Clarification of C-3 (Interest Rate Risk) RBC Instructions ...

Clarification of C-3 (Interest Rate Risk) RBC Instructions

Presented by the American Academy of Actuaries' Life Capital Adequacy Subcommittee to the National Association of Insurance Commissioners' Life Risk-

Based Capital Working Group

Reno, NV ? March 2002

The American Academy of Actuaries is the public policy organization for actuaries practicing in all specialties within the United States. A major purpose of the Academy is to act as the public information organization for the profession. The Academy is non-partisan and assists the public policy process through the presentation of clear and objective actuarial analysis. The Academy regularly prepares testimony for Congress, provides information to federal elected officials, comments on proposed federal regulations, and works closely with state officials on issues related to insurance. The Academy also develops and upholds actuarial standards of conduct, qualification and practice and the Code of Professional Conduct for all actuaries practicing in the United States.

Life Capital Adequacy Subcommittee

Alastair G. Longley-Cook, F.S.A., M.A.A.A., Chair Robert A. Brown, F.S.A., M.A.A.A., Vice-Chair

Gerald A. Anderson, F.S.A., M.A.A.A. Stephen M. Batza, F.S.A., M.A.A.A.

Jeffrey M. Brown, F.S.A., M.A.A.A.

Martin R. Claire, F.S.A., M.A.A.A.

Joseph L. Dunn, F.S.A., M.A.A.A.

Arnold N. Greenspoon, F.S.A., M.A.A.A.

David E. Neve, F.S.A., M.A.A.A.

Keith D. Osinski, F.S.A., M.A.A.A.

Jan L. Pollnow, F.S.A., M.A.A.A.

Craig R. Raymond, F.S.A., M.A.A.A.

James F. Reiskytl, F.S.A., M.A.A.A.

Michael S. Smith, F.S.A., M.A.A.A.

James A. Tolliver, F.S.A., M.A.A.A.

George M. Wahle, F.S.A., M.A.A.A.

Bill Wilton, F.S.A., M.A.A.A.

Michael L. Zurcher, F.S.A., M.A.A.A.

The subcommittee members would also like to recognize Mark C. Rowley for his work on this report.

It has been determined that some companies have been confused by the C-3 RBC instructions. The confusion comes from not being able to distinguish between what is meant by cash flow testing for reserve adequacy (which is part of Section 8 opinions) and cash flow scenario testing (which is required for C-3 for companies who are not exempt). To clear up the confusion we suggest the following wording changes (see Attachment 1 ? pages 40-43, 58-62 of the original 2001 Instructions and Attachment 2 ? LR023) for the 2002 RBC instructions. We are proposing several changes that we hope will clarify the C-3 RBC instructions. The most significant comments include: ? Change "cash flow scenario testing" to "cash flow testing for C-3 RBC." ? Use consistent reference to cash flow testing for asset or reserve adequacy. We suggest

changing "cash flow testing for reserve adequacy" to "cash flow testing for asset adequacy."

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2001 NAIC Life Risk-Based Capital Report Including

Overview and Instructions for Companies

as of December 31, 2001

Confidential when Completed

? 2001 National Association of Insurance Commissioners

NAIC

National Association of Insurance Commissioners

? Copyright NAIC 1993, 2001 by National Association of Insurance Commissioners Revised edition.

All rights reserved.

ISBN 0-89382-975-7

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? 2001 National Association of Insurance Commissioners

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PREMIUM STABILIZATION RESERVES

LR022

Basis of Factors

Premium stabilization reserves are funds held by the company in order to stabilize the premium a group policyholder must pay from year to year. Usually experience rating refunds are accumulated in such a reserve so that they can be drawn upon in the event of poor future experience. This reduces the insurers risk.

For group life and health insurance, 50 percent of premium stabilization reserves held in the Annual Statement as a liability (not as appropriated surplus) are permitted as an offset up to the amount of risk-based capital. The 50 percent factor was chosen to approximate the portion of premium stabilization reserves that would be an appropriate offset if the formula were applied on a contract by contract basis, and the reserve offset was limited to the amount of risk-based capital required for each contract. Life and health coverages are aggregated due to many companies combining these coverages.

Specific Instructions for Application of the Formula

There is some variance for reporting liabilities that are appropriately considered premium stabilization reserves. These possible Annual Statement sources are noted.

The sum of these various types of premium stabilization reserves equals the preliminary premium stabilization reserve credit. The final premium stabilization reserve credit is limited to the risk-based capital previously calculated. Since the limitation is applied on an aggregate basis, there is no need to differentiate the premium stabilization reserve between life and health.

INTEREST RATE RISK

LR023

Basis of Factors

The interest rate risk is the risk of losses due to changes in interest rate levels. The factors chosen represent the surplus necessary to provide for a lack of synchronization of asset and liability cash flows.

The impact of interest rate changes will be greatest on those products where the guarantees are most in favor of the policyholder and where the policyholder is most likely to be responsive to changes in interest rates. Therefore, risk categories vary by withdrawal provision. Factors for each risk category were developed based on the assumption of well matched asset and liability durations. A loading of 50 percent was then added on to represent the extra risk of less well matched portfolios. Companies must submit an unqualified Section 8 opinion under the revised Standard Valuation Law to be eligible for a credit of one-third of the RBC otherwise needed.

? 2001 National Association of Insurance Commissioners

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