ASSET ADEQUACY ANALYSIS PRACTICE NOTE – DECEMBER 2004 This practice note was prepared by a work group organized by the Life Valuation Subcommittee of the American Academy of Actuaries. The work group was charged with updating the initial practice notes written in 1995 regarding asset adequacy analysis practices used by appointed actuaries in the United States. The practice note represents a description of practices believed by the work group to be commonly employed by actuaries in the United States in 2004. The purpose of the practice note is to assist actuaries who are faced with the requirement of asset adequacy testing by supplying examples of some of the common approaches to this work. However, no representation of completeness is made, nor whether these constitute best practice at the time they are read; other approaches may also be in common use. It should be recognized that the information contained in this practice note provides guidance, but is not a definitive statement as to what constitutes generally accepted actuarial practice in this area. Moreover, this practice note reflects the results of a survey of actuaries who practice in jurisdictions in which the model Standard Valuation Law of the National Association of Insurance Commissioners (NAIC) applies. To the extent that the laws of a particular state differ from the NAIC model, practices described in this practice note may not be appropriate for actuarial practice in that state. The Actuarial Standards Board has not promulgated this practice note, and the note is not binding on any actuary. The members of the work group responsible for the practice note are as follows: David E. Neve, chairperson William W. Carter Craig F. Likkel William M. Sayre Douglas C. Doll Meredith A. Ratajczak Narayan S. Shankar Lance D. Grigsby Linn K. Richardson Steven G. Sorrentino Robert W. Guth Marcia S. Sander Carolyn Janda Stontz Michael L. Kaster Comments are welcome as to the appropriateness of the practice notes, desirability of annual updating, validity of substantive disagreements, etc. They should be sent to the Academy’s Senior Life Policy Analyst, Steve English, at [email protected]. ASSET ADEQUACY ANALYSIS PRACTICE NOTE – DECEMBER 2004 TABLE OF CONTENTS A. INTRODUCTION AND BACKGROUND........................................................................1 Q1. WHAT CURRENT PRACTICES IS THE PRACTICE NOTE BASED ON?..............................................................1 Q2. Is THIS PRACTICE NOTE EXPECTED TO BECOME A STANDARD THAT ACTUARIES MUST FOLLOW?............2 Q3. WHAT IS THE GOAL OF ASSET ADEQUACY ANALYSIS?.............................................................................2 Q4. WHAT RESOURCES ARE AVAILABLE TO ASSIST THE APPOINTED ACTUARY IN ASSET ADEQUACY ANALYSIS?...............................................................................................................................................5 Q5. HOW IS AN ASSET (RESERVE) ADEQUACY ANALYSIS DIFFERENT FROM A SOLVENCY TEST?.....................6 B. PROCEDURES FOR ACCEPTING/RESIGNING THE POSITION OF APPOINTED ACTUARY...................................................................................................8 Q6. WHAT ARE PROCEDURES THAT AN ACTUARY FOLLOWS IN ACCEPTING OR RESIGNING A POSITION AS APPOINTED ACTUARY?.............................................................................................................................8 Q7. WHAT INFORMATION MAY THE APPOINTED ACTUARY WISH TO OBTAIN FROM THE PREVIOUS APPOINTED ACTUARY?...............................................................................................................................................8 Q8. WHAT IS THE RELATIONSHIP BETWEEN THE APPOINTED ACTUARY AND THE BOARD OF DIRECTORS?.......9 Q9. WHAT DOCUMENTATION IS PROVIDED WITH REGARD TO THE APPOINTED ACTUARY'S PERSONAL QUALIFICATIONS?....................................................................................................................................9 C. GENERAL CONSIDERATIONS FOR PERFORMING ASSET ADEQUACY ANALYSIS..........................................................................................................................10 Q10. HOW DOES THE ACTUARY DECIDE WHAT TO TEST?................................................................................10 Q11. WHAT METHODS ARE USED TO TEST THE ADEQUACY OF RESERVES?.....................................................10 Q12. WHAT ARE THE PRIMARY DIFFERENCES BETWEEN CASH FLOW TESTING AND GROSS PREMIUM VALUATION?..........................................................................................................................................13 Q13. ARE DIFFERENT LINES OF BUSINESS AGGREGATED FOR PURPOSES OF ASSET ADEQUACY ANALYSIS?.....13 Q14. HOW ARE ASSETS ALLOCATED AMONG LINES IF CASH FLOW TESTING IS DONE SEPARATELY FOR EACH LINE?.....................................................................................................................................................15 Q15. CAN THE ACTUARY USE A TESTING DATE PRIOR TO DECEMBER 31 FOR THE PURPOSE OF THE YEAR-END ACTUARIAL OPINION?...........................................................................................................................16 Q16. HOW DO ACTUARIES INTERPRET “MODERATELY ADVERSE CONDITIONS” IN ASSET ADEQUACY ANALYSIS FOR PURPOSES OF COMPLIANCE WITH ASOP NO. 22?...........................................................17 D. MODELING CONSIDERATIONS - GENERALERROR! BOOKMARK NOT DEFINED. Q17. WHAT MODELING PLATFORMS ARE USED TO MODEL LIABILITIES?.........................................................18 Q18. HOW LONG ARE THE PROJECTION PERIODS USED BY ACTUARIES?..........................................................18 Q19. WHAT TYPES OF MODEL VALIDATION DO APPOINTED ACTUARIES PERFORM?........................................19 Q20. HOW IS THE DISCOUNT RATE DETERMINED THAT IS USED TO CALCULATE THE PRESENT VALUE OF ENDING SURPLUS AT THE VALUATION DATE?.........................................................................................19 Q21. HOW DOES THE ACTUARY SET THE DISCOUNT RATES FOR A GROSS PREMIUM VALUATION?...................20 i ASSET ADEQUACY ANALYSIS PRACTICE NOTE – DECEMBER 2004 Q22. THE AOMR STATES THAT THE INTEREST MAINTENANCE RESERVE (IMR) MUST BE USED IN ASSET ADEQUACY TESTING. WHY?..................................................................................................................20 Q23. HOW DOES THE ACTUARY DETERMINE WHICH PORTION OF THE IMR CAN BE USED TO SUPPORT CERTAIN PRODUCTS, AND HOW IS THE PORTION OF THE IMR USED?................................................................................21 Q24. HOW IS THE ASSET VALUATION RESERVE (AVR) TREATED IN CASH FLOW TESTING?............................21 Q25. HOW DOES THE ACTUARY DETERMINE THE PORTION OF THE AVR THAT CAN BE USED TO SUPPORT A CERTAIN BUSINESS UNIT?......................................................................................................................22 Q26. IF PRODUCTS WITH RELATIVELY SHORT LIVES ARE CASHED OUT AT THE END OF THE PROJECTION PERIOD, AND THE IMR AND AVR ARE BEING MODELED, WHAT HAPPENS TO THE IMR AND AVR AT THE END OF THE PERIOD?..............................................................................................................................23 Q27. WHAT ARE SOME METHODS FOR REFLECTING ANY NET DEFERRED TAX ASSET (“DTA”) OR NET DEFERRED TAX LIABILITY (“DTL”) IN THE ASSET ADEQUACY DETERMINATION?..................................24 Q28. HOW ARE SHAREHOLDER DIVIDENDS TREATED IN ASSET ADEQUACY ANALYSIS?..................................25 Q29. HOW ARE POLICYHOLDER DIVIDENDS TREATED IN ASSET ADEQUACY ANALYSIS?.................................25 Q30. DO ACTUARIES REFLECT REINSURANCE IN MODELING?.........................................................................26 Q31. HOW IS MODIFIED COINSURANCE TREATED IN ASSET ADEQUACY ANALYSIS?........................................26 E. MODELING CONSIDERATIONS - SCENARIOS.......................................................27 Q32. WHAT APPROACHES TO MODELING ECONOMIC SCENARIOS ARE CURRENTLY INCLUDED IN APPOINTED ACTUARIES' PRACTICE WHEN DOING ASSET ADEQUACY TESTING?....................................................................27 Q33. WHICH OF THE ABOVE APPROACHES ARE APPROPRIATE IF ASSET ADEQUACY ANALYSIS IS REQUIRED, AND HOW MANY AND WHAT TYPES OF SCENARIOS ARE TESTED?...........................................................27 Q34. IS THERE ANY TIME WHEN A SINGLE INTEREST RATE SCENARIO PATH MAY BE APPROPRIATE?...............29 Q35. WHAT TYPES OF STOCHASTIC SCENARIO MODELS ARE INCLUDED IN CURRENT ACTUARIAL PRACTICE?.29 Q36. WHAT IS REVERSION TO THE MEAN?......................................................................................................29 Q37. HOW CAN AN ECONOMIC SCENARIO MODEL BE VALIDATED?.................................................................30 Q38. IF SOME ELEMENTS OF A SET OF STOCHASTIC SCENARIOS ARE CLEARLY UNREASONABLE, CAN THESE BE IGNORED OR REPLACED?........................................................................................................................30 F. MODELING CONSIDERATIONS - ASSETS................................................................31 Q39. WHAT TYPES OF ASSETS ARE USED BY ACTUARIES IN ASSET ADEQUACY ANALYSIS?.............................31 Q40. WHAT SOFTWARE PLATFORMS ARE USED BY APPOINTED ACTUARIES TO MODEL ASSETS?.....................32 Q41. HOW IS ASSET MANAGEMENT STRATEGY MODELED FOR ASSET ADEQUACY ANALYSIS?........................32 Q42. HOW IS THE REINVESTMENT STRATEGY MODELED?...............................................................................33 Q43. HOW IS DISINVESTMENT MODELED?......................................................................................................33 Q44. WHAT ARE THE SOURCES OF GUIDANCE ON HOW TO SELECT ASSUMPTIONS FOR ASSET MODELING?.....34 Q45. WHAT ARE THE MAIN ASSET-SPECIFIC CHARACTERISTICS THAT AFFECT CASH FLOWS?.........................35 Q46. WHAT TYPES OF ASSET EMBEDDED OPTIONS ARE MODELED FOR CASH FLOWING TESTING?...................36 Q47. HOW ARE EXPECTED CREDIT LOSSES ON BONDS MODELED?..................................................................36 Q48. DO BOND CREDIT LOSSES VARY BY INTEREST RATE SCENARIO?............................................................37 Q49. HOW IS THE RISK OF FLUCTUATION IN BOND CREDIT LOSSES EVALUATED?...........................................37 Q50. HOW ARE BOND OPTIONS MODELED?.....................................................................................................38 Q51. HOW ARE VARIABLE RATE BONDS MODELED?.......................................................................................39 ii ASSET ADEQUACY ANALYSIS PRACTICE NOTE – DECEMBER 2004 Q52. WHAT ARE THE TYPICAL RISKS ASSOCIATED WITH RESIDENTIAL MORTGAGES AND SECURITIES COLLATERALIZED BY THEM?.................................................................................................................39 Q53. WHAT TYPICALLY CONSTITUTES AN ADEQUATE CMO MODEL?............................................................41 Q54. WHAT ARE SOME CONSIDERATIONS FOR MODELING PREPAYMENT ASSUMPTIONS FOR SECURITIES COLLATERALIZED BY RESIDENTIAL MORTGAGES?.................................................................................42 Q55. WHAT ARE SOME ADDITIONAL CONSIDERATIONS IN MODELING SECURITIES COLLATERALIZED BY RESIDENTIAL MORTGAGES?...................................................................................................................43 Q56. WHAT ARE SOME COMMON METHODS FOR DETERMINING THE MARKET VALUE OF CMOS AT A FUTURE POINT IN TIME?......................................................................................................................................43 Q57. WHAT ARE THE RELEVANT ASPECTS OF COMMERCIAL MORTGAGES?....................................................44 Q58. HOW DO ACTUARIES ASSESS THE RISK WITH RESPECT TO COMMERCIAL MORTGAGES?..........................44 Q59. WHAT ARE SOME APPROACHES USED TO MODEL DEFAULT LOSSES ON MORTGAGES?............................46 Q60. HOW MIGHT THE APPOINTED ACTUARY USE THE COMPANY’S INTERNAL RATING SYSTEM?...................47 Q61. HOW IS EXISTING FORECLOSED REAL ESTATE MODELED?......................................................................47 Q62. HOW MIGHT LIMITED PARTNERSHIPS BE EVALUATED?..........................................................................47 Q63. WHAT ARE THE RELEVANT CONSIDERATIONS FOR ASSET-BACKED SECURITIES (ABS)?.......................47 G. MODELING CONSIDERATIONS – POLICY CASH FLOW RISK..........................49 Q64. WHAT IS POLICY CASH FLOW RISK?.......................................................................................................49 Q65. HOW MIGHT THE APPOINTED ACTUARY TYPICALLY DECIDE ON THE SCOPE OF POLICY CASH FLOW RISK TESTING?...............................................................................................................................................49 Q66. WHAT IS MEANT BY “SENSITIVITY TESTING” FOR POLICY CASH FLOW RISK?.........................................49 Q67. WHAT TYPE OF SENSITIVITY TESTING IS COMMONLY DONE?.................................................................50 Q68. HOW IS SENSITIVITY TESTING DONE UNDER GROSS PREMIUM VALUATION?...........................................50 Q69. DO ACTUARIES USE THEIR COMPANY’S OWN EXPERIENCE TO SET MODELING ASSUMPIONS FOR POLICY CASH FLOW RISK?..................................................................................................................................51 Q70. WHEN MAY THE USE OF DYNAMIC LAPSE ASSUMPTIONS BE APPROPRIATE?...........................................51 Q71. WHAT INSURER RISKS ARE ASSOCIATED WITH VARIABLE ANNUITIES?...................................................51 Q72. WHAT METHODS ARE USED TO PERFORM ASSET ADEQUACY ANALYSIS FOR VARIABLE LIFE AND ANNUITY BUSINESS?..............................................................................................................................52 H. MODELING CONSIDERATIONS – EXPENSES.........................................................54 Q73. WHAT KINDS OF EXPENSES ARE MODELED FOR ASSET ADEQUACY ANALYSIS?......................................54 Q74. MUST ACQUISITION EXPENSES BE CONSIDERED?...................................................................................54 Q75. HOW ARE EXPENSE ASSUMPTIONS CHECKED FOR REASONABLENESS?...................................................54 Q76. SOME PRICING ACTUARIES ASSUME THAT EXPENSES WILL DECREASE OVER TIME, AS ECONOMIES OF SCALE RE REACHED. MAY THIS BE REFLECTED IN TESTING?.......................................................................................54 Q77. ARE INSURANCE EXPENSES GENERALLY ADJUSTED FOR INFLATION?.....................................................55 Q78. DO ACTUARIES PERFORM SENSITIVITY TESTS ON THE EXPENSE LEVELS ASSUMED IN TESTING?.............55 Q79. HOW ARE OVERHEAD EXPENSES COMMONLY REFLECTED IN TESTING?..................................................55 Q80. HOW ARE INVESTMENT EXPENSES TYPICALLY HANDLED IN CASH FLOW TESTING?................................56 iii ASSET ADEQUACY ANALYSIS PRACTICE NOTE – DECEMBER 2004 I. RELIANCE ON OTHER PARTIES................................................................................57 Q81. WHAT IS THE RELATIONSHIP BETWEEN THE APPOINTED ACTUARY AND THOSE ON WHOM THE ACTUARY RELIES?..................................................................................................................................................57 Q82. WHAT TESTS OF DATA RELIABILITY DOES THE APPOINTED ACTUARY PERFORM?...................................57 Q83. MAY THE APPOINTED ACTUARY RELY UPON THE COMPANY’S EXTERNAL AUDITOR FOR THE SUBSTANTIAL ACCURACY OF RECORDS AND INFORMATION?.................................................................57 Q84. UPON WHOM MAY THE APPOINTED ACTUARY RELY FOR SUBSTANTIAL ACCURACY OF RECORDS AND INFORMATION?......................................................................................................................................58 Q85. WHAT LEVEL OF DETAIL IS USED TO REVIEW THE UNDERLYING LIABILITY INFORCE RECORDS FROM A THIRD PARTY?.......................................................................................................................................60 Q86. WHAT LEVEL OF DETAIL IS USED TO REVIEW THE UNDERLYING ASSET INFORCE RECORDS FROM A THIRD PARTY?..................................................................................................................................................60 Q87. WHAT LEVEL OF DETAIL IS USED TO REVIEW ASSUMPTION SUPPORT FROM A THIRD PARTY?.................61 J. ANALYSIS OF RESULTS................................................................................................62 Q88. WHAT MEASURES ARE COMMONLY USED TO TEST RESERVE ADEQUACY FOR THE ACTUARIAL OPINION?62 Q89. HOW DO ACTUARIES DEFINE THE CRITERIA USED TO DETERMINE RESERVE ADEQUACY?.......................62 Q90. WHAT FACTORS ARE CONSIDERED IN SETTING THE CRITERIA FOR RESERVE ADEQUACY?......................63 Q91. HOW OFTEN HAVE ACTUARIES ESTABLISHED ADDITIONAL RESERVES AS A RESULT OF ASSET ADEQUACY TESTING?...............................................................................................................................................64 Q92. TO WHAT EXTENT DO ACTUARIES LOOK AT INTERIM RESULTS TO DETERMINE RESERVE ADEQUACY?...64 Q93. IF, BASED ON THE ASSET ADEQUACY TESTS, THE RESERVES ARE JUDGED TO BE INADEQUATE, HOW DOES THE ACTUARY DECIDE UPON THE AMOUNT OF ADDITIONAL RESERVES?.......................................................64 Q94. WHEN ADDITIONAL RESERVES ARE ESTABLISHED OR RELEASED, DOES THE CHANGE IN RESERVE GO THROUGH THE GAIN FROM OPERATIONS, OR IS IT BOOKED DIRECTLY TO THE SURPLUS OF THE COMPANY?................65 Q95. WHAT MUST THE APPOINTED ACTUARY DO IF NOTIFIED OF A MATERIAL RESERVE MISSTATEMENT?.....65 K. PREPARING THE OPINION AND MEMORANDUM................................................67 Q96. HOW DO ACTUARIES DEFINE “QUALIFIED OPINION”?.............................................................................67 Q97. WHAT DETERMINES WHETHER A RESERVE IS IN THE FORMULA RESERVE, ADDITIONAL RESERVE, OR OTHER AMOUNT COLUMN OF THE RESERVE TABLE THAT APPEARS IN THE SCOPE PARAGRAPH OF THE ACTUARIAL OPINION?...............................................................................................................................................67 Q98. WHAT TYPES OF ACTUARIAL REPORTS DO ACTUARIES PREPARE IN CONNECTION WITH ASSET ADEQUACY ANALYSIS?.............................................................................................................................................68 Q99. WHAT LEVEL OF DETAIL IS TYPICALLY INCLUDED IN THE ACTUARIAL MEMORANDUM?.......................69 Q100. WHAT IS TYPICALLY CONTAINED IN THE EXECUTIVE SUMMARY FOR MANAGEMENT?...........................71 Q101. WHAT IS DISCUSSED IN THE REGULATORY ASSET ADEQUACY ISSUES SUMMARY (RAAIS)?................71 Q102. WHAT MAY THE ACTUARY DO IF THE ACTUARY THINKS A CONFLICT EXISTS BETWEEN THE RESPONSIBILITIES TO NOTIFY THE COMMISSIONER AND THE ACTUARY’S RESPONSIBILITIES TO HIS OR HER EMPLOYER?.........72 Q103. IN WHAT WAYS DID REGULATORS FEEL THAT ACTUARIAL OPINIONS AND MEMORANDA COULD BE IMPROVED?............................................................................................................................................72 iv ASSET ADEQUACY ANALYSIS PRACTICE NOTE – DECEMBER 2004 A. Introduction and Background Q1. WHAT CURRENT PRACTICES IS THE PRACTICE NOTE BASED ON? A1. Since 1986, actuaries have been performing asset adequacy analysis for certain annuity and other interest-sensitive lines of business under the requirements of New York Regulation 126. More recently, the types of business subject to asset adequacy analysis have been expanded into all other product lines as a result of the adoption of the Actuarial Opinion and Memorandum Regulation (“AOMR”) and the release of several Actuarial Guidelines requiring stand-alone asset adequacy analysis. Many practices that have been developed were in response to these regulations and guidelines. Reviews of these practices have been published from time to time in industry publications (e.g., Proceedings of the Valuation Actuary Symposium, Financial Reporter). The current1 Actuarial Standards and Actuarial Compliance Guidelines (ACGS) related to when asset adequacy analysis is necessary and what the appointed actuary considers during the testing process are: • ASOP No. 22, Statements of Opinion Based on Asset Adequacy Analysis by Actuaries for Life or Health Insurers, • ASOP No. 7, Analysis of Life, Health & Property Casualty Insurance Cash Flows; • ASOP No. 23, Data Quality, pertaining to reliance on data provided and guidance on reviewing such data, and • Actuarial Compliance Guideline (ACG) No. 4, Statutory Statements of Opinion Not Including an Asset Adequacy Analysis by Appointed Actuaries for Life or Health Insurers (pertaining to Section 7 opinions under the 1991 AOMR). A survey was taken in early 2004 on the practices followed by appointed actuaries for year-end 2003 (the “survey”). The results have been incorporated into this practice note. The survey was sponsored jointly by the Society of Actuaries and the American Academy of Actuaries. There were 169 responses to the survey. Below is a breakdown of the survey respondents by company size (in terms of total assets) for the 168 respondents to that question: 1 All references to “current” in this practice note are as of the date of this writing, July 2004. - 1 - ASSET ADEQUACY ANALYSIS PRACTICE NOTE – DECEMBER 2004 Company size (assets) of respondents Number of respondents $25 billion or more 20 $5 - $25 billion 31 $1 - $5 billion 47 $500 million - $1 billion 23 $100 million - $500 million 27 $100 million or less 20 Total 168 Q2. IS THIS PRACTICE NOTE EXPECTED TO BECOME A STANDARD THAT ACTUARIES MUST FOLLOW? A2. Absolutely not. This practice note documents what is believed to be current practice. There are a number of reasons an actuary might choose to use methods other than those described in this practice note: • The actuary could be aware of special circumstances pertaining to a particular company or block of business that warrant the use of other methods. • The actuary may have developed other acceptable testing methods • This practice note may not sufficiently include current practices that are relevant and appropriate. It may not have captured the total range of current practice in all areas (although the practice note was reviewed by actuaries familiar with the topics of the practice note, and these actuaries have concluded that the practice note represents approaches that fall within current practice.) Even though comments were solicited from the actuarial community, it is quite possible that other approaches that could properly be termed current practices have not been documented here. Q3. WHAT IS THE GOAL OF ASSET ADEQUACY ANALYSIS? A3. The goal of asset adequacy analysis normally is to ascertain the ability of a block of assets to support a corresponding block of liabilities. As reported in the survey, most actuaries believe the primary use of asset adequacy testing is to satisfy regulatory requirements. - 2 - ASSET ADEQUACY ANALYSIS PRACTICE NOTE – DECEMBER 2004 There are a number of regulatory requirements that necessitate asset adequacy analysis, including: 2001 AOMR. The National Association of Insurance Commissioners (NAIC) adopted the AOMR in 1991. Asset adequacy analysis was required for certain, but not all, companies, based on a defined set of criteria. Effective in 2001, the NAIC amended the AOMR. Key to this revision was the elimination of an opinion based on the formula-derived reserves without consideration of the assets backing the reserves (formerly referred to as a “Section 7 opinion” under the 1991 AOMR). Under the 2001 AOMR provisions, all companies must perform an asset adequacy analysis in forming the required opinion. States have been slow to enact the new regulation but eight states have already adopted it (as of the date of this note development, July 2004), with other states strongly considering it. Companies domiciled in a state that has adopted the 2001 AOMR must submit an opinion based on asset adequacy analysis. Companies domiciled in other states that would otherwise satisfy Section 7 criteria, but licensed in states that have passed the 2001 AOMR, may choose to contact those states to see if an opinion based on asset adequacy analysis is required Codification. The NAIC Statutory Accounting Practices Group has incorporated certain provisions of the AOMR into codification. Codification requires the disclosure of any material differences between the reserves reported in the annual statement reserves and the reserves that would have been developed had asset adequacy analysis been performed. Since codification applies to business written on or after January 1, 2001, asset adequacy analysis may be required to the extent that this business is material and the company is not already performing asset adequacy analysis. “Regulation XXX.” The Valuation of Life Insurance Policies regulation (Regulation XXX) is in effect in the majority of states. As part of this regulation, companies may apply prescribed factors less than 100% (“X- factors”) to the valuation mortality table to reduce the deficiency reserve burden of their life insurance policies. To take advantage of this feature of the regulation, a company must have an asset adequacy actuarial opinion and memorandum prepared annually in conformance with the requirements of the AOMR. New York Regulation 127. New York’s reserving of Market Value Adjusted Annuities that are held in a market-value separate account requires that the assets in the separate account make good and sufficient provision for the company’s liabilities with respect to these policies. - 3 - ASSET ADEQUACY ANALYSIS PRACTICE NOTE – DECEMBER 2004 Actuarial Guideline 34 and 39. The NAIC has adopted Actuarial Guideline 34 (AG 34) (Variable Annuity Minimum Death Benefit Reserves) and Actuarial Guideline 39 (AG39) (Reserves for Variable Annuities with Guaranteed Living Benefits). AG34 states that, “the appointed actuary shall perform a standalone asset adequacy analysis of the total reserve held for all of the contracts falling within the scope of this Guideline”. AG39 also requires a standalone asset adequacy analysis of the VAGLB reserve. (See Practice Note for the Application of Actuarial Guideline XXXIX, December 2002.) 2001 CSO. Regulatory action is moving at a far more rapid pace in the implementation of the 2001 CSO mortality table than on the AOMR revision: as of this writing (July 2004), 25 states have adopted the new table. The AOMR permits early recognition of the 2001 CSO table, but requires the preparation of an asset adequacy analysis opinion for the reserves of the business applied to if a company uses the table as the minimum reserve mortality standard for any plan. The Standard Valuation Law requires the use of the 2001 CSO table beginning January 1, 2009. State Insurance Department Requests. Even if an asset adequacy opinion is not required for any of the reasons listed above, under Section 3 of the 1991 AOMR, a state insurance department may request that one be prepared based on the circumstances of any company. Beginning with year-end 2002, the New York State Insurance Department made this request for Category C companies (those with admitted assets between $100 million and $500 million, which by regulation were required to prepare asset adequacy opinions only every third year if they met certain exemption eligibility tests). In their request letter, the New York Department specifically cited concerns about the continued low interest rate environment, the recent period of high default experience, and the depressed stock market as reasons for the request. Given the universality of these problems for all companies doing business in the United States, other states may follow New York’s lead in requesting such asset adequacy analyses, possibly on an individual company basis. Regulatory requirements notwithstanding, some actuaries believe that the primary purpose of asset adequacy analyses is to inform management of actual or possible problems that may arise due to the current management of the business (e.g., due to the current crediting or investment strategies) through at least one report resulting from the analysis, such as an executive summary for management. Many regulators take a keen interest in how the asset adequacy results are communicated to management, and one state, New York, requires that the appointed actuary inform management of the results. The Regulatory Asset Adequacy Issues Summary (see Q101) is used by some actuaries for communication with management as well as regulators. - 4 - ASSET ADEQUACY ANALYSIS PRACTICE NOTE – DECEMBER 2004 Q4. WHAT RESOURCES ARE AVAILABLE TO ASSIST THE APPOINTED ACTUARY IN ASSET ADEQUACY ANALYSIS? A4. Numerous support resources have been developed and maintained by actuarial firms, associations and regulatory bodies to assist the appointed actuary in asset adequacy analysis. The primary providers of these resources include the Society of Actuaries (SOA), the American Academy of Actuaries (the Academy), the NAIC, and state regulatory bodies. The SOA sponsors the annual Valuation Actuary Symposium. These annual meetings provide the appointed actuary with practical information about anticipated regulatory changes that will impact the asset adequacy analysis process. The Valuation Actuary Symposium also provides the appointed actuary with a forum to discuss issues with a group of peers or with recognized experts. The proceedings for these meetings are published to provide a useful resource available for those not attending the Symposium. The SOA also sponsors periodic continuing education sessions on specific topics related to asset adequacy testing, including modeling. Other available resources include SOA section newsletters such as the Financial Reporter, and the Record of other SOA meetings. The Academy, through the ASOPs of the Actuarial Standards Board, Practice Notes and the Life and Health Valuation Manual, is also a resource to assist the appointed actuary in asset adequacy analysis. Among the current ASOPs and ACGs that discuss when cash flow testing is appropriate and considerations for the appointed actuary performing asset adequacy analysis are: ASOP No. 22, Statements of Opinion Based on Asset Adequacy Analysis by Actuaries for Life or Health Insurers; ASOP No. 7, Analysis of Life, Health & Property Casualty Insurance Cash Flows; ACG No. 4, Statutory Statements of Opinion Not Including an Asset Adequacy Analysis by Appointed Actuaries for Life or Health Insurers; and ASOP No. 23, Data Quality, pertaining to reliance on data provided and guidance on reviewing such data. The remainder of this Practice Note is intended to be a resource to the appointed actuary by providing information regarding current practices in asset adequacy testing. The Academy also publishes a Life and Health Valuation Manual each year. This publication provides a state-by-state summary of valuation standards and provides a one- stop source for model laws and Actuarial Guidelines pertaining to valuation requirements. - 5 -