Smaller Insurance Company Section

Topic - Discussion of Impact of PBR being Primarily on Competitive Term and ULSG Subject to AG38

VM-20 is applicable to all life insurance products except for Credit Life and Pre-Need Life insurance. It represents a major change in how reserves will be computed for new business, including computation of a stochastic reserve, a deterministic reserve and a Net Premium Reserve (NPR). The stochastic and deterministic reserves are determined in aggregate for a group of policies and are calculated using modeled projections of policy cash flows. The Net Premium Reserve amount uses a formulaic calculation and prescribed assumptions applied to each individual policy in the group of policies. There are optional exclusion tests which, if passed, allow companies to exclude groups of policies from the stochastic calculation and potentially from the deterministic reserve calculation.

Absent the exclusion tests, VM-20 defines the minimum reserve for a group of policies as the larger of its three component reserves: Stochastic Reserve, Deterministic Reserve and Net Premium Reserve.

Because of the availability of the exclusion tests, some have concluded that the most likely policies to be affected by VM-20 are Universal Life with Secondary Guarantees (ULSG) and Competitive Term. There is no definition of Competitive Term in VM-20. In the NAIC invitation to participate in the Impact study, Competitive Term was defined as "at least one premium in top quartile." A ULSG product would be any UL product that is subject to AG38.

As mentioned above, the Net Premium Reserve (NPR) is a formulaic construct with prescribed assumptions of mortality, lapse and interest. For any policy the NPR is floored at the greater of the policy cash surrender value, or the remaining cost of insurance. At this time the NPR is specifically defined for ULSG and Term insurance products and is a seriatim formulaic reserve that is similar to the current CRVM method. For products other than ULSG and Term, VM-20 uses the current Commissioner's Reserve Valuation Method (CRVM) as representative of NPR. So we know that for ULSG and Competitive Term products, there is a change from the current CRVM method.

The exclusion tests are a Stochastic Exclusion Test (SET) which can be used for all products and a Deterministic Exclusion Test (DET). ULSG products are ineligible for the DET, so the result is that ULSG products will at least have to compute the deterministic reserve defined in VM-20 along with the new NPR calculation as noted above.

The SET is a test to determine whether a group of policies is required to comply with the stochastic modeling requirements. The SET is designed to identify whether the subject group of policies is sensitive to interest rate or equity risk. If this test is passed, a company may elect to exclude these groups of policies from the stochastic reserve calculation in VM-20.

The DET is similar to a deficiency reserve test. If a group of policies has passed the SET, the company can perform this test to see if the sum of valuation net premiums is less than the sum of guaranteed gross premiums. If passed, a company may elect to exclude the group of policies from the deterministic reserve computation. (Again, note that ULSG is not eligible for this test.)

The NAIC engaged Towers Watson in 2010 to assist in conducting an Impact Study on VM-20. The study was based on the February 28, 2011 working draft of VM-20. See the following link to access the study results . See the following link for access to a Milliman Research Report by Karen Rudolph for more background on the impact study . There have been changes to VM-20 since that study, some made as a result of the feedback from the study. Note that while a number of companies participated it is difficult to extrapolate the outcomes of the Impact Study to any particular insurer or the industry at large. Another consideration regarding the Impact Study is the results may not be indicative of results to be seen "post-implementation" as the industry will likely be marketing different product designs by then. However, there are some things we can take away from the study results.

The study showed that some term and all ULSG products that were part of the study failed the SET. Universal Life products with no secondary guarantee, Traditional Whole Life and Simplified Issue Whole Life products in the study passed both the SET and DET. One Variable Universal Life product did not pass the SET.

Given the results of the NAIC Study, a conclusion could be made that, if a reasonable investment strategy is used, Competitive Term is likely to require at least the NPR and deterministic reserve calculations, and for some companies the stochastic reserve calculation may be required. ULSG results indicate that the stochastic reserve will need to be computed along with the deterministic and NPR reserves. While all the Traditional Whole Life policies in the study passed both the SET and DET, a company with non-par products would want to determine if premiums are generally low enough for these products to be premium deficient. That result could prevent passage of the DET, resulting in the requirement for a deterministic reserve calculation along with the NPR calculation.

It seems likely that for companies selling ULSG and/or Competitive Term, VM-20 will require a significant change in the reserving process for new business, requiring modeling to compute reserves. Companies not participating in the ULSG or competitive term markets will want to familiarize themselves with the requirements for the SET and DET and prepare for evaluating those products under these exclusion tests.