Society of Actuaries Committee on Life Insurance Research Report to the NAIC Life Disclosure Working Group Life Insurance Illustrations Generally Recognized Expense Table for 2001 Illustrations

Note: The following SOA report was adopted by the NAIC Life Disclosure Working Group at its September 2000 meeting with no objections, with an effective date of 1/1/2001. It was approved at the December 2000, NAIC meeting effective for any illustration actuary's opinion on illustrations after January 1, 2001, in the U.S.A.

The SoA Board of Directors, at their meeting on September 12, 2000, unanimously agreed to authorize the Project Oversight Group of the Committee on Life Insurance Research to submit a public statement of opinion to the NAIC Life Disclosure Working Group on "Generally Recognized Expense Table for 2001 Illustrations" with the stipulation that the comments received when the paper was exposed must accompany it. Please see those comments at the end of this document.

The Society of Actuaries Committee on Life Insurance Research (Committee) established a Project Oversight Group (POG) to develop or identify a table of expenses that would qualify as a "Generally Recognized Expense Table" (GRET) for the life insurance industry.

This GRET is to be relied upon by actuaries and insurance companies in their compliance with the NAIC Life Insurance Illustration Model Regulation (Model Reg) and the Actuarial Standard of Practice "Compliance with the NAIC Model Regulation on Life Insurance Sales Illustrations" (ASOP).

This table will represent the industry's expenses on a fully allocated basis. The use of this table, however, does not relieve actuaries and companies from the allocation of direct expenses in complying with the Model Reg and ASOP.

During the process of developing a Model Reg which both met the concerns of the regulators and still allowed the insurance industry to efficiently function, the issue of expenses became a sticking point.

A compromise position on the expense issue was proposed at the 1995 Snowbird, Utah meeting among representatives from the NAIC, consumer organizations, the insurance industry and the Actuarial Standards Board (ASB). The proposed compromise was that the actuaries and the insurance industry would be allowed to use marginal expenses in complying with the self-supporting provision of the Model Reg to the extent that these marginal expenses (ME) were not less than those of the GRET. GRET expenses may be used if they are greater than the company's marginal expenses (Note: this is not clear from the Model Reg but is spelled out in the ASOP). The company's fully allocated expenses (FAE) may always be used regardless of their relationship to the GRET. Note that company direct sales costs are in addition to the GRET.

The following relationships result from this compromise using the acronyms previously defined and assuming that ME < FAE.

1. If GRET < ME < FAE Then use ME or FAE
2. If ME < GRET < FAE Then use GRET or FAE
3. If ME < FAE < GRET Then use GRET or FAE

The mission of the POG was to:

• Address any questions that were previously raised regarding the GRET that had been previously developed.
• Determine the appropriate method for developing the 2001 GRET.
  1. Timeliness of presentation of results to the NAIC and the industry.
  2. Resolution of any issues that were raised regarding last year's GRET.
• Interface with the NAIC and insurance industry representatives throughout this process.
• Present a proposed GRET to the NAIC for their approval before the June 2000 NAIC Meeting.
• Establish the set of expense factors that are appropriate for use as the 2001 GRET.

Our source for company information was a database containing annual statement data for most U.S. companies maintained by Sheshunoff Information Services, Inc. ( formerly One Source.) .

The following NAIC annual statement fields were accessed in the Sheshunoff database.

NAIC Annual Statement References

1. Group products to which the regulation is applicable were thought to be very similar in their expense elements to ordinary life. Therefore, no attempt was made to isolate the annual statement expenses attributable to group products marketed directly to individual members of a group.
2. Single premiums were weighted using 6% after reduction for any dividends applied.
3. Only the estimated life insurance component of FICA and unemployment tax was included. Premium taxes and other state and municipal taxes must be considered separately.

The group again used LOMA's functional cost expense factors as seed expense factors used in one of the published expense studies based on Sheshunoff data. For consistency, the POG decided to continue using the same LOMA seed expense factors that have been used in previous years.

The POG was still of the opinion that expense factors should not be shown separately by type of company ownership (stock vs mutual) and should not be stratified by company size. The group again examined variations in expenses attributable to company distribution methods and decided that this refinement was appropriate. The POG has in the past received requests for additional definitions of distribution systems but was unable to consider such request due to the lack of available expense study data. The POG has also received requests to consider developing a separate set of factors or some adjustment of Universal Life pour-in premiums but was again unable to consider this request due to the lack of available data.

The POG again grouped expenses into the four categories of distribution systems: Branch Office, Direct Marketing, Home Service and All Other. Companies were placed in the appropriate category based on research performed by Conning and Co. and public information (e.g. Bests' Reports) for our analysis.

The expense factors were developed based on a review of the application of the LOMA seed expense factors to the 1999 statutory results of 175 of the largest life insurance companies as measured by life insurance expenses. The final sample represented approximately 75% of industry life insurance expenses. The expense factors were then derived by scaling the LOMA seed factors to cover the 50th percentile of the companies in each distribution system. This produced a set of expense factors which was generally higher than the average for the respective groups. Note that the 2001 factors are higher than the 1998 factors for all distribution systems except for Direct Marketing. Further analysis indicates that two of the ten companies in the Direct Marketing category in 1998 were not included in the 2001 process due to the lack of current annual statement data. In the 1998 GRET, one company was the median company and the other company had the highest ratio of actual expenses to GRET expenses (1.86).

The tables of expense factors by distribution system are shown below. Values from the 1998 GRET and the 2001 GRET are shown for comparison purposes. We assume the same set of relationships among Marginal Expenses (ME), Fully Allocated Expenses (FAE) and GRET used for the 1998 GRET will be continued for the 2001 GRET.

Branch Office

Direct Marketing

All Other

Note the following in applying these expense factors:

• All of the expense factors are to be used and the results summed.
• Premiums for single premium products should be multiplied by 6% prior to the application of the percent of premium factor.
• These factors do not cover premium taxes, state and federal income taxes or commissions. All of these items must be considered in addition to the expenses generated by the GRET.

The factors by distribution system may be used by a company or division that meets the description of that distribution system. A company may use one set of GRET factors for a specific distribution system and another set of GRET factors for a separate distribution system but cannot mix GRET factors and the company's own e.g., if a company chooses to use the GRET factors for their Home Service Division they can not use fully allocated factors for their Direct Marketing Division.

General descriptions of the different distribution systems are shown below. It is expected that actuaries will apply professional judgement in determining distribution system categories.

Branch Office - A company or division which operates an agency building system featuring field management that are employees although their compensation may be largely based on production. The company provides significant employee benefits to field employees in addition to direct compensation.

Direct Marketing - A company or division that markets directly to the public through printed or other media. No direct field compensation is involved.

Home Service - A company or division that markets smaller insurance policies through an organization that resembles the Branch Office system in organizational and compensation structure but focuses on smaller policies and agent collections of premiums. Note that we have focused only on the ordinary life business of companies and have not considered industrial business.

Other - Companies or divisions other than those described above including those that market through Brokers and General Agents.

This POG included the following individuals:

• Tim Harris - Milliman & Robertson (Co-Chair)
• Sam Gutterman - PricewaterhouseCoopers (Co-Chair)
• Tom Edwalds - Society of Actuaries Staff
• Robert J. Johansen - Member
• Leon L. Langlitz - Lewis and Ellis
• Lawrence S. Carson - RGA/Swiss Financial Group
• Philip J. T. Cernanec - Cap Gemini
• Dan Segal - Howard N. Stern School of Business

We wish once again to thank LOMA for their assistance in providing the seed expense factors that allow us to use an experience based set of seed factors. This provides a method of allocation by type of expense factor that is based on research.

The comments that were received included:

• A comment that the date of the Snowbird meeting was August 20-22, 1995. This has been corrected.
• Requests that more time be allowed to implement the changed factors. This has been accommodated through the January 1, 2001 effective date allowing actuaries who render opinions in 2000 to continue using the current table.
• Comments on the lack of an adjustment for Universal Life pour-in/ dump-in premiums similar to the adjustment for single premium life. This is a recurring issue, which the POG tried to address several years ago through a survey of Life Insurance Companies. The response to the survey was dismal and only two companies provided any information on dump-in/pour-in business and related expenses. This was insufficient to allow the calculation of an adjustment. The POG has evolved into a Committee and will continue to focus on this issue among others.

Please contact Steven Siegel if you have any questions.