SOA 2010 Life & Annuity Symposium
May 17-18, 2010
Session 23 PD, What is the 'X-factor'?
Moderator:
Philip Ferrari, ASA, MAAA
Presenters:
Michael Andrew Fox, FSA, MAAA
Michael J. LeBoeuf, FSA, MAAA
2010 LAS –
S i 23
Session
23:
What is the X-Factor?
A global expert services company providing expert testimony, authoritative studies, and strategic advisory services to
clients including Fortune Global 500 corporations, major law firms, and governments worldwide. www.lecg.com
2
Panel and Structure
• Introductions
• Phil Ferrari
• LECG-SMART
• Michael LeBoeuf
• LECG-SMART
• Michael Fox
• Protective Life
• Session structure
1
2010 LAS – Session 23:
What is the X-Factor?
Phil Ferrari, ASA, MAAA
Senior Manager and Actuary
LECG-SMART
A global expert services company providing expert testimony, authoritative studies, and strategic advisory services to
clients including Fortune Global 500 corporations, major law firms, and governments worldwide. www.lecg.com
4
Regulation XXX
• Purpose
• Long duration Term and Secondary Guarantee Universal Life
• 19 year select factors for 1980 CSO table
• Several new valuation ideas
• Main focus was option to use expected mortality assumptions in
the calculation of deficiency reserves
• Customized assumptions through the use of “X-factors”
• Actuarial opinion and supporting report
• Appointed actuary obligated to provide if X-factors utilized
• Annual demonstration and opining
2
5
The X-factor
• “X% of the selection factors”
• Apply an additional factor to the select factors
introduced by XXX
• Chosen by appointed actuary
• Can vary
y byy anything
y
g affecting
g mortality
y
• policy year, policy form, class
• Should reflect credible mortality experience
• Can add explicit margin for conservatism
6
The X-factor
• Main requirements
•
•
•
•
•
Used for first segment defined using deficiency reserve mortality
20% floor
Non-decreasing requirement
APV of deficiency reserve mortality >= APV of expected mortality
X-factor morality > = expected mortality
• Joint life policies
• Involved process to determine X-factors
• Reinsurance
• Ceding company X-factors vs. assuming reinsurer
3
7
Practical Issues
• Quantifying emerging mortality
• Mortality studies are not prevalent in the industry
• Where conducted, actuarial resources are often limited
• Could outsource or use a company’s reinsurer
• On-going analysis
• Annual statistical demonstration of appropriateness
pp p
• Hypothesis testing a popular method
• Must determine aggregate distribution of claims, e.g. Monte Carlo
• By X-factor class and overall X-factor classes combined
• If actual amount of claims exceeds amount under aggregate distribution and
confidence level chosen, X-factor is rejected
8
Practical Issues (cont.)
• Changes to future X-factor mortality
• If X-factors rejected, X-factor mortality must be increased for
classes of failure
• Opinion and Report Development
• Annual preparation
• Full documentation of work supporting conclusions
• All requirements of regulation met
4
Session 23 – What is the X-factor?
Current Stat and Tax Issues
Michael LeBoeuf, FSA, MAAA
Managing Director
LECG-SMART
A global expert services company providing expert testimony, authoritative studies, and strategic advisory services to
clients including Fortune Global 500 corporations, major law firms, and governments worldwide. www.lecg.com
10
Current Statutory Developments
• Limitations on X-factors in Section 5 of
Valuation Model Regulation 830 eliminated
• No more 20% floor
• X-factor can decrease duration by duration
• Should eliminate most, but not all, deficiency
reserves
• If adopted by companies
• Effective for 12/31/2009
5
11
Reasons for Change
• It is believed that deficiency reserves are
redundant and have been supplanted by asset
adequacy analysis
• Change does not eliminate deficiency reserves
12
Impact of Change
• American Council of Life Insurers Study
• Estimated decrease in reserves of $2 - $3 billion
• Reduction in deficiency reserves, if any, should
be reported as change in valuation method
• Report in Exhibit 5A of annual statement
• Will be reflected as a release into surplus
• Not an increment to operating earnings
6
13
Impact on Taxes
• We do not use X-factors or select factors to
compute tax reserves, so how does this X-factor
change impact taxes?
• The statutory cap
14
Impact on Taxes
• For many term insurance products, seriatim tax
reserves are lower than statutory reserves
• So deductibility is capped at the reported statutory
level.
• The statutory cap should also include any deficiency
reserves
• Somewhat controversial
• IRC defines statutory reserves as amount set forth in annual
statement - IRC 807(d)(6)
7
15
Impact on Taxes
• Nevertheless even considering deficiency
reserves, tax reserves are often capped at
statutory levels.
• The changes to X-factors end up representing a
weakening of the statutory reserves, and
th f
therefore
th
the statutory
t t t
cap.
• How does that impact taxes?
16
Impact on Taxes
• Should the reserve weakening, which only
impacts the statutory cap be subject to a 10 year
spread rules IRC Section 807(f)?
• No, we have not changed the basis for
computing the tax reserve
• Yes, the statutory cap is a component of the
basis of computing tax reserves
8
17
Impact on Taxes
• Which is correct?
• Notice 2010-29
• Deals with VA CARVM (Actuarial Guideline XLIII)
• Section 3.04 calls for a 10 year spread
• Implementation of new guideline has resulted in
reserve increases and decreases depending on mix
of business inforce
18
Example 1
Year End
Statutory
Reserves
2008
150 million
2009
185 million
2010
Restated
Statutory
Reserve
Tax Reserve
160 million
175 million
195 million
200 million
215 million
9
19
Example 1
• If we do not consider the change reserve
weakening then we have a 2009 statutory
reserve increase of $25 million (175 – 150)
• If we consider the change reserve weakening
then we have a 2009 statutory (tax) reserve
increase of $
$35 million ((185 – 150))
• Opening reserve for 2010 is $175 million
• Amortization of $10 million of reserve weakening
begins in the 2010 return and runs through 2019
20
Example 1
• 2010 increase in tax reserves will be $25 million
(200 – 175)
• $1 million of the reserve weakening flows into
income beginning this taxable year and
continues for following 9 years
10
21
Example 2
Year End
Statutory
Reserves
2008
150 million
2009
135 million
2010
Restated
Statutory
Reserve
Tax Reserve
160 million
130 million
145 million
120 million
130 million
22
Example 2
• If we do not consider the change reserve
weakening then we have a 2009 statutory
reserve decrease of $20 million (150 – 130)
• If we consider the change reserve weakening
then we have a 2009 statutory (tax) reserve
decrease of $
$15 million ((150 – 135))
• Opening reserve for 2010 is $130 million
• Amortization of $5 million of reserve weakening
begins in the 2010 return
11
23
Example 2
• 2010 decrease in tax reserves will be $10 million
(130 – 120)
• $0.5 million of the reserve weakening begins this
taxable year and continues for following 9 years.
24
Conclusion
• If the reserve change is considered an IRC
Section 807(f) change in basis, then the
weakening will defer federal income taxes for
the company
12
What is the ‘X-Factor’?
May 17, 2010
Michael Fox
Fox, FSA
FSA, MAAA
nd
2 Vice President
Protective Life Insurance
What is the ‘X-Factor’?

Practical considerations regarding X-factors

X-factor development
p

X-factor certification
1
What is the ‘X-Factor’?

X-factor development

Pricing
g or valuation?

Define X-factor classes

Mortality experience


Credibility
Relevance
What is the ‘X-Factor’?

X-factor development

Use of PAD?

Preliminary testing for compliance

Sensitivity of reserves to X-factors
2
What is the ‘X-Factor’?

X-factor certification

Timing
g of testing
g / certification

Methodology used

Software used

Changes to X
X-factors
factors
Questions?
3