Actuarial Guideline LIII APPLICATION OF THE VALUATION

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Actuarial Guideline LIII

APPLICATION OF THE VALUATION MANUAL FOR TESTING THE

ADEQUACY OF LIFE INSURER RESERVES

Background

The NAIC Valuation Manual (VM-30) contains actuarial opinion and supporting actuarial memorandum

requirements, including requirements for asset adequacy analysis. Regulators have observed a lack of

uniform practice in the implementation of asset adequacy analysis. The variety of practice in incorporating

the risk of complex assets into testing does not provide regulators comfort as to reserve adequacy. Examples

of complex assets are structured securities, including asset-backed securities and collateralized loan

obligations, as well as assets originated by the company or affiliated or contracted entity. An initial increase

of this activity has been noted in support of general account annuity blocks; however, recent activity was

noted in other life insurer blocks.

This Guideline is intended to provide uniform guidance and clarification of requirements for the appropriate

support of certain assumptions for asset adequacy analysis performed by life insurers. In particular, this

Guideline:

(1) Helps identify reserve adequacy and claims-paying ability in moderately adverse

conditions, including conditions negatively impacting cash flows from complex assets.

(2) Clarifies elements to consider in establishing margins on asset-related assumptions.

(3) Ensures recognition that higher expected gross returns from assets are, to some extent,

associated with higher risk, and that assumptions fit reasonably within the risk-return

spectrum.

(4) Requires sensitivity testing regarding complex assets supporting life insurer business.

(5) Identifies expectations in practice regarding the valuation of complex assets within asset

adequacy analysis.

(6) Reflects that while complex assets tend to have higher uncertainty regarding timing and

amount of cash flows than more traditional investments, because complex assets are

difficult to classify, and the regulatory concern is regarding the projected net yields and

cash flows from those assets, the focus of the analysis requirements will be on assets

categorized as high-yielding.

(7) Requires additional documentation of investment fee income relationships with affiliated

entities or entities close to the company.

Text

1. Effective Date

This Guideline shall be effective for asset adequacy analysis of the reserves reported in the

December 31, 2022, Annual Statement and for the asset adequacy analysis of the reserves reported

in all subsequent Annual Statements.

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Guidance Note: It is anticipated that the requirements contained in this Guideline will be

incorporated into VM-30 at a future date, effective for a future valuation year. Requirements in the

Guideline will cease to apply to annual statutory financial statements when the corresponding or

replacement VM-30 requirements become effective.

2. Scope

This Guideline shall apply to all life insurers with:

A. Over $5 billion of general account actuarial reserves (from Exhibits 5, 6, 7 and 8 of the

annual statement) and non-unitized separate account assets, or

B. Over $100 million of general account actuarial reserves (from Exhibits 5, 6, 7 and 8 of the

annual statement) and non-unitized separate account assets and over 5% of supporting assets

(selected for asset adequacy analysis) in the category of Projected High Net Yield Assets,

as defined in Section 3.F.

Actuarial reserve amounts are included in the amounts in A and B whether directly written or

assumed through reinsurance and are determined before any reinsurance ceded credit.

This Guideline applies to assets supporting liabilities tested in the asset adequacy analysis except it

does not apply to unitized separate account assets or policy/contract loans.

3. Definitions

A. Equity-Like Instruments – Assets that include the following:

i. Any assets that, for purposes of risk-based capital C-1 reporting, are in the category

of common stock, i.e., have a 30% or higher risk-based capital charge.

ii. Any assets that are captured on Schedule A or Schedule BA of the annual

statement.

iii. Bond funds.

B. Fair Value – The price that would be received to sell an asset or paid to transfer a liability

in an orderly transaction between market participants at the measurement date, consistent

with methodology of fair value, as reported in the Annual Statement.

C. Net Market Spread – For each asset grouping, shall mean the spread over comparable

Treasury bonds that equates the fair value as of the valuation date with modeled cash flows,

less the default assumption used in asset adequacy analysis.

Market conventions and other approximations are acceptable for the purposes of this definition.

D. Investment Grade Net Spread Benchmark – The applicable spread found in Appendix I

using the weighted average life (WAL) of the associated non-equity-like instrument.

E. Guideline Excess Spread – The net spread derived by subtracting the Investment Grade Net

Spread Benchmark from the Net Market Spread for non-equity-like instruments.

Investment expenses shall be excluded from this calculation.

F. Projected High Net Yield Assets – Currently held or reinvestment assets that are either:

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i. An equity-like instrument assumed to have higher value at projection year 10 or

later than under an assumption of annual total returns, before the deduction of

investment expenses, of 4% for the first 10 projection years after the valuation date

followed by 5% for projection year 11 and after. Aggregation shall be done at a

level of granularity that is consistent with or more granular than how the assets are

grouped, i.e., compressed, in the asset adequacy analysis model, or

ii. Assets other than equity-like instruments where the assumed Guideline Excess

Spread is higher than zero. In addition:

(a) Aggregation of the comparison between the assumed Net Market Spread

from each asset and the Investment Grade Net Spread Benchmark shall be

done at a level of granularity that is consistent with or more granular than

how the assets are grouped, i.e., compressed, in the asset adequacy analysis

model.

(b) For applicable assets that do not have an explicit WAL or term to maturity,

the appointed actuary shall disclose the method used to determine the

appropriate WAL used for comparing to the Investment Grade Net Spread

Benchmark.

from each asset and the Investment Grade Net Spread Benchmark,

investment expenses shall be excluded.

iii. The following asset types can be excluded from the scope of requirements in

sections 4.A.ii. through 5.:

(a) Cash or cash equivalents

(b) Treasuries and agency bonds

callability

4. Asset Adequacy Considerations and Documentation Expectations

A. Net Return and Risk Documentation

i. For all assets, either currently held or in assumed reinvestments, provide:

(a) Identification of the assumed gross asset yield and the key components (for

example, default and investment expenses) deducted to arrive at the

assumed net asset yield.

(b) Explanation of any future reinvestment strategy assumptions that

materially differ from current practices.

ii. For projected high net yield assets, either currently held or in assumed

reinvestments, provide:

(a) A detailed explanation describing the relationship between the expected

gross returns from these assets and the risk. It shall also include, for the

aspect of any higher expected gross returns not assumed to be associated

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with higher risk, an explanation of how overperforming assets with

expected returns lying outside the risk-return spectrum can be assumed to

persist and be available for reinvestments throughout the projection period

in moderately adverse conditions.

(b) Commentary on how assumptions on assets with risk factors leading to

substantial volatility of returns, as identified through sensitivity testing or

other means, contain an appropriate margin to reflect the uncertainty in the

timing and amounts of asset cash flows.

supporting major product categories, e.g., individual fixed annuities and

pension risk transfers.

(d) Explanation of rationale for materially changing or not changing complex-

asset-based assumptions from the prior year’s analysis.

B. Model Rigor – Where significant risks associated with complex, projected high net yield

assets are not adequately captured with traditional modeling techniques, more rigorous

modeling of those risks should occur.

i. Where necessary to adequately reflect the risk:

(a) Multi-scenario testing of those risks specific to complex assets should be

performed. For example, investments that may provide a higher expected

return in part due to limited information, niche skill sets, or other factors

may require unique scenarios (for instance to adequately capture credit or

liquidity risk) to fully encompass potential sources of loss.

(b) Asset cash flows should be appropriately projected to reflect anticipated

liquidity under adverse conditions. If such model aspects are not

developed, sufficient additional conservatism to reflect this risk shall be

applied.

risks is complex, and the potential for disconnect between reality and

modeling increases, an additional margin to assumption(s) should be

applied. Any such margin shall be applied in the direction of asset

adequacy analysis results being less favorable.

(d) The full distribution of risk associated with complex assets should be

considered.

ii. An appointed actuary may use simplifications, approximations, and modeling

efficiency techniques if the appointed actuary can demonstrate that the use of such

techniques does not make asset adequacy analysis results more favorable. These

techniques may be less appropriate if the amount of complex, high-yielding assets

becomes a higher percentage of total assets.

Guidance Note: Actuarial Standards of Practice (ASOPs), including ASOP No. 7

and No. 56 contain additional guidance on the use of models in the analysis of cash

flows.

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C. Fair Value Determination – In asset adequacy analysis, when an asset is projected to be

available for sale, a fair value of that asset is established, based on the projected market

conditions. Fair value should only be determined internally (by the insurance or investment

management company) when the market-based value of the asset or similar asset cannot

be obtained or expected to be obtained in a projected scenario.

i. When the fair value of a material portion of supporting assets is determined

internally, the actuarial memorandum shall contain a step-by-step description of

the approach used to calculate the fair value of such assets.

ii. Provide the total fair value of assets that have values determined internally.

iii. When the fair value of a material portion of assets is determined internally, a

sensitivity test should be performed (and the impact on asset adequacy analysis

results presented) assuming a haircut to internally derived fair values that the

appointed actuary deems reasonable given the commensurate level of anticipated

uncertainty.

D. Non-Publicly Traded Assets – For non-publicly traded assets originated by the company,

within the company’s group, or within an entity closely tied to a company’s group

(inclusive of the company's investment manager), provide the following:

i. Documentation of practices to help ensure accurate valuation of those assets.

ii. The total fair value of such assets.

iii. To the extent the contractual agreement affects the investment income revenue

streams included in the asset adequacy analysis, disclose in detail applicable

contractual agreements and revenue sharing, e.g., performance fees, between the

entity responsible for providing investment or other types of services and the

insurer.

Also, assumed net cash flows from assets should be net of all explicit or implicit fees or

expenses, such as origination fees, as well as reflective of other asset-related risks including

credit risk, illiquidity risk, and other market risks.

E. Investments Expenses (Fees) – Assumed investment expenses, whether paid to an external

asset manager or to internal investment management staff, as well as additional expenses

that are directly attributable to the specific investments, should be commensurate with the

expected expenses in light of the complexity of the assets.

F. Reinsurance Modeling – Related to reinsurance, relevant communications and disclosures,

for instance commentary on collectability and counterparty risk, should be presented in the

memorandum.

Guidance Note: Section 4.F is consistent with the standard laid out in ASOP No. 11 –

Reinsurance Involving Life Insurance, Annuities, or Health Benefit Plans in Financial

Reports.

G. Borrowing – Please identify if any borrowing is modeled besides to address very short-term

liquidity needs. Also, verify borrowing and reinvestment rates to ensure that projections

are not materially benefiting from arbitrage advantages.

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5. Sensitivity Tests and Attribution Analysis related to Assumptions on Projected High Net Yield

Assets

A. Sensitivity Testing

i. Perform and disclose, separately for (a) and (b), the asset adequacy analysis results

from the following sensitivity tests:

(a) For reinvestment assets other than equity-like instruments, assume the Net

Market Spreads (before deduction of investment expenses) for Projected

High Net Yield Assets do not exceed the Investment Grade Net Spread

Benchmark and apply the test to a baseline of a level Treasury rate

scenario.

For the purposes of limiting the Net Market Spreads at the Investment

Grade Net Spread Benchmark, Projected High Net Yield Assets may be

aggregated together but shall not include any assets that are not Projected

High Net Yield Assets.

(b) For reinvestment assets that are equity-like instruments, assume annual

total returns, before the deduction of investment expenses, of 4% for the

first 10 projection years after the valuation date followed by 5% for

projection year 11 and after.

ii. Strict technical compliance for each asset may not be practical for reasons such as

model limitations. Professional judgment should be applied to produce sensitivity

testing results that are consistent with the spirit of the test. A variety of alternative

methods may be acceptable. Appropriate explanation and justification should be

provided for the method that was employed.

iii. Sensitivity testing for the purpose of this Guideline does not reflect commentary

on moderately adverse conditions, but the volatility and impact demonstrated from

the testing should be contemplated in Section 4.A.ii.(b) considerations.

B. For projected high net yield assets for non-equity-like instruments, either currently held or

in assumed reinvestments, perform and disclose the following attribution analysis steps at

the asset type level associated with the templates in Section 6:

i. State the assumed Guideline Excess Spread.

ii. Estimate the proportion of the Guideline Excess Spread attributable to the

following factors:

(a) Credit risk

(b) Illiquidity risk

(d) Volatility and other risks (identify and describe these risks in detail)

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iii. Provide commentary on the results of Section 5.B.ii. Also, where judgment is

applied, provide supporting rationale of how the expected return in excess of the

Investment Grade Net Spread Benchmark is estimated.

Guidance Note: A best-efforts approach is expected for the year-end 2022

attribution analysis.

6. Reporting, Review, and Templates

Guidance Note: The NAIC Valuation Analysis (E) Working Group (VAWG) shall serve as a

resource in the targeted review of asset adequacy analysis related to modeling of business supported

with projected high net yield assets. VAWG shall provide periodic reports identifying outliers and

concerns regarding the analysis to help inform regulators on the effectiveness of this Guideline in

meeting the seven objectives stated in the Background section.

A. The documentation, sensitivity test results, and attribution analysis referenced above are to

be incorporated as a separate, easily identifiable section of the actuarial memorandum

required by VM-30 or as a standalone document, with a due date of April 1 following the

applicable valuation date. The domiciliary commissioner may approve a later due date for

companies seeking a hardship extension. The separate section or standalone document shall

be available to other state insurance commissioners in which the company is licensed upon

request to the company. The confidentiality and information provisions in state adoptions

of NAIC Model 820 regarding the actuarial memorandum are applicable to the separate

section or standalone document required by this Guideline.

B. The following sample templates adopted by the Life Actuarial (A) Task Force (LATF) are

available on the LATF web page (https://content.naic.org/cmte_a_latf.htm) under the

“Documents” tab:

i. Asset summary

ii. Components of net asset yield for various asset classes, with separate tables to be

provided for initial assets and reinvestment assets

iii. Sensitivity test aspects for projected high net yield assets that are fixed-income

iv. Sensitivity test results for projected high net yield assets

v. Attribution analysis, with separate tables to be provided for initial assets and

reinvestment assets for projected high net yield assets

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Appendix I – Investment Grade Net Spread Benchmark

WAL (Weighted Avg Life)

Investment Grade Net Spread Benchmark

(in bps)

1-10 170

11-20 175

21-30 185