Asset Asset Adequacy Adequacy Testing Testing For For LTC LTC Products Products Dennis Dennis O'Brien O'Brien New New York York Life Life Insurance Insurance Company Company June June 16, 16, 2006 2006
Methods Methods of of Asset Asset Adequacy Adequacy Testing Testing •• Cash Cash Flow Flow Testing Testing •• Gross Gross Premium Premium Valuation Valuation •• Other Other
Actuarial Actuarial Standards Standards of of Practice Practice •• ASOP ASOP 7 7 -- Analysis Analysis of of Life, Life, Health Health or or Property/Casualty Property/Casualty Insurer Insurer Cash Cash Flows Flows •• ASOP ASOP 18 18 -- Long Long Term Term Care Care Insurance Insurance •• ASOP ASOP 22 22 -- Statements Statements of of Opinion Opinion Based Based on on Asset Asset Adequacy Adequacy Analysis Analysis by by Actuaries Actuaries for for Life Life or or Health Health Insurers Insurers
ASOP ASOP 7 7 Reasons Reasons for for Cash Cash Flow Flow Testing Testing •• Where Where there there are are material material asset asset risks risks (for (for example, example, below below investment investment grade grade bonds, bonds, assets assets with with payment payment timing timing risks risks such such as as CMOs CMOs or or mortgage-backed mortgage-backed securities, securities, mortgages mortgages concentrated concentrated in in certain certain regions regions of of the the country, country, and and large large illiquid illiquid assets assets such such as as real real estate estate •• Where Where there there are are liabilities liabilities that that have have cash cash flows flows far far our our into into the the future future
ASOP ASOP 7 7 -- Cash Cash Flow Flow Test Test is is Not Not Always Always Necessary Necessary •• If, If, in in the the actuary's actuary's judgment, judgment, aa block block of of business, business, taken taken together together with with its its policy policy term term and and the the associated associated investment investment strategy, strategy, is is relatively relatively insensitive insensitive to to influences influences such such as as changes changes in in economic economic conditions conditions or or interest-rate interest-rate scenarios scenarios
ASOP ASOP 18 18 -- LTC LTC Insurance Insurance Cash Cash Flow Flow Testing Testing •• Because Because of of the the long-term long-term nature nature of of the the LTC LTC benefits, benefits, future future liability liability cash cash flows flows may may be be different different from from future future asset asset cash cash flows. flows. Therefore, Therefore, the the actuary actuary should should consider consider cash cash flow flow testing testing as as aa potentially potentially important important part part of of any any LTC LTC insurance insurance plan's plan's financial financial analysis. analysis. This This is is especially especially true true if if LTC LTC insurance insurance is is the the sponsoring sponsoring entity's entity's only only product product or or aa major major portion portion of of the the entity's entity's business business
ASOP ASOP 22 22 -- Analysis Analysis Methods Methods •• A A gross gross premium premium reserve reserve test test may may be be appropriate appropriate where where the the policy policy and and other other liability liability cash cash flows flows are are sensitive sensitive to to moderately moderately adverse adverse deviations deviations in in the the actuarial actuarial assumptions assumptions underlying underlying these these cash cash flows. flows.
Considerations Considerations in in Choosing Choosing aa Testing Testing Method Method for for LTC LTC •• Asset Asset characteristics characteristics (callable (callable bonds, bonds, CMOs, CMOs, mortgage mortgage backed, backed, illiquid illiquid assets) assets) •• Asset Asset liability liability mismatch mismatch •• Size Size of of block block •• Fraction Fraction of of company company business business •• Liquidity Liquidity
Special Special Considerations Considerations for for LTC LTC •• Very Very steep steep slope slope •• Very Very low low lapse lapse •• Investment Investment sensitivity sensitivity (especially (especially positive positive future future cash cash flows) flows) •• Lapse Lapse supported supported product product •• Politically Politically sensitive sensitive market market •• Claim Claim reserve reserve tail tail
Assumption Assumption Setting Setting •• Morbidity Morbidity •• Earned Earned investment investment income income rate rate •• Mortality Mortality •• Voluntary Voluntary Lapse Lapse •• Expenses Expenses •• Rate Rate Increases Increases
Assumption Assumption Setting Setting -- Morbidity Morbidity •• Current Current best best estimate estimate •• Validate Validate against against company's company's experience experience •• Considerations Considerations regarding regarding inflation inflation protection protection – – Relationship Relationship of of interest interest rate rate and and inflation inflation – – Cash Cash vs. vs. service service reimbursement reimbursement
•• Inflation Inflation for for existing existing claimants claimants •• "Salvage" "Salvage" •• Considerations Considerations in in morbidity morbidity improvement improvement •• Sex Sex distinct distinct vs. vs. unisex unisex
Assumptions Assumptions Setting Setting -- Earned Earned Rate Rate •• Characteristics Characteristics of of assets assets backing backing LTC LTC – – Segregated Segregated assets? assets? – – Dedicated Dedicated LTC LTC investment investment strategy? strategy?
•• Provision Provision for for defaults defaults •• Provision Provision for for investment investment expenses expenses •• Current Current and and expected expected new new money money rates rates – – Large Large future future positive positive cash cash flows flows
Assumption Assumption Setting Setting -- Mortality Mortality •• Best Best estimate estimate •• Selection Selection Factors Factors •• Sex Sex distinct distinct vs. vs. unisex unisex •• Mortality Mortality improvement improvement
Assumption Assumption Setting Setting -- Voluntary Voluntary Lapse Lapse •• Best Best estimate estimate •• Validate Validate against against company company experience experience •• Issue Issue age/attained age/attained age age considerations considerations •• Group Group vs. vs. individual individual •• Trend Trend
Assumption Assumption Setting Setting -- Expenses Expenses •• Best Best estimate estimate validated validated against against company company experience experience •• New New business business vs. vs. maintenance maintenance •• Provision Provision for for claims claims expense expense
Assumption Assumption Setting Setting -- Rate Rate Increases Increases •• Increase Increase status status •• In In process process of of implementation implementation •• Submitted Submitted to to states states for for approval approval •• Next Next in in regular regular round, round, documented documented as as approved approved by by management management •• Actuary Actuary trying trying not not to to set set up up more more reserves? reserves?
Assumption Assumption Setting Setting -- Rate Rate Increase Increase Shock Shock Lapses Lapses •• Company Company history? history? •• Contingent Contingent Non-Forfeiture Non-Forfeiture – – Contractually? Contractually? – – As As aa negotiable negotiable item item in in rate rate increase? increase?
•• Offers Offers if if reduced reduced coverage? coverage? •• Changing Changing regulatory regulatory environment environment
Sensitivity Sensitivity Tests Tests for for Moderate Moderate Adverse Adverse Outcomes Outcomes •• Interest Interest rate rate scenarios scenarios •• Morbidity Morbidity •• Lapse/mortality Lapse/mortality •• Expenses Expenses •• Stochastic Stochastic testing testing •• Role Role of of rate rate increases increases in in sensitivity sensitivity testing testing – – Is Is increase increase justifiable? justifiable? (lifetime (lifetime loss loss ratio) ratio)
How How to to Mitigate Mitigate Risks Risks •• Interest Interest rate rate hedging hedging strategies strategies •• Reinsurance Reinsurance •• New New business business pricing pricing – – If If you're you're in in aa hole, hole, stop stop digging digging
Interest Interest Rate Rate Hedging Hedging Strategies Strategies •• Interest Interest Rate Rate Swaps Swaps – – Cash Cash exchanged exchanged based based on on notional notional amount amount and and difference difference between between fixed fixed and and floating floating rate rate of of interest interest
•• Example: Example: five five year year forward, forward, $100M $100M notional, notional, received received fixed fixed pay pay floating floating for for 25 25 years years (say (say fixed fixed is is 6%) 6%)
Impact Impact of of Swap Swap •• End End of of five five years, years, immediate immediate fixed fixed 25 25 year year rate rate drops drops to to 4% 4% •• Enter Enter into into immediate immediate $100M $100M notional notional 25 25 year year swap, swap, receive receive floating floating pay pay fixed fixed •• Net Net -- company company receives receives (6% (6% -- 4%) 4%) xx $100M $100M or or $2M $2M annually annually •• Floating Floating cancels cancels out out •• Usually Usually settled settled in in cash cash
Reinsurance Reinsurance •• Quota Quota share share •• Excess Excess loss loss •• Risk Risk considerations considerations •• Rate Rate control control
Other Other Considerations Considerations •• Implications Implications for for GAAP GAAP loss loss recognition recognition •• Interim Interim results results •• Asset/liability Asset/liability matching matching
Questions??? Questions???