s asset adequacy testing model and to know how to adjust it to be compliant with the Valuation Manual.

ASOP No. 10, Methods and Assumptions for Use in Life Insurance Company Financial Statements Prepared in Accordance with U.S. GAAP, might seem to be out of scope. Looking deeper, however, we see that this ASOP discusses important considerations for setting margins around assumptions. Practically, we believe that one must consider how a company is likely to actually implement its processes around setting assumptions and margins. In our view, in a PBR world, pricing, valuation, risk management, and capital functions cannot be “siloed.” If insurers gravitate toward having “one version of the truth” about what the company believes about a particular assumption in a particular scenario or environment, they are more likely to vary their “loaded” assumptions by functional department through using differing margins, with increasingly larger margins to reflect whether one is considering an economic reserve, a GAAP or reserve, a statutory reserve under PBR, or the tail risk under a capital or solvency model. Viewed in this light, we think that ASOP No. 10 can be read to permit the Qualified Actuary to put the PBR margin in context compared to the GAAP or other margins used in the company, especially because the VM-31 Actuarial Report must comment on, and under VM-G the board must be satisfied with, the relative conservatism of the company’s PBR reserves.

ASOP No. 11, Financial Statement Treatment of Reinsurance Transactions Involving Life or Health Insurance, is applicable to actuaries performing professional services with respect to financial statements that involve material reinsurance transactions and, as such, we think it clearly involves the Qualified Actuary. ASOP No. 12, Risk Classification ( for All Practice Areas), provides guidance to actuaries involved in designing, reviewing, or changing a risk classification system. This would not seem to include setting reserves, principle-based or otherwise. However, our reading of the scope makes clear to us that the ASOP applies if the actuary believes the setting of reserves could have an impact on risk classification. Thus, for example, if the grouping procedures of Section 7 or the credibility rules of Section 9 of the Valuation Manual could impact a company’s decisions regard- ing the criteria used in setting select classes, we believe that the actuary assisting or advising on PBR should consult this ASOP. As mentioned above, ASOP No. 21 addresses assisting auditors and examiners in connection with financial audits, reviews, or examinations. It falls into the category of recently revised ASOPs that we believe Qualified Actuaries would benefit from re-examining to make sure that they keep abreast of new requirements related to governance. In particular, ASOP No. 21 was updated and exposed for comment in September of 2015 to reflect Sarbanes-Oxley (“SOX”), the NAIC Model Audit Rule (“MAR”), and risk-focused examinations. Given our discussion above that the Qualified Actuary has a duty to verify that standards and controls appropriately reflect Valuation Manual requirements and to report on controls to the board, it is our view that the Qualified Actuary is definitely thrust into the company’s MAR and SOX compliance framework, not to mention its enterprise risk management (ERM) and internal audit processes.

Although this could be the subject of an entire article itself, we think that, in conjunction with his or her consideration of ASOP No. 21, the Qualified Actuary could benefit from consulting several non-ASOP resources for clarification with respect to controls. The NAIC’s Audit Rule Implementation Guide clarifies the Model Audit Rule without changing its requirements. The Academy’s Model Audit Rule practice note (November 2010) provides non- binding description of current practices regarding documentation and controls for processes used to establish reserves. When verifying the appropriateness of controls, Qualified Actuaries working for SEC-registered insurers might consider that these typically larger companies tend to adopt either the Internal Control-Integrated Framework of the Committee of Sponsoring Organizations of the Treadway Commission (COSO) or the COSO ERM-integrated Framework. Finally, we believe that Qualified Actuaries at smaller companies may find that the Public Company Accounting Oversight Board’s Guidance for Auditors of Smaller Public Companies to be a useful reference document.

On the surface, ASOP No. 22, Statements of Opinion Based on Asset Adequacy Analysis by Actuaries for Life or Health Insurers, might also seem out of scope and, like ASOP No. 7, again the purview of the appointed actuary. But when we focus on the practical implementation of PBR, we envision that Qualified Actuaries will be working closely with experience study functional teams and the pricing function to determine assumptions with the appointed actuaries relying on much of their “core work.” Our own close read of Section VM-30 leads us to conclude that the bar is raised so that the appointed actuary may not merely rely on the work of others; we believe that he or she will likely need to do additional testing and validation of data when forming an opinion. So if, as we anticipate, the Qualified Actuary comes to view the appointed actuary as a potential user of his or her work product, then ASOP No. 22 might become quite relevant.

ASOP No. 23, Data Quality, applies to an actuary performing actuarial services involving data, a scope that includes actuaries involved in preparing or reviewing principle-based reserves. The ASOP defines “appropriate data” as “data suitable for the intended purpose and relevant to the system or process being analyzed,” requires disclosure if regulation or other circumstances require the use of unsuitable data. We read this ASOP as giving the Qualified Actuary, who is charged with verifying the appropriateness of assumptions, the additional responsibility of determining if the data themselves are “appropriate.”

The recent revisions to ASOP No. 23 include the clarification that “data” includes data derived mathematically from other data. ASOP No. 23 also now explicitly requires that, for Actuarial Services performed on or after April 30, 2017, “If an actuary prepares data, or is responsible for the preparation of data, to be used by other actuaries in performing actuarial services, the actuary should apply the relevant portions of this standard as though the actuary were planning to use the data, taking into account the preparing actuary’s understanding of the assignment for which the data will be used.” These changes, in our view, only strengthen the argument that the appointed actuary should be viewed as a user of data generated in the PBR process that the Qualified Actuary oversees. The revised ASOP requires actuaries using data to disclose limitations to the data itself and the impact of any uncertainty or bias in the data on the actuarial work product. The Valuation Manual requires that uncertainty be addressed through larger margins on the inputs (i.e., assumptions) rather than adjusting the outputs (i.e., modeled reserves). As a result, we believe that this will likely be the approach that prevails in a PBR context. In our view, familiarity with ASOP No. 23 is essential for actuaries working on PBR given the heavy reliance on the company’s own experience data.

Another standard that falls into the relatively recently revised category is ASOP No. 25, Credibility Procedures. Effective May 1, 2014, this ASOP was expanded to cover all practice areas, not just health and property/casualty. It’s applicable when credibility analysis is required by law, when the actuary chooses to apply credibility techniques to subject data, when an actuary communicates that credibility has been evaluated, when the actuary has blended subject experience with other experience, or when the actuary represents that data is statistically or mathematically credible. Because credibility analyses are required in setting VM-20 mortality and other assumptions used in modeled reserves, we believe that ASOP No. 25 will likely be of interest to the Qualified Actuary. It also is our view that, because credibility procedures are to a great extent prescribed by the Valuation Manual, the provisions of ASOP No. 41 requiring disclosure of such situations apply to the Qualified Actuary. The requirements in ASOP No. 41, Actuarial Communications,in situations where someone other than the communicating actuary chooses an actuarial assumption, already have been mentioned. The ASOP has many other requirements that we believe will be applicable in a variety of PBR contexts, but especially in the preparation of the PBR Actuarial Report required under VM-31 where the Qualified Actuary must describe the data used, describe decisions made as to choice of models, and certify that the assumptions and margins that were used were prudent. The ASOP is not limited to written actuarial reports, such as the PBR Actuarial Report. It applies to any communication of actuarial findings, including oral communications and it applies to all actuaries, not just the Qualified Actuary. Required disclosures include the name of the actuary responsible for the communication, the names of those responsible for material assumptions or methods, any conflicts of interest, material differences from previous actuarial findings, and more.

Finally, we consider that ASOP No. 46, Risk Evaluation in Enterprise Risk Management, and ASOP No. 47, Risk Treatment in Enterprise Risk Management, are also relevant and applicable to the work of the Qualified Actuary—the former because grouping of policies for VM-20 mortality and credibility will typically reflect the company’s actual risk underwriting practices and claims results, and the latter because VM-20 only permits reflecting documented company ERM practices that are actually implemented. This is of particular importance to NGEs, hedging, and other management actions that respond to the economic environment or policyholder behavior.

Four to Watch

If this list weren’t long enough already, we haven’t yet considered exposed ASOPs. There are four relevant exposure drafts that we believe warrant attention.

The first is the draft ASOP on principle-based reserving. This proposed ASOP has been through the Actuarial Standards Board’s exposure process, but has been held so that the final changes to the Valuation Manual that will be applicable to 2017 valuations can be reflected. The pending draft, available on the ASB website, is relevant (not binding) advisory guidance, keeping in mind that changes to the Valuation Manual, such as the VM-G changes described above, may require corresponding changes to the ASOP. It will provide guidance on the aspects of the Valuation Manual that require professional judgment, as well as on disclosure and documentation requirements.

The second is a proposed revision to ASOP No. 38, Using Models Outside the Actuary’s Area of Expertise. ASOP No. 38 currently applies to property/casualty actuaries who use economic or other models outside their area of expertise. An exposure draft revising ASOP No. 38 would, among other things, expand its scope to include all practice areas. The proposed revisions, in our view, provide insight into possible considerations surrounding economic and other models. We believe that in a PBR context, models of assets—such as mortgage-backed securities, options, etc.—as well as liability-side models of tail risk, hedging, scenario-based stress testing, mortality securitizations, policyholder behavior, and NGEs, could fall within this category. ASOP No. 38 requires that the actuary understand the basic functional workings of the model and its limitations and the implications thereof. To us this means that the actuary cannot simply assert that he or she is using a “black box,” but instead needs to have some understanding of how the model works and the ramifications of how well it works.

The third exposure draft of a proposed ASOP on modeling, which had an Oct. 31, 2016, comment deadline and would take effect nine months after formal adoption by the ASB, if and when that occurs, also merits watching. This proposed ASOP has extensive requirements regarding inputs and assumptions, model structure, model risk, reliance on others, and documentation.

The fourth draft ASOP is a current exposure draft, Setting Assumptions, with a comment deadline of April 30, 2017. One interesting provision requires that the actuary, when determining the reasonableness of assumptions, ensure that the assumptions are not set with the purpose of counteracting prescribed assumptions set by law.

Given the responsibilities of the Qualified Actuary to oversee the calculation of principle-based reserves and to verify the appropriateness of internal controls over the valuation processes, as well as the heavy reliance of PBR on internal company models, we envision that the ASOP on modeling will become very important in shaping the content of these processes and the methods by which they will be controlled. In particular, this possible new ASOP on modeling, if adopted as currently exposed, would require, using “should” language, the use of actual experience to the extent that it is available, relevant, and sufficiently reliable. This proposed requirement is aligned with the wording of Sections 7 and 9 of VM-20. This ASOP exposure draft also includes the requirement that the actuary consider whether the range of assumptions and parameters used and the number of model runs analyzed reflect a range of conditions consistent with the intended purpose. The exposure draft, further, using “should” language, directs consideration of grouping of model inputs, model granularity, whether deterministic or stochastic inputs or both are needed, and whether embedded optionality and choices are reflected. In a PBR context, this last requirement would appear to us to apply to assumptions about policyholder behavior, counterparty risk, and management actions in the form of NGE policy and documented ERM processes, and could involve evaluation of natural hedges and correlations, given that every assumption used in determining a modeled reserve (except prescribed and stochastic assumptions) must have its own margin.

We hope that this article has given you a sense of what we consider to be the broad responsibilities of the new role of the Qualified Actuary or an actuary assisting with a principle-based valuation, and provides you with a useful overview of our take on the various resources and ASOPs that can help guide you if you find yourself in either of these roles.


ARNOLD DICKE, MAAA, FSA, FCA, CERA, is president of AADicke LLC, a member of the Actuarial Standards Board’s Task Force on Principle-Based Reserves and the Academy’s Life Reserve Work Group, and is a former vice-president of the Academy. LEONARD MANGINI, MAAA, FSA, FRM, FALU, is president of Mangini Actuarial and Risk Advisory LLC, a member of the Academy’s Committee on Professional Responsibility and the Life Reserve Work Group, and is a former chair of the Society of Actuaries’ Financial Reporting Section Council. Along with TIM CARDINAL, MAAA, FSA, CERA, and STEVE STOCKMAN, MAAA, ASA, who are both principals at Actuarial Compass LLC, they are members of The PBR Consortium, which provides consulting and corporate training services surrounding principle-based reserving.

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