Larry J. Bruning FSA, MAAA, CLU International Life Actuary, NAIC USA 7 September 2011

1. Larry J. Bruning FSA, MAAA, CLUInternational Life Actuary, NAIC USA7 September 2011 Investment Policy and Asset Liability Management USA

2. Presentation Outline International Regulatory Developments Insurance Core Principles related to Investments Investment Policy Regulation in the United States Insurance Core Principles related to Asset Liability Management Asset Liability Management Regulation in the United States Questions

3. International Regulatory Developments International Association of Insurance Supervisors (IAIS) • Established 1994 • 180 jurisdictions • 100 observers representing industry and professional associations, insurers, reinsurers, consultants and international financial institutions • Standard Setting Body issuing global insurance principles, standards and guidance papers • 26 Insurance Core Principles (ICP) drafted

4. International Regulatory Developments Insurance Core Principles ICP 1 Objectives, powers and responsibilities of the Supervisor ICP 17 Capital Adequacy ICP 2 Supervisor ICP 18 Intermediaries ICP 3 Information Exchange ICP 19 Conduct of Business ICP 4 Licensing ICP 20 Public Disclosure ICP 5 Suitability of Persons ICP 21 Countering Fraud in Insurance ICP 6 Changes in control and portfolio transfers ICP 22 Anti-money Laundering and Combating ICP 7 Corporate Governance the Financing of Terrorism ICP 8 Risk Management and Internal Controls ICP 23 Group-wide Supervision ICP 9 Supervisory Review and Reporting ICP 24 Macro-prudential Surveillance and Market ICP 10 Preventive and Corrective Measures Analysis ICP 11 Enforcement ICP 25 Supervisory Cooperation and Coordination ICP 12 Winding-up and Exit from the Market ICP 26 Cross-border Cooperation and Coordination ICP 13 Reinsurance and Other Forms of Risk Transfer on Crisis Management ICP 14 Valuation ICP 15 Investment ICP 16 Enterprise Risk Management for Solvency Purposes

5. International Regulatory Developments International Association of Insurance Supervisors (IAIS) • Financial Stability Committee (FSC) • June 2010 IAIS Position Statement on Key Financial Stability Issues • January 2011 delivered FSB draft methodology of quantitative and qualitative indicators to assess the systemic importance of insurers • Provides guidance on how to identify global and domestic SIFIs • Solvency and Actuarial Issues Subcommittee • Develop Common Framework (ComFrame) for supervision of Internationally Active Insurance Groups (IAIGs)

6. International Regulatory Developments International Association of Insurance Supervisors (IAIS) • Supervisory Forum • Promote effective and globally consistent regulation and supervision • Provide platform for supervisors to share ideas, receive feedback and develop best practices • Evaluate potential impact on large and complex insurers from global macro-economic scenarios

7. International Regulatory Developments International Association of Insurance Supervisors (IAIS) • Macro-prudential Policy and Surveillance Working Group (MPSWG) • Develop economic expertise within IAIS • Develop macro-prudential tools to assess the insurance sector • Identify components of macro-prudential surveillance relative to supervision • Identify cross-border and cross-sector issues relative to supervision • Take measures to mitigate regulatory arbitrage • Liaise with other regulatory bodies both domestic and international

8. Insurance Core Principles Related to Investments ICP 14 Valuation – The Supervisor establishes requirements for the valuation of assets and liabilities. 14.1 The valuation addresses recognition, de-recognition and measurement of assets and liabilities. 14.2 The valuation of assets and of liabilities is undertaken on consistent bases. 14.3 The valuation of assets and liabilities is undertaken in a reliable, decision useful and transparent manner. 14.4 The valuation of assets and liabilities is an economic valuation.

9. Insurance Core Principles Related to Investments ICP 14 Valuation – 14.5 An economic valuation of assets and liabilities reflects the risk-adjusted present values of their cash flows.

10. Insurance Core Principles Related to Investments ICP 15 Investment – The Supervisor establishes requirements for solvency purposes on the investment activities of insurers in order to address the risks faced by insurers. 15.1 The solvency regime establishes requirements that are applicable to the investment activities of the insurer. 15.2 The solvency regime is open and transparent as to the regulatory investment requirements that apply and is explicit about the objectives of those requirements.

11. Insurance Core Principles Related to Investments ICP 15 Investment – 15.3 The regulatory investment requirements address at a minimum the Security, Liquidity and Diversification of an insurer’s portfolio of investments as a whole. 15.4 The solvency regime requires the insurer to invest in a manner that is appropriate to the nature of its liabilities. 15.5 The solvency regime requires the insurer to invest only in assets whose risks it can properly assess and manage.

12. Insurance Core Principles Related to Investments ICP 15 Investment – 15.6 The solvency regime establishes quantitative and qualitative requirements, where appropriate, on the use of more complex and less transparent classes of assets and investment in markets or instruments that are subject to less governance or regulation.

13. Insurance Core Principles Related to Investments ICP 16 Enterprise Risk Management for solvency purposes – The Supervisor establishes enterprise risk management requirements for solvency purposes that require insurers to address all relevant and material risks. 16.6 The supervisor requires the insurer to have a risk management policy which is reflected in an explicit investment policy which: Specifies the nature, role and extent of the insurer’s investment activities and how the insurer complies with the regulatory investment requirements established by the supervisor.

14. Insurance Core Principles Related to Investments ICP 16 Enterprise Risk Management for solvency purposes – 16.6 The supervisor requires the insurer to have a risk management policy which is reflected in an explicit investment policy which: Establishes explicit risk management procedures within its investment policy with regard to more complex and less transparent classes of asset and investment in markets or instruments that are subject to less governance or regulation.

15. Investment Policy Regulation in the United States Investments of Insurers Model Act (Defined Limits NAIC Model Law 280) Investments of Insurers Model Act (Defined Standards NAIC Model Law 283) Derivatives Instruments Model Regulation (NAIC Model Regulation 282) Disclosure of Material Transactions Model Act (NAIC Model Law 285)

16. Investment Policy Regulation in the United States Investments of Insurers Model Act (Defined Limits) Article I General Provisions Section 1. Purpose and Scope Section 2. Definitions Section 3. General Investment Qualifications Section 4. Authorization of Investments by the Board of Directors Section 5. Prohibited Investments Section 6. Loans to Officers and Directors Section 7. Valuation of Investments Section 8. Regulations

17. Investment Policy Regulation in the United States Investments of Insurers Model Act (Defined Limits) Article II Life and Health Insurers Section 9. Applicability Section 10. General Three Percent Diversification, Medium and Lower Grade Investments and Canadian Investments Section 11. Rated Credit Instruments Section 12. Insurer Investment Pools Section 13. Equity Interests Section 14. Tangible Personal Property Under Lease Section 15. Mortgage Loans and Real Estate

18. Investment Policy Regulation in the United States Investments of Insurers Model Act (Defined Limits) Article II Life and Health Insurers Section 16. Securities Lending, Repurchase, Reverse Repurchase and Dollar Roll Transactions Section 17. Foreign Investments and Foreign Currency Exposure Section 18. Derivatives Transactions Section 19. Policy Loans Section 20. Additional Investment Authority

19. Investment Policy Regulation in the United States Investments of Insurers Model Act (Defined Limits) Article III Property and Casualty, Financial Guaranty and Mortgage Guaranty Insurers Section 21. Applicability Section 22. Reserve Requirements Section 23. General Five Percent Diversification, Medium and Lower Grade Investments and Canadian Investments Section 24. Rated Credit Instruments Section 25. Insurer Investment Pools Section 26. Equity Interests Section 27. Tangible Personal Property Under Lease

20. Investment Policy Regulation in the United States Investments of Insurers Model Act (Defined Limits) Article III Property and Casualty, Financial Guaranty and Mortgage Guaranty Insurers Section 28. Mortgage Loans and Real Estate Section 29. Securities Lending, Repurchase, Reverse Repurchase and Dollar Roll Transactions Section 30. Foreign Investments and Foreign Currency Exposure Section 31. Derivative Transactions Section 32. Additional Investment Authority

21. Investment Policy Regulation in the United States Section 5. Prohibited Investments An insurer shall not, directly or indirectly: Invest in an obligation or security or make a guarantee for the benefit of or in favor of an officer or director of the insurer. Invest in an obligation of a business entity in which 10% or more of the voting interests are owned by officer or director. Engage on its own behalf or through one or more affiliates in a transaction designed to evade the prohibitions of this Act. Invest in or lend its funds upon the security of shares of its own stock.

22. Investment Policy Regulation in the United States Section 6. Loans to Officers and Directors An insurer shall not, without prior written approval of the commissioner : Make a loan to or other investment in an officer or director of the insurer. Enter into an agreement for the purchase or sale of property from or to an officer or director of the insurer. Make a guarantee for the benefit of or in favor of an officer or director of the insurer.

23. Investment Policy Regulation in the United States Section 10. Medium and Lower Grade Investments An insurer shall not acquire, directly or indirectly after giving effect to the investment: The aggregate amount of medium and lower grade investments then held by the insurer would exceed 20% of its admitted assets. The aggregate amount of lower grade investments then held by the insurer would exceed 10% of its admitted assets. The aggregate amount of investments rated 5 or 6 by the SVO then held by the insurer would exceed 3% of its admitted assets The aggregate amount of investments rated 6 by the SVO then held by the insurer would exceed 1% of its admitted assets.

24. Investment Policy Regulation in the United States Section 16. Mortgage Loans and Real Estate The obligations held by the insurer shall not at the time of acquisition of the obligation exceed: 90% of the fair market value of the real estate if the mortgage loan is secured by a purchase money mortgage or like security received by the insurer upon disposition of the real estate. 80% of the fair market value of the real estate if the mortgage loan requires immediate scheduled payment in periodic installment of principal and interest with an amortization period of 30 years or less. 75% of the fair market value of the real estate for mortgage loans that do not meet the requirements of the above.

25. Investment Policy Regulation in the United States Investments of Insurers Model Act (Defined Standards) Section 1. Purpose and Scope Section 2. Definitions Section 3. Minimum Financial Security Benchmark Section 4. Authorized Investments Section 5. Prudence Evaluation Criteria Section 6. Insurer Investment Policy Section 7. Authorized Classes of Investments Section 8. Limitations Generally Applicable Section 9. Protection Against Currency Fluctuations Section 10. Prohibited Investments

26. Investment Policy Regulation in the United States Investments of Insurers Model Act (Defined Standards) Section 11. Effect of Investment Restrictions Section 12. Reports and Replies Section 13. Retention of Experts Section 14. Commissioner’s Orders Section 15. Administrative Hearings Section 16. Confidentiality of Information Section 17. Conflict of Laws and Other Standards Section 18. Regulations Section 19. Effective Date

27. Investment Policy Regulation in the United States Section 7. Authorized Classes of Investments The following classes of investments may be counted for the purposes specified in Section 11: Cash in the direct possession of the insurer or on deposit with a financial institution regulated by any federal or state agency of the United States Bonds, debt-like preferred stock of governments in the US and Canada or private business domiciled in the US or Canada Loans secured by mortgages, trust deeds of property located in US and Canada Common Stock or equity-like preferred stock of business in US and Canada Real property necessary for the convenient transaction of the insurers business

28. Investment Policy Regulation in the United States Section 7. Authorized Classes of Investments The following classes of investments may be counted for the purposes specified in Section 11: F. Real property together with the fixtures, furniture, furnishings and equipment pertaining thereto in the US or Canada which produces substantial income G. Loans, securities or other investments of the types described in subsections A to F in countries other than the US or Canada.

29. Investment Policy Regulation in the United States Section 8. Limitations Generally Applicable Investments authorized by Section 7B and Section 7G: The aggregate amount of medium and lower grade investments are limited to 20% of admitted assets. The aggregate amount of lower grade investments are limited to 10% of admitted assets. The aggregate amount of investments rated 5 or 6 by the SVO are limited to 5% of admitted assets. The aggregate amount of investments rated 6 by the SVO are limited to 1% of admitted assets.

30. Investment Policy Regulation in the United States Derivatives Instruments Model Regulation Section 1. Authority Section 2. Purpose Section 3. Definitions Section 4. Guidelines and Internal Control Procedures Section 5. Commissioner Approval Section 6. Documentation Requirements Section 7. Trading Requirements Section 8. Effective Date

31. Investment Policy Regulation in the United States Section 4. Guidelines and Internal Control Procedures Before engaging in a derivative transaction an insurance company shall establish written guidelines, approved by the Commissioner, that shall be used for effecting and maintaining derivative transactions. The guidelines shall: Specify insurance company objectives for engaging in derivative transactions and derivative strategies and all applicable risk constraints, including credit risk limits. Establish counterparty exposure limits and credit quality standards. Identify permissible derivative transactions and the relationship of those transactions to insurance company operations e.g. a precise identification of the risks being hedged by a derivative transaction. Require compliance with internal control procedures.

32. Investment Policy Regulation in the United States Section 4. Guidelines and Internal Control Procedures An insurance company shall have a written methodology for determining whether a derivative instrument used for hedging has been effective. An insurance company shall have written policies and procedures describing the credit risk management process and a credit risk management system for over-the-counter derivative transactions that measures credit risk exposure using the counterparty exposure amount

33. Investment Policy Regulation in the United States Section 4. Guidelines and Internal Control Procedures An insurance company’s board of directors shall in accordance with this Act: Approve the written guidelines, methodology and policies and procedures required by this Act. Determine whether the insurance company has adequate professional personnel, technical expertise and systems to implement investment practices involving derivatives. Review whether derivatives transactions have been made in accordance with the approved guidelines and consistent with stated objectives. Take action to correct any deficiencies in internal controls relative to derivative transactions.

34. Investment Policy Regulation in the United States Disclosure of Material Transactions Model Act Section 1. Report Section 2. Acquisitions and Dispositions of Assets Section 3. Non-renewals, Cancellations or Revisions of Ceded Reinsurance Agreements Section 4. Confidentiality Section 5. Effective Date

35. Insurance Core Principles Related to Asset Liability Management ICP 16 Enterprise Risk Management for solvency purposes – The Supervisor establishes enterprise risk management requirements for solvency purposes that require insurers to address all relevant and material risks. 16.2 The supervisor requires the insurer’s measurement of risk to be supported by accurate documentation providing appropriately detailed descriptions and explanations of risks, the measurement approaches used and the key assumptions made.

36. Insurance Core Principles Related to Asset Liability Management ICP 16 Enterprise Risk Management for solvency purposes – 16.5 The supervisor requires the insurer to have a risk management policy which includes an explicit asset-liability management (ALM) policy which clearly specifies the nature, role and extent of ALM activities and their relationship with product development, pricing functions and investment management.

37. Asset Liability Management Regulation in the United States Standard Valuation Law (NAIC Model Law 820) Actuarial Opinion and Memorandum Regulation (NAIC Model Regulation 822)

38. Asset Liability Management Regulation in the United States Standard Valuation Law Section 3 Actuarial Opinion of Reserves Opinion required annually (submitted with annual financial statement) Submitted by a Qualified Actuary Opinion covers in force business (liabilities) Opinion takes into account the assets a company owns Opinion must follow actuarial standards of practice adopted by the Actuarial Standards Board Opinion accompanied by an actuarial memorandum

39. Asset Liability Management Regulation in the United States Actuarial Opinion and Memorandum Regulation – General Requirements Company Board of Directors must appoint a Qualified Actuary to prepare the Statement of Actuarial Opinion Qualified Actuary Member in good standing of the American Academy of Actuaries Qualified to sign statements of actuarial opinion for life and health insurance company annual statements in accordance with the American Academy of Actuaries qualification standards

40. Asset Liability Management Regulation in the United States Actuarial Opinion and Memorandum Regulation – General Requirements If appointed actuary determines as the result of asset adequacy analysis that a reserve should be held in addition to the aggregate reserve held by the company and calculated in accordance with methods set forth in the Standard Valuation Law, the company shall establish the additional reserve. Any additional reserve established above and deemed not necessary in subsequent years may be released and any amounts released shall be disclosed in the actuarial opinion for the applicable year.

41. Asset Liability Management Regulation in the United States Opinion should include a statement such as “In my opinion the reserves and related actuarial values: Are computed in accordance with presently accepted actuarial standards consistently applied and are fairly stated in accordance with sound actuarial principles; Are based on actuarial assumptions that produce reserves at least as great as those called for in any contract provision as to reserve basis and method; Meet the requirements of the Insurance Law and regulation of the state and are at least as great as the minimum aggregate amounts required by the state; Are computed on the basis of assumptions consistent with those used in computing the corresponding items in the annual statement of the preceding year-end;

42. Asset Liability Management Regulation in the United States Opinion should include a statement such as “In my opinion the reserves and related actuarial values: Include provision for all actuarial reserves and related statement items which ought to be established; When considered in light of the assets held by the company including, but not limited to, the investment earnings on the assets, and the considerations anticipated to be received and retained under the policies and contracts, make adequate provision, according to presently accepted actuarial standards of practice, for the anticipated cash flows required by the contractual obligations and related expenses of the company; and This opinion is updated annually as required by statute and to the best of my knowledge, there have been no material changes from the applicable date of the annual statement to the date of my rendering of this opinion which should be considered in reviewing this opinion.

43. Asset Liability Management Regulation in the United States Asset Adequacy Analysis involves the following: Building a financial model of a company’s in force insurance contracts Building a financial model of a company’s in force assets Setting liability assumptions such as: Premium payment patterns Lapse Rates (base and excess) Interest crediting rate strategy Mortality Policy owner dividend strategy Competitor or market interest rate structure Annuitization rates Company commissions and expenses Morbidity Policy owner utilization

44. Asset Liability Management Regulation in the United States Asset Adequacy Analysis involves the following: Setting asset assumptions such as: Reinvestment and dis-investment of cash flows Asset valuation bases for assets held Default costs Bond call functions Mortgage pre-payment functions Market values for assets sold Determining yields on asset purchased Investment expenses Generating Interest Rate or Market Rate scenarios to test Deterministic such as New York 7 Stochastic (American Academy of Actuaries Economic Scenario Generator)

45. Asset Liability Management Regulation in the United States Asset Adequacy Analysis involves the following: Running the financial models under each interest rate/market rate scenario over a period long enough such that no material liability exists Calculating the metric for each scenario Present Value of Ending Market Surplus Present Value of Ending Book Surplus Determining the additional reserve, if any, after evaluating the results of each scenario

46. Asset Liability Management Regulation in the United States New York 7 Interest Rate Scenarios (Stress Tests) Level Scenario Uniformly increasing over 10 years at 0.50% then level Uniformly increasing over 5 years at 1.0% then uniformly decreasing at 1.0% for 5 years then level Immediate increase of 3.0% forever Uniformly decreasing over 10 years at 0.50% then level Uniformly decreasing over 5 years at 1.0% then uniformly increasing at 1.0% for 5 years then level Immediate decrease of 3.0% forever

47. Asset Liability Management Regulation in the United States In addition to the NY 7 interest rate scenarios, most companies also run a set of stochastic interest rate scenarios Cash flow models contain many assumptions so most companies run additional sensitivity tests on the assumptions such as increased and decreased lapse rates, mortality rates, expenses, default costs, pre-payment speeds etc. Must consider rationale for inclusion or exclusion of different blocks of business Must consider impact and treatment of reinsurance Must consider definition of moderately adverse conditions

48. Asset Liability Management Regulation in the United States Company must file annually a Regulatory Asset Adequacy Issues Summary (RAAIS) which: Disclose scenarios tested, sensitivity testing done, scenarios that generated negative ending surplus, additional reserve needed to eliminate negative ending surplus. Disclose any asset adequacy assumptions that were materially different from the previous year’s assumptions. Disclose the amount of reserves and product lines subjected to asset adequacy analysis in the prior opinion but not subject to analysis in the current opinion. Disclose any interim results that may be of significant concern to the appointed actuary.

49. Asset Liability Management Regulation in the United States Company must file annually a Regulatory Asset Adequacy Issues Summary (RAAIS) which: Disclose methods used to recognize the impact of reinsurance on company’s cash flows. Disclose whether the actuary is satisfied that all options whether explicit or embedded in any asset or liability and any equity-like features in any investments have been appropriately considered in the asset adequacy analysis.

50. Questions Questions ???