System Challenges in Fixed Index Annuity US GAAP Implementation - PDF document

Equity-Based Insurance Guarantees Conference Nov. 5-6, 2018 Chicago, IL System Challenges in Fixed Index Annuity US GAAP Implementation Peter Phillips SOA Antitrust Compliance Guidelines SOA Presentation Disclaimer Sponsored by

System Challenges in Fixed Index Annuity US GAAP Implementation Peter Phillips Jerry Mao November 6, 2018 1:30-2:30 p.m. Prepared by PathWise TM Solutions Group Proprietary & Confidential

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Agenda Section 1 FIA Reporting Changes Section 2 Implementation Challenges Implementation Strategies Section 3 Prepared by PathWise TM Solutions Group 3 Proprietary & Confidential

Agenda Section 1 FIA Reporting Changes Section 2 Implementation Challenges Implementation Strategies Section 3 Prepared by PathWise TM Solutions Group 4 Proprietary & Confidential

Introduction  Accounting Standards Update 2018-12 outlines 4 areas of improvements for long-duration contracts.  December 15, 2020 implementation date poses challenges from a system perspective. Market Risk Assumptions Benefits DAC Disclosures Amortization Prepared by PathWise TM Solutions Group 5 Proprietary & Confidential

US GAAP Targeted Improvements  Review and update cash flow measurement assumptions at least annually – Recognized in net income  Review and update discount rate assumption at each reporting date – Recognized in other comprehensive income  Deferred acquisition costs (DAC) amortization – Constant level basis over the expected term (simplification)  Disclosures – Disaggregated rollforwards • Reserve, account balances, separate account liabilities, DAC • Market risk benefits – Significant inputs, judgements, assumptions, and methods Prepared by PathWise TM Solutions Group 6 Proprietary & Confidential

FIA US GAAP Targeted Improvements  Measurement of market risk benefits The amendments require that an insurance entity measure all market risk benefits associated with deposit (or account balance) contracts at fair value. The portion of any change in fair value attributable to a change in the instrument- specific credit risk is required to be recognized in other comprehensive income. Prepared by PathWise TM Solutions Group 7 Proprietary & Confidential

Agenda Section 1 FIA Reporting Changes Section 2 Implementation Challenges Implementation Strategies Section 3 Prepared by PathWise TM Solutions Group 8 Proprietary & Confidential

Common Challenges  Computation time – Large-scale seriatim calculations or Monte Carlo simulations  Memory and data bottlenecks – Inefficient use of memory and unnecessary data input / output  Multitude of special-purpose systems – Lack of integration and high-level control of various systems and platforms Prepared by PathWise TM Solutions Group 9 Proprietary & Confidential

Exotic Options in FIA End of Year 2011 2012 2013 2014 2015 2016 2017 S&P 500 Return -0.003% 13.41% 29.60% 11.39% -0.73% 9.54% 19.42% Rate Credited 0% 5% 5% 5% 0% 5% 5% Sample Illustration (Annual Point-to-Point with 5% Cap)  Options are embedded in FIA contracts to back crediting rates – Non-exotic options: call spreads – Exotic options: Asian options, cliquets (forward starting options) – Reported according to ASC 815 (Embedded Derivatives)  Option valuation methods: – Closed-form: not always available, numerical methods required – Approximation: not always reliable, further complexity in approximation methodology – Monte Carlo simulation: most general method, slow under legacy systems Prepared by PathWise TM Solutions Group 10 Proprietary & Confidential

Market Risk Benefits  Most GMxB riders are going to be classified as market risk benefits according to ASC 944 and valued on a fair-value basis  GLWB is an increasingly popular feature for FIA contracts  Switching to fair value measurement will impact valuation, hedging, and reported results – Hedging mismatch if currently hedge is on current accounting basis  Increase balance sheet volatility  Significant increase in computational load  Modifications to existing processes Prepared by PathWise TM Solutions Group 11 Proprietary & Confidential

Existing Production Processes  The existing accounting processes ASC 815 and ASC 944 are complex enough, projection of financial statements and hedging are usually nested simulations  New reporting changes further increase the demand for computation resources Hedging Embedded Host Additional Real-World reporting derivatives contract liability Scenarios and (ASC 815) reporting reporting reporting Sensitivities (ASC 815) (ASC 944) (ASC 944) Market-consistent SOP 03-1 Scenarios and Scenarios Shocks Prepared by PathWise TM Solutions Group 12 Proprietary & Confidential

Potential Changes  The following changes may be required: – Replace old real-world valuation methodology with the new fair-value methodology – Integrate market-consistent scenarios – Update hedging methodology – Update and consolidate reporting processes – Restatement of financial results Prepared by PathWise TM Solutions Group 13 Proprietary & Confidential

Change Management  Impact analysis – Systems and processes impacted – New processes required – Estimate computational load and run times – Estimate human resource requirements – Assessing the impact on financial results  Transition planning – Update existing systems and processes or – Introduce new systems and processes – Running multiple systems or multiple versions in parallel – Pathway from development to production Prepared by PathWise TM Solutions Group 14 Proprietary & Confidential

What’s in a system?  To understand how the system is impacted, we need to take a closer look at the system itself  A modern computation platform can be described as a vertical stack User Input File I/O Output Front End Applications Models and Analytics Middle Layer Back End Services Computation Hardware Prepared by PathWise TM Solutions Group 15 Proprietary & Confidential

What’s in a system? User User  User is at the top of the stack Input File I/O Output Models and Analytics  Legacy systems – Poor user experience (UX) Data Flow Front End Applications – Steep learning curve – Poor documentation – Low-level language skills needed Middle Layer  Modern systems Back End Services – Intelligently designed UX – Gentle learning curve Computation Hardware – Integrated documentation system – Visual programming Prepared by PathWise TM Solutions Group 16 Proprietary & Confidential