Insurers have long been using stochastic modeling on a companywide basis for risk management purposes, but have not applied it to separate product lines -- which will be necessary if and when PBR is adopted, SMART's Robbins points out. "Getting away from prescribed assumptions for individual reserves and product line reserves will constitute a tremendous expansion of what's going to be required from a regulatory perspective," he says. "That's where the sea change is going to happen, and that's where technology will play a larger part."
The transition from universally applied statutory assumptions to entity-specific assumptions will require ramping-up the capability of insurers' staff to execute experience analyses -- that is, assessments of what ought to be assumed based on a carrier's particular experience of risk factors. "For example, you're going to have to do good expense analyses to figure your future expense assumptions; you're going to have to do lapse-rate assumptions based on your experience of mortality -- all of those assumptions will be based on your experience and the current markets," Robbins explains. That will require "getting people familiar with how to crunch these numbers to come up with these assumptions quickly."
The generation of proper dependencies between those assumptions will be a major technology issue because of the complexity of the variables they include, Robbins predicts. "You have to have a good sense not only of your experience assumptions, but also where they're headed and how they link to each other," he says. "For example, with interest-sensitive life contracts, you have a chain of the yield curve [the graphic profile of investment returns], your crediting rate and your [policy] lapse rate."
Multiplying the complexity factor is that insurers will be required to do such number-crunching repeatedly. Currently carriers do their reserves quarterly. To do so under a PBR regime would be a far greater challenge.
The bright side is that principle-based reserving is unlikely to be required before 2011 or so. Several issues are yet to be resolved, including addressing the difficulties small companies face in bringing to bear the needed resources to do PBR, and also what proportion of PBR will be tax deductible. Further, remarks Robbins, "There is still a lot of wrestling with some of the concepts right in the model regulations, and it might be premature for a company to prepare to hit what is really a moving target."
Ahead of the Curve
Tara Hansen, senior actuarial adviser in Ernst & Young's (New York) insurance and actuarial advisory services (IAAS), counters that, even without new economic capital adequacy requirements or PBR, sophisticated modeling can be used to better understand a company's business from a risk analysis standpoint. "If the timeline gets delayed, there's no harm in getting ahead of the curve, and you can get ahead of your competitors because you understand your business better," she asserts.
In addition to Robbins' caveats, Hansen sees PBR being delayed by state regulators' reluctance to relinquish their statutory reins and give insurers a free hand to determine their own assumptions. "They are not convinced that we can put an adequate review structure around that," she comments.
That hardly matters, Hansen opines, since the capital reserve requirements being put forth by the NAIC on a national basis will come sooner and may present a greater challenge. "Only business issued as of the date of adoption will be valued on the PBR methods, whereas the capital will be required on all in-force business," she explains. "So in many respects, in terms of technology, the capital is a much bigger job -- you're going to have all your business up and running on this stochastic platform, and you're going to have to look at period-to-period results based on complex stochastic runs that will require data management systems."
Data investments also will be required for the input of original data traditionally captured within isolated spreadsheets, according to Hansen's colleague, Steve Goren, senior manager, IAAS, Ernst & Young. "Many of our clients say that they are moving as far from spreadsheets as possible, to fully automated, integrated data repositories," he says.
Anthony O'Donnell has covered technology in the insurance industry since 2000, when he joined the editorial staff of Insurance & Technology. As an editor and reporter for I&T and the InformationWeek Financial Services of TechWeb he has written on all areas of information ... View Full Bio