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Principles-Based Reserves, Here We Come

2006-Apr-01 - Christopher H. Hause

I have written in these pages and elsewhere that the only logical place for statutory reserving principles to end up would be "natural reserves, plus a margin."

From the most recent drafts, it looks like the direction we are headed is "gross premium reserves with asset considerations plus a margin."

The differences are enough so that I do not consider myself completely and victoriously correct, but the deviation from traditional statutory reserving practices is significant enough to claim partial prescience (apologies to fans of Muad Dib).

I think where I went wrong (about 25 years ago) is that I did not anticipate the folding in of actual asset performance into statutory reserving practices. I reserve the right to judge on this point until this theory is put into practice.

A 10,000-foot look at where we appear to be headed may be in order.

From the model that appears to be emerging, several things are coming to light.

  • The primary driver for this movement is companies who do not want to establish currently required reserves on preferred term products and UL secondary guarantees.
  • A cash value floor for reserves provides little difference for many permanent plan
  • The initial scope of PBR is fully underwritten ordinary life, but there is sufficient likelihood it will apply across all lines of business eventually.
  • A tremendous amount of study and documentation will be necessary
  • Companies that adopt PBR will be able to price more aggressively and will quickly force all companies to use PBR.
  • However, smaller companies will not have resources to take advantage of PBR and will almost certainly not have credibility.
  • As a result, smaller companies will be put at a disadvantage even if they reinsure heavily because of the expense of compliance.

One issue that immediately leaps to mind is the levels of RBC under a PBR system. Clearly, the risk of being under-reserved increases with lower reserves.

An area that is almost sure to cause some spirited discussion is peer-review. How much are the regulators willing to rely on company-appointments and ASOPs?

One regulator has been heard to say "you guys will sign anything" when referring to the various certifications by actuaries.

I have faith in our professionalism and in our integrity. PBR is a logical step, but one that will put a lot of pressure on the diligence and backbone of the profession. If we are up to the challenge, we will solidify our places in the executive offices and board rooms.