VARIABLE ANNUITIES ISSUES (E) WORKING GROUP · PDF fileVariable Annuities Issues (E) Working...

© 2015 National Association of Insurance Commissioners 1

Date: 10/16/15

Conference Call

VARIABLE ANNUITIES ISSUES (E) WORKING GROUP Thursday, October 22, 2015

11:30 a.m. ET / 10:30 a.m. CT / 9:30 a.m. MT / 8:30 a.m. PT

ROLL CALL Iowa, Chair Nebraska California New Jersey Connecticut New York Michigan Ohio Missouri

AGENDA

1. Finalize Report to the Financial Condition (E ) Committee—Commissioner Nick Gerhart (IA)

• Exposed report Pages 3-5 • Report as revised with non-substantive changes Page 7-11 • Comment Letters

o Connecticut non-substantive changes 3-17 o Connecticut Page 19 o Northwestern Mutual Page 21 o ACLI Page 23-29 o New York Life Page 31-33 o New York DFS Page 35-36 o AAA Page 37-42

2. Discuss Any Other Matters Brought Before the Working Group— Commissioner Nick Gerhart (IA) 3. Adjournment

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Report to the Financial Condition (E) Committee Variable Annuities Issues (E) Working Group—At the 2015 Spring National Meeting, the Variable Annuities Issues (E) Working Group was formed and given the following charge:

• Oversee the NAIC’s efforts to study and address, as appropriate, regulatory issues resulting in variable annuity captive reinsurance transactions.—Essential

Simultaneous with the formation and charge given to this Working Group, the NAIC Executive Committee and Internal Administration (EX1) Subcommittee established resources to allow the NAIC to engage a consultant to assist the Working Group in meeting this charge. Oliver Wyman was engaged by the NAIC to fulfill this role, and in September, delivered a report of observations and recommendations which was discussed during an interim meeting of the Variable Annuities Issues (E) Working Group on Sept. 10. During that meeting, the Working Group and members of the industry provided feedback on the recommendations which was used to develop this report. The report has since been discussed and adopted. The Financial Condition (E) Committee is asked to adopt this report, including adoption of the Variable Annuities-Framework for Change, in concept (Exhibit 1) and the charges for NAIC groups (Exhibit 2). Variable Annuities-Framework for Change • The Variable Annuities Framework for Change (Framework) is intended to address concerns that have led to

the industry’s development and utilization of captive reinsurance transactions with regard to variable annuity business. In general, the general conclusion is that the utilization of these transactions has been driven by the existing statutory requirements which are generally considered to be non-economic, or structured in a manner that does not promote strong risk management.

• Unlike the NAICs XXX/AXXX Reinsurance Framework, which was adopted to apply prospectively, this framework for changes is intended to make changes that apply retrospectively. This is because XXX/AXXX products are both subject to life insurance non-forfeiture and valuation laws whose valuation and non-forfeiture interest rates change on a calendar issue year by calendar issue year basis and are locked in at policy issue and remain locked in for the life of the contract. In contrast, variable annuities with and without guaranteed benefits are exempt from the annuity non-forfeiture law. In addition, the reserve valuations for variable annuities with and without guarantees are defined by AG43 which is based on a stochastic methodology and are not based on a calendar year valuation interest rates that are locked in at issue, rather these rates are generated and are unlocked at each valuation. The AG43 valuation methodology is currently applied retroactively back to January 1, 1981.

• The Working Group was supportive of the numerous changes you see listed in the Framework for two reasons:

1) to encourage strong risk management within the insurance company; 2) to remove the need to reinsure variable annuity business to captive reinsurers. With respect to the later, the Working Group would recommend that once these changes, or the majority of these changes are effective (anticipated effective date of 1/1/17), domestic regulators of insurers ceding variable annuity to captive reinsurers should request their company to recapture the business and for the group to dissolve the captive reinsurer.

• Unlike XXX/AXXX, this Framework impacts all insurers writing the specified line of business, and is not

implemented through specific requirements on the reinsurance contract, but rather on the requirements of the direct writer of the contract. In summary, those changes are to the following areas:

o Actuarial Guideline 43; o Risk-Based Capital Requirements (C3 Phase II); o Allowing hedge accounting treatment under SSAP No. 86 for certain limited derivative contracts

that otherwise do not meet hedge effectiveness requirements; o Allowing states a consistent mechanism to utilize hedges without any size limitations that may

otherwise apply in investment statutes.

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Exhibit 1

Exhibit 1— Variable Annuities-Framework for Change 1. The Framework will result in changes to AG 43 that will be designed to result in a less non-economic reserve

requirement for variable annuities. The changes are expected to include the following: a. Development of calibration criteria for the Interest Rate (USD and possibly international) scenario

generation with a market-sensitive mean reversion asymptote – this will align the interest scenarios with broader efforts underway at the NAIC level. Potential to integrate the Interest Rate calibration criteria with Equity Return calibration criteria and to add a volatility calibration prescription;

b. In the Standard Scenario calculation: Introduce more granular benefit-specific prescriptions of policyholder behavior assumptions. Separately, the prescribed set of assumptions is to be calibrated to adverse, yet plausible levels informed by credible industry experience;

c. Additionally, the Standard Scenario calculation will be conducted on a portfolio as opposed to seriatim basis with the existing seriatim Standard Scenario calculation made available as a disclosure item;

d. Hedging reflection in the Adjusted CTE 70 calculation to allow for the reduction of gross market risk positions for hedge instruments prior to expiration of existing hedges rather than a simple hold-to-maturity treatment;

e. Increased regulator only disclosure designed to ensure regulators understand the potential impact under different assumptions;

f. The addition of a feedback loop that continuously reviews granular industry data as a means to modify the AG in the future to ensure the framework continues to operate as redesigned. This will require additional granular data to be submitted to the NAIC and analyzed and presented to a group of regulators.

2. The Framework will result in changes to the Life Risk Based Capital formula that includes material expected

changes to C3 Phase II. Similar to changes to AG 43, these will be designed to result in less non-economic capital requirements on variable annuities. The changes that are expected include the following:

a. Complete elimination of the standard scenario; b. Alignment of the total asset requirement (TAR) and the AG 43 reserve requirements through use of the

AG43 stochastic CTE calculation as the basis for a difference calculation for the direct determination of the C3 charge and the indirect determination to Total Assets Required as the sum of reserves plus the newly defined C3 charge. The C3 charge will be the difference between two AG43 CTE calculations at different confidence levels. The individual CTE calculations will apply an effectiveness factor for the reflection of a CDHS that is calibrated to be consistent with the error factors of the C3 Phase 2 framework. The confidence levels will be determined in the calibration phase during a forthcoming Quantitative Impact Study. The resulting difference will be appropriately tax effected and scaled to arrive at the C3 charge. This use of the AG43 calculation will eliminate the need for a separate C3 Phase 2 calculation;

c. The addition of a feedback loop that continuously reviews granular industry data as a means to modify the C3 Phase II in the future to ensure the framework continues to operate as redesigned. This will require additional granular data to be submitted to the NAIC and analyzed and presented to a group of regulators.

3. The Framework will result in changes to SSAP No. 86 that are designed to reduce the accounting mismatch that

exists between the value of the hedge and the value of the hedged item (the variable annuity liability) so that as market conditions change, gains or losses that are not consistent with the economic value of the hedges are not created within the financial statements. In addition, requirements for increased public disclosure on variable annuity risks will be added to the SSAPs, and data captured in the notes to the financial statements.

4. The Framework will result in the development of narrowly defined statutory language that states may use in removing the limitations that may exist within their investment statutes that may otherwise limit the extent of hedges an insurer may use in their risk management.

***********

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Exhibit 2

Proposed Charges to NAIC Groups

C-3 Phase II/AG 43 (E/A) Subgroup of the Life Risk Based Capital Working Group • The joint C-3 Phase II/AG 43 (E/A) Subgroup of the Life Risk-Based Capital (E) Working Group and Life

Actuarial (A) Task Force will develop and recommend changes to C3 Phase 2 and AG 43 for 2017 adoption that implement the Variable Annuities Framework. —Essential

Statutory Accounting Principles (E) Working Group • Develop and adopt changes to SSAP No. 86-Derivatives, with an effective date of January 1, 2017 or earlier,

which allow hedge accounting treatment under SSAP No. 86 for certain limited derivative contracts (e.g. interest rate hedges with counterintuitive effects) that otherwise do not meet hedge effectiveness requirements. In adopting such an allowance, consider if the requirement to meet hedge effectiveness can be replaced by some other information that demonstrates strong risk management is in place over the identified hedges. —Essential

• Finalize public disclosure on variable annuity risks as developed by the Variable Annuity Issues (E) Working Group. —Essential

Blanks (E) Working Group • Based upon the disclosure developed by the Variable Annuities Issues (E) Working Group on variable

annuities, finalize a data captured note with an effective date of December 31, 2017 or earlier —Essential Variable Annuities Issues (E) Working Group • Develop a model guideline in 2016 that represents narrowly defined statutory language that states may use in

removing the limitations that may exist within their investment statutes that may otherwise limit the extent of hedges an insurer may use in their risk management. —Essential

• Redesign the annual statement disclosures on variable annuities to add more meaningful information about the valuation of the guaranteed liabilities with an effective date of December 31, 2017 or earlier. The objective of the improved disclosure should be to provide all stakeholders (e.g., regulators, consumers, and investors) with more transparency and additional insights into how the contractual obligations could change over time as well as the insurance company’s ability to both manage those obligations. The disclosure information must be provided in a prescribed, easy-to-understand, format including key risk driver assumptions (e.g., interest rates, lapse rates, and benefit utilization) and the impact of “shocks” to the key risk driver assumptions (e.g., benefit utilization becomes more efficient, interest rates drop by 1%, etc.). Upon development, refer to the Statutory Accounting Principles (E) Working Group and Blanks (E) Working Group for finalization and incorporation into NAIC publications. —Essential

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G:\FRS\DATA\Staff\DJD\Variable Annuities\Calls & Meetings\2015\Oct 2\Variable Annuities-Framework for Changes.docx

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the industry’s development and utilization of captive reinsurance transactions with regard to variable annuity business. In general, Tthe general conclusion is that the utilization of these transactions has been driven by aspects of the existing statutory requirements which areare generally considered to be be introduce substantial non-economic balance sheet volatility and/or , orare structured in a manner that does not promote strong risk management, and which introduce volatile and incongruous changes in reserves and RBC requirements. The Framework is intended to demonstrate the NAIC commitment to make changes in the areas identified. The Framework uses the phrase “will result in change” in a number of areas to demonstrate the commitment to change. The commitment is necessary as the NAIC EX1 Subcommittee is expected to receive a request for funding to retain a consultant to help implement the types of changes that are being commitment to.

• Unlike the NAICs XXX/AXXX Reinsurance Framework, which was adopted to apply prospectively, this framework Framework for changes Change is intended to make changes that apply retrospectively consistent with the fact that the AG43 valuation methodology is currently applied retroactively to January 1, 1981. This is because XXX term and /AXXX UL products are both subject to life insurance non-forfeiture and valuation laws whose valuation and non-forfeiture interest rates change on a calendar issue year by calendar issue year basis and are locked in at policy issue and remain locked in for the life of the contract. In contrast, variable annuities with and without guaranteed benefits are exempt from the annuity non-forfeiture law. In addition, the reserve valuations for variable annuities with and without guarantees are defined by AG43 which is partly based on a stochastic methodology and are is not based on a calendar year valuation interest rates that are locked in at issue,. Rrather, these rates are generated and are unlocked at each valuation. The AG43 valuation methodology is currently applied retroactively back to January 1, 1981.


1) to encourage strong risk management within the insurance companiesy; 2) to remove the need to reinsure variable annuity business to captive reinsurers. With respect to the later, the Working Group would recommend that once these changes, or the majority of these changes are effective (anticipated effective date of 1/1/17), domestic regulators of insurers ceding variable annuity to captive reinsurers should request their company to recapture the business and for the group to dissolve the captive reinsurer.

• The determination of the exact changes to the actuarial statutory requirements will be based in large part upon a

quantitative impact study performed by the NAICs consultant, and the decisions reached by the regulators based upon the aggregate (non-company specific data) from this study. Therefore the actuarial listing of items that may be included in the change are NOT definitive, but they are intended to be used as a guide in the likely

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direction of the changes to the statutory requirements and they will be used in the design of the of the changes that will be tested in this quantitative impact study. It’s possible that other solutions may be identified during and after the quantitative impact study that could ultimately be incorporated into the final changes to the statutory requirements. Results from the quantitative impact study will need to be reported and consolidated for regulatory review. Design of the study by the consultant will need careful attention with input from individual members of the industry and individual identified regulators so that the work can progress in a timely and efficient manner. The design may include things not initially identified, such as the evaluation of elements related to revenue sharing provisions or potential statutory tax implications.


implemented through specific requirements on the reinsurance contract, but rather focuses on the requirements of impacting the direct writer of the contract. In summary, those changes are will be proposed to the following areas:

o Actuarial Guideline 43; o Risk-Based Capital Requirements (C3 Phase II); o Allowing Hhedge accounting treatment under SSAP No. 86 for certain limited derivative contracts

that otherwise do not meet hedge effectiveness requirements; o Allowing states a consistent mechanism to utilize hedges without any size limitations that may

otherwise apply in investment statutes.Narrowly defined statutory language that states may use to remove limitations that may exist within their investment statutes that may otherwise limit the extent to which an insurer may use hedges in its risk management.

8


Exhibit 1

Exhibit 1— Variable Annuities-Framework for Change 1. The Framework will result in changes to AG 43 that will be designedhave the potential to result in a less

reduced and less volatile non-economic reserve requirement for variable annuities that is better aligned with the business economics while providing sufficient amounts to cover moderately adverse circumstances. These changes identified and to be tested in the quantitative impact study (QIS) are expected to may include, but are not limited to, the following:

a. Development of calibration criteria for the Interest Rate (USD and possibly international) scenario generation with a market-sensitive mean reversion asymptote – this will align the interest scenarios with broader efforts underway at the NAIC level. Potential to integrate the Interest Rate calibration criteria with Equity Return calibration criteria and to add a volatility calibration prescription;

b. In the Standard Scenario calculation: Introduce more granular benefit-specific prescriptions of policyholder behavior assumptions in the Standard Scenario calculation. Separately, the prescribed set of assumptions is to be calibrated to moderately adverse, yet plausible, levels informed by credible industry experience;

c. Additionally, Calculate the Standard Scenario calculation will be conducted on a portfolio as opposed to seriatim basis with the existing seriatim Standard Scenario calculation made available as a disclosure item;

d. Reflect hHedging reflection in the Adjusted CTE 70 calculation to allow for the reduction of gross market risk positions for hedge instruments prior to expiration of existing hedges rather than a simple hold-to-maturity treatment;


f. The establishment The addition ofAdd ofEstablish a feedback loop that continuously reviews granular industry data as a basis means to modify the reserve requirements AG in the future to ensure the framework continues to operate as redesigned. This will require additional granular data to be submitted to the NAIC and analyzed and presented to a group of regulators.


changes to C3 Phase II. Similar to changes to AG 43, these will be designed to result in less reduced and less volatile non-economic capital requirements on variable annuities that are better aligned with the business economics and statutory reserve calculations while remaining consistent with Risk-Based capital standards. These changes identified and to be tested in a QISthat are expected may include, but are not limited to, the following:

a. Complete Eeliminatione of the standard scenario; b. Alignment of the total asset requirement (TAR) and the AG 43 reserve requirements. This will involve

through use of the AG43 stochastic CTE calculation as the basis for a difference calculation for both (i) the direct determination of the C3 charge and (ii) the indirect determination to Total Assets Required as the sum of reserves plus the newly defined C3 charge. The C3 charge will be the difference between two AG43 CTE calculations at different confidence levels, with the lower CTE calculation anticipated to be subject to a floor equal to the AG43 standard scenario (itself subject to revision). The individual CTE calculations will apply an effectiveness factor for the reflection of a CDHS that is calibrated to be consistent with the error factors of the C3 Phase 2 framework. The confidence levels will be determined in the calibration phase during athe forthcoming Quantitative Impact Study. The resulting difference will be appropriately tax effected and scaled to arrive at the C3 charge. This use of the AG43 calculation will eliminate the need for a separate C3 Phase 2 calculation;

c. The eEstablishment The Aaddition of a feedback loop that continuously reviews granular industry data as a means to modify the C3 Phase II requirements in the future to ensure the framework continues to operate as redesigned. This will require additional granular data to be submitted to the NAIC and analyzed and presented to a group of regulators.

3. The Framework will result in changes to SSAP No. 86 that are would be designed to reduce the accounting

mismatch that exists between the value of the hedge and the value of the hedged item (the variable annuity liability). so thatIt is anticipated that the changes will be constructed such that as market conditions change,

9


gains or losses that are not inconsistent with the changes in the economic value of the hedges are not created within the financial statements. In addition, requirements for increased public disclosure on variable annuity risks will be considered for added to the SSAPs, and data captured in the notes to the financial statements.

4. The Framework will result in the development of narrowly defined statutory language that states may use in to removing removethe limitations that may exist within their investment statutes that may otherwise limit the extent of to which hedges an insurer may use hedges in their its risk management.

***********

Exhibit 2




Variable Annuities Issues (E) Working Group • Develop guidance in 2016 that represents narrowly defined statutory language that states may use in removing

the limitations that may exist within their investment statutes that may otherwise limit the extent to which an insurer may use hedges in its risk management. —Essential

• Redesign the annual statement disclosures applicable to variable annuities to add more meaningful information about the valuation of the guaranteed liabilities with an effective date of December 31, 2017 or earlier. The objective of the improved disclosure should be to provide all stakeholders (e.g., regulators, consumers, and investors) with more transparency and additional insights into how the contractual obligations could change over time as well as the insurance company’s ability to manage those obligations. The disclosure information must be provided in a prescribed, easy-to-understand, format including key risk driver assumptions (e.g., interest rates, lapse rates, and benefit utilization) and the impact of “shocks” to the key risk driver assumptions (e.g., benefit utilization becomes more efficient, interest rates drop by 1%, etc.). Upon development, refer to the Statutory Accounting Principles (E) Working Group and Blanks (E) Working Group for finalization and incorporation into NAIC publications. —Essential

• Evaluate the results of the Variable Annuities Framework Quantitative Impact Study and develop recommendations that will reduce the level and volatility of the non-economic aspect of current reserve and RBC requirements.




• Consider whether current or future changes to reserves resulting from implementation of the Variable Annuities Framework will be reported in the Annual Statement as a “Change in basis.” —Essential

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annuities, finalize a data captured note with an effective date of December 31, 2017 or earlier —Essential

*********** G:\FRS\DATA\Staff\DJD\Variable Annuities\Calls & Meetings\2015\Oct 2\Variable Annuities-Framework for Changes.docx

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the industry’s development and utilization of captive reinsurance transactions with regard to variable annuity business. In general, Tthe general conclusion is that the utilization of these transactions has been driven by aspects of the existing statutory requirements which areare generally considered to be introduce substantial non-economic balance sheet volatility and/or , orare structured in a manner that does not promote strong risk management.

• Unlike the NAICs XXX/AXXX Reinsurance Framework, which was adopted to apply prospectively, this framework Framework for changes Change is intended to make changes that apply retrospectively consistent with the fact that the AG43 valuation methodology is currently applied retroactively to January 1, 1981. This is because XXX term and /AXXX UL products are both subject to life insurance non-forfeiture and valuation laws whose valuation and non-forfeiture interest rates change on a calendar issue year by calendar issue year basis and are locked in at policy issue and remain locked in for the life of the contract. In contrast, variable annuities with and without guaranteed benefits are exempt from the annuity non-forfeiture law. In addition, the reserve valuations for variable annuities with and without guarantees are defined by AG43 which is partly based on a stochastic methodology and are is not based on a calendar year valuation interest rates that are locked in at issue,. Rrather, these rates are generated and are unlocked at each valuation. The AG43 valuation methodology is currently applied retroactively back to January 1, 1981.


1) to encourage strong risk management within the insurance companiesy; 2) to remove the need to reinsure variable annuity business to captive reinsurers. With respect to the later, the Working Group would recommend that once these changes, or the majority of these changes are effective (anticipated effective date of 1/1/17), domestic regulators of insurers ceding variable annuity to captive reinsurers should request their company to recapture the business and for the group to dissolve the captive reinsurer.


implemented through specific requirements on the reinsurance contract, but rather focuses on the requirements of impacting the direct writer of the contract. In summary, those changes are will be proposed to the following areas:

o Actuarial Guideline 43; o Risk-Based Capital Requirements (C3 Phase II); o Allowing Hhedge accounting treatment under SSAP No. 86 for certain limited derivative contracts

that otherwise do not meet hedge effectiveness requirements;

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o Allowing states a consistent mechanism to utilize hedges without any size limitations that may otherwise apply in investment statutes.Narrowly defined statutory language that states may use to remove limitations that may exist within their investment statutes that may otherwise limit the extent to which an insurer may use hedges in its risk management.

14


Exhibit 1

Exhibit 1— Variable Annuities-Framework for Change 1. The Framework will result in consider changes to AG 43 that will be designedhave the potential to result in a

less reduced and less volatile non-economic reserve requirement for variable annuities. These changes are expected to may include, but are not limited to, the following:


b. In the Standard Scenario calculation: Introduce more granular benefit-specific prescriptions of policyholder behavior assumptions in the Standard Scenario calculation. Separately, the prescribed set of assumptions is to be calibrated to adverse, yet plausible, levels informed by credible industry experience;

c. Additionally, Calculate the Standard Scenario calculation will be conducted on a portfolio as opposed to seriatim basis with the existing seriatim Standard Scenario calculation made available as a disclosure item;

d. Reflect hHedging reflection in the Adjusted CTE 70 calculation to allow for the reduction of gross market risk positions for hedge instruments prior to expiration of existing hedges rather than a simple hold-to-maturity treatment;


f. The addition ofAdd a feedback loop that continuously reviews granular industry data as a means to modify the AG in the future to ensure the framework continues to operate as redesigned. This will require additional granular data to be submitted to the NAIC and analyzed and presented to a group of regulators.

2. The Framework will result in consider changes to the Life Risk Based Capital formula that includes material

expected changes to C3 Phase II. Similar to changes to AG 43, these will be designed to result in less reduced and less volatile non-economic capital requirements on variable annuities. These changes that are expected may include, but are not limited to the following:

a. Complete Eeliminatione of the standard scenario; b. Alignment of the total asset requirement (TAR) and the AG 43 reserve requirements through use of the

AG43 stochastic CTE calculation as the basis for a difference calculation for the direct determination of the C3 charge and the indirect determination to Total Assets Required as the sum of reserves plus the newly defined C3 charge. The C3 charge will be the difference between two AG43 CTE calculations at different confidence levels. The individual CTE calculations will apply an effectiveness factor for the reflection of a CDHS that is calibrated to be consistent with the error factors of the C3 Phase 2 framework. The confidence levels will be determined in the calibration phase during a forthcoming Quantitative Impact Study. The resulting difference will be appropriately tax effected and scaled to arrive at the C3 charge. This use of the AG43 calculation will eliminate the need for a separate C3 Phase 2 calculation;

c. The Aaddition of a feedback loop that continuously reviews granular industry data as a means to modify the C3 Phase II in the future to ensure the framework continues to operate as redesigned. This will require additional granular data to be submitted to the NAIC and analyzed and presented to a group of regulators.

3. The Framework will result in consider changes to SSAP No. 86 that are designed to reduce the accounting

mismatch that exists between the value of the hedge and the value of the hedged item (the variable annuity liability). so thatIt is anticipated that the changes will be constructed such that as market conditions change, gains or losses that are not inconsistent with the changes in the economic value of the hedges are not created within the financial statements. In addition, requirements for increased public disclosure on variable annuity risks will be added to the SSAPs, and data captured in the notes to the financial statements.

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4. The Framework will result in consider the development of narrowly defined statutory language that states may use in to removing removethe limitations that may exist within their investment statutes that may otherwise limit the extent of to which hedges an insurer may use hedges in their its risk management.

***********

Exhibit 2




Variable Annuities Issues (E) Working Group • Develop guidance in 2016 that represents narrowly defined statutory language that states may use in removing

the limitations that may exist within their investment statutes that may otherwise limit the extent to which an insurer may use hedges in its risk management. —Essential

• Redesign the annual statement disclosures applicable to variable annuities to add more meaningful information about the valuation of the guaranteed liabilities with an effective date of December 31, 2017 or earlier. The objective of the improved disclosure should be to provide all stakeholders (e.g., regulators, consumers, and investors) with more transparency and additional insights into how the contractual obligations could change over time as well as the insurance company’s ability to manage those obligations. The disclosure information must be provided in a prescribed, easy-to-understand, format including key risk driver assumptions (e.g., interest rates, lapse rates, and benefit utilization) and the impact of “shocks” to the key risk driver assumptions (e.g., benefit utilization becomes more efficient, interest rates drop by 1%, etc.). Upon development, refer to the Statutory Accounting Principles (E) Working Group and Blanks (E) Working Group for finalization and incorporation into NAIC publications. —Essential

• Evaluate the results of the Oliver Wyman Impact Study and develop recommendations that will reduce the level and volatility of the non-economic aspect of current reserve and RBC requirements.





annuities, finalize a data captured note with an effective date of December 31, 2017 or earlier —Essential

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Variable Annuities Issues (E) Working Group • Develop a model guideline in 2016 that represents narrowly defined statutory language that states may use in

removing the limitations that may exist within their investment statutes that may otherwise limit the extent of hedges an insurer may use in their risk management. —Essential

• Redesign the annual statement disclosures on variable annuities to add more meaningful information about the valuation of the guaranteed liabilities with an effective date of December 31, 2017 or earlier. The objective of the improved disclosure should be to provide all stakeholders (e.g., regulators, consumers, and investors) with more transparency and additional insights into how the contractual obligations could change over time as well as the insurance company’s ability to both manage those obligations. The disclosure information must be provided in a prescribed, easy-to-understand, format including key risk driver assumptions (e.g., interest rates, lapse rates, and benefit utilization) and the impact of “shocks” to the key risk driver assumptions (e.g., benefit utilization becomes more efficient, interest rates drop by 1%, etc.). Upon development, refer to the Statutory Accounting Principles (E) Working Group and Blanks (E) Working Group for finalization and incorporation into NAIC publications. —Essential

***********


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From: Rarus, Andrew [mailto:[email protected]] Sent: Friday, October 16, 2015 11:12 AM To: Daveline, Dan Cc: Zadzilko, Debra; Belfi, Kathryn; Wade, Katharine; Jakielo, James Subject: Variable Annuities Framework for Change - Bullet 3, Page 1 Dan, As we previously discussed, Connecticut formally recommends a revision to bullet 3 on page 1 of the “Variable Annuities-Framework for Change” document (attached). Bullet 3, page 1 currently reads as follows:

The Working Group was supportive of the numerous changes you see listed in the Framework for two reasons: 1) to encourage strong risk management within the insurance company; 2) to remove the need to reinsure variable annuity business to captive reinsurers. With respect to the later, the Working Group would recommend that once these changes, or the majority of these changes are effective (anticipated effective date of 1/1/17), domestic regulators of insurers ceding variable annuity to captive reinsurers should request their company to recapture the business and for the group to dissolve the captive reinsurer

Connecticut suggests the following edits to this bullet:

The Working Group was supportive of the numerous changes you see listed in the Framework for two reasons: 1) to encourage strong risk management within the insurance companies; 2) to remove the need to reinsure variable annuity business to captive reinsurers. With respect to the later, the Working Group would recommend anticipates that once these changes, or the majority of these changes are effective (anticipated effective date of 1/1/17), domestic regulators of insurers ceding variable annuity liabilities to captive reinsurers should request their company to will recapture the business and for the group to dissolve the captive reinsurer.

Please let me know if you have any questions. Thanks, Andy

Andrew J. Rarus Chief Actuary - Life & Health | State of Connecticut Insurance Department P.O. Box 816 | Hartford, CT 06142-0816 | 860.297.3943 | Fax: 860.297.3978 | [email protected]

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October 16, 2015

Commissioner Nick Gerhart

Chair, NAIC Variable Annuities Issues (E) Working Group

Via email: [email protected]; [email protected]

Re: Exposure – Variable Annuities Framework for Change

Dear Commissioner Gerhart:

Northwestern Mutual appreciates this opportunity to offer comments on the exposure of the

Variable Annuities Issues (E) Working Group regarding potential changes to the statutory

accounting, reserving, and capital standards surrounding variable annuities. We support the

Framework in general, which appropriately attempts to address the statutory issues leading to

variable annuity (VA) captives use. As we’ve consistently stated, Northwestern Mutual strongly

supports uniformity and transparency for critical regulatory issues, such as reserving and capital

requirements. We feel this proposal will bring us closer to those objectives.

The Framework is intended to make changes that apply retrospectively, and further indicates:

“…the Working Group would recommend that once these changes, or the majority of

these changes are effective (anticipated effective date of 1/1/17), domestic regulators of

insurers ceding variable annuity to captive reinsurers should request their company to

recapture the business and for the group to dissolve the captive reinsurer.”

We strongly support retrospective application and the unwinding of existing VA captive

transactions. Robust mechanisms should be developed to enforce unwinding and to prevent new

captive arrangements. We would caution against an approach that could be seen to condone the

continuing use of VA captives if it is perceived that the feedback loops outlined in the

Framework are untimely or ineffective, i.e. an implication that VA captives are acceptable until

the NAIC fixes each and every perceived imperfection in the reserving and capital rules.

If you would like to discuss this letter with us, please let us know.

Sincerely,

David R. Remstad

Senior Vice President & Chief Actuary

David R. Remstad, FSA Senior Vice President & Chief Actuary 720 East Wisconsin Avenue 720 East Wisconsin Avenue Milwaukee, WI 53202-4797 414 665 2568 office [email protected]

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mailto:[email protected]


John Bruins Vice President & Senior Actuary 202.624.2169 October 16, 2015 The Honorable Nick Gerhart Chair – Variable Annuities Issues (E) Working Group National Association of Insurance Commissioners Re Exposed Variable Annuities - Framework for Change Dear Commissioner Gerhart; The ACLI1 submits the following comments regarding the Variable Annuities - Framework for Change (Framework) on behalf of our member companies. ACLI members appreciate the direction set by the Working Group, and generally agree with the preliminary findings and recommendations that Oliver Wyman presented. Those findings focus on the misalignment of the regulatory requirements both internally and with the economic realities resulting in volatile and incongruous changes to reserves and capital requirements, and inconsistent risk management incentives. ACLI members generally support the concepts outlined in the Framework to address these issues, and offer the following comments to help refine it. As drafted, the Framework implies that the proposed changes will be implemented. We suggest that the Framework identify the concerns to be addressed, and offer preliminary solutions subject to confirmation. A number of the issues still need to be tested, hence the need for a Quantitative Impact Study (QIS). The Framework should explicitly recognize the plans to conduct a QIS and include a charge to accomplish it. The Framework should also recognize that not all possible solutions may have been identified, and therefore include a statement that other items, e.g., revenue sharing or potential statutory tax implications, may be explored in the QIS as well. We have provided suggested wording in the draft Framework to address these issues, including a new item 5 in Exhibit 1 to identify the QIS as a core part of the Framework and a suggested charge for the VAIWG to oversee the QIS (see Attachment). The Framework identifies calibration of interest rates as an enhancement to the requirements. We agree that the calibration of scenarios should be reviewed, but are concerned that the time required for this element could preclude it from being part of a QIS. Given the importance of this element to the end result, testing of any calibration changes is vitally important. The Framework recognizes the significant role of hedge programs and other risk mitigation techniques by multiple references throughout the Framework document. Treatment of these hedges in the reserve calculation, in the RBC calculation, and in the accounting need to be considered holistically and consistently, and the impacts evaluated in the QIS.

1 The American Council of Life Insurers (ACLI) is a Washington, D.C.-based trade association with 284 member companies operating in the United States and abroad. ACLI advocates in federal, state, and international forums for public policy that supports the industry marketplace and the 75 million American families that rely on life insurers’ products for financial and retirement security. ACLI members offer life insurance, annuities, retirement plans, long-term care and disability income insurance, and reinsurance, representing more than 90 percent of industry assets and premiums. Learn more at www.acli.com.

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http://www.acli.com/

We support the elimination of the standard scenario in the RBC calculations. Conceptually, we support the change to C3P2 for RBC to be an add-on to reported reserves rather than the difference between the reserve and another calculation, so long as the revisions account for any excess of standard scenario reserves over the stochastic CTE 70 amounts. Companies agree that more granular prescribed assumptions for lapse and utilization in the reserve standard scenario might be useful and appropriate, so long as they are not overly granular and thus create unnecessary complexity. New assumptions should be based on observed experience. Additional granularity makes sense when the differentiation is meaningful. Introducing aggregation in the standard scenario for reserves should also be a substantial improvement. Combined, these two changes should help the standard scenario to produce reasonable results more of the time. If the standard scenario is computed on an aggregate basis, reserves will still need to be established at a policy level by allocation of aggregate values. This will be needed both for allocation purposes in the event of a receivership situation and to coordinate with the need to have policy level values for tax. Industry expects to provide recommendations for implementation in order to facilitate coordination with tax requirements as proposed changes approach finalization. We support disclosure that is relevant, meaningful, and informative so that regulator can effectively oversee business. Disclosure requirements should provide useful information to regulators, be flexible so that adjustments can be made to reflect different company circumstances, and balance the benefit with the cost. In addition, proprietary company information should not be subject to public disclosure requirements. We support the idea of a feedback loop as that will help to keep assumptions grounded in experience. We recommend that an efficient process for potential future changes be developed as part of the Framework implementation. The Framework anticipates that changes will apply retroactively to inforce business. We request that a charge be given to Statutory Accounting Principles Working Group to consider how the impact of these changes should be accounted for at the time of implementation, both the direct changes from this Framework and future potential updates to assumptions. In addition, we note that the rationale for the retroactive application contains two incorrect statements, namely:

• The Framework implies that variable annuities are exempt from nonforfeiture. VA’s are subject to Nonforfeiture requirements, which are defined in the Variable Annuities Model Regulation (Model # 250).

• The Framework says that AG-43 does not rely on statutory valuation interest rates that are locked in at issue. AG-43 has a dual calculation with the standard scenario amount determined using the statutory valuation interest rates defined at issue plus a stochastic calculation based on current rates.

We look forward to working with you to resolve these issues, thus allowing better management and accounting measurement of the variable annuities. Attached is a copy of the Framework with suggested changes consistent with the above comments.

cc Dan Daveline, NAIC

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Attachment Page 3



Simultaneous with the formation and charge given to this Working Group, the NAIC Executive Committee and Internal Administration (EX1) Subcommittee established resources to allow the NAIC to engage a consultant to assist the Working Group in meeting this charge. Oliver Wyman was engaged by the NAIC to fulfill this role, and in September, delivered a report of observations and recommendations which was discussed during an interim meeting of the Variable Annuities Issues (E) Working Group on Sept. 10. During that meeting, the Working Group and members of the industry provided feedback on the recommendations which was used to develop this report. The report has since been discussed and adopted. The Financial Condition (E) Committee is asked to adopt this report, including adoption of the Variable Annuities-Framework for Change, in concept (Exhibit 1) and the charges for NAIC groups (Exhibit 2). Variable Annuities-Framework for Change • The Variable Annuities Framework for Change (Framework) is intended to address concerns

that have led to the industry’s development and utilization of captive reinsurance transactions with regard to variable annuity business. In general, tThe general conclusion is that the utilization of these transactions has been driven by the existing statutory requirements which are generally considered to be non-economic, or structured in a manner that does not promote strong risk management, and which create volatile and incongruous changes in reserves and RBC requirements..

• Unlike the NAICs XXX/AXXX Reinsurance Framework, which was adopted to apply prospectively, this framework for changes is intended to make changes that apply retrospectively. This is because XXX/AXXX products are both subject to life insurance non-forfeiture and valuation laws whose valuation and non-forfeiture interest rates change on a calendar issue year by calendar issue year basis and are locked in at policy issue and remain locked in for the life of the contract. In contrast, variable annuities with and without guaranteed benefits are subject to nonforfeiture requirements that do not lock in interest rates at issue due to the nature of the benefit which are provided based on the values of the underlying assets.exempt from the annuity non-forfeiture law. In addition, the reserve valuations for variable annuities with and without guarantees are defined by AG43 useswhich incorporates a dual calculation of a standard scenario that utilizes statutory interest rates which are locked in at issue plus a which is based on a stochastic methodology and are not based on a calendar year valuation interest rates that are locked in at issue, rather theseusing rates which are generated and are unlocked at each valuation. The AG43 valuation methodology is currently applied retroactively back to to contracts issued since January 1, 1981.

• The Working Group was supportive of the numerous changes you see listed in the

Framework for two reasons: 1) to encourage strong risk management within the insurance company; 2) to remove the need to reinsure variable annuity business to captive reinsurers.

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With respect to the latter, the Working Group would recommend that once these changes, or the majority of these changes are effective (anticipated effective date of 1/1/17), domestic regulators of insurers ceding variable annuity to captive reinsurers should request their company to recapture the business and for the group to dissolve the captive reinsurer.

• Unlike XXX/AXXX, this Framework is expected to impacts all insurers writing the specified line

of business, and is not implemented through specific requirements on the reinsurance contract, but rather on the requirements of the direct writer of the contract. In summary, those changes are expected to the following areas:

o Actuarial Guideline 43; o Risk-Based Capital Requirements (C3 Phase II); o Allowing hedge accounting treatment under SSAP No. 86 for certain limited

derivative contracts that otherwise do not meet hedge effectiveness requirements;

o Allowing states a consistent mechanism to utilize hedges without any size limitations that may otherwise apply in investment statutes.

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Exhibit 1

Exhibit 1— Variable Annuities-Framework for Change 1. The Framework is intended towill result in changes to AG 43 that will be designed to result in

a less non-economic reserve requirement for variable annuities that areis better aligned with the business economics while providing sufficient amounts to cover moderately adverse circumstances. moderately . The changes identified and to be tested in a Quantitative Impact Study (QIS) are expected to include the following:


b. In the Standard Scenario calculation: Introduce more granular benefit-specific prescriptions of policyholder behavior assumptions. Separately, the prescribed set of assumptions is to be calibrated to moderately adverse, yet plausible levels informed by credible industry experience;

c. Additionally, the Standard Scenario calculation will be conducted on a portfolio as opposed to seriatim basis with the existing seriatim Standard Scenario calculation made available as a disclosure item;

d. Hedging reflection in the Adjusted CTE 70 calculation to allow for the reduction of gross market risk positions for hedge instruments prior to expiration of existing hedges rather than a simple hold-to-maturity treatment;


f. The additionestablishment of a feedback loop that continuously reviews granular industry data as a meansbasis to modify the AG AG 43reserve requirements in the future to ensure the framework continues to operate as redesigned. This will require additional granular data to be submitted to the NAIC and analyzed and presented to a group of regulators.

2. The Framework is intended towill result in changes to the Life Risk Based Capital formula

that includess material expected changes to C3 Phase II. Similar to changes to AG 43, these will be designed to result in less non-economic capital requirements on variable annuities that are better aligned with the business economics and statutory reserve calculations while remaining consistent with Risk Based Capital standards.moderately conservative. The changes identified and to be tested in a Quantitative Impact Study that are expected include the following:

a. Complete elimination of the standard scenario; b. Alignment of the total asset requirement (TAR) and the AG 43 reserve requirements

through use of the AG43 stochastic CTE calculation as the basis for a difference calculation for the direct determination of the C3 charge and the indirect determination to Total Assets Required as the sum of reserves plus the newly defined C3 charge. The C3 charge will be the difference between two AG43 CTE calculations at different confidence levels. The individual CTE calculations will apply an effectiveness factor for the reflection of a CDHS that is calibrated to be consistent with the error factors of the C3 Phase 2 framework. The confidence levels will be determined in the calibration phase during athe forthcoming Quantitative Impact Study. The resulting difference will be appropriately tax effected and scaled to arrive at the C3 charge. This use of the AG43 calculation will eliminate the need for a separate C3 Phase 2 calculation;

27

c. The additionestablishment of a feedback loop that continuously reviews granular industry data as a means to modify the C3 Phase II requirements in the future to ensure the framework continues to operate as redesigned. This will require additional granular data to be submitted to the NAIC and analyzed and presented to a group of regulators.

3. The Framework will considerresult in changes to SSAP No. 86 that arewould be designed to

reduce the accounting mismatch that exists between the value of the hedge and the value of the hedged item (the variable annuity liability) so that as market conditions change, gains or losses that are not consistent with the economic value of the hedges are not created within the financial statements. In addition, requirements for increased public disclosure on variable annuity risks will be addedconsidered for to the SSAPs, and data captured in the notes to the financial statements.

4. The Framework willis intended to result in the development of narrowly defined statutory language that states maycould use in removing the limitations that may exist within their investment statutes that may otherwise limit the extent of hedges an insurer may use in their risk management.

4.5. It is planned that all of the potential changes outlined in 1. through 4. above will be tested in a Quantitative Impact Study. Individual companies will need to test the proposed changes in a coordinated manner with the results reported and consolidated for regulatory review. Design of the study will need careful attention, with input from regulators, consultants and industry in order to create a well designed analysis that will provide the necessary information in a timely and efficient manner.

***********

Exhibit 2


C-3 Phase II/AG 43 (E/A) Subgroup of the Life Risk Based Capital Working Group • The joint C-3 Phase II/AG 43 (E/A) Subgroup of the Life Risk-Based Capital (E) Working Group

and Life Actuarial (A) Task Force will develop and recommend changes to C3 Phase 2 and AG 43 for 2017 adoption that implement the Variable Annuities Framework. —Essential

Statutory Accounting Principles (E) Working Group • Develop and adopt changes to SSAP No. 86-Derivatives, with an effective date of January 1,

2017 or earlier, which allow hedge accounting treatment under SSAP No. 86 for certain limited derivative contracts (e.g. interest rate hedges with counterintuitive effects) that otherwise do not meet hedge effectiveness requirements. In adopting such an allowance, consider if the requirement to meet hedge effectiveness can be replaced by some other information that demonstrates strong risk management is in place over the identified hedges. —Essential


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• Consider whether current or future changes to reserves resulting from implementation of this Framework will be reported in the Annual Statement as a ‘Change in Basis’. - Essential

Blanks (E) Working Group • Based upon the disclosure developed by the Variable Annuities Issues (E) Working Group on

variable annuities, finalize a data captured note with an effective date of December 31, 2017 or earlier —Essential

Variable Annuities Issues (E) Working Group • Develop a model guideline in 2016 that represents narrowly defined statutory language that

states may use in removing the limitations that may exist within their investment statutes that may otherwise limit the extent of hedges an insurer may use in their risk management. —Essential

• Oversee a Quantitative Impact Study designed to evaluate the financial impacts of the proposed changes, including their interactions. This study may include evaluation of additional elements such as Revenue Sharing provisions or potential statutory tax implications. - Essential

• Redesign the annual statement disclosures on variable annuities to add more meaningful

information about the valuation of the guaranteed liabilities with an effective date of December 31, 2017 or earlier. The objective of the improved disclosure should be to provide all stakeholders (e.g., regulators, consumers, and investors) with more transparency and additional insights into how the contractual obligations could change over time as well as the insurance company’s ability to both manage those obligations. The disclosure information must be provided in a prescribed, easy-to-understand, format including key risk driver assumptions (e.g., interest rates, lapse rates, and benefit utilization) and the impact of “shocks” to the key risk driver assumptions (e.g., benefit utilization becomes more efficient, interest rates drop by 1%, etc.). Upon development, refer to the Statutory Accounting Principles (E) Working Group and Blanks (E) Working Group for finalization and incorporation into NAIC publications. —Essential

***********


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1

BY E-MAIL

October 16, 2015

Commissioner Nick Gerhart

Chair, NAIC Variable Annuities Issues (E) Working Group

Attention: Dan Daveline ([email protected])

Todd Sells ([email protected])

Re: Exposure – Variable Annuities Framework for Change and Proposed Charges to

NAIC Groups

Dear Commissioner Gerhart,

New York Life offers the following comments on the Variable Annuities Framework for Change

and the related proposed charges to NAIC groups (the Framework).

We appreciate the efforts of the Variable Annuities Issues (E) Working Group (the Working

Group), with the assistance of Oliver Wyman, to evaluate and consider changes to the statutory

accounting, reserving, and capital standards surrounding variable annuities. We support the

direction laid out by the Framework and we look forward to working with regulators and other

stakeholders as the technical details of the Framework are explored further in the coming

months.

While we support the Framework and the objectives of the Working Group in general, a critical

end goal of this effort must be the elimination of non-uniform variable annuity accounting,

reserving and capital standards enabled today through the use of captive reinsurance

transactions. We encourage the Working Group to make this end goal explicit. As Oliver

Wyman noted in their September 10, 2015 preliminary report, through the use of variable

annuity captives, “resulting accounting standards differ widely,” and “a multitude of reserving

standards are applied that represent modifications of GAAP FAS/SOP, IFRS, or AG43.”1 This

lack of uniformity threatens the viability of the state-based system of insurance regulation and

must cease once the work outlined in the Framework is complete. The development and

implementation of the Framework is inadequate unless this goal is achieved.

As such, we suggest the following three changes to the Framework documents.

First, we suggest revising the following bullet point in the Report to the Financial Condition (E)

Committee that appears in the first page of the document (suggested additions double-

underscored):

The Working Group was supportive of the numerous changes you see listed in the

Framework for two reasons: 1) to encourage strong risk management within the

1 Oliver Wyman. “NAIC VA Captive Study Preliminary Findings and Conclusions”. September 10, 2015. Slide 8.

31

2

insurance company; 2) to remove the need to reinsure variable annuity business to

captive reinsurers. With respect to the later, the Working Group would recommend that

once these changes, or the majority of these changes are effective (anticipated effective

date of 1/1/17), (a) domestic regulators of insurers ceding variable annuity to captive

reinsurers should request their company to recapture the business and for the group to

dissolve the captive reinsurer, and (b) the Reinsurance (E) Task Force should revise the

Credit for Reinsurance Model Law and Regulation to ensure compliance with the

variable annuity statutory reserving and risk-based capital standards in a manner similar

to the compliance mechanism under the NAIC’s XXX/AXXX Captive Reinsurance

Framework. We recommend revising the credit for reinsurance models now, while they

are currently open and under discussion in the context of the XXX/AXXX Captive

Reinsurance Framework, rather than re-opening them at a later date.

Second, we suggest that a fifth item be added to Exhibit 1 of the document:

5. The Framework will result in revisions to the Credit for Reinsurance Model Law and

Regulation, similar to those made under the NAIC’s XXX/AXXX Captive

Reinsurance Framework, to ensure compliance with statutory reserving and risk-

based capital standards for any variable annuity policies ceded to a captive reinsurer

that are not recaptured once these changes, or the majority of these changes, are

effective.

Third, we suggest that the following charge be added to Exhibit 2 of the document:

Reinsurance (E) Task Force

Revise the Credit for Reinsurance Model Regulation in a manner similar to the

NAIC’s XXX/AXXX Captive Reinsurance Framework such that, in order for a

ceding company to receive reserve credit for variable annuity policies ceded to a

captive reinsurer, (1) the policies must be supported by assets of appropriate quality

at the level of statutory reserves, (2) risk-based capital must be calculated in

accordance with NAIC standards, and (3) the captive must produce robust public

disclosure including, but not limited to, statutory reserves, the level and nature of

assets supporting the statutory reserves, and risk-based capital.

The NAIC’s XXX/AXXX Captive Reinsurance Framework provides a valuable model that

regulators should leverage to bring greater uniformity to variable annuity accounting, reserving

and capital standards. Although variable annuity captives are used for purposes that differ from

XXX and AXXX life insurer captives, the structure of the XXX/AXXX Framework can be

adapted readily to suit this different context. Among other things, a framework of this kind

would not necessarily bar the use of variable annuity captives once the underlying accounting,

reserving and capital standards have been modified. Instead, if deemed appropriate by

regulators, captive use could conceivably continue for purposes other than avoidance of the

underlying standards, including, for example, for the purpose of achieving benefits of scale that

come from consolidating hedging operations in a single entity. With a framework of this kind in

place, any captives that survive reform of the underlying standards would be regulated in a

robust, nationally consistent manner.

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3

In addition, we strongly suggest that the NAIC utilize a similar process as it used to develop and

adopt the XXX/AXXX Captive Reinsurance Framework. In particular, we highly recommend

that the NAIC retain a consulting firm like Rector & Associates to shepherd all proposed

changes through the NAIC process.

We are grateful for your time and attention to our comments. If you would like to discuss this

letter with us, please let us know.

Sincerely,

George Nichols, III

Senior Vice President in Charge of the Office of Governmental Affairs

New York Life Insurance Company

Joel M. Steinberg

Senior Vice President

Chief Actuary & Chief Risk Officer

New York Life Insurance Company

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From: Fenwick, Amanda (DFS) [mailto:[email protected]] Sent: Friday, October 16, 2015 10:45 AM To: Daveline, Dan Cc: Carmello, William; Cebula, Michael; Hazzard, Dwight J (DFS); Leifer, Daniel; Lochner, David J (DFS) Subject: NAIC VAIWG-Please submit comments by COB Friday, October 16th Below are NY’s comments on the VAIWGs report to the Financial Condition (E) Committee regarding a framework to remove the incentive to use captives. Overall we are not comfortable with the direction the working group is heading. The report focuses on the use of captives but not the appropriateness of the reserves/capital. To revise the requirements without due consideration of level of reserves and capital would be inappropriate and lead to inadequate levels. Alternatively, the use of captives could be eliminated by no longer allowing captive transactions as we have done in NY. The primary objective in establishing reserves and capital should be to ensure companies can make good on their promises to policyholders. New York submitted amendment proposal forms several years ago to address the level of reserves and capital which have not yet been discussed. We feel that these proposals should be discussed and vetted prior to moving forward with this report. That being said we have the following specific comments on the report and the attached Exhibit. 1. The report seems to suggest that the Working Group reached a consensus for the suggested changes.

Please note New York is not in agreement with these changes. As stated above the proposal does not appear to consider the resulting level of reserves and capital.

2. Throughout the Exhibit, it states that the Framework “will result” in changes. We feel that language like this

should be revised to state that the Framework “should consider”. The current suggestions to address the use of captives have not been thoroughly tested or reviewed to the extent that they should be considered final.

3. The report states that the “Standard Scenario calculation will be conducted on a portfolio as opposed to seriatim basis with the existing seriatim Standard Scenario calculation made available as a disclosure item”. We do not support an aggregate calculation for the Standard Scenario. AG43/VACRVM was meant to be in the spirit of CARVM. Since CARVM is a policy-level calculation, the Standard Scenario floor should be aligned with this principle.

4. We disagree with the idea of eilimating the standard scenario for C3 Phase II. We feel that there is too

much pressure on companies to lower capital and having an objective floor for both reserves and capital is vital .

5. We feel that the change to determine the C3 Phase II charge to be the stated difference calcultion may

introduce unintended conseqences into the formula. For instance, certain assumptions could be made that purposefully move the two CTE amounts closer and effectively eliminate the charge. The group may want to consider the difference between the maximum of the high CTE and the Standard Scenario less the lower CTE amount.

6. The Exhibit states that the Framework will result in changes to SSAP No. 86 . However it is not clear what

form of hedges (e.g. equity or interest) would be accounted for on an amortized cost basis. Clarification on this item would be helfpul.

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Amanda Fenwick, FSA Assistant Chief Life Actuary NYS Department of Financial Services Insurance Division Life Bureau (518) 474-7929

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1850 M Street NW Suite 300 Washington, DC 20036 Telephone 202 223 8196 Facsimile 202 872 1948 www.actuary.org

1

October 16, 2015

The Honorable Nick Gerhart

Chair, Variable Annuities Issues (E) Working Group

National Association of Insurance Commissioners

Dear Commissioner Gerhart:

The American Academy of Actuaries’1 AG 43/C-3 Phase II Work Group appreciates the

opportunity to provide comments on the October 2, 2015, Variable Annuities Framework for

Change (Framework) exposed by the NAIC Variable Annuities Issues (E) Working Group

(VAIWG).

We have been monitoring the work of the NAIC C-3 Phase II/AG 43 (E/A) Subgroup and

providing material and important input since early 2012. We have issued several reports

discussing many of the issues covered in the Framework; we ask that the VAIWG review those

materials as part of its work. Other Academy work groups have been actively involved in reserve

and risk-based capital requirements for variable annuities since 2001; these work groups have

been instrumental in the development of Actuarial Guideline XLIII (AG 43) and C-3 Phase II

(C3P2). We hope the VAIWG will continue to view the Academy as central to the development

and implementation of the Framework.

The Framework, as exposed, has the tone of a completed effort, with the Quantitative Impact

Study (QIS) serving only to validate the Framework. While we support enhancements to the

reserve and capital requirements for variable annuities, we believe an industry impact study

(which we strongly support) of the exposed framework is premature at this time. We believe that

more work is needed to determine whether the exposed framework will achieve the objectives

stated by the VAIWG.

We also believe the January 1, 2017, effective date is too aggressive. This effective date will

make it very difficult to test any proposed changes or conduct a suitable QIS. While a target date

is useful, we believe January 1, 2018 is more realistic. Because AG 43 and C3P2 apply to inforce

contracts, the potential impact of proposed changes could be in the billions of dollars. Therefore,

it is critical that viable alternatives to the ideas in the current Framework are tested in advance. It

would be difficult to have vetted solutions in place by January 2017.

1 The American Academy of Actuaries is an 18,500+ member professional association whose mission is to serve the

public and the U.S. actuarial profession. The Academy assists public policymakers on all levels by providing

leadership, objective expertise, and actuarial advice on risk and financial security issues. The Academy also sets

qualification, practice, and professionalism standards for actuaries in the United States.

37


2

We do think it may make sense to consider identifying a phased approach, where a subset of the

proposed changes that could be made by January 2017 are identified. These changes would move

toward a final solution with a defined timetable for completely implementing the changes. As

noted above, any such changes should undergo an impact study before they are implemented.

In addition, we suggest that the ideas being discussed be first tested on simple products. This

testing should be performed before a full industry impact study is started. If the testing does not

produce the intended results for simple products, the Framework will likely not achieve the

desired objectives when applied to more complex real-world products.

We have offered specific comments to the NAIC’s C-3 Phase II/AG 43 (E/A) Subgroup

suggesting revisions to some of the features in AG 43 and C3P2 that have created unintuitive

results. Our December 10, 2012, letter2 discusses several of these suggestions. While many of

our suggestions have been addressed in the exposed Framework, we believe there should be

opportunity to discuss other ideas and refine existing proposals.

We offer specific comments on the exposed Framework in the attached appendix and also offer

these suggestions:

1. Use the same scenarios and assumptions for statutory reserves and risk-based capital

(RBC). The only difference should be tax treatment and confidence level.

2. Modify the treatment of hedging in the requirements to address counterintuitive

results. Doing so should include eliminating the Clearly Defined Hedging Strategy

(CDHS) concept in the reserve and RBC calculations, requiring hedging strategies to be

modeled, and supporting the modeling of hedging strategies with a combination of actuarial

judgment, disclosure, margins, and guidance that provides checks and balances.

3. Evaluate the calibration criteria for equity scenarios to determine whether updates

are needed. This evaluation should include consideration of a more dynamic (i.e., state-

dependent) approach.

4. Consider adding calibration criteria for interest rate scenario generators. This effort

should include a review of the interest rate calibration criteria recommended by the

Academy’s Economic Scenario Work Group (ESG WG) in 2008.3

5. Align the common requirements included in C3P2 and AG 43.

6. Remove the standard scenario from both AG 43 and C3P2 as a required minimum. We do understand, however, that a standard scenario can be a useful tool to facilitate the

regulatory comparison of reserves. As such, certain improvements could be devised to

improve how the reserve standard scenario functions.

7. Evaluate the tax risk surrounding the creation of captives and determining whether

accounting adjustments are needed. While the impact varies by company, the

2 http://www.actuary.org/files/Revised_AG43_Work_Plan_12-10-12.pdf

3 http://actuary.org/files/publications/report_lbrc_dec08.pdf

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http://www.actuary.org/files/Revised_AG43_Work_Plan_12-10-12.pdf

http://actuary.org/files/publications/report_lbrc_dec08.pdf


3

admissibility of the Deferred Tax Asset (DTA) can have a material impact on both the

creation and the recapture of variable annuity captive arrangements.

8. Evaluate the need to modify SSAP 86 to allow hedge accounting under certain

conditions related to variable annuities.

Finally, we suggest the VAIWG consider a cash flow framework as the basis for reserve and

RBC calculations. We recognize that a cash flow framework is a change from current practice,

but we believe a cash flow framework will solve many of the concerns with the current

Framework (including hedging impact) and stand the test of time. Practically, we recognize that

gaining support for a cash flow framework will take time and therefore, recommend pursuing a

shift to a cash flow framework for January 2018.

We encourage the VAIWG to consider our suggestions and to expose a revised Framework,

along with a plan for testing, evaluating, and modifying the Framework prior to commencing the

QIS.

We look forward to working with the VAIWG in the design and testing of these changes to the

regulations affecting variable annuities. If you have any questions or would like to discuss

further, please contact Scot Davies, life policy analyst ([email protected]; 202-223-8196).

Sincerely,

Thomas A. Campbell, MAAA, FSA, CERA

Chairperson

AG 43/C-3 Phase II Work Group

American Academy of Actuaries

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4

Appendix

Exhibit 1— Variable Annuities: Framework for Change

1. The Framework will result in changes to AG 43 that will be designed to result in a less non-economic reserve

requirement for variable annuities. The changes are expected to include the following:

a. Development of calibration criteria for the Interest Rate (USD and possibly international) scenario

generation with a market-sensitive mean reversion asymptote – this will align the interest scenarios

with broader efforts underway at the NAIC level. Potential to integrate the Interest Rate calibration

criteria with Equity Return calibration criteria and to add a volatility calibration prescription;

Academy Work Group comments: We suggest providing more guidance to

improve the current interest rate projection requirements. The Academy’s ESG WG

recommended interest rate calibration criteria in 2008,4 and this criteria should be

considered for variable annuities. The ESG WG’s economic scenario generator for

interest rates has been modified to include a dynamic mean reversion parameter, and

it has been adopted for VM-20 and used for the 2014 C-3 Phase I field test. Any

changes to the scenario generation process need to be completed before the impact

study starts.

Regarding the equity scenario generator, the Academy’s AG 43/C-3 Phase II Work

Group reviewed the parameters and calibration criteria for the equity scenarios and

the need to update parameters and/or calibration criteria in light of recent market

experience in 2013. An additional 12 years of experience was added to the historical

dataset and the scenario generator was evaluated. We presented this work5 to the

NAIC’s Life Actuarial Task Force in 2013. We encourage the VAIWG to consider

this analysis in laying the foundation for the impact study.

Regarding the suggested refinements to add specific criteria for international funds,

we believe the current calibration criteria, which limit the ability to assume funds

experience higher average returns than U.S. equities without also displaying higher

volatility, appropriately addresses this category of funds.

In addition, it is isn’t clear what is meant by integrating interest rate and equity

calibration criteria and adding a volatility calibration prescription. We would like to

better understand the direction that the VAIWG envisions for these ideas and/or

review any specific proposals before commenting.

b. In the Standard Scenario calculation: Introduce more granular benefit-specific prescriptions of

policyholder behavior assumptions. Separately, the prescribed set of assumptions is to be calibrated to

adverse yet plausible levels informed by credible industry experience;

c. Additionally, the Standard Scenario calculation will be conducted on a portfolio as opposed to seriatim

basis with the existing seriatim Standard Scenario calculation made available as a disclosure item;

Academy Work Group comments: These ideas will improve the standard scenario

(SS) and could be developed for a January 2017 implementation date, but we believe

there are fundamental flaws with an SS floor. We recognize the expedience of using

an SS in facilitating regulatory comparisons and tax calculations, but do not believe

4 http://actuary.org/files/publications/report_lbrc_dec08.pdf

5 http://actuary.org/files/VAREQ_Equity_Calibration_Criteria_Analysis_6-4-13.pdf

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http://actuary.org/files/publications/report_lbrc_dec08.pdf

http://actuary.org/files/VAREQ_Equity_Calibration_Criteria_Analysis_6-4-13.pdf


5

it is possible to develop one scenario that will capture the risks of a broad array of

complex products and company practices. We do not support the use of an SS in

either AG 43 or C-3 Phase II as a floor. We support the use of an SS as a disclosure

item to facilitate regulatory comparison.

Note that various Academy work groups have commented in the past that a standard

scenario cannot possibly address all product designs and features. The standard

scenario may produce inappropriate results for certain products (i.e., either too high

or too low) and it requires continual updates to address new products and new

features; so care is needed to properly balance the work involved in maintaining the

standard scenario with the need to have a useful tool.

d. Hedging reflection in the Adjusted CTE 70 calculation to allow for the reduction of gross market risk

positions for hedge instruments prior to expiration of existing hedges rather than a simple hold-to-

maturity treatment;

Academy Work Group comments: We support modifications to better reflect

hedging activities. If hedging activities are not properly reflected, the entire

Framework suffers.

We also support the elimination of the CDHS concept because it does not reflect

actual hedging practices. An insurer’s hedging strategy should be reflected in all

calculations and include the judgment of the actuary, margins, and guidance to

provide checks and balances. This will assure the hedging strategy has been

appropriately reflected.

e. Increased regulator only disclosure designed to ensure regulators understand the potential impact under

different assumptions;

Academy Work Group comments: We support increased disclosure related to

variable annuities and offer the following suggestions:

Consider expanding the required disclosures to include more information about

how the experience assumptions in the calculation of the CTE Amount were

validated to actual experience data to include an assessment of their credibility.

Better align documentation in the AG 43 Actuarial Memorandum with VM-31.

Consider aligning risk and risk mitigation disclosures with those contained in a

company’s own-risk and solvency assessment (ORSA) documentation.

Consider mandatory reporting of variable annuity experience data, including for

the important types of dynamic policyholder behavior.

f. The addition of a feedback loop that continuously reviews granular industry data as a means to modify

the AG in the future to ensure the framework continues to operate as redesigned. This will require

additional granular data to be submitted to the NAIC and analyzed and presented to a group of

regulators.

Academy Work Group comments: We support establishing processes that will

facilitate a feedback loop. Variable annuities are complex products requiring

sophisticated risk management practices. Periodic evaluation of the effectiveness of

the regulatory requirements will benefit consumers, regulators, and insurers.

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changes to C3 Phase II. Similar to changes to AG 43, these will be designed to result in less non-economic

capital requirements on variable annuities. The changes that are expected include the following:

a. Complete elimination of the standard scenario;

Academy Work Group comments: We support the elimination of the SS in the C-3

Phase II calculation, as noted above.

b. Alignment of the total asset requirement (TAR) and the AG 43 reserve requirements through use of the

AG43 stochastic CTE calculation as the basis for a difference calculation for the direct determination

of the C3 charge and the indirect determination to Total Assets Required as the sum of reserves plus

the newly defined C3 charge. The C3 charge will be the difference between two AG43 CTE

calculations at different confidence levels. The individual CTE calculations will apply an effectiveness

factor for the reflection of a CDHS that is calibrated to be consistent with the error factors of the C3

Phase 2 framework. The confidence levels will be determined in the calibration phase during a

forthcoming Quantitative Impact Study. The resulting difference will be appropriately tax effected and

scaled to arrive at the C3 charge. This use of the AG43 calculation will eliminate the need for a

separate C3 Phase 2 calculation;

Academy Work Group comments: We note that there are already efforts under

way at the NAIC to modify the C-3 calculation and make the Phase I, II, and III (if

applicable) consistent. We urge the VAIWG to be cautious about changing C-3

Phase II without proper consideration of the changes already under consideration.

Consistency across the C-3 calculation is important as many insurers manage their

interest rate risk across all products for the entire company.

c. The addition of a feedback loop that continuously reviews granular industry data as a means to modify

the C3 Phase II in the future to ensure the framework continues to operate as redesigned. This will

require additional granular data to be submitted to the NAIC and analyzed and presented to a group of

regulators.

Academy Work Group comments: We support establishing processes that will

facilitate a feedback loop. Variable annuities are complex products requiring

sophisticated risk management practices. Periodic evaluation of the effectiveness of

the regulatory requirements will benefit consumers, regulators, and insurers.

3. The Framework will result in changes to SSAP No. 86 that are designed to reduce the accounting mismatch that

exists between the value of the hedge and the value of the hedged item (the variable annuity liability) so that as

market conditions change, gains or losses that are not consistent with the economic value of the hedges are not

created within the financial statements. In addition, requirements for increased public disclosure on variable

annuity risks will be added to the SSAPs, and data captured in the notes to the financial statements.

4. The Framework will result in the development of narrowly defined statutory language that states may use in

removing the limitations that may exist within their investment statutes that may otherwise limit the extent of

hedges an insurer may use in their risk management.

Academy Work Group comments: We support the evaluation of modifications to SSAP 86 to

allow for more effective treatment of hedge activity under certain conditions related to variable

annuities. However, we believe that in order to get hedge accounting treatment, the insurer needs

to show a track record of hedging and a commitment to continue with a hedging strategy. The

insurer should be allowed to modify its hedging strategy, but should demonstrate an ongoing

commitment to hedge the business.

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