Comfortable with your Reserves?

1. Comfortable with your Reserves? Session 9: February 27, 2006 Session Producer: Mark Press, FSA, MAAA Gen Re LifeHealth

2. Panelists • Judy Hanna, ASA, MAAA Consulting Actuary, Ernst & Young • Allen Schmitz, FSA, MAAA Consulting Actuary, Milliman • Mark Press, FSA, MAAA Actuary, Gen Re LifeHealth

3. Long Term Care Active & Disabled Life GAAP Considerations Comfortable with your Reserves? Judith Hanna, ASA, MAAA Ernst & Young, LLP February 27, 2006

4. Agenda • Active Life Reserves (“ALR”) and Deferred Acquisition Costs (“DAC”) • Recoverability and Loss Recognition Testing • Prospective Unlocking • Disabled Life Reserves

5. Active Life Reserves and Deferred Acquisition Costs

6. LTC Classification: FAS 60 Long Duration Contracts • Provides insurance protection over an extended period • The contract generally is not subject to unilateral changes by the insurer

7. ALR & DAC Assumptions Assumptions needed for: • morbidity • salvage • investment earnings • termination • mortality • deferrable and maintenance expenses

8. ALR & DAC Assumptions • Assumptions must be consistent with experience at the time policies are issued* • Assumptions must contain mild provision for adverse deviation • Assumptions must be “locked-in” at issue* * more on prospective unlocking later

9. ALR Benefit ReservesBenefit Net Premium = The portion of gross premiums required to provide for all benefits (including inflation options and surrender benefits) and maintenance expenses Year 1Year 5 Gross Premium (annual) 1,000 650 PV Benefits & Maintenance Expenses/PV Premiums (at issue) = 4,847 / 6,606 = 73.4% x Gross Premium = Net Premium 734 477

10. ALR Benefit ReservesProspective View

11. DAC • Represents unamortized balance of deferrable acquisition expenses

12. DACDAC Amortization Rate = The percentage of gross premiums (calculated at issue) required to provide for deferred policy acquisition expenses PV of Deferrable Expenses 1,300 PV of Gross Premiums 6,606 Amortization Rate 19.7%

13. DACDAC Expense Charge =The portion of gross premiums required to provide for deferrable acquisition expenses Year 1Year 5 DAC Amortization Rate 19.7% 19.7% x Gross Premium 1,000 650 = Expense charge 197 128

14. DACRollforward View Year 1Year 5 Beginning DAC 0 882 + Deferrable expense 1,300 0 - DAC expense charge (197) (128) + Interest accrual 66 45 = Ending DAC 1,169 799

15. Recoverability and Loss Recognition Testing

16. Recoverability Testing • Testing is performed on current year’s issues • Is the block of business profitable enough to recover deferrable expenses? • Deferrable costs are limited by • PV of premiums less benefits and maintenance expenses • Non-recoverable costs may not be deferred, even if product eventually becomes more profitable

17. Loss Recognition Testing • Can think of it as recoverability testing after issue • Basic principle: probable future losses must be anticipated – PV future GAAP profits may not be negative • Need to decide on what defines a block of business to be tested. Multiple years’ issues, products, etc. can be aggregated

18. Loss Recognition and Recoverability Assumptions • Best estimate assumptions w/o PADs • Do not include overhead expenses • Once in loss recognition, these new best estimate assumptions are locked in • Consider consistency with Statutory Asset Adequacy Testing

19. Shadow Loss Recognition Testing EITF D-41 • Adjust certain balance sheet items assuming that unrealized gains and losses on Available for Sale (AFS) securities are realized • Generates consistency in the balance sheet • Cushions the impact of movements in valuations caused by interest rate movements • Only occurs in declining interest rate environments

20. Prospective Unlocking

21. FAS 60 Prospective Unlocking • Exceptions to “lock-in” principle are rare: Guaranteed renewable A&H, Indeterminate premium non-par life • Method for Unlocking: • Lock-in current benefit reserve, DAC • Recalculate net premiums prospectively • Considers actual or expected increases • Supporting References • Cloninger, TSA 1981 Vol.33 • Ernst & Ernst GAAP Stock Life Companies, Chapter 19 Individual Health Insurance, Guaranteed Renewable Business • ASOP 10, Paragraph 3.7.2 • US GAAP, SOA, 2006, Chapter 10 Individual Health Insurance, Section 10.7

22. ALR: Original vs. Prospective

23. Disabled Life Reserves

24. DLR Assumptions • FAS 60 guidance for termination rates: FAS 60, paragraph 18, states “Changes in estimates of claim costs resulting from the continuous review process and differences between estimates and payments for claims shall be recognized in income of the period in which the estimates are changed or payments are made.” • SEC guidance for interest rates for certain types of P&C coverages: SAB 62, Section N interpretative response references rates that are used “…for reporting to statutory authorities” or rates that are “…reasonable on the facts and circumstances applicable to the registrant at the time the claims are settled.”

25. Comfortable with your Reserves? Allen J. Schmitz, F.S.A. Milliman Inc.

26. Reserve Testing • Active Life Reserves • Disabled Life Reserves

27. Discuss One Approach… Why is this one Approach Important?

28. You Have To Do It ! Part of the New LTC Experience Forms

29. LTC Experience Forms • What is Changing? • Why / When Change? • Form I, II, III • Implications and Uses

30. What is Changing? Current: • Form A – Claim Experience by Calendar Duration • Form B – Cumulative Claim Experience • Form C – State Specific Form B New: • Form I – Actual Claims and Persistency Against Expected • Form II – Ratio of Experience Reserve to Reported Reserve • Form III – Claim Runout

31. What is Changing? (continued) Current Forms: • Form A – Claim Experience by Calendar Duration • Form B – Cumulative Claim Experience • Form C – State Specific Form B • Pricing Basis • Loss Ratio Focus • “Expected” Based on Original Pricing • Distribution of Business • Persistency

32. What is Changing? (continued) New Forms: • Form I – Actual Claims and Persistency Against Expected • Form II – Ratio of Experience Reserve to Reported Reserve • Form III – Claim Runout • Valuation Basis • Pricing and Reserve Adequacy Focus • “Expected” Based on Actual • Distribution of Business • Persistency • Sample Calculations

33. Why / When Change? Why? • New Model Regulation • No longer Loss Ratio Focus • Regulatory Request • AAA When? • 2007 Experience Year

34. Form I Purpose / Description: • Track Claims and Persistency Against Expected • Group Separate from Individual • Three Policy Form Categories: • Comprehensive • Institutional • Non-institutional • Policy Form Level Information Should be Kept • Direct Basis • Accelerated Benefits

35. Form I

36. Form I • Column 1 – Earned Premiums Collected Premiums + Change in Due Premiums – Change in Advanced Premiums – Change in Unearned Premium Reserves = Earned Premiums

37. Form I • Column 2 – Incurred Claims

38. Form I • Valuation Expected Incurred Claims • Exposure Adjustment: [Actual Number of Lives Inforce at Beginning of Year – (Expected Deaths + Expected Lapses) ÷ 2] ÷ Actual Number of Lives Inforce at Beginning of Year

39. Form II Purpose / Description • Calculate Ratio of Experience Reserve to Reported Reserve • Experience Reserve Developed from: • The experience reserve at the end of the prior reporting year (E-1) • Valuation net premiums and interest rates, and • Experience incurred claims, earned premiums, and actual persistency.

40. Form IIExperience Reserve to Reported Reserve

41. Form II • Column 5 – Incurred Claims

42. Form II • Column 13 – Experience Policy Reserves

43. Form III • Claim Reserve Adequacy • Similar to Schedule O – But LTCI Only • Track Development for 8 Incurred Years • Split Between Individual and Group • Require Individual Claim Data

44. Parts of Form III

45. Part 1Payment Triangle

46. Part 2Cumulative Claim Triangle

47. Part 2Cumulative Claim Triangle

48. Part 4Interest Adjusted Development

49. Implications / Uses Form I • Review Actual vs. Valuation Expected Claims • Review Open and New Claims • Review Actual vs. Expected Persistency

50. Implications and Uses Form II • Review Experience Reserve vs. Reported Reserve • Experience Reserve Formula: