2008-03-16 02:49:09 -

- Padilla Speer Beardsley Malkie Bernheim, 212-752-8338 mbernheim@psbpr.com or Padilla Speer Beardsley Deanna Decker, 212-752-8338 ddecker@psbpr.com The Insurance and Actuarial Advisory Services (IAAS) practice of Ernst & Young LLP today announced highlights from its "Moving Forward in a Principles-based World" roundtable which addressed the number of upcoming regulatory changes set to alter the existing financial reporting

terrain.

Participants, including Chief Financial Officers and senior life insurance executives, discussed new developments and implementation issues surrounding statutory principles-based reserve and capital regulations (PBR) as well as the convergence of the US Generally Accepted Accounting Principles (GAAP), International Financial Reporting Standards (IFRS), and Solvency II.

The group acknowledged the challenges ahead, and there was an over-riding consensus that the industry is struggling to understand and prepare for the impact on the business. Despite the fact that the regulations are still in flux, participants agreed that companies who seek to understand the ramifications of the coming changes in advance of their adoption will be in a better future position and that the time is right to begin mapping out a plan for meeting the new requirements.

"Impacting pricing and risk management, the transition to principles-based reserving and capital, coupled with pending regulatory convergence, will require significant changes in processes and systems," explains Tara Hansen, senior actuarial advisor with Ernst & Young LLP. "The onus is on the actuarial team to grab the reins and take action so they can proactively lead their companies through the extensive changes to come and ultimately improve risk management and enhance profitability."

Following are key highlights from the roundtable dialogue:

Principles-Based Reality Beginning to Come into Focus

Participants are still dealing with the aftermath of C3 Phase 2 implementation and many admitted that PBR has only recently started to hit their radar screen. The group expressed angst about being able to meet the new PBR hurdles as there are multiple legs to putting the principles-based reserves framework in place and the standards have not yet been fully defined. While there have been extensive drafts, the American Academy of Actuaries has not finalized its Life Reserve Work Group proposal and participants are eager to know when the exposure drafts will be finalized.

Despite the number of questions that have yet to be answered regarding PBR, roundtable participants stressed the importance of acting now. There was also recognition that, though there is a great deal of work required in moving towards a principles-based approach, it is a worthwhile investment.

The group addressed key issues to begin pondering, including:

-- Benefits from a Decrease in Reserves - It appears that term and secondary guarantee universal life insurance reserves will be decreasing on a PBR basis and reserves may be significantly lower for certain products. It remains to be seen, however, whether or not total capital will decrease because, under C3 Phase 3, a reduction in reserves may be coupled with an increase in required capital. This also begs the question of how rating agencies will evaluate companies in the future.

-- Complexity of Tax Reserves and Impact on Deduction - In a recent notice distributed by the Treasury Department and the Internal Revenue Service, comments were requested from life insurance companies on a number of issues, including concerns about principles-based valuation methodologies making audits difficult or impossible for examiners. The notice identifies some of the approaches being considered to address this and other issues, including calculating tax reserves on a contract-by-contract basis versus aggregate, prevailing mortality tables, transition rules, and qualification of contracts as life insurance. These approaches, which are subject to comment and further notice, have the potential to impact tax reserve deductions.

-- Reflection of Risk - Company risk processes will now be able to be reflected in the reserve calculation. As such, the lower the risk, the lower reserves will be. Companies will now be rewarded for sound risk management processes by way of lower reserve and capital requirements.

-- Inclusion of Risk Margins - While risk margins need to be developed on a stand alone basis for each risk, they also must be assessed in aggregate to avoid having reserves that are excessive. Performing preliminary analysis upfront will help companies understand the interplay of risk margins and avoid the possibility of over-reserving.

-- Securitization as a Short-term Fix - Removing excess reserves through securitization may no longer be necessary and companies need to be cognizant of this when developing their risk management strategies.

-- More Flexibility Requires Greater Governance - In the future, there will be more leeway in the determination of reserves. Indeed, margins will be left up to the judgment of actuaries, and participants suggested a need for a solid checks and balances system to avoid potential gray areas and abuse.

Danger of Addressing PBR in a Vacuum...Global Convergence Groundwork Already in Place

While the timetable is uncertain, the group overwhelmingly agreed that US GAAP rules appear set to converge with emerging fair value-based IFRS accounting rules. At the same time, the European Commission continues to move forward with Solvency II and its economic risk-based solvency requirements which currently carry an implementation deadline of 2012.

Although the final outcomes of PBR, IFRS, and Solvency II are not the same, it was noted that the modeling and infrastructure changes US companies are making to prepare for PBR can serve as a solid foundation for the regulatory convergence further down the road.

"As regulatory initiatives are announced on both sides of the Atlantic, a clearer picture of the future is beginning to emerge," explains Matt Clark, senior actuarial advisor, Ernst & Young LLP. "This includes a principles-based approach for worldwide financial reporting that relies on stochastic models and actuarial judgment. By keeping an eye on developments in Europe and taking an integrated approach as they prepare for the more immediate local regulatory changes, US insurers will be able to put modeling tools in place that can be reused as global convergence emerges."

Implementation Challenges...Consistency as the Brass Ring

As regulations converge, participants suggested that implementation will need to revolve around creating consistency through an integrated set of reporting processes. While lack of resources to make the necessary changes was the greatest implementation concern mentioned by participants, the group also acknowledged that even with the right people and funding, significant issues remain, such as:

-- Modeling and Technology Platform Challenges and Opportunities - Topics for insurers to address include projection capabilities and runtime as well as the credibility and availability of data.

-- Shift to Stochastic Processing - There will likely be a need for a platform that is projection-based and stochastic in nature.

-- Systems for Analyzing Reserve Changes - Moving forward, companies need systems in place to explain results and analyze reserve movements from period to period in a stochastic environment, with the ability to change assumptions as best estimates migrate over time.

-- Greater Communication Between Pricing, Valuation, and Corporate - This will be crucial to eliminate unwanted surprises.

-- Auditability - This includes creating an appropriate control environment and review process as well as the appropriate documentation. Since periodic reassessment of assumptions is required to obtain principles-based results, this is particularly complicated.

"Having active members of the executive management team in place who can interpret and explain how these pending regulatory changes will affect product pricing, capital requirements, and profit emergence will be critical," adds Hansen. "This will require a proactive outlook and an early investment in strategy, development, and implementation. Companies who take a wait and see approach will pay for their delayed reaction in the long run."

The Ernst & Young "Moving Forward in a Principles-based World" roundtable is the first in a series of insurance industry gatherings the firm is hosting to discuss the impact of evolving regulations. For a full roundtable report, which will be available later this month, please contact Deanna Decker at 212-752-8338 or ddecker@psbpr.com.

About Ernst & Young IAAS

The Insurance and Actuarial Advisory Services (IAAS) practice of Ernst & Young includes a professional staff of 150 with more than 90 credentialed actuaries throughout the United States and Canada. IAAS delivers actionable business advice to its clients in the life/health and property/casualty insurance industries. It also provides insurance, risk management and claims advisory services to a range of businesses and corporations. IAAS employs financial modeling and other quantitative analysis techniques and technologies to assist clients in making decisions that will improve performance and achieve competitive advantage. For more information, please visit www.ey.com/us/actuarial.

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Industry Facing Uncertainty of Principles-Based Regulations and
Global Convergence