Challenges faced in Asset Share calculations 25th India Fellowship Seminar Challenges faced in Asset Share calculations Presented by: Samit Upadhyay Jasdeep Singh Abhinandan Reddy Guide: Madhura Maheshwari 9 June 2016, Mumbai Indian Actuarial Profession Serving the Cause of Public Interest

Agenda Define Asset Share Role of Asset Share Introduction Principles – From Guidance Note 6 Challenges in calculation Possible Alternatives Key Consideration in Asset Share Calculation Questions www.actuariesindia.org

Introduction www.actuariesindia.org

Introduction Asset Share is Accumulation of - www.actuariesindia.org Premiums Investment Returns Benefit Outgo Expenses Commission Taxes Shareholder Transfers Cost of Guarantee & Capital Charges Miscellaneous Surplus Accumulation of - GN6 definition - An asset share for a policy grouping at a given point in time is the accumulation of the premiums received plus investment income earned from the inception of the policies, less deductions due to benefit payments, commission, expenses, tax, a reasonable cost of capital and of guarantees, contribution from miscellaneous surplus (if considered appropriate) and transfers to shareholders. www.actuariesindia.org

Introduction Role of Asset Share Declaration of Bonuses Surrender Value Calculation Death Value Calculation Maturity Value Calculation Role of Asset Share Reserving Investment Strategy Cost of Guarantee Calculations Survey Result - Role of Asset Shares among Indian Companies Milliman India Asset Share Survey – 04th February 2014 www.actuariesindia.org

Key Considerations www.actuariesindia.org

Key Considerations Policy Grouping Data Basis Smoothing Others www.actuariesindia.org

Key Considerations Policy Grouping Data Basis Smoothing Others www.actuariesindia.org

Policy Grouping – Principles As per GN6 – The Appointed Actuary should consider whether it is appropriate to group policies for the purpose of determining bonus rates. Asset Share where calculated, should be determined for each policy grouping Key Considerations for Setting Groups 1. Maintaining Equity – The Grouping of policies should not materially disadvantage one group at the cost of other. 2. Guided by Risk Sharing Rules – Such as views on - Policy holder’s Reasonable Expectation - Balance Between Risk & Reward Basis for Setting up Groups 1. Based on Key Product Features, such as - Similar Bonus Structure - Type of Plan - Date of issue - Policyholder’s age 2. Other Features, such as - Bonus earning capacity - Moneyness of Guarantee www.actuariesindia.org

Policy Grouping – Challenges Key Challenges in determining level of grouping for asset share calculation Avoidance of cross subsidy especially if its systematic Determination of homogeneity Large Group : High extent of cross subsidy Small Group : Credibility of basis and absence of sufficient pooling Too large Vs too small groups Investment : Hypothecation of assets and measurement of performance Mortality : Experience with sufficient credibility Ability to measure / estimate parameters at the group level. Establish equity, given practical constraints of systems Others www.actuariesindia.org

Policy Grouping – Alternatives Possible Solution to address the challenges in grouping By considering volume Discounts Limit options under a bonus series Minimise cross subsidy at pricing stage Start with broader groups and keep splitting as gain credibility Consider policyholder’s reasonable expectation Consider the ability of declaration of different regular / terminal bonus rates Grouping Asset Share at appropriate level Example - Expenses based on year of issue and product , Investment based on SP/RP, moneyness of guarantees Aggregate policy level asset shares in groups of regular / terminal bonus series Policy Level Asset Share & different groups for different parameters www.actuariesindia.org

Key Considerations Policy Grouping Data Basis Smoothing Others www.actuariesindia.org

Data : Challenges As per GN6 – Wherever possible, the Appointed Actuary should make use of actual historical data ... to derive the historical asset share. Of contracts – for policy level asset share calculation For measurement of experience Availability of complete and valid data Availability of granular data for historical operating experience - most significant challenges faced by companies* Exacerbated if historical data not stored / captured / complete Further, difficult to validate Especially an issue for companies moving to late adoption of asset share * Millman - India Asset Share Survey 2014 www.actuariesindia.org

Data : Challenges Availability of granular data for historical operating experience - most significant challenges faced by companies* * Millman - India Asset Share Survey 2014 www.actuariesindia.org

Data : Possible Solutions Consistent with Statutory Valuation Invest in resources to collate & validate data Only when detailed historical data not available As per GN 6 – use of proxies to the actual historical experience Alternate systems like accounting etc. Checking split between asset share and estate by sources of surplus method Validate the parameters used www.actuariesindia.org

Key Considerations Policy Grouping Data Basis Smoothing Others www.actuariesindia.org

Basis – Principles Identification & Documentation Treatment (for both surplus & deficit) of various sources of surplus Guides : Past practice / Benefit Illustration / PRE Equity, fairness & consistency of approach from year on year Once sources to be shared ascertained Use historical experience, only if not available, proxy best estimates can be used Correspondence between benefit and charge Consistency depending on the use of asset shares Statutory valuation basis and book value asset shares Bonus declaration and possibly market value asset shares www.actuariesindia.org

Basis – Challenges(1) In general for various parameters need to establish if asset shares would be allocated Charges : No sharing of surplus Experience : Sharing of surplus Identification of sources : Requires complex modelling, granular experience and attribution analysis Distribution of a source : usually requires some evidence of recurrence Companies are in various stages of operation and emergence of surplus is not uniform in each stage Initial phase : expense overrun Growth phase : high lapse profits Maturity phase : relatively low surrender profits www.actuariesindia.org

Basis – Challenges(2) Conflicting choices for attribution of a source Competitiveness of existing business vs Support New Business overruns Solvency of the fund vs boost to payout values Fairness vs Smoothing and implications to PRE Equitable allocation of lapse / surrender surplus to continuing policies May not be fair to share deficit automatically if surplus was shared, eg. Mortality deficit due to increase in Non Medical Limits for new business Suitability of expression of a charge wrt a dependent variable, eg. Moneyness and Cost of Guarantee may not correspond to Charge for Guarantee (% of asset shares) Allocation of global items like burn through cost Deferred Tax Asset www.actuariesindia.org

Basis – Alternatives (1) Attribution of Charge vs Experience Consistency with Benefit Illustration is paramount (not only figures but also foot-notes) Adequate documentation (possibly in PPFM) of rationale with expected future treatment shall ensure continuity Decision making could be shared with the WPC - to ensure consideration from a wider perspective Test recurrence / emergence of surplus in various plausible scenarios Decision could be made given FCR scenarios ( possibly even longer term, if appropriate) Depending on lifestage of the Company, form risk sharing groups, eg Only policies that supported acquisition overruns shall be shielded from renewal expense overrun or will not be charged cost of capital etc. www.actuariesindia.org

Basis – Alternatives (2) Target minimising inter generational cross subsidy Measure and attribute parameters at appropriate risk group level Test suitability of charge and its expression by dynamic projection of Asset Shares Allocation of investment returns commensurate with CoG Allocation of global Items like burn through cost and DTA could be on Marginal basis : allocate marginal cost to incremental business Contribution basis : Each policy contributes to its share of tax and a higher CoG contribution www.actuariesindia.org

Key Considerations Policy Grouping Data Basis Smoothing Others www.actuariesindia.org

Smoothing : Principle Essential characteristic of with profits business May pool business both within a generation and between generations Presence of some discretion, however the AA should consider following Genuine reduction in volatility of payouts Change in risks of statutory / realistic solvency All policyholders treated fairly Consider treatment of smoothing surplus / deficit and if it is Shared with survivors Credited to estate / asset shares Is consistent with PRE www.actuariesindia.org

Smoothing : Challenges Explicit identification of smoothing account Should be supported by asset share or estate Appropriateness of various smoothing methods Balance between extent of smoothing and deemed satisfaction of PRE Choice between smoothing input parameters like investment return or pay out values Joint impact of smoothing rules with dynamic management actions Impact on charge for guarantee Requires complex modelling www.actuariesindia.org

Smoothing : Possible Solutions May be simpler to input unsmoothed parameters and smooth payouts Test resilience of smoothing rules with management actions using stochastic methods Test if the account tends to zero over medium term Document the approach - after testing run off of entire business in various economic / operating scenarios Minimise reliance on estate for smoothing by Maintain smoothing reserve account as a component of reserve for future bonus to avoid reserving over and above asset share Smooth both regular bonuses as well as terminal bonus to keep smoothing reserve to its minimum as well as meet PRE www.actuariesindia.org

Key Considerations Policy Grouping Data Basis Smoothing Others www.actuariesindia.org

Others – Principle Miscellaneous attribution Pricing of rider / non par elements needs to be fair  Reinsurance arrangement should consider risk vs reward, especially if non par business is written in the fund and surplus shared Overall should be as per PRE of par policyholders  Segregation and merger considerations Formal / notional segregation of funds and respective asset shares Could also be merged if benefits expected from diversification Separation of measurement / allocation of parameters Appropriate disclosure made to existing and prospective policyholders www.actuariesindia.org

Other – Challenges Allocation of miscellaneous surplus due to absence of separate bonus series could lead to inequity if material between reinsured and not reinsured policies between with rider and without rider policies Allocating the effects of reinsurance especially in surplus/ non proportional type of reinsurance  In case of non par business / riders a balance between solvency of the par fund and fairness of pricing Ability to administer multiple systems in case of a merger Can significantly increase complexity around data and measurement of parameters Trade off between diversification credit and separation of allocation to asset shares www.actuariesindia.org

Others – Alternatives Reinsurance Rider/ Non par business The effect of reinsurance can be clubbed with mortality experience / charge This could include the allocated premium for cat re or any other non proportional arrangement Rider/ Non par business Could shield the par policyholders till parameter estimates gain credibility Experience sharing reinsurance arrangements can be helpful to balance solvency and fairness  Segregation / Merger AA should document the structure and rationale of the sub-funds and the risks that are shared within each sub-fund for experience pooling Consistent treatment from year on year  www.actuariesindia.org

Thank You Questions? www.actuariesindia.org