Life Perspectives, Fall 2022

Q&A—Inflation Discussion Brief

ClaireRecently, high inflation in the U.S. has been making news. The Life Practice Council’s (LPC) Life Experience Committee prepared a discussion brief, Reflection of Inflation, Interest Rates, Stock Market Volatility, and Potential Recession on Life Insurance Business, which looks at how inflation—and possible secondary impacts such as higher interest rates, a potential recession and stock market volatility—could impact the work of life insurance actuaries. Considerations include principle-based reserving (PBR) determinations, asset adequacy testing, input into business planning, and product design.

Life Perspectives did a Q&A with Life Experience Committee Chairperson Donna Claire, who will be a presenter at the LPC’s Oct. 19 webinar, Economic Turmoil and Life Insurance—What’s an Actuary to Do? The webinar will include experts from the committee, who will discuss inflation and other issues raised in the discussion brief.

The discussion brief suggests there are varying assumptions about inflation rates and that actuaries should consider updating recent studies if the studies on inflation versus interest rates are out of date. What scenarios could or should be considered to evaluate the impact of inflation and second-order effects such as recession, higher expenses, bond defaults, etc.?

Each situation the actuary finds themselves in is different—the actuary may determine how inflation and other economic factors can influence the project the actuary is working on. For example, inflation can make some products, such as those with cost-of-living adjustments (COLAs), more attractive. On the other hand, inflation can make some inforce policies that had locked in credited interest now less attractive, and may lead to higher lapses on those products.

The discussion brief observes that interest rates typically spike when inflation spikes and that higher rates can have varying impacts on insurers. Generally speaking, how will higher interest rates affect policyholders, products, and companies?

The brief points out that higher interest rates can be a positive or negative for insurance companies. On one hand, the higher rates can lead to higher earnings which can lead to being able to credit higher rates to policyholders and more profitable products. On the other hand, higher rates will mean that the current assets owned by the insurance company will likely be worth less than before; this means that, if assets need to be sold to pay policyholder benefits, there may be losses on investments.

Regarding modeling—always an important aspect of actuarial work, what can you say about some of the interest rate scenario assumptions that go into actuarial modeling, given inflation concerns?

It is important for the actuary to understand the impact of inflation on the particular project they may be working on. This includes not only the impact on assets but also the impact on policyholder behavior. The brief discusses general economic conditions and how inflation can lead to secondary impacts such as higher interest rates, stock market volatility and potential recession.

For those who want to understand the current levels of interest rates and related economic factors, the brief gives sources of information on these subjects. There are certain interest rate scenarios that are required in some actuarial modeling such as PBR testing. In addition, for much of the modeling an actuary does—such as asset adequacy testing or business planning and product pricing—it is important for the actuary to give their client, be it company management or regulators, the best information as to possible/probable impacts of the current economic conditions on the results of the modeling.

The brief also includes a section on the potential impact on insurance companies, noting that if inflation and interest rates are high, some products may be less attractive, and that if salary increases do not match inflation could lead to more policy lapses, etc. How will inflation affect policyholder behavior assumptions?

The impact of inflation depends on the product and the clients. As noted in the question, if salary increases do not match the increase in the rate of inflation, some people’s budget may be strained, leading to higher lapses. If it is an option, some policyholders may take out additional loans. There could also be good news in that insurance companies may be earning additional spreads in their product, which gives an opportunity to offer more options in a product, such as higher participation rates on equity-indexed products or greater benefits on guaranteed living benefits.

What guidance or requirements exist regarding inclusion of increased expenses? Some actuaries may not take into account higher expense levels, thinking they’re temporary. What are the requirements here?

The answer as to what to reflect for inflation in expenses depends on the purpose and audience of the modeling. There are some requirements in PBR and in some state regulations to cover all expenses in asset adequacy testing. Specifically, the National Association of Insurance Commissioners (NAIC) PBR Valuation Manual (VM) states that fully allocated expenses should be included, and the modeling should reflect the impact of inflation. The VM also states that future expense improvement should not be assumed in the modeling; New York regulation provides for similar requirements in asset adequacy testing. However, if the modeling is being done for business planning, the company management may also want to look at the cash flows assuming a different level of expenses. Whatever assumptions the actuary is using in the modeling should be clearly described in the documentation of the modeling.

After modeling different scenarios, what does the actuary do with the results? Do you have any thoughts on when the results suggest a specific action (e.g., higher reserves, lower dividends, lower crediting rates, etc.)?

Whenever the actuary is doing modeling, they should consider documenting and communicating the assumptions used in the modeling and results, remembering the audience for the testing, be it a client, a direct supervisor, senior management, the Board of Directors, or a regulator.

A recommendation for those actuaries doing PBR and/or asset adequacy testing this year-end (there are a lot of moving parts, some positive, some negative): consider how all the moving parts—e.g., policyholder behavior and asset earnings and defaults—could impact the assumptions used in the modeling. Incorporate any needed changes in the model as soon as possible so that the user is not surprised at the last minute if there is a need to put up extra reserves or take other corrective action.

The discussion brief does not provide all the answers as to what assumptions should be made, but it does describe a number of items that actuaries should consider when modeling in times of inflation and other economic uncertainty.

Webinar Looks at What’s New With ASOP No. 22

Hanson presents at the webinar

The Academy’s webinar series on recently revised actuarial standards of practice (ASOPs) continued with “The Revised ASOP No. 22: What You Need to Know,” which looked at ASOP No. 22, Statements of Actuarial Opinion Based on Asset Adequacy Analysis for Life Insurance, Annuity, or Health Insurance Reserves and Other Liabilities, which took effect in June.

Presenters Laura Hanson and Tom Campbell—chairperson and member of the Actuarial Standards Board’s (ASB’s) ASOP No. 22 Task Force, respectively—discussed the recent changes to ASOP No. 22. The session was moderated by Linda Lankowski, chairperson of the ASB’s Life Committee and a member of the task force.

Lankowski discussed why the ASOP was revised and noted that it now applies to all life, annuity, or health asset adequacy analyses regardless of company type, including property/casualty carriers.

Campbell spoke about assumption margins, saying that the level of margin should consider the uncertainty of the assumption, degree of adverse deviation, variation over time, individual vs. aggregate margins, and interaction between assumptions. He also covered discount rates, sensitivity testing, and reinsurance issues.

Hanson discussed other financial calculations, separate account assets, management action, documentation, and disclosures. She also covered changes in methods, models, or assumptions, and said that the actuary should consider quantifying the impacts of changes if the methods, models, or assumptions differ from those in the prior statement of actuarial opinion.

Webinar recordings, including slides and audio, are made available free to logged-in members in the professionalism webinar archive.

Webinar Explores Life Insurance Policy Issues

The Academy hosted “Life Practice Webinar—Spring 2022 Policy Update,” which looked at a public policy activity in life insurance issues, such as the work of the NAIC’s new Innovation, Cybersecurity, and Technology (H) Committee; high-yield asset adequacy testing actuarial guideline; the economic scenario generator (ESG) field test; and the Academy model office for ESG testing. Slides and audio are available free to logged-in members.

Life Groups Comment to NAIC

Life Practice Council (LPC) committees and work groups commented to the National Association of Insurance Commissioners (NAIC) and NAIC’s Life (A) Actuarial Task Force (LATF).

• The Annuity Reserves and Capital Work Group (ARCWG), along with the Life Reserves and the Variable Annuity Reserves and Capital work groups, submitted a comment letter to LATF on the exposure of APF 2022-04 on swap spreads and the transition from LIBOR to SOFR.
• The Life Experience Committee submitted a discussion brief to LATF regarding COVID-19 in life insurance mortality improvement. The committee subsequently submitted a list of available resources related to the topic.
• The Life Illustrations Work Group submitted a letter to LATF and the Indexed Universal Life (IUL) Illustration (A) Subgroup regarding the IUL Exposure.
• The Life Illustrations Work Group submitted a comment letter to the IUL Illustration (A) Subgroup regarding the IUL Exposure.
• The Economic Scenario Generator (ESG) Work Group presented to LATF regarding a proposed schedule to develop acceptance criteria for stochastic sets of economic scenarios.
• The ESG Work Group submitted a presentation to LATF’s Subgroup on ESG stylized facts for equities.
• The Life Experience Committee and the Society of Actuaries’ Preferred Mortality Project Oversight Group gave a presentation providing an update to LATF on Future Mortality Improvement Scale Development (VM-20).
• Group Life Work Group Waiver Premium Valuation Table Work Group Chairperson Sue Sames presented an update on proposed recommendations to NAIC’s Health Actuarial (B) Task Force on the Group Life Waiver of Premium Valuation Table and Actuarial Guideline XLIV (AG 44).
• The Index-Linked Variable Annuity (ILVA) Work Group sent a comment letter to NAIC’s Index-Linked Variable Annuity (A) Subgroup regarding Exposure 3.1 of the proposed Actuarial Guideline ILVA, Nonforfeiture Requirements for Index Linked Variable Annuity Products Supported by Non-Unitized Accounts.
• The ILVA Work Group submitted comments to the NAIC’s ILVA (A) Subgroup regarding Exposure 4, and a comment letter regarding Exposure 5, of the proposed Actuarial Guideline ILVA, Nonforfeiture Requirements for Index Linked Variable Annuity Products.