1. The Representative Scenarios Method (RSM) Field Test Phase 1: Fixed Annuities Slides prepared by Steve Strommen, FSA, CERA, MAAA Blufftop LLC March, 2015

2. Outline of field test phase 1: Motivation: – Some belief that reserves under CARVM are overly conservative for GLIBs Purpose: – Test the application of RSM and formulaic floors to blocks of recently issued fixed annuities with GLIBs. Participants: – Two companies with blocks of annuities – Consultants to carry out the modeling and reserving – Kansas (Mark Birdsall) as manager and coordinator

3. Characteristics of business modeled Both Company A and Company B sell fixed indexed annuities with GLIBs. Significant differences in the generousness of guaranteed benefits (strength of guarantees) – Company B’s business includes more generous GLIB levels, making GLIBs more likely to be in-the- money.

4. Reserve methodology tested Two-part formulaic floor reserve – Floor 1 excludes “listed benefits” like GLIBS – Floor 2 reflects election of the “listed benefits” Modeled reserve using the Representative Scenarios Method (RSM)

5. Comparative reserve levels $millions Company ACompany B ItemReserve% of acct valueReserve% of acct value Account value5,139100.0%2,635100.0% Surrender value4,60889.7%2,29287.0% Formulaic reserves CARVM4,75392.5%2,54296.5% Floor4,69191.3%2,47293.8% Floor 14,65290.5%2,18983.1% Floor 23,91376.1%2,41391.6% Modeled reserves RSM (cost of capital margin)4,08179.4%2,911110.5% RSM (percentile margin)3,96577.2%2,681101.7% Stochastic CTE703,94176.7%2,741104.0%

6. Comparative margins in modeled reserves $millions Company ACompany B ItemReserve% of acct valueReserve% of acct value Central estimates RSM3,94476.7%2,49394.6% Stochastic3,91176.1%2,62199.4% Margins RSM (cost of capital)1372.7%41815.9% RSM (percentile)210.4%1897.2% Stochastic CTE70300.6%1204.6% Reserves RSM (cost of capital)4,08179.4%2,911110.5% RSM (percentile)3,96577.2%2,681101.7% Stochastic CTE703,94176.7%2,741104.0%

7. Lessons learned in phase 1 RSM produced modeled reserves in the same ballpark as full stochastic modeling May need to separate “investment returns” into two separate risk drivers (interest rates and equity returns) Aggregate margin under the cost of capital method is larger than under the percentile method for a new block of business with many years before expiry.

8. Other lessons learned in phase 1 Projection of capital to calculate cost of capital – Should be in proportion to PV of remaining benefit- only cash flows (exclude future premium cash flows) Monthly sum indexing – Sensitive to scenario volatility – Little volatility within each RSM scenario – Results not representative unless “monthly sum” indexing is simulated as “annual point-to-point”

9. Next steps – phase 2 Phase 2 involves study of RSM application to other products using a case-study approach – Variable annuities with listed benefits – Level premium term life insurance – Universal life insurance with secondary guarantees – Long term care insurance RSM discussion being split into two separable issues: – General methodology Identification of risk drivers and their distributions – Form of the aggregate margin Cost of capital or percentile will both be studied