INNA KOGAN: Thank you, and welcome, Karen. And Rick.
RICK HAYES: Hi, Inna. Thanks for having me today as well. I'm Rick Hayes. I'm a director at WTW, and I've been focused on the individual deferred annuity market for the better part of my career.
I've supported clients with annuity pricing, valuation, hedging, and risk management projects. I've been an interested party in the annuity reserves and capital subcommittee for a number of years and more recently took on the role of Chairperson of the Academy of Actuaries C3 Subcommittee. So very excited to talk about this topic today.
INNA KOGAN: Thank you, and welcome, Rick. And I'm happy to have you both on the show. Now, as you may know, we like to learn a little bit more about our guests on the show before we jump into our main topic. And for today, the question is, what is your dream travel destination, which is on your bucket list? Let's start with Karen.
KAREN GROTE: Thanks. This is a tough one. But if I have to pick one, I would say Bali. And that's really because I have an aunt and uncle who traveled the world, and I always ask them, where's the most beautiful place? And their answer has been Bali for a number of years now.
INNA KOGAN: Wow, that's good. I'll mark my bucket list. And Rick?
RICK HAYES: I struggle to find a single destination to answer this with. But if push comes to shove, I guess I'd have to say I'd like to go on a safari in Africa. I've been to the Amazon in South America, and I've been to Asia and Europe and North America. But Africa is pretty high on my bucket list, so I'll stick with that one.
INNA KOGAN: Thank you. I'll consider that, as well, for the future. Now let's jump into VM-22. The best place to start is probably with an overview of the new proposed VM-22 framework and how it differs from the current CARVM method.
KAREN GROTE: I'll take this one. So the latest proposed updates to VM-22 are really a major change in how we will reserve non-variable annuity products in the U.S. So instead of current CARVM's rigid, one-size-fits-all methodology, this will shift us towards a more flexible framework and moves us into a world where actuarial judgment, asset liability modeling or ALM, and strong governance play a much bigger role.
From a practical standpoint, some notable changes include using assumptions based on company experience with margins versus the current prescribed assumptions, a switch to using scenarios, as well as reflecting general account and hedge assets. It also comes with some ability to aggregate business, as well as requirements for detailed governance documentation.
So clearly, this all means there is going to be greater demands on models and actuarial teams. But it is exciting, as the new framework is more reflective of how companies actually manage risk.
INNA KOGAN: Good. That's a great intro. So I understand that there are some options for insurers within the VM-22 framework. Can you describe what they are?
KAREN GROTE: That's right. So one example is something I just briefly mentioned, which is the ability to aggregate results across various lines of business that are included within the scope of VM-22.
And while there are restrictions, which I will come back to in a second, it is worth noting that, just recently, there was a change proposed which allows for even greater aggregation than we first thought. The remaining key restrictions here are that different lines of business can only be aggregated if the company manages the risks and the asset portfolio for those businesses in aggregate as well.
Another key decision point is whether to elect the single-scenario test. Now, as you might imagine, it's not just a matter of electing it. Companies do have to meet all of the conditions of the single-scenario test, as well as certain parts of the stochastic exclusion test.
But if all those items are met, they would then be permitted to calculate a deterministic reserve, instead of a stochastic reserve, which, as you might imagine, substantially reduces the modeling needs.
INNA KOGAN: Yeah, these are some very helpful options. I'm sure some companies would appreciate them. Now, how will the new methodologies affect the reserves for non-variable annuities? And is there anything we can possibly glean from the field testing that occurred?
RICK HAYES: I can take that one. So unfortunately, field-testing participation wasn't as plentiful as some may have hoped for. And it was noted that companies used varying levels of simplifications to produce results within the submission timeline.
Some examples given were the use of placeholder assumptions and simplified asset portfolios. But despite all that, there were some key takeaways when comparing the VM-22 PBR reserves to the carbon results. And I'll try to go through them as best I can.
On the payout annuity side-- so these are your SPIAs, PRT blocks, and structured settlements-- all had decreased reserves when calculated in the field-testing model office. So an actuarial projection system that was built for modeling of a theoretical block of business.
And the explanation given was that there was work done to optimize the assets backing the liabilities in the model office. Participant reserves showed a slight decrease for the speed and PRT business too, but the structured settlement results actually increased.
So this could be driven by suboptimal asset selection, but may also just point to the fact that structured asset settlement blocks can vary substantially across the industry in terms of complexity, and that mortality assumptions can drive the outcomes.
For deferred annuities without WBs, so the guaranteed living withdrawal benefits, I was actually a little surprised to see both model office and participant results increase under VM-22.
So my expectation was that MYGA reserves, the multiyear guaranteed annuities, would decrease, especially with modeled asset yields expected to be greater than what's currently used for discounting under AG33, as this has recently driven reserves on new business north of fund value.
For FIAS with GLWBs, they showed a decrease in both the model office and participant results. This is actually what I'd expected, as CARVM requires companies to hold a rather punitive amount based on perfectly efficient policyholder behavior. The magnitude of the decrease seems to be quite different between the model office and participants, though, so again, I think, just speaking to the fact that products can vary across the space.
So without knowing more details, I think the biggest takeaway is that product specific features, actuarial assumptions, and the selection of assets will drive company specific results, which motivates companies to be on top of pricing assumptions setting, and ALM practices going forward.
INNA KOGAN: Nice. So speaking of design and pricing, what are the potential impacts of VM-22 on the design and pricing for annuity products?
RICK HAYES: So I think there are a few key impacts on pricing post-VM-22, at least ones that I can think of for now. So the first would be determining which product features are optimized within the new reserve framework.
As an example, there might be some GLWB designs which helped keep carbon reserves low. That may not be as favorable when equity returns are explicitly modeled within the reserve calculation under VM-22.
The second would be how to reflect stochastic reserves in the pricing runs. So this is a complication with VAs and RILAs, which fall under VM-22 another PBR-based reserving method. And there are varying methods being employed to get around the computational strain.
So some may use a subset of scenarios within the pricing exercise, reduce the frequency of reserve calculations as the block ages, or at the extreme, use a factor-based approach, rather than explicitly calculate reserves at all. All methods could be defensible, but depends on the product characteristics.
Finally, some companies may be pricing on a liability-only basis today, and VM-22 may prompt them to shift to an ALM model. So the additional complexity of modeling assets will be an issue for those companies to tackle as well.
INNA KOGAN: Very good. Are there any other impacts of the new VM-22 requirements, such as possibly on assets or capital management?
KAREN GROTE: Yeah, and actually, Rick's previous response was a perfect segue here. So as you said, the key here is that, yes, assets would now be reflected in reserve calculations, and therefore, their performance will impact reserves.
So because of this, we expect this may lead to different asset-selection criteria as insurers adjust and optimize their asset and liability management processes under the new regime. Then, of course, those new investment strategies will also have to be reflected in the reserve calculation.
Now, because statutory reserves influence statutory capital, of course, VM-22 will also make capital levels more product specific, assumptions sensitive, and economically responsive, just like the reserves themselves would be.
So this may result in either weakened or volatile risk-based capital ratios, even if the company's actual risk hasn't changed. So all in all, it really will be interesting to see how the impacts unfold as companies begin to shift to the new framework.
INNA KOGAN: I agree the time will tell. And this is actually a very good segue to my next question. What are the main challenges and opportunities that insurers face with the implementation of PBR framework under VM-22?
RICK HAYES: So I think the challenge is perhaps most pronounced on the modeling side for valuation, pricing and projections, especially for companies that don't already have a PBR block of business, such as VM-20 or VM-21. So setting up the models is step one, but understanding the nuances of PBR reserves in terms of attribution analysis and key drivers will be another big challenge for some.
Once that hurdle has been overcome, I think there are opportunities for companies under VM-22 to build up experience study processes, ALM practices, and other risk management techniques to optimize the reserve levels and the profits generated for the business being written.
I'd also add that documentation is going to be a big challenge in terms of setting up the initial PBR reports. And that's probably another area to point to outside of the modeling realm.
INNA KOGAN: Right. Now, let's talk about technology. What technological and system changes are necessary for insurers to comply with the new VM-22 requirements? And how can insurers ensure a smooth transition?
KAREN GROTE: So given the introduction of assets and scenarios, particularly those stochastic scenarios, into the reserve calculation, the proposed VM-22 framework will, no doubt, require more sophisticated modeling. So insurers should begin by evaluating whether their current actuarial systems can even handle the complexity of principle-based reserves.
But of course, capacity alone isn't enough. Speed is going to matter too. So a model that takes days or weeks to run leaves little time for meaningful analysis or decision making. So that's why it's equally important to evaluate areas where modeling efficiencies can be gained as well.
And then remember, it's not just about compliance. So the sooner you can begin running parallel reserve calculations, the sooner you will gain the insights your business is going to need. Because, as Rick and I have been saying, VM-22 will shape product design, reinsurance strategies, ALM, and overall business planning.
And just like Rick mentioned, the documentation, I would similarly be remiss if I didn't also mention that the governance and controls within and around the systems will also need to be assessed and likely strengthened.
INNA KOGAN: Right. Documentation is always very important, as well as governance and controls. Now, I have one more important question for you. How should the actuaries be approaching communication of the changes and implications of VM-22 within their organizations?
RICK HAYES: I think that starting with a ground-up approach may be best in terms of showcasing how a single product's reserve would move from CARVM to VM-22. As I previously mentioned, there are some key takeaways from field testing, but company specific results may not align perfectly with them. So I think taking a step-wise approach to moving away from the prescribed CARVM assumptions to the VM-22 framework would provide valuable insight in terms of drivers of results and potential product features that can be tweaked.
Furthermore, companies can then incorporate the anticipated aggregation benefits based on expected new business sales, or variations thereof, to determine what mix might sit best for them going forward and in the long run.
KAREN GROTE: We don't mean to scare you, but hopefully, we've made it clear by now that if you haven't started preparing for the new VM-22 now is definitely the time.
INNA KOGAN: Companies certainly have a lot to consider over the next few months so that they can be ready to comply by January 1. Thank you very much, Karen and Rick, for joining us.
RICK HAYES: Thank you, Inna
KAREN GROTE: Thank you.
INNA KOGAN: And to all our listeners, thank you for joining our (Re)thinking Insurance podcast about VM-22. Have a great day.
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