ASOP 11: Treatment of Reinsurance or Similar Risk Transfer Programs in Financial Reports
By David Brentlinger
Reinsurance News, October 2023
The revised Actuarial Standard of Practice 11 (ASOP 11), “Treatment of Reinsurance or Similar Risk Transfer Programs Involving Life Insurance, Annuities, or Health Benefit Plans in Financial Reports,” is likely old hat to some of the readers of this newsletter, since it was effective Dec. 1, 2022. For other readers, this article may be a catalyst to invest a bit of time better understanding the impact of the revised ASOP 11 and the intentionality used in supporting the guidance provided by ASOP 11.
ASOP 11 includes an expanded scope and significantly more guidance than the prior version of the ASOP. The ASOP includes a history of the ASOP and background and current practices of reinsurance. In this article, I will not be addressing all aspects of ASOP 11 but rather only spotlighting key takeaways and consequences.[1]
This article contains opinions of the author and does not replace reading, understanding, and exercising independent professional judgment when applying the Code of Professional Conduct or ASOP 11.
Preparing for the Revised ASOP
The guidance in ASOP 11 was revised to reflect the significant new guidelines and requirements related to life insurance policies, annuity contracts, and health benefit plans since the prior ASOP was adopted in 2005.
The ASOP was adopted in April of 2021 after the Actuarial Standards Board (ASB) approved a task force to draft a revision of ASOP 11 in November 2017. The time to finalize the ASOP, three and a half years, demonstrates the care and effort the ASB takes when revising an existing ASOP. One draft was exposed for comment (in November 2019). Drafts are non-binding on an actuary but can be considered “advisory guidance” for use by the actuary prior to the revision being finalized.
Summary of Changes from the Existing Standard
Below is a summary of the key changes included in the current ASOP 11 relative to the prior version:
- The title and scope were changed to reflect risk transfer programs similar to reinsurance.
- The scope was clarified and expanded to apply to internal and external financial reports.
- The guidance related to health benefit plans was expanded.
- Guidance regarding the impact of risks reinsured was clarified and expanded.
- Guidance in the following areas was added:
- Financial reporting aspect of nonguaranteed reinsurance elements,
- impact of risks retained,
- modeling,
- counterparty risk, and
- impact of nonguaranteed elements of the policies being reinsured.
- Disclosures were added.
Scope and Purpose (Section 1)
Before addressing the purpose and scope of ASOP 11, it is valuable to understand the scope of ASOPs in general.
Per ASOP 1, “Introductory Actuarial Standard of Practice,” ASOPs are binding on members of the U.S.-based actuarial organizations when rendering actuarial services in the United States. Per the Code of Professional Conduct, actuarial services are considered to be rendered in the jurisdictions in which the actuary intends them to be used. Actuaries specializing in reinsurance programs to clients that cross national borders should understand the applicable rules of professional conduct, ethical standards, laws, and regulations in the jurisdictions in which the actuarial services will be used.
The purpose and scope of ASOP 11 is included in Section 1. The purpose of ASOP 11 is broad, “provides guidance to actuaries when performing actuarial services with respect to financial reports that reflect reinsurance programs that involve life insurance, annuities, or health benefit plans.” “Financial report” has a broad definition as a “report that conveys the performance or experience of an assuming entity or ceding entity at a specific point in time or over an account or measurement period” and includes reports for both external and internal use. A financial report as used in ASOP 11 is broader than an income statement or balance sheet created as part of a financial reporting process.
Actuarial services are defined in ASOPs 1 as “Professional services provided to a principal by an individual acting in the capacity of an actuary. Such services include the rendering of advice, recommendations, findings, or opinions based upon actuarial considerations.” Two terms stand out. First, the actuary should be acting in the capacity of an actuary. A service being performed by an actuary in a non-actuarial role may not be an “actuarial service.” Second, the service is to be “based on actuarial considerations.” Actuarial considerations could be thought of as those areas in which an actuary is trained, per the examination process, to practice as an actuary.
The scope is also broad, “This standard applies to actuaries when performing actuarial services in connection with preparing, determining, analyzing, or reviewing financial reports for internal or external use that reflect reinsurance or similar risk transfer programs on life insurance, annuities, or health benefit plans.” The inclusion of “or similar risk transfer programs” is noteworthy. A risk transfer program need not qualify or be identified as reinsurance to be in scope of the ASOP. To the extent that a self-insured plan is a standalone product with no third-party involvement, the standard does not apply.
Many actuaries are involved in reviewing the work of others. “Reviewing” is further addressed in the ASOP by the sentence “If the actuary is performing actuarial services that involve reviewing financial reports for internal or external use that reflect reinsurance programs, the actuary should use the guidance in section 3 to the extent practicable.” Per ASOP 1, it is appropriate for the actuary, exercising professional judgment, to decide that the circumstances surrounding a particular assignment are such that it would not be necessary to undertake a particular task.
Analysis of Issues and Recommended Practices (Section 3)
Below are key takeaways from Section 3, which contains the bulk of the guidance in ASOP 11.
The guidance provided is more detailed than the prior version of the ASOP. The guidance does not need to be applied to immaterial aspects of reinsurance programs. An item or a combination of related items is material if its omission or misstatement could influence a decision of an intended user. Materiality is a defined term in ASOP 1.
Materiality can vary depending on the type of financial report. For example, the actuary may deem the materiality of an aspect of a reinsurance program (e.g., the ability for a reinsurer to fulfill its contractual obligations) differently under a cash flow projection without any provision for adverse deviations (e.g., a projection of expected cash flows), a cash flow projection under materially adverse conditions (e.g., asset adequacy analysis used to support statutory reserves), and a cash flow projection under severe stress conditions (e.g., ORSA).
One aspect of a reinsurance program the actuary should consider includes the responsibilities of service providers. Service providers were not explicitly identified in the prior version of ASOP 11. Service providers are defined in the ASOP as entities providing contractual services related to a reinsurance agreement. ASOP 11 provides guidance that activities provided by service providers should be considered in determining reinsurance cash flows and that the actuary should consider in the financial report the potential impact of a termination due to an inability of a service provider to perform as specified in their agreement.
The ASOP provides guidance on “analyzing the impact of risks reinsured under a reinsurance program.” The guidance in this section applies to both the cedant and the reinsurer in a reinsurance agreement. The ASOP also provides guidance on “analyzing the impact of risks retained under the terms and conditions of any reinsurance program.” This section provides guidance on how the management of the net retained business (e.g., the business not insured) may be impacted by the existence of the reinsurance program. Topics include the management of net retained business, assumption setting, investment policy, modeling, and the management of contractual provisions.
The ASOP includes guidance on nonguaranteed reinsurance elements, “any premium, charge, or benefit within a reinsurance program that affects reinsurance costs or values, is not guaranteed in the reinsurance program, and can be changed at the discretion of the assuming entity or service provider.” Guidance includes reflecting nonguaranteed reinsurance elements in expected cash flows, reflecting risk associated with nonguaranteed reinsurance elements when preparing values related to a reinsurance program in a financial report, and considering nonguaranteed reinsurance elements when considering the need to establish additional liabilities, reserves, or an allocation of capital.
Guidance focused on the implications of modeling a reinsurance program is included in the ASOP: How the terms and conditions of the reinsurance program are reflected in the model and the assumptions, and how the assumptions contain appropriate margins. The modeling section refers the actuary to ASOP 23 (Data Quality), ASOP 25 (Credibility Procedures), and ASOP 56 (Modeling).
ASOP 11 includes guidance stating the actuary should take into account counterparty risks that could impact the financial report. In considering counterparty risk of a reinsurer, the actuary should take into account:
- Any collateral that has been posted,
- risk mitigation in place,
- the reinsurer’s financial health,
- counterparty contractual features/risk management policies that affect the risk, and
- where assets are held.
Similar to how materiality may vary depending on the financial report, the impact of counterparty risk will vary. For example, the impact of a counterparty not fulfilling its contractual obligations is much different under a 1-in-200-year event scenario (e.g., used in ORSA) compared to under a “moderately adverse condition” scenario (e.g., an unfavorable but not an extreme event that is used for asset adequacy testing of statutory reserves).
Collectability risk, the ability of the counterparty to obtain funds owed to it according to the terms of the reinsurance program, is also addressed in ASOP 11 with guidance dispersed in several sections.
Actuarial Guideline 53, “Application of The Valuation Manual for Testing the Adequacy of Life Insurer Reserves,” which was effective for year-end 2022, specifically called out the need for actuarial memorandums to include communication and disclosures regarding collectability and counterparty risk modeling.
ASOP 11 includes five sections on reliances made by an actuary: Data and other information supplied by others, assumptions and methods selected by another party, models developed by others, reliance on another actuary, and expertise of others. The actuary may rely on others without assuming responsibility for the item being relied upon. However, in supporting a reliance, the actuary must meet certain communication, disclosure, and other requirements that are addressed in ASOPs applicable to the actuarial services associated with the financial report. The actuary should be intentional about the reliances that are being made, particularly with reinsurance programs where several parties are typically involved in a program.
Othe provisions included in ASOP 11 are:
- Understanding of risks transferred in a reinsurance program;
- treatment of reinsurance risks in financial reports;
- treatment of the risk of counterparty termination;
- considerations for additional liabilities, reserves or allocation of capital based upon the terms and conditions of the reinsurance program;
- accounting guidance; and
- experience analysis.
Documenting Compliance with an ASOP
ASOP 11 calls for the actuary to consider preparing and retaining documentation to support compliance with the requirements of the ASOP. I have found creating a worksheet, with each guidance point from the ASOP being identified and listed, to be helpful in meeting the documentation requirements. There are over 100 guidance points in ASOP 11 (statements and lists that begin with either “the actuary should” or “the actuary may”). For each financial report (or group of related reports), a gap analysis can be undertaken to compare current practices to each of the guidance points in the ASOP. For each guidance point, document either (1) how the guidance point is being addressed, or (2) a strategy to address the guidance point that is not being addressed. After the gaps are satisfactorily addressed, this type of documentation can be used to demonstrate evidence of support for regulators or similar stakeholders, as well as current and future actuaries of the company.
It is never too late to mature the documentation of support for an ASOP. The acid test for documentation is if the documentation is in a form such that another actuary qualified in the same practice area could assess the reasonableness of the actuary’s work.
Statements of fact and opinions expressed herein are those of the individual authors and are not necessarily those of the Society of Actuaries, the newsletter editors, or the respective authors’ employers.
David Brentlinger, FSA, MAAA, CERA is president of Brentlinger Consulting LLC and can be contacted at david@brentlingerconsulting.com.