Chapter 6

Question 1

Nature and Purpose of reserves

Answer 1

Nature: Insurance reserves are the means by which life insurance companies determine the liabilities that must be established to assure that future policy benefits such as death claims can be paid.

Purpose: These reserves are required both by law and by actuarial theory to ensure fulfillment of commitments guaranteed to policyholders and their beneficiaries, even though the obligations may not be due for many years.

Question 2

Individual Life Insurance Reserves

Answer 2

These premiums or gross premiums, consist of several elements, e.g., interest, mortality, expenses, taxes, voluntary terminations, and contingency margins (if the insurer is a mutual company), and profit margins (if the insurer is a stock company).

• Net Premium: For purposes of reserving, only a portion of the gross premium is used involving interest and mortality.

Loading: The difference between the gross premium and the net premium

Question 3

level premium method

Answer 3

This approach provides that the insured can continue insurance protection from year to year by the payment of a premium that does not change.

Under the level premium approach, the insured is paying excess premiums during the early years (compared to a one-year term policy) of the policy and inadequate premiums during the later years. The insurance company accumulates a reserve that is built up from these excess premiums in the early years and interest thereon to supplement the later premiums. It is from this concept that the reserve is developed.

Question 4

Reserve Valuation

Answer 4

To assure this conservatism, insurance laws and regulations specify what assumptions will be acceptable in the valuation of a company’s minimum reserve liability.

• These assumptions concern interest and mortality only.
• Statutory reserve requirements do not allow discounting of benefits or premiums for voluntary terminations, such as surrenders or lapses.
• The NAIC model law also provides that the maximum interest rate for any year will not be changed from that of the prior year if the newly calculated rate varies less than one-half of one percent (or 0.50%) from the prior year’s rate.

Question 5

Net Level Reserves

Answer 5

Reserves can be calculated by either a prospective method or an equivalent retrospective method.

• It is very important to note that the two methods produce exactly the same reserve for any duration of the policy.

Question 6

Net Level Reserves

Prosprospective method or retrospective method
(that the two methods produce exactly the same reserve for any duration of the policy)

Answer 6

• Prosprospective method:
  > Formula: PV of its Future Benefits minus PV of Its Future Net Premiums.

Retrospective method: reserve may be calculated by looking backwards at what has occurred in the past
> Formula: Accumulated Value of the Past Net Premiums minus Accumulated Value of Past Benefits

Question 7

Net Level Reserves

David Parks Fackler (Successive reserves)

Answer 7

• Derived from the retrospective formula for calculating reserves.
• The Fackler formula is the basis of a convenient method for preparing reserve tables for a particular policy, at a given age at issue, for consecutive durations.
• The formula can be programmed for computers.
• It is also very efficient for calculating reserves for policies that have changing net premiums or changing benefits throughout their coverage periods.

* Formula:
Reserve at End of Year (t+l)
=
[Reserve at End of Previous Year (t) + The Net Premium]
x
[Accumulation Factor for One Year Using Interest and Mortality]
-
[The Cost of That Year’s Benefits]

Question 8

Mean Reserves

Answer 8

Valuations are commonly done using “mean reserves.” * A mean reserve is the reserve as of the middle of a policy year and is simply the average of the initial reserve and the terminal reserve. *The mean reserve is 50% of the initial reserve plus 50% of the terminal reserve.This assumes that a full annual net premium has been paid.

mean reserves are commonly used for individual life insurance reserves.

Minimum Level: common insurance department requirement and a common actuarial practice to set the mean reserve to be not less than 50% of the net cost of one year’s term insurance for the benefit that year.

This is the same as 50 percent of the net premium for a one-year term insurance policy at the insured’s attained age.

Question 9

Modified Reserves

Full Preliminary Term Method.

Answer 9

• This method allows the entire first year gross premium, less the first year mortality cost, to be used for expenses.

Thus, the first year net premium is set equal to one year’s mortality cost.

Question 10

Modification of Assumptions

Interest?
Mortality?
Timing of Premiums and Death Claims?

Answer 10

Interest:
an increase in the rate of interest produces a decrease in reserves, and a decrease in the rate of interest produces an increase in reserves, provided that the reserves increase with duration.

Mortality :
constant increase in the rate of mortality produces a decrease in reserves, and a constant decrease in the rate of mortality produces an increase in reserves, provided that the reserves increase with duration.

Timing of Premiums and Death Claims:
* > Curtate assumption: assumptions that the annual premium is paid at the beginning of a policy year, and that death claims are paid at the end of the policy year.

Adjustments:
Curtate assumption
+ Reserve for Immediate Payment of Claims (claims paid immediately)
+ Reserve for Nondeduction of Deferred Fractional Premiums on Death (for premiums not paid annually)
+ Reserve for Refund of Premium Paid Beyond the Date of Death (Return of unearned premium beyond death)

Question 11

Premium Adjustments

Answer 11

These adjustments are primarily a function of the valuation method of using mean reserves.

The mean reserve was shown to be 50% of the initial reserve plus 50% of the terminal reserve. This assumes that a full annual net premium has been paid.

• However, that is not the case if a policy is on a mode of premium payment other than annual and the full annual premium for the policy year has not been paid.
  • Since a liability has been set up for 50% of the net premium, an adjustment then has to be made to give credit back to the insurance company for any unpaid portion of the annual premium.

• This adjustment is accomplished by setting up an asset account for deferred and uncollected premiums

Question 12

Methods of Calculating the Policy Reserve

Five methods by which reserves are commonly calculated?

Answer 12

1 namely 
2 seriatim 
3 group
4 attained age 
5 retrospective
6 approximate

Question 13

Methods of Calculating the Policy Reserve

Seriatim

Answer 13

• High-speed computers have generally allowed the seriatim method to be the method of choice
* • Applies the reserve factors on a policy-by-policy basis. The total reserve liability for the company then
becomes the summation of the individual calculations

Advantages:

1. It is a simple method not requiring complicated records.
2. Accuracy is easily checked by checking individual policies to see if the appropriate factor has been applied.
3. It is easily adaptable to electronic equipment, specially where the in force business is recorded on a master file from which the valuation indicative data can be gathered.
4. If the company is small and there are a number of different plans being issued, a grouping method may not save much time.

Disadvantages:

1. The size of the in force file may make it prohibitive.
2. It can cause a peak load on calculation equipment at the time valuation is done.
3. The accuracy of the valuation depends upon the correctness of the reserve factors, which have been placed in some type of machine-readable form. Any errors in those reserve factors would be hard to detect on an individual basis.
4. To obtain any type of grouping, various sorts and summations would have to be performed.

Question 14

Methods of Calculating the Policy Reserve

Group.

Answer 14

• The group method utilizes a summarization of records within each valuation cell.Once the valuation cells have been summarized and grouped together, the method becomes exactly like the seriatim method, with individual factors being applied to each cell.

The advantages of the group method are similar to those for the seriatim method with the added advantage that the number of calculations is lessened by grouping of policies.

Question 15

Methods of Calculating the Policy Reserve

Attained Age

Answer 15

It is a form of group method, which minimizes the number of valuation cells.

This method eliminates the use of durations as used in the seriatim and group methods, and utilizes reserve factors only varying by attained age.

Disadvantages:

1. It is a complicated method that is not easily understood by those not technically trained in it, thereby increasing error potential.
2. It is difficult to prepare reports with fine breakdowns, which might be needed, for management information.
3. It is not suitable if the valuation bases involve dual interest rates or if the policies have varying amounts of insurance and varying premium levels.

Question 16

Methods of Calculating the Policy Reserve

Retrospective.

Answer 16

reserves are calculated as the excess of the accumulation of the net premiums over the accumulated costs of insurance.

Advantage
• it reduces the number of valuation cells and the number of calculations.

Disadvantage (outweigh advantages)
• it has no breakdown by plan of insurance, which otherwise provides valuable management information;

• there are difficulties if there are modified premiums or changing levels of amount of insurance;
• it is difficult to use for paid-up policies.

Question 17

Methods of Calculating the Policy Reserve

Approximate

Answer 17

is not a method unto itself but is a name applied to several methods that are not exact calculations.

Question 18

Indeterminate Premium Plans

Answer 18

A plan of insurance that provides a maximum guaranteed premium but permits the insurance company to charge a premium less than or equal to that guaranteed premium.

Based on policy experience evaluated (expenses, mortality, interest, and lapses), a gross premium will be determined that does not exceed the maximum guarantee. This gross premium may be guaranteed for one or more policy years.

reserves under such plans must be
a. appropriate in relation to the benefits and the pattern of premiums for that plan, and

b. computed by a method, which is consistent with the principles of the Standard Valuation Law, as determined by regulations promulgated by the commissioner.

Question 19

Deposit Term Plans

Answer 19

• a typical plan is where the 1 yr premium exceeds the renewal premiums for the 9 yrs.

At the end of the 10th yr the policy provides an endowment equal to a multiple (such as 250 percent) of the excess first year premium.

The actual reserve to be used is the greater of the regular CRVM reserve or the alternative reserve.

Question 20

Multiple Life Policies

Answer 20

Joint life: policy that paid the death benefit when the first of two insured lives died was among the first of these types of policies.

Second to die or last to die policy: pays a death benefit when the last of two named insureds dies.

Question 21

Valuation of Life Insurance Policies Model Regulation /

A.K.A. Regulation XXX

Answer 21

Select and ultimate adjustment factors for 20 years are applied to the valuation mortality table. These dramatically lower the valuation mortality rates in the early durations.

Furthermore, the company’s appointed actuary can determine “X” factors to apply to these select and ultimate factors based upon actual company experience. If X is less than 100 percent, the actuary must annually give a professional opinion on the appropriateness of X.

Question 22

Variable Insurance Products

Answer 22

• These products are a hybrid of insurance and investments where the owner is taking most or all of the investment risk. The insurance company assumes the mortality and expense risk.

The reserves are based upon the values of the investments. The values fluctuate up or down based upon the performance of the assets.

Question 23

Equity Indexed Insurance Policies

Answer 23

The basic structure of the policy is that the fund accumulation underlying these universal life type policies will receive the larger of a guaranteed interest rate or a percentage of an equity index.

Question 24

Miscellaneous Life Reserves

Supplemental Contracts with Life Contingencies

Answer 24

• the funds have been derived from life insurance or annuity contracts through death, maturity, or surrender.
• The funds are applied to purchase a contract for the insured or a beneficiary to provide income for the payee’s life.
• These contracts generally take the form of an immediate annuity, possibly with period certain or refund guarantees.
• The mortality standard generally used has lower mortality rates than that used for life insurance valuation, recognizing that persons taking life income options usually have longer life expectancies than life insureds.

Question 25

Miscellaneous Life Reserves Accidental Death Benefit

Answer 25

This benefit provides an additional amount of insurance in case the insured dies accidentally. It is normally a supplemental benefit attached to a basic life insurance policy. The reserves are calculated according to a valuation interest rate and an accidental death mortality table. Generally, these reserves are calculated according to a net level method on a seriatim or group basis.

Question 26

Miscellaneous Life Reserves Disability - Active Lives

Answer 26

This is a reserve for a benefit usually provided by a supplemental rider attached to a basic life insurance policy for waiver of premium or supplemental income in the event of disability of the insured.

Question 27

Miscellaneous Life Reserves Disability - Disabled Lives

Answer 27

* Once a claim is approved, its reserve is calculated according to valuation factors based upon appropriate mortality and morbidity tables, age at disability, duration of disability, benefit period, and interest rate. These are reserves on insureds who have become disabled and are receiving a disability benefit such as waiver of premium or supplemental income.

Question 28

Miscellaneous Life Reserves Additional Mortality under Group Conversions

Answer 28

* Convert his group insurance to an individual policy: the company may establish an additional reserve to recognize the fact that mortality under group conversions is significantly higher than on normally underwritten policies. This additional reserve may be calculated by applying specific reserve factors to converted policies. Alternative Method: "Run-off" factor by studying the experience of converted policies. An additional reserve for the extra mortality on a group of converted policies is determined for each year after conversion, and converted to a percentage of the initial amount of insurance or the initial reserve at conversion.

Question 29

Miscellaneous Life Reserves Additional Mortality under Term Conversions

Answer 29

Like group conversions, term conversions require additional reserves because higher mortality is usually experienced on term conversions over that experienced on normally underwritten policies.

Question 30

Miscellaneous Life Reserves Reserve for Excess of Valuation Net Premiums over Corresponding Gross Premiums on Respective Policies

Answer 30

AKA "Deficiency reserve"and must be recognized whenever the net valuation premium exceeds the gross premium for a policy. (net premium exceed the gross premium) For purposes of calculating the deficiency reserve, the net valuation premium is computed by using the method (e.g., CRVM) used in calculating the basic reserve, but using the minimum permitted interest and mortality valuation standards.

Question 31

Miscellaneous Life Reserves Substandard Policies

Answer 31

* An additional reserve is recognized to anticipate the additional mortality risk over that expected for a standard policy. Reserve can be calculated on either an exact or approximate basis.

Question 32

Miscellaneous Life Reserves Payor Benefits

Answer 32

* These reserves are required when there is a supplemental benefit attached to a policy covering a second party who is the payor of the premium. A common example is a juvenile policy where the premium will be waived in the event of the death or disability of an adult payor. are calculated according to the premiums that would be waived in the event of the payor’s death or disability and recognizing mortality, morbidity, and interest rates.

Question 33

Accelerated Benefits

Answer 33

These provisions accelerate benefits in the event of a defined qualifying event. Examples of commonly used events are (1) drastically reduced lifespan or (2) an extraordinary medical condition such as organ transplant, cancers, heart problems, etc., or (3) conditions requiring institutional confinement such as Alzheimer’s disease. Payments under these provisions reduce the cash values and the death benefits provided by the policy.

Question 34

Annuity Reserves

Answer 34

Annuity policies take three basic forms: * • Annual PDA: annual premiums are paid during an accumulation period until such time as the annuitant takes income, surrenders the policy, or it terminates by death. * SPDA: accumulates until such time as the annuitant desires to take income or the policy is otherwise terminated. * SPIA: Reserves are calculated in the same manner as the reserves for Supplemental Contracts with Life Contingencies. All deferred annuities under the NAIC model Standard Valuation Law are reserved using the CARVM. Miscellaneous Life Reserves Supplemental Contracts with Life Contingencies. • the funds have been derived from life insurance or annuity contracts through death, maturity, or surrender. • The funds are applied to purchase a contract for the insured or a beneficiary to provide income for the payee’s life. • These contracts generally take the form of an immediate annuity, possibly with period certain or refund guarantees. • The mortality standard generally used has lower mortality rates than that used for life insurance valuation, recognizing that persons taking life income options usually have longer life expectancies than life insureds.

Question 35

Group Life Insurance Reserves

Answer 35

Most group life insurance is monthly renewable term insurance. Gross premiums are typically recalculated periodically using the age and sex census of the group along with experience adjustments. Therefore, the reserve liability is usually calculated as the unearned premiums or a percentage thereof to estimate the claim exposure. The NAIC model Standard Valuation Law does not specify a mortality table for group life insurance but leaves that to the discretion and approval of the insurance commissioner.

Question 36

Industrial Life Insurance Reserves

Answer 36

* Industrial life insurance is similar to individual life insurance but is characterized by higher unit premiums, smaller policies, and higher mortality expectations. * industrial life insurance use midterminal reserves instead of mean reserves.

Question 37

Other Reserve Considerations

Answer 37

When reserve assumptions are changed on in force insurance, it must be disclosed in Exhibit 5A of the Annual Statement. Policies issued in the current year can be reserved differently from policies issued in prior years, and that is not considered a change in valuation basis. Thus, only changes in reserve bases on business that as in force at the beginning of the statement year need to be disclosed. However, if the company wished to lower reserves on in force business, the company generally has to get approval at least from the state of domicile.

Question 38

Accident and Health Insurance Reserves Legal Requirements

Answer 38

Many states have not adopted specific reserve requirements for accident and health coverages. Their law either remains silent or relies upon the catchall requirement that the insurance commissioner has the right to determine what reserve liabilities should be established by a company.

Question 39

Accident and Health Insurance Reserves Two form of reserves?

Answer 39

1. Active Life Reserve 2. Disabled life reserves Active Life Reserve: 1. unearned premium reserve: is merely the pro-rata proportion of any paid premium that covers the insured beyond the date of valuation. 2. additional reserves

Question 40

Accident and Health Insurance Reserves Forms of Reserves (Active and Disability Life Reserve) Active Life Reserve have two primary types:?

Answer 40

Active Life Reserve: 1. unearned premium reserve: is merely the pro-rata proportion of any paid premium that covers the insured beyond the date of valuation. 2. Additional reserves: it is created whenever a policy is priced on the level premium concept and the claim costs increase with duration

Question 41

Accident and Health Insurance Reserves Forms of Reserves (Active and Disability Life Reserve) Disability Life Reserve?:

Answer 41

AKA claim reserve. The principal disabled life reserve is the present value of amounts not yet due. This reserve is established for estimated payments in the future on claims, which are either reported or unreported. A disabled life reserve is required whenever a claim exists and the company has a liability or has a potential liability in the future, provided the claimant continues to be entitled to benefits.

Question 42

Accident and Health Insurance Reserves Reserve for Present Value of Amounts Not Yet Due

Answer 42

is established for disability income claims when an insured becomes disabled, because of the potential of paying future payments provided the claimant remains disabled. This claim reserve is a present value of the future potential monthly income payments, discounted for the contingencies that the insured will recover or die, and also discounted at interest.

Question 43

Accident and Health Insurance Reserves Reserve for Future Contingent Benefits.

Answer 43

Miscellaneous reserve provides for future contingent benefits. This reserve results from policy provisions that might cause a valid claim in the future. A common descriptive example of this type of claim liability is a lapsed hospital expense policy, which provides for payment of a maternity claim, when conception occurred prior to the policy’s termination and therefore is a covered claim.

Question 44

Accident and Health Insurance Reserves Contingency Reserves

Answer 44

The size of the contingency reserve will depend upon such factors as the general surplus level of the company, conservative elements that are built into the additional reserves and claim reserves, the amount of business in force, and the judgment of the insurer and its actuaries.

Question 45

Consumer Credit Life and Disability Insurance Reserves Less developed actuarial theory and practice than in any other insurance coverage due to?

Answer 45

covers the loan payments on consumer loans such as automobile and personal bank loans. * Less developed actuarial theory and practice due to: 1. Compared to other insurance coverages, it is a relatively new coverage, first introduced after World War I and realizing its greatest growth in the last 30 years. 2. Until recently, this insurance has not been regulated extensively by the states. 3. Also until recently, credit coverages have not come under close public scrutiny. 4. Only a small percentage of companies write this insurance. 5. Rate regulation for credit insurance has been used to control “reverse competition” (where the writing agent seeks the maximum premium to maximize commission income) by specifying maximum rates. 6. Until recently, loss experience has generally been favorable to the insurance company. 7. The relatively small amounts of coverage on each debtor coupled with large numbers of policies or group certificates has complicated record keeping. 8. Much of this insurance is sold on a single premium basis.

Question 46

Policy and Contract Claim Liability Liabilities for Claims in Course of Settlement

Answer 46

* Liabilities are established for claims that are in course of settlement.These are claims that are on file in the company at the time the valuation is done, but have not been approved or paid. * If a claim is being resisted by the company, a liability must still be set up for it. Usually the full amount of the claim is established as a liability even though the company may not feel it is a valid claim and is contesting its payment.

Question 47

Policy and Contract Claim Liability Liabilities for Due and Unpaid Claims

Answer 47

* A liability for due and unpaid claims is established to pay claims that have been approved, but for which the payment checks have not been sent. Since many companies make payment immediately after a claim has been approved, they regard all pending claims as “in course of settlement” and do not establish a due and unpaid liability.

Question 48

Reinsurance

Answer 48

The ceding company will reduce its reserve liabilities by reinsurance credits and the assuming company will correspondingly increase its reserves.

Question 49

Statement of Actuarial Opinion * A Clean option must state that in the opinion of the actuary such amounts are?

Answer 49

(i) are computed in accordance with commonly accepted actuarial standards consistently applied and are fairly stated in accordance with sound actuarial principles, (ii) are based on actuarial assumptions which are in accordance with or stronger than those called for in policy provisions, (iii) meet the requirements of the insurance laws of (state of domicile), (iv) make a good and sufficient provision for all unmatured obligations of the Company guaranteed under the terms of its policies, (v) are computed on the basis of assumptions consistent with those used in computing the corresponding items in the Annual Statement of the preceding year-end, and (vi) include provision for all actuarial reserves and related statement items which ought to be established.”

Question 50

Statement of Actuarial Opinion Exhibits for reserves

Answer 50

Exhibit 5- aggregate reserves for life contracts Exhibit 6 - A&H reserves Exhibit 7 - liability for deposit type contracts Exhibit 8, Part 1. - net deferred and uncollected premiums and the contract claims liabilities

Question 51

Statement of Actuarial Opinion insurance companies are divided into two classes?

Answer 51

Section 7- asset adequacy analysis is not required with less than$100 million in assets. Companies with assets between $100 million and $500 million are required to do asset adequacy analysis every third year provided they do not fail any of the ratio tests mentioned above. If a company fails one or more of these ratios, it must do annual analysis. Section 8- asset adequacy analysis is required with over $500 million in assets.

Question 52

Modified Reserves Net level reserve

Answer 52

The net level reserve method assumes that the expense loading within the gross premium is a level percentage of the gross premium, and therefore that expenses are level. Of course expenses are not level by policy year.This causes a material drain on surplus due to first year reserves that could have an adverse effect upon insurance companies whose surplus is not large. This drain would have a more profound effect upon relatively small and young companies, whereas older and more established companies would normally have larger amounts of surplus and could thereby more easily support this surplus drain. Requiring full net level reserves could make it much more difficult for a new life insurance company to be started, and would also adversely affect any company that was growing rapidly. Therefore, various modified reserve systems are accepted that allow substantial relief from this initial burden without impairing the company’s financial condition.

Question 53

Modified Reserves Commissioners’ Reserve Valuation Method (CRVM)

Answer 53

The NAIC model Standard Valuation Law, which has been adopted by all the states, requires minimum reserves to be calculated by the CRVM. This method requires a special modification for those policies having a net renewal premium under the full preliminary term method that is greater than the net renewal premium for a twenty-pay life insurance policy under the full preliminary term method at the same issue age. * CRVM thus prescribes an expense allowance for those higher premium policies equal to the expense allowance for a twenty-payment life policy. This causes a positive first year terminal reserve for the higher premium plans.

Question 54

Universal Life Policies

Answer 54

* The reserve calculations are very complex for universal life policies. They require a custom computer program that is unique to these policies. Therefore, the reserves cannot be fixed for the lifetime of the policies on their issue date as can be done for traditional policies. The NAIC model regulation for universal life policies also requires a Statement of Actuarial Opinion for interest-indexed universal life insurance policies.

Question 55

Policy and Contract Claim Liability Liability for Incurred but Not Reported Claims (IBNR)

Answer 55

* An incurred but not reported (IBNR) liability is established to allow for a time lag between the date a claim is incurred by an insured and the time it is reported to the insurance company. * This claim liability is generally established after the company has done a review of its experience and factors are developed that can be applied to known quantities, such as premiums in force, paid claims, or claim liabilities on existing known claims.