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Introduction to the

Actuarial Standards of Practice

Developed by the
Actuarial Standards Board

Approved by the
Actuarial Standards Board
October 2008

(Doc. No. 113)


Introduction to the Actuarial Standards of Practice — October 2008

TABLE OF CONTENTS

Transmittal Memorandum iii

Section 1. Overview...................................................................................................................1
Section 2. The Actuarial Standards Board ..................................................................................1
Section 3. Actuarial Standards of Practice ..................................................................................1
Section 4. Compliance with ASOPs ...........................................................................................5

APPENDIX

Appendix: Comments on the Exposure Draft and Responses.......................................................8

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Introduction to the Actuarial Standards of Practice — October 2008

October 2008

TO: Members of Actuarial Organizations Governed by the Standards of Practice of the


Actuarial Standards Board and Other Interested Persons

FROM: Actuarial Standards Board (ASB)

SUBJ: Introduction to the Actuarial Standards of Practice (ASOPs)

This document contains the October 2008 revision to the Introduction to the Actuarial Standards
of Practice (“Introduction”).

Background

In 1989, the ASB published a Preface to its standards that provided insight into the nature of
professions and the role that professionalism standards and disciplinary procedures play, with
specific reference to those of the actuarial profession.

Since that time, there have been significant developments in the structure of the professionalism
standards and disciplinary procedures of the actuarial profession. The ASB determined that it
would be beneficial to adopt an introduction to the standards to offer actuaries guidance on the
ASB’s operations, the content and format of standards, and the ASB’s intent with respect to
certain terms that appear frequently in the text of the standards themselves. For these reasons, the
ASB withdrew the Preface and prepared the Introduction to the Actuarial Standards of Practice
in 2004.

Recently, the ASB concluded that a limited review of the Introduction was appropriate in order
to clarify and update certain language.

Exposure Draft

The exposure draft of this revision was issued in July 2008 with a comment deadline of August
22, 2008. The ASB reviewed the 14 comment letters received and made changes to the draft as
appropriate.

This revision clarifies the language in sections 3.1.2 and 3.1.3 (now 3.1.3 and 3.1.4) regarding
the process that the ASB follows when developing ASOPs. Apparently, some actuaries have
interpreted the prior language to indicate that the Board merely codifies (or catalogs) current
practices when developing an ASOP. The actual process in developing ASOPs goes well beyond
a simple codification of practices. Therefore, the language was clarified to articulate more clearly
the process the Board has been following to develop ASOPs.

Second, language in section 3.2.3 that related to prescribed statements of actuarial opinion was
deleted in light of the new revisions (effective January 1, 2008) to the Qualification Standards

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Introduction to the Actuarial Standards of Practice — October 2008

for Actuaries Issuing Statements of Actuarial Opinion in the United States (Including Continuing
Education Requirements).

Third, due to the current ASB project to standardize the “deviation” provisions in all ASOPs and
move to the substantial guidance to ASOP No. 41, Actuarial Communications, the language in
section 4.6 was substantially altered to conform to the new deviation procedures.

The transmittal memorandum accompanying the exposure draft indicated that the proposal had a
limited purpose—to clarify language in four specified sections. The proposal was not intended to
be reflective of any changes in the way standards are set. At the same time, the ASB recognizes
that there may be larger issues with the Introduction than those that are being addressed by these
revisions. Accordingly, the ASB, in a separate document, is inviting members of the profession
or other interested parties who have suggestions on how to improve the standard setting process
to share their ideas with the ASB.

Although the Board did not request comments on other areas of the Introduction, it did review
and react to comments suggesting clarifications on sections outside the original mandate of the
Exposure Draft, making changes where appropriate. See the Appendix for a detailed discussion
of the comments received and the Board’s responses.

The Board thanks everyone who took the time to comment on the exposure draft.

The ASB voted in October 2008 to adopt this Introduction.

Actuarial Standards Board

Stephen G. Kellison, Chairperson


Albert J. Beer Robert G. Meilander
Alan D. Ford James J. Murphy
Patrick J. Grannan Godfrey Perrott
David R. Kass Lawrence J. Sher

The ASB establishes and improves standards of actuarial practice. These ASOPs identify what
the actuary should consider, document, and disclose when performing an actuarial assignment.
The ASB’s goal is to set standards for appropriate practice for the U.S.

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Introduction to the Actuarial Standards of Practice — October 2008

INTRODUCTION TO THE ACTUARIAL STANDARDS OF PRACTICE

Section 1. Overview

The Actuarial Standards Board (ASB) promulgates actuarial standards of practice (ASOPs) for
use by actuaries when providing professional services in the United States. For purposes of this
Introduction, Financial Reporting Recommendations and Actuarial Compliance Guidelines
promulgated or republished by the ASB that have not been superseded are also ASOPs. This
Introduction sets forth principles that have been broadly applicable to the work of the ASB since
its inception. This Introduction is part of the standards and carries the same weight and authority
as the ASOPs themselves.

Section 2. The Actuarial Standards Board

2.1 The ASB is vested by the U.S.-based actuarial organizations1 with the responsibility for
promulgating ASOPs for actuaries providing professional services in the United States.
Each of these organizations requires its members, through its Code of Professional
Conduct2, to observe the ASOPs of the ASB when practicing in the United States.
Actuaries who are required by their non-U.S. actuarial organizations to observe
applicable standards of practice when providing professional services should also look to
these ASOPs when practicing in the United States.

2.2 The ASB promulgates ASOPs through a notice and comment process described in the
ASB Procedures Manual. The ASB has exclusive authority in the United States to
determine whether an ASOP is needed in a particular practice area, to promulgate
ASOPs, and to amend or withdraw ASOPs when, in the ASB’s judgment, such
amendment or withdrawal is appropriate. The ASB is the final authority for determining
the content of its ASOPs.

Section 3. Actuarial Standards of Practice

3.1 The Purpose of ASOPs

3.1.1 The ASOPs are not narrowly prescriptive and neither dictate a single approach
nor mandate a particular outcome. ASOPs are intended to provide actuaries with a
framework for performing professional assignments and to offer guidance on
relevant issues, recommended practices, documentation, and disclosure. Each

1
The American Academy of Actuaries (Academy), the American Society of Pension Professionals and Actuaries,
the Casualty Actuarial Society, the Conference of Consulting Actuaries, and the Society of Actuaries.
2
These organizations adopted identical Codes of Professional Conduct effective January 1, 2001.

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Introduction to the Actuarial Standards of Practice — October 2008

ASOP articulates a process of analysis, documentation, and disclosure that, in the


ASB’s judgment, constitutes appropriate practice within the scope and purpose of
the ASOP.

3.1.2 Proposals for developing new ASOPs and revising existing ones come from a
variety of sources, including individual actuaries, actuarial firms, professional
committees (e.g., American Academy of Actuaries practice councils), the
Actuarial Board for Counseling and Discipline, and the ASB (and its committees)
itself. If it accepts the proposal, the ASB assigns it to the appropriate committee
or task force to begin the project.

3.1.3 The process of developing a new ASOP or revising an existing ASOP generally
begins with the identification of practices that the ASB believes are broadly
accepted by qualified actuaries as appropriate to the proper performance of a
particular type of professional assignment or aspect of professional practice. After
reviewing the current range of practices, the ASB determines whether it is
appropriate under the circumstances to restrict or elevate practice to serve the
public interest, to reflect recent advancements in actuarial science, or for other
reasons. Additionally, the ASB may provide supporting context to delineate how
the appropriate level of practice may be achieved in specific situations.

3.1.4 The ASB seeks to define an appropriate level of practice, recognizing that the
adoption of an ASOP and its subsequent use by practitioners and enforcement by
the U.S.-based actuarial organizations will have the effect of rendering practices
described in the ASOP as “generally accepted.” Similarly, the ASB sometimes
promulgates an ASOP in a new area of practice. Again, the ASB seeks to define
an appropriate level of practice for actuaries working in the new area, often by
looking at current practice in other areas. The process of exposure to the
profession and other interested parties is intended to confirm the general range of
practice and to seek input on the impact that the proposed ASOP would have on
the level of practice.

3.1.5 ASOPs are intended for use by actuaries who, by virtue of having the necessary
education and experience to understand and apply them, are qualified to make use
of them. Other individuals should consider obtaining the advice of a qualified
actuary before making use of or otherwise relying upon these ASOPs. ASOPs are
not intended to shift the burden of proof or production in litigation, and failure to
satisfy one or more provisions of an ASOP should not, in and of itself, be
presumed to be malpractice.

3.1.6 The ASB recognizes that actuarial practice involves the identification,
measurement, and management of contingent future events in environments that
rarely, if ever, emerge exactly as projected. Moreover, the ASOPs are intended to
provide guidance for dealing with commonly encountered situations. ASOPs take
into account relevant issues arising from the scope of the assignment, limited
information, time constraints, and other practical difficulties such as conflicts with
regulatory or other restrictions. Actuaries in professional practice may also have
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Introduction to the Actuarial Standards of Practice — October 2008

to handle new or nonroutine situations not anticipated by the ASOPs. In those


situations, the actuary should exercise professional judgment in applying the
ASOPs.

3.1.7 The ASOPs are principles-based and do not attempt to dictate every step and
decision in an actuarial assignment. Rather, the ASOPs provide the actuary with
an analytical framework for exercising professional judgment, identifying factors
that the actuary typically should consider when faced with a particular type or
aspect of professional service. The ASOPs generally leave room for the actuary to
use professional judgment when selecting methods and assumptions, conducting
an analysis, and reaching a conclusion. Emphasizing process over outcome, the
ASOPs recognize that actuaries can and do reasonably differ in their preferred
methodologies and choices of assumptions and can reasonably reach differing
opinions, even when faced with the same facts. Two actuaries could follow a
particular ASOP, both using reasonable methods and assumptions, and reach
appropriate results that could be substantially different.

3.1.8 There are situations where legislative or regulatory bodies or other professional
organizations have established rules or requirements that are not in accordance
with generally accepted actuarial principles and practice or where an actuary is
prevented from applying professional judgment. To deal with these situations, the
ASB provides guidance on compliance in such environments. ASOPs that focus
on compliance issues typically contain the word “compliance” in their titles.

3.1.9 Unlike the ASOPs, which actuaries are required to observe, the actuarial literature
provides information that an actuary might choose, but is not required, to consider
when providing professional services. Practice notes published by the Academy,
for example, describe various methods actuaries use to satisfy an ASOP or to
comply with a legal or regulatory requirement, but do not purport to codify
generally accepted practice and are not binding upon actuaries. Similarly, learned
treatises, study notes, actuarial textbooks, journal articles, and presentations at
actuarial meetings can be informative, keeping the actuary abreast of
developments as actuarial science evolves, but do not establish binding
requirements upon the actuary. Practice also evolves as actuarial research and
literature document new methods and improved techniques, and generally
accepted practice frequently comes into use through the profession’s collective
adoption of techniques described in the actuarial literature. However, unlike the
ASOPs, such literature is not binding upon the actuary, and the actuary can
legitimately exercise professional judgment in deciding whether and how to make
use of such materials.

3.2 The Format of ASOPs—Each ASOP document contains (1) a transmittal memorandum,
(2) the ASOP itself, and (3) one or more supporting appendices.3

3
With respect to how the ASOP document is organized, the current ASOP format differs from that of some earlier
ASOPs, but all ASOP documents contain similar content, as described in sections 3.2.1–3.2.3 of this Introduction.

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Introduction to the Actuarial Standards of Practice — October 2008

3.2.1 The transmittal memorandum and the appendices are not part of the ASOP and
are nonbinding. The transmittal memorandum provides background information
and a description of the key issues related to the development of the ASOP. The
appendices (1) provide the background and historical issues involved and describe
current or alternative practices and (2) summarize the major issues raised in the
exposure process and their disposition by the drafting committee. Additional
appendices may also contain supporting documents, bibliographies, or illustrative
examples.

3.2.2 Each ASOP begins with two sections that (1) summarize briefly the purpose,
scope, cross references, and effective date of the ASOP, and (2) define the special
terms used within the ASOP.

a. The purpose and scope identify the intended application of the ASOP to
the work of the actuary. In some instances, the actuary serves as an
advisor to a principal and does not actually make decisions or take actions
on the principal’s behalf. In those instances, the ASOP may indicate in its
scope to what extent the ASOP addresses the actuary’s role in advising the
principal. However, the ASOPs are not intended to make the actuary
responsible if the principal acts contrary to the actuary’s advice.

b. Each ASOP has a specified effective date. Prior to that date, exposure
drafts of the ASOP, and the ASOP itself from the date of its publication to
its effective date, form part of the literature of the actuarial profession;
actuaries may look to them at their discretion for advisory guidance. An
ASOP is not binding, i.e., actuaries are not required to ensure that
professional services performed by them or under their direction satisfy
the ASOP, until the effective date of the ASOP, because in adopting the
ASOP the ASB may have defined a new practice or elevated practice, as
described in section 3.1.3 above. In the case of a revision to an existing
ASOP, the existing ASOP is binding until the effective date of the revised
ASOP.

c. Each ASOP contains a list of definitions of terms used within it. Those
terms are defined only for use in that particular ASOP, and the definitions
can and do differ among ASOPs, reflecting different uses of language in
various segments of the profession.

3.2.3 The other two sections of the ASOP (1) provide an analysis of issues and
recommended practices and (2) address communications and disclosures.

a. The Analysis of Issues and Recommended Practices section is organized


by major topics or issues, or by major tasks involved in completing
assignments within the ASOP’s scope. Emphasis is placed on providing

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Introduction to the Actuarial Standards of Practice — October 2008

the actuary with an appropriate analytical framework for completing the


assignment that is within the scope of the ASOP.

b. The Communications and Disclosures section contains a clause that


describes what an actuary should do when, in the actuary’s professional
judgment, a deviation from one or more provisions of the ASOP is
deemed to be appropriate. Special communications or disclosures
pertinent to the subject of the ASOP and applicable limitations are
identified in this section. Where appropriate, reference may be made to
applicable provisions of the Code of Professional Conduct.

Section 4. Compliance with ASOPs

4.1 Actuaries are required by Precept 3 of the Code of Professional Conduct to ensure that
work performed by them or under their direction satisfies applicable ASOPs. ASOPs are,
therefore, binding upon actuaries because failure to follow an applicable ASOP can
breach the Code of Professional Conduct, rendering the actuary subject to the
profession’s counseling and discipline processes.

4.2 Actuaries are expected to take a good faith approach in applying ASOPs, exercising good
judgment and common sense; it would be inappropriate for any user of an ASOP to make
a strained interpretation of the provisions of the ASOP.

4.3 Actuaries should observe those ASOPs that are relevant to the task at hand; not all
ASOPs will apply. An ASOP should not be interpreted as having applicability beyond its
stated scope and purpose. Most, but not all, of the ASOPs are task-specific, dealing with
particular kinds of professional services performed by actuaries. A few ASOPs, however,
deal more broadly with particular aspects of many types of actuarial assignments (for
example, ASOP No. 23, Data Quality). Actuaries are responsible for identifying the
ASOPs that apply to the task at hand. The Academy’s Council on Professionalism
publishes advisory Applicability Guidelines to assist actuaries in identifying the ASOPs
that may be relevant.

4.4 The ASB seeks to avoid creating conflicts between the ASOPs. When an actuary believes
that two ASOPs have conflicting requirements when applied to a specific situation and
neither ASOP provides explicit guidance concerning which of the two takes precedence,
the actuary is encouraged to contact the Actuarial Board for Counseling and Discipline
(ABCD) for confidential guidance on appropriate practice. Where two ASOPs have
differing but not conflicting requirements, the ASB anticipates that the actuary will apply
professional judgment to harmonize the two ASOPs in a reasonable fashion. The actuary
may choose to seek confidential guidance from the ABCD to support the actuary’s
judgment.

4.5 ASOPs frequently use a few terms that, while not defined within them, are integral to an
informed reading of the ASOPs. For example:

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Introduction to the Actuarial Standards of Practice — October 2008

4.5.1 KnownASOPs frequently refer to circumstances, factors, practices of the


principal, or other information or items that are known. The ASB recognizes that,
in many cases, the actuary relies upon the principal and others acting on the
principal’s behalf for information and cannot reasonably be expected to act based
on information that was not provided to the actuary. Consequently, unless an
ASOP clearly indicates otherwise, “known” means that the actuary had actual
knowledge of the item in question at the time the actuary performed professional
services under the ASOP.

4.5.2 Practical/Practicable—ASOPs frequently call upon actuaries to undertake certain


inquiries, perform certain analytical tests, or make disclosures if it is “practical”
or “practicable” to do so. Neither of these terms is intended to suggest that all
possible steps should always be taken to complete an assignment. To the contrary,
the constraints of a professional relationship or assignment and the specifics of a
given environment frequently require the actuary to choose a course of action that
is likely to yield an appropriate result without being unnecessarily time-
consuming, elaborate, or costly relative to the principal’s legitimate needs. Thus,
it is appropriate for the actuary, exercising professional judgment, to decide that
the circumstances surrounding a particular assignment are such that it would not
be practical or practicable to undertake a particular task. The actuary might
choose to disregard items that, in the actuary’s professional judgment, are not
material to the purpose and nature of the assignment.

4.5.3 Professional judgment—Actuaries bring to their assignments not only highly


specialized training, but also the broader knowledge and understanding that come
from experience. The ASOPs frequently call upon actuaries to thoughtfully apply
both training and experience to their professional assignments, recognizing that
reasonable differences of opinion are appropriate, if not inevitable, when
professionals undertake to project the effect of contingent future events. The ASB
anticipates that the actuary’s use of professional judgment will be presented in
such a way that another qualified actuary would recognize when and where
judgment has been applied, even if the other qualified actuary might disagree with
the resulting conclusions.

4.5.4 Reasonable—In many instances, the ASOPs call for the actuary to take reasonable
steps, make reasonable inquiries, or otherwise exercise reason when performing a
professional service. The intent is not to require the actuary to go beyond what the
actuary deems to be appropriate under the circumstances, given the nature of the
assignment and the professional relationship and relevant business considerations.
Rather, the intent is to call upon the actuary to exercise the level of care and
diligence that, in the actuary’s professional judgment, is consistent with generally
accepted actuarial practice and necessary to complete the assignment in an
appropriate manner.

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Introduction to the Actuarial Standards of Practice — October 2008

4.5.5 Reliance—The ASOPs recognize that actuaries are frequently required to rely
upon non-actuaries such as other professionals, management, and trustees for
information and professional opinions that are pertinent to an assignment.
Similarly, actuaries often rely upon their actuarial colleagues to perform some
component of a larger actuarial analysis in circumstances where it would be
inappropriate or impractical for the actuary to redo the colleagues’ work or where
the actuary would not be qualified to do so. Accordingly, the ASOPs usually
permit the actuary to rely in good faith upon such individuals, subject to
appropriate disclosure of such reliance.

4.6 The ASOPs make specific provision for those situations where the actuary deems it
appropriate to deviate from one or more provisions of an ASOP. It is not a breach of an
ASOP to deviate from one or more of its provisions if the actuary does so in the manner
described in the ASOP, including making the disclosures related to the deviation required
in such ASOP and in ASOP No. 41.

4.6.1 It may be appropriate for the actuary to deviate from one or more provisions of an
ASOP, such as in situations that differ from those contemplated when the ASOP
was adopted or where, in the professional judgment of the actuary, the application
of new practice based on recent advances in actuarial science would be more
appropriate.

4.6.2 It is appropriate for the actuary to deviate from one or more provisions of an
ASOP to the extent that a law, regulation, or other binding authority requires such
deviation.

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Introduction to the Actuarial Standards of Practice — October 2008

APPENDIX

Comments on the Exposure Draft and Responses

The exposure draft of revisions to the Introduction to the Actuarial Standards of Practice was
issued in July 2008 with a comment deadline of August 22, 2008. Fourteen comment letters were
received, some of which were submitted on behalf of multiple commentators, such as by firms or
committees. For purposes of this appendix, the term “commentator” may refer to more than one
person associated with a particular comment letter. The ASB carefully considered all comments
received, and reviewed (and modified, where appropriate) the proposed changes. Summarized
below are the significant issues and questions contained in the comment letters and the responses
to each. Unless otherwise noted, the section numbers and titles used below refer to those in the
exposure draft.

GENERAL COMMENTS

Comment One comment sent on behalf of 29 actuaries noted that the proposed changes are
relatively minor but requested that the comment deadline be extended by 120 days in
order to give members of the profession more time to address how standards are set.

Response The transmittal memorandum accompanying the exposure draft indicated that the
proposal had a limited purpose -- to clarify language in four specified sections. The
proposal was not intended to be reflective of any changes in the way standards are set.
The reviewers believed there was sufficient time to review and comment on the
limited changes. The ASB invites members of the profession or other interested
parties who have suggestions on how to improve the standard setting process to share
their specific ideas with the ASB.

C OMMENTS ON REQUESTED SECTIONS FOR REVIEW

Section 3.1.2 (Now 3.1.3)

Comment One commentator suggested that the last sentence in 3.1.2 (now 3.1.3) be changed to
the following: “Additionally, the ASB may provide supporting context to delineate how
the level of practice may appropriately be achieved in specific situations. Such contextual
language is recognized as being potential (sic) time sensitive. The actuary should not
blindly follow such contextual language when it is no longer appropriate.”

Response The reviewers agree that the addition of “may” in the first sentence is appropriate and
made the change. They did not feel that the additional language was needed and made
no additional change.

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Introduction to the Actuarial Standards of Practice — October 2008

Comment Two commentators suggested changing the wording in the first sentence of 3.1.2 (now
3.1.3) to expand the scope not only to developing a new ASOP but also to include
revisions of ASOPs.

Response The reviewers agree and made the change.

Comment One commentator suggested adding “pertinent to the ASOP at hand” to the end of the
second sentence of 3.1.2 (now 3.1.3).

Response The reviewers did not feel that this addition was needed and made no change.

Comment One commentator suggested adding a modifier to make clear what level of practice is
expected in the last sentence of the section.

Response The reviewers agreed that the addition of the modifier would be beneficial to clarify
intent, and inserted the word “appropriate.”

Section 3.1.3 (Now 3.1.4)

Comment One commentator suggested adding wording to address the criteria that determine when
ASOPs are updated.

Response The reviewers agree and have added a new subsection, 3.1.2, to address this (and
renumbered the subsequent subsections accordingly).

Comment One commentator suggested adding a sentence following the third sentence of the
existing 3.1.3 (now 3.1.4) that states the following: “Again, the ASB seeks to define an
appropriate level of practice for actuaries working in the new area, often by looking at
current practice in other areas and deciding on the appropriateness of current practices.”

Response The reviewers do not believe that this addition is needed and made no change.

Section 3.2.3

Comment One commentator suggested that “Code” be changed to “Code of Professional


Conduct” in all instances for clarity.

Response The reviewers agree and made the change.

Section 4.6

Comment Several commentators expressed concern that the current section 4.6, as exposed, did
not adequately convey the purpose for deviation language and the process, including
disclosure, for a deviation. One of these commentators indicated that the proposed
section 4.6 language would be adequate assuming the amendments to ASOP 41 which
include standardized deviation language were adopted no later than the amendments to
the Introduction.

Response The reviewers agree and have expanded and clarified this section.

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Introduction to the Actuarial Standards of Practice — October 2008

COMMENTS ON OTHER SECTIONS OF THE ASOP

Overvi ew

Comment One commentator suggested making the last line of the overview more direct by
changing it to the following: “This introductory material is part of the standards and
carries the same weight and authority as the ASOPs themselves.”

Response The reviewers agree and made the change.

Section 3.1.4 (Now 3.1.5)

Comment One commentator questioned the usage of “litigation” and “malpractice,” and
suggested that since “malpractice” can be charged in a legal context or other context,
perhaps it should be in a standalone statement.

Response The reviewers disagree, and made no change.

Section 3.1.5 (Now 3.1.6)

Comment One commentator suggested that the last sentence in the section should be modified to
excise the phrase “must be able to.”

Response The reviewers agree and reworded the sentence for clarity.

Section 3.1.6 (Now 3.1.7)

Comment One commentator took issue with the following sentence: “The ASOPs intentionally
leave significant room for the actuary to use professional judgment when selecting
methods and assumptions.” He believes this is not universally true, and that the draft
should reflect that.

Response The reviewers agree and revised the sentence to clarify its meaning.

Comment One commentator suggested that the phrase “generally accepted practice” be changed
to “a particular ASOP.”

Response The reviewers agree and made the change.

Comment One commentator noted the language "two actuaries advising a principal could provide
appropriate yet substantially different results to that principal” and questioned whether the
actuary would be obliged to advise the principal of this possibility. The commentator
suggested that if this is the case, then the text in 3.1.6 should be modified to reflect this.

Response The reviewers decided that any change of this nature is outside of the scope of this update
to the Introduction.

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Introduction to the Actuarial Standards of Practice — October 2008

Section 3.1.7 (Now 3.1.8)

Comment One commentator suggested that the Introduction is not clear on the applicability of
ASOPs when they are inconsistent with law or regulation, and suggested that this be
addressed in section 3.1.7.

Response The reviewers note that the newly added section 4.6.2 addresses this point.

Comment One commentator suggested that the Introduction should remind actuaries working for
legislative or regulatory bodies that they are subject to the ASOPs, or, if that is not the
case, it should expressly exempt them from following ASOPs when they make
recommendations on law or regulations.

Response The reviews agree that all U.S. actuaries, including those who work for legislative or
regulatory bodies are subject to the ASOPs to the extent that their advice involves the
performance of actuarial services. The reviewers do not see a need to remind one
subset of the actuarial profession that they are subject to ASOPs.

Section 3.1.8 (Now 3.1.9)

Comment One commentator pointed out that the Introduction has no discussion on the
procedures the ASB uses when reviewing and revising ASOPs.

Response The reviewers agree that this needs to be addressed and added section 3.1.2 to address
the issue.

Comment One commentator suggested that it might be appropriate for section 3.1.8 to include a
statement that the ASB does not approve nor disapprove of materials other than
ASOPs used by the actuary in providing professional services.

Response The reviewers do not feel such a statement is needed.

Section 3.2.2.b

Comment One commentator suggested adding a comma for clarity in the following sentence: “An
ASOP is not binding, i.e., actuaries are not required to ensure that professional services
performed by them or under their direction satisfy the ASOP, until the effective date of the
ASOP, because in adopting the ASOP the ASB may have defined a new practice or
elevated practice, as described in section 3.1.3 above.”

Response The reviewers agree and made the change.

11
Actuarial Standard
of Practice
No. 1

Nonguaranteed Charges or Benefits


for Life Insurance Policies and Annuity Contracts

Revised Edition

Developed by the
Task Force to Revise ASOP No. 1 of the
Life Committee of the
Actuarial Standards Board

Adopted by the
Actuarial Standards Board
March 2004

(Doc. No. 092)


ASOP No. 1March 2004

T A B L E OF C O N T E N T S

Transmittal Memorandum iii

Section 1. Purpose, Scope, Cross References, and Effective Date 1


1.1 Purpose 1
1.2 Scope 1
1.3 Cross References 1
1.4 Effective Date 2

Section 2. Definitions 2
2.1 Anticipated Experience Factor 2
2.2 Applicable Law 2
2.3 Determination Policy 2
2.4 Nonguaranteed Charge or Benefit 2
2.5 Policy 2
2.6 Policy Class 2
2.7 Policy Factor 2

Section 3. Analysis of Issues and Recommended Practices 3


3.1 Advice on Determination Policy 3
3.2 Determination of Nonguaranteed Charges or Benefits 3
3.3 Determination Process 3
3.4 Policy Classes 3
3.5 Nonguaranteed Charges or Benefits Used in Illustrations 4
3.6 Documentation 4

Section 4. Communications and Disclosures 4


4.1 Actuarial Communication 4
4.2 Disclosure 4
4.3 Reliance on Data Supplied by Others 5
4.4 Prescribed Statement of Actuarial Opinion 5
4.5 Deviation from Standard 5

APPENDIXES

Appendix 1—Background and Current Practices 6


Background 6
Current Practices 7

Appendix 2—Comments on the Exposure Draft and Task Force Responses 9

ii
ASOP No. 1March 2004

March 2004

TO: Members of Actuarial Organizations Governed by the Standards of Practice of the


Actuarial Standards Board and Other Persons Interested in Nonguaranteed
Charges or Benefits for Life Insurance Policies and Annuity Contracts

FROM: Actuarial Standards Board (ASB)

SUBJ: Actuarial Standard of Practice (ASOP) No. 1

This booklet contains the final version of ASOP No. 1, Nonguaranteed Charges or Benefits for
Life Insurance Policies and Annuity Contracts.

Background

In 1986, the Interim Actuarial Standards Board adopted the original version of ASOP No. 1,
which was titled The Redetermination (or Initial Determination) of Non-Guaranteed Charges
and/or Benefits for Life Insurance and Annuity Contracts. In 1990, the Actuarial Standards
Board adopted a reformatted version of ASOP No. 1.

As originally written, ASOP No. 1 was primarily concerned with the determination of
nonguaranteed charges or benefits in individual life insurance policies and annuity contracts. In
light of evolving practice, the ASB believed it was appropriate to revise ASOP No. 1. This
revision of ASOP No. 1 adds additional guidance on the determination of nonguaranteed charges
or benefits.

In 1995, the ASB adopted ASOP No. 24, Compliance with the NAIC Life Insurance Illustrations
Model Regulation, which was created in conjunction with the National Association of Insurance
Commissioners’ (NAIC) Life Insurance Illustrations Model Regulation (hereafter the Model).
The Model itself was drafted to accomplish specific regulatory objectives. ASOP No. 24
concerns itself with guidelines for compliance with the Model. With respect to illustrated
nonguaranteed charges or benefits for life insurance policies and annuity contracts that are not
subject to or represented as being in accordance with the Model, this revision of ASOP No. 1
imposes new obligations on the actuary that reflect generally accepted actuarial practice.

Exposure Draft

The exposure draft of this ASOP was issued in March 2003, with a comment deadline of
August 15, 2003. Fifteen comment letters were received. The task force carefully considered all
comments received and made clarifying changes to the language in some sections. For a
summary of the substantive issues contained in the exposure draft comment letters and the task
force’s responses, please see appendix 2.

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ASOP No. 1March 2004

The most significant changes from the exposure draft are as follows:

1. The task force revised the standard to utilize the term “determination” in place of
“redetermination.”

2. The task force modified section 3.1 to clarify that the actuary should consider relevant
policy provisions and applicable law.

3. The task force clarified section 3.5, which addresses the actuary’s responsibilities with
respect to illustrations not subject to ASOP No. 24.

4. Section 3.6, Documentation, was added to conform with other recently adopted ASOPs.
In addition, the task force changed the heading of section 4.2 to Disclosure and changed
the requirements to provide more flexibility.

5. The task force changed the term “company” to “insurer” throughout the ASOP to
recognize that an insurer is not necessarily a company.

The ASB voted in March 2004 to adopt this standard.

Task Force to Revise ASOP No. 1

Thomas A. Phillips, Chairperson


Thomas A. Campbell Nik Godon
Michael A. Cioffi Kenton L. Scheiwe

Life Committee of the ASB

Robert G. Meilander, Chairperson


Charles Carroll Thomas A. Phillips
Michael A. Cioffi Allan W. Ryan
Stephen N. Patzman Barry L. Shemin

Actuarial Standards Board

Michael A. LaMonica, Chairperson


Cecil D. Bykerk William A. Reimert
Ken W. Hartwell Lawrence J. Sher
Lew H. Nathan Karen F. Terry
Godfrey Perrott William C. Weller

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ASOP No. 1March 2004

ACTUARIAL STANDARD OF PRACTICE NO. 1

NONGUARANTEED CHARGES OR BENEFITS


FOR LIFE INSURANCE POLICIES AND ANNUITY CONTRACTS

STANDARD OF PRACTICE

Section 1. Purpose, Scope, Cross References, and Effective Date

1.1 Purpose—This actuarial standard of practice (ASOP) provides guidance to actuaries with
respect to the determination of, or the development of determination policy on,
nonguaranteed charges or benefits for life insurance policies and annuity contracts.
Throughout this standard, the term determination includes both initial determination and
subsequent redeterminations, where appropriate.

1.2 Scope—This standard applies to actuaries when performing professional services in


connection with the determination and illustration of nonguaranteed charges or benefits
(except as provided below) for life insurance policies and annuity contracts where
nonguaranteed charges or benefits may vary at the discretion of the insurer. Examples of
such policies include fixed and variable universal life policies, indeterminate premium
policies, deferred annuity contracts, and equity-indexed policies.

This standard does not apply to actuaries when performing professional services with
respect to illustrations of nonguaranteed charges or benefits subject to ASOP No. 24,
Compliance with the NAIC Life Insurance Illustrations Model Regulation.

This standard does not apply to actuaries when performing professional services with
respect to policyholder dividends, which are covered by ASOP No. 15, Dividend
Determination for Participating Individual Life Insurance Policies and Annuity
Contracts. To the extent that a policy involves both nonguaranteed charges or benefits
and policyholder dividends, this standard applies with respect to nonguaranteed charges
or benefits, and ASOP No. 15 applies with respect to policyholder dividends.

When applicable law conflicts with this standard, compliance with such applicable law
shall not be deemed a deviation from this standard, provided the actuary discloses that the
professional services were performed in accordance with the requirements of such
applicable law.

1.3 Cross ReferencesWhen this standard refers to the provisions of other documents, the
reference includes the referenced documents as they may be amended or restated in the
future, and any successor to them, by whatever name called. If any amended or restated
document differs materially from the originally referenced document, the actuary should
consider the guidance in this standard to the extent it is applicable and appropriate.

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ASOP No. 1March 2004

1.4 Effective Date—This standard is effective for all actuarial work performed within the
scope of this standard on or after September 30, 2004.

Section 2. Definitions

The terms below are defined for use in this actuarial standard of practice.

2.1 Anticipated Experience Factor—An assumption that reflects anticipated experience and
may be used to determine nonguaranteed charges or benefits. A particular anticipated
experience factor reflects future experience of a specific type. Examples of experience
factors include investment income, mortality, policy termination, and expense rates.

2.2 Applicable Law—Federal, state, and local statutes, regulations, case law, and other legal
binding authority that may govern the actuarial work being performed.

2.3 Determination PolicyThe insurer’s criteria or objectives for determining nonguaranteed


charges or benefits for a particular policy class.

2.4 Nonguaranteed Charge or Benefit—Any element within a policy (as defined in


section 2.5), other than policy dividends, which affects policyholder costs or value, and
which may be changed at the discretion of the insurer after issue. Examples of
nonguaranteed charges or benefits include excess interest, mortality charges or expense
charges lower than those guaranteed in the policy, indeterminate premiums, and
participation rates for equity-indexed products.

2.5 PolicyExcept when used in the term determination policy, policy refers to individual
life insurance policies and annuity contracts and group life insurance and annuity
certificates with nonguaranteed charges or benefits that operate in substantially the same
manner as individual life insurance policies and individual annuity contracts with respect
to nonguaranteed charges or benefits.

2.6 Policy Class—A group of policies considered together for purposes of determining a
nonguaranteed charge or benefit.

2.7 Policy Factor—A premium, value, charge, or benefit that limits a nonguaranteed charge
or benefit. Policy factors are based on the guarantees defined in the policy. Examples of
policy factors include minimum cash values, minimum interest rates, maximum mortality
charges, maximum gross premiums, and maximum policy loan interest rates.

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ASOP No. 1March 2004

Section 3. Analysis of Issues and Recommended Practices

3.1 Advice on Determination Policy—When advising the insurer on the actuarial aspects of a
determination policy, the actuary’s advice should be consistent with the insurer’s stated
marketing, financial, and other objectives. The actuary should consider relevant policy
provisions and applicable law.

3.2 Determination of Nonguaranteed Charges or Benefits—The actuary should recommend


nonguaranteed charges or benefits that are consistent with the insurer’s determination
policy. When the determination policy is not provided to the actuary, the actuary should
inquire about the insurer’s intentions for the determination of nonguaranteed charges or
benefits and have the insurer confirm those intentions as the determination policy.

3.3 Determination Process—The actuary may use modeling, averaging, grouping of policy
classes, or other methods, as the actuary deems appropriate, to calculate the specific
nonguaranteed charges or benefits.

Determination is a process subject to practical constraints. The actuary should consider


relevant conditions and circumstances such as the size of a particular group of policies,
and the costs, practical difficulties, and effects of making changes to the nonguaranteed
charges or benefits.

The actuary should consider conducting sensitivity tests of the impact of likely deviations
from the anticipated experience on which the actuary’s advice is based, if the actuary
expects such deviations to have a material effect.

3.4 Policy Classes—Policies will usually be grouped into classes for purposes of determining
nonguaranteed charges or benefits. The determination policy may include a definition of
the policy classes to be used. If the policy classes have not been defined in the
determination policy, the actuary should establish policy classes considering criteria such
as the following:

a. the similarity of the policy types;

b. the structure of policy factors and nonguaranteed charges or benefits;

c. the similarity of anticipated experience factors;

d. the time period over which the policies were issued; and

e. the underwriting and marketing characteristics of the policies.

In addition, the actuary may consider combining policy classes that are reasonably
consistent based on the above criteria if, in the actuary’s professional judgment, such
combinations would be appropriate.

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ASOP No. 1March 2004

3.5 Nonguaranteed Charges or Benefits Used in IllustrationsThe actuary should determine


nonguaranteed charges or benefits to be used in illustrations not subject to ASOP No. 24
consistently with how the actuary determines nonguaranteed charges or benefits for the
policies involved. The actuary should consider conducting tests of illustrated
nonguaranteed charges or benefits to ascertain whether those could be supported by
reasonably anticipated experience.

3.6 DocumentationThe actuary should prepare and retain adequate documentation in


compliance with the requirements of ASOP No. 41, Actuarial Communications. The
actuary should prepare sufficient documentation to comply with the disclosure
requirements of section 4.2.

Section 4. Communications and Disclosures

4.1 Actuarial Communication—The actuary should issue an actuarial communication in


accordance with ASOP No. 41 to the insurer stating the actuary’s recommendations for
the nonguaranteed charges or benefits and the bases therefor, unless another actuary
advising the same insurer is issuing such an actuarial communication that incorporates
such work.

4.2 DisclosureThe actuary should disclose the following items when appropriate and
available:

a. a description of the insurer’s determination policy for the policies and policy
classes involved. The actuary should describe any additional material assumptions
with respect to the determination policy that were made to complete the analysis;

b. any known areas in which the recommended nonguaranteed charges or benefits


do not follow the insurer’s determination policy;

c. any material change in the determination policy or in the assumptions the actuary
has made about the determination policy since the previous determination;

d. the policy classes involved and any material changes in the assignment of policies
to policy classes;

e. a description of the processes and methods used in the determination of


nonguaranteed charges or benefits, including any significant modeling, averaging,
or other approximation methods;

f. the nonguaranteed charges or benefits recommended for the forthcoming period;

g. the significant policy factors used in the determination of nonguaranteed charges


and benefits;

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ASOP No. 1March 2004

h. the anticipated experience factors used in the determination of nonguaranteed


charges and benefits and any material changes in such factors from the last
determination;

i. any conclusions or recommendations related to sensitivity testing; and

j. applicable law recognized in formulating the actuary’s recommendations.

4.3 Reliance on Data Supplied by Others—The actuary may rely on data supplied by another.
In doing so, the actuary should disclose both the fact and the extent of such reliance. The
accuracy and comprehensiveness of data supplied by others are the responsibility of those
who supply the data. For further guidance, the actuary is directed to ASOP No. 23, Data
Quality.

4.4 Prescribed Statement of Actuarial Opinion—This ASOP does not require a prescribed
statement of actuarial opinion as described in the Qualification Standards for Prescribed
Statements of Actuarial Opinion promulgated by the American Academy of Actuaries.
However, law, regulation, or accounting requirements may also apply to an actuarial
communication prepared under this standard, and as a result, such actuarial
communication may be a prescribed statement of actuarial opinion.

4.5 Deviation from Standard—An actuary should be prepared to justify the use of any
procedures that depart materially from those set forth in this standard and must include,
in any actuarial communication disclosing the result of the procedures, an appropriate
statement with respect to the nature, rationale, and effect of such departures. Compliance
with applicable law that conflicts with this standard shall not be deemed a deviation from
this standard, provided the actuary discloses that the professional services were
performed in accordance with the requirements of such applicable law.

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ASOP No. 1March 2004

Appendix 1

Background and Current Practices

Note: This appendix is provided for informational purposes, but is not part of the standard of
practice.

Background

In the mid-1970s, there began to be increased activity with respect to products with
nonguaranteed charges or benefits as opposed to dividends under traditional participating
policies. Reasons for this included items such as the increased volatility in the North American
economy, increased competition within the insurance industry, and the advent of universal life
whose unbundled form required nonguaranteed charges or benefits.

Because of the increased activity on these products, they came to represent significant market
share and financial significance, and it was deemed necessary to develop an actuarial standard of
practice in this area. Thus, the Interim Actuarial Standards Board adopted the original version of
ASOP No. 1 in October 1986. The Actuarial Standards Board adopted a reformatted version of
ASOP No. 1 in 1990.

In 1986, the policies in question were still evolving and there was little standardization in such
areas as benefit design, pricing structure, marketing practices, and investment philosophies. It
was, therefore, impossible for the standard to offer guidance on issues for which there was no
generally accepted actuarial practice, such as for the applicability of the contribution principle,
which had been accepted and in effect for many years for traditional participating life policies.
Rather, the standard reflected that the actuary’s essential obligations were (1) to assure the com-
pletion of all of the activities required to advise the client professionally; and (2) to prepare an
actuarial communication for the client presenting this advice.

Since the promulgation of the original standard in 1986, the volume of these products sold has
continued to grow and considerable product innovation has taken place. As a result, there is now
a clearer understanding of what represents generally accepted actuarial practice with respect to
these products, and ASOP No. 1 has been revised to reflect these practices.

Furthermore, ASOP No. 15, Dividend Determination for Participating Individual Life Insurance
Policies and Annuity Contracts, has been revised and ASOP No. 24, Compliance with the NAIC
Life Insurance Illustration Model Regulation, has been promulgated. ASOP No. 1 has also been
revised to be consistent, where appropriate, with these newer standards.

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ASOP No. 1March 2004

Current Practices

The actuary may provide professional services in two principal areas with respect to non-
guaranteed charges or benefits. The actuary is normally involved in the determination of
nonguaranteed charges or benefits in accordance with insurer determination policy. The actuary
may also be involved in advising the insurer in setting the determination policy.

It is common in current practice to base advice on the determination of nonguaranteed charges or


benefits of policies, including the relationship between nonguaranteed charges and benefits and
the anticipated experience factors, on insurer determination policy. Insurer determination policy
may be documented in sufficient detail (for example, in a previous actuarial communication) for
the actuary to appropriately determine the nonguaranteed elements in question. If not, the actuary
will generally gather sufficient information from the insurer to provide the actuarial services.

The recovery of past losses or the distribution of past gains may be an aspect of the deter-
mination policy. In addressing this issue, the actuary will typically look to policy provisions,
insurer determination policy, and applicable law.

It is also common in practice for the actuary to adjust nonguaranteed charges or benefits for
items not directly related to the actual nonguaranteed charge or benefit, such as the following:

a. to reflect anticipated gains or losses on supplementary benefit riders;

b. to reflect anticipated gains or losses arising from the usage of settlement option
guarantees;

c. to reflect other anticipated gains or losses arising from policy factors, such as
nonforfeiture interest rates that are low or high relative to projected investment income
rates;

d. to smooth the transition from one set of nonguaranteed charges or benefits to another;

e. to smooth the incidence of nonguaranteed charges or benefits between policy durations;


and

f. to be consistent with nonguaranteed charges or benefits of other similar products.

The actuary may also advise the insurer on the formulation of insurer determination policy.
When advising on determination policy, the actuary commonly reviews the determination policy
of similar polices with respect to the policy classes and nonguaranteed charges or benefits.
Insurer determination policy with respect to nonguaranteed charges or benefits is not necessarily
fixed. The insurer may appropriately adjust determination policy among groups of policies or
may revise a determination policy for a given product in order to meet changing financial,
marketing, and other goals.

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ASOP No. 1March 2004

The actuary may have responsibilities in addition to the requirements of this ASOP. For
example, the Exhibit 5 Interrogatories of the National Association of Insurance Commissioners’
current annual statement address additional issues with respect to the determination of non-
guaranteed charges or benefits (see section 3.5 of this standard).

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ASOP No. 1March 2004

Appendix 2

Comments on the Exposure Draft and Task Force Responses

The exposure draft of this revised actuarial standard of practice (ASOP), titled The
Determination of Nonguaranteed Charges or Benefits for Life Insurance Policies and Annuity
Contracts, was issued in March 2003, with a comment deadline of August 15, 2003. Fifteen
comment letters were received. The ASOP No. 1 Task Force carefully considered all comments
received. Summarized below are the significant issues and questions contained in the comment
letters and the task force’s responses. Unless otherwise noted, the section numbers and titles used
below refer to those in the exposure draft. Where the task force changed a term between the
exposure draft and the final standard (for example, replacing company with insurer), the
comment reflects the original term used by the commentator, whereas the response uses the term
as it appears in the final standard.

GENERAL COMMENTS
Comment A few commentators stated that the use of the terminology “redetermination (or initial determination)”
in the title and the reliance on the term “redetermination” in the standard was unnecessarily obtuse.

Response The task force agreed and revised the standard to utilize the term “determination.”
SECTION 1. PURPOSE, SCOPE, CROSS-REFERENCES, AND EFFECTIVE DATE
Section 1.2, Scope
Comment One commentator observed that this standard is limited in scope by two other standards, ASOP
No. 15, Dividend Determination for Participating Individual Life Insurance Policies and Annuity
Contracts, and ASOP No. 24, Compliance with the NAIC Life Insurance Illustrations Model
Regulation. The commentator also suggested that the scope be expanded to allow for future standards
that may take precedence over the current standard.

Response The task force agreed that future standards might take precedence over current ones, but believed that
it was beyond the scope of the standard to provide for possible future standards.
Comment The task force solicited comments on whether the scope should provide guidance in other areas such
as health or credit insurance policies with nonguaranteed elements. The general consensus of the
commentators was that the scope was appropriately determined.

Response The task force agreed with the general consensus and made no change in scope.
Comment One commentator suggested that variable products be included in the examples of policies with
nonguaranteed elements.

Response The task force agreed and added variable products.


SECTION 2. DEFINITIONS
Section 2.2, Applicable Law
Comment One commentator suggested that sections 2.2 and 4.2(j) may place an excessively burdensome
requirement on the actuary to recognize and document all applicable law in the determination of
nonguaranteed charges or benefits.

Response The task force believed that applicable law should be considered and added language to section 3.1 to
make this clear. Section 4.2 was modified to reflect appropriate documentation of the applicable law.

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ASOP No. 1March 2004

New section 2.3, Determination Policy and section 2.4, Policy (now section 2.5)
Comment One commentator questioned the dual usage of the word “policy.” The standard utilizes the term to
refer to life insurance policies (contracts) and to refer to the determination policy of the company. The
commentator suggested that the dual usage might be confusing.

Response The task force made clarifying changes to the standard to distinguish between the terms “policy” and
“determination policy.” The term “policy” is used exclusively to refer to contracts of insurance while
the term “determination policy” is used exclusively to refer to the determination policy of the insurer.
Section 2.3, Nonguaranteed Charge or Benefit (now section 2.4)
Comment One commentator suggested that the examples of nonguaranteed charges or benefits be expanded to
include the “mortality and expense risk charge” commonly found in variable life products.

Response The task force expanded the list to include expense charges.
Section 2.4, Policy (now section 2.5)
Comment Several commentators suggested changes to this definition to improve the description of “group life
insurance and annuity certificates with nonguaranteed charges or benefits that operate in substantially
the same manner as individual life policies and individual annuity contracts with respect to
nonguaranteed charges or benefits.”

Response There was clear support in the comments for including group life insurance and annuity certificates in
the definition of policy. However, there was no clear consensus on significant improvements to the
definition. After review, the task force concluded the original definition was most appropriate.
SECTION 3. ANALYSIS OF ISSUES AND RECOMMENDED PRACTICES
Section 3.1, Advice on Redetermination Policy (now titled Advice on Determination Policy)
Comment A few commentators stated that there was insufficient guidance in this section as to what the actuary
should consider in advising the company on determination policy. Comments included various
suggestions for items to be added to the list of company objectives.

Response The task force considered changes but determined that “stated marketing, financial, and other
objectives” was sufficiently broad and flexible for guidance. The task force, however, added an
additional sentence to provide for consideration of legal and regulatory requirements.
Section 3.2, Redetermination of Nonguaranteed Charges or Benefits (now titled Determination of
Nonguaranteed Charges or Benefits)
Comment One commentator suggested that the standard should provide guidance on the impacts of capital gains
and losses on nonguaranteed charges or benefits.

Response The task force believed that section 3.3 gives the actuary appropriate flexibility to address capital
gains and losses.
Section 3.5, Illustrations Not Subject to ASOP No. 24 (now titled Nonguaranteed Charges or Benefits Used in
Illustrations)
Comment Several commentators questioned the clarity and objective of treating the determination of illustrated
nonguaranteed elements the same as the determination of nonguaranteed elements.

Response The task force clarified the section.


Comment One commentator recommended that a statement be added that anticipated experience should not
reflect any assumed improvement beyond the current date.

Response This ASOP applies only to illustrations that are not subject to ASOP No. 24. The task force was not
aware of any requirement such as that proposed by the commentator with respect to such illustrations.
Comment One commentator suggested the standard should provide guidance regarding the timing of conducting
tests of illustrated nonguaranteed charges or benefits.

Response The task force discussed timing, but decided the actuary should have flexibility in this matter.

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ASOP No. 1March 2004

Comment One commentator noted that section 3.5 used the phrase “currently anticipated experience” while
other parts of the standard used “anticipated experience.”

Response The task force replaced the word “currently” with “reasonably.”
SECTION 4. COMMUNICATIONS AND DISCLOSURES
Section 4.2, Documentation (now section 4.2, Disclosure)
Comment Several commentators made general comments that the documentation section seemed overly
burdensome.

Response The task force added the phrase “when appropriate and available” to provide more flexibility in
disclosure.
Comment Regarding section 4.2(c), a few commentators remarked that the documentation of the impact of
changes in determination policy may be beyond the scope of the actuary’s responsibilities, as the
company establishes determination policy.

Response The task force agreed and deleted the phrase.


Comment Regarding section 4.2(f), a few commentators stated that the documentation of all specific
nonguaranteed charges or benefits might be overly burdensome.

Response The task force believes that the standard of practice, when taken in conjunction with ASOP No. 41,
Actuarial Communications, gives the actuary sufficient flexibility to determine the method, means,
and amount of disclosure necessary to describe specific nonguaranteed charges or benefits.
Comment Regarding section 4.2(i), one commentator suggested that documentation of all sensitivity tests
performed and the results of all sensitivity tests might be overly burdensome.

Response The task force agreed and changed the wording of section 4.2(i).

11
Actuarial Standard
of Practice
No. 2

Recommendations for Actuarial Communications Related to


Statements of Financial Accounting Standards Nos. 87 and 88

Developed by the
Pension Committee of the
Interim Actuarial Standards Board

Adopted by the
Interim Actuarial Standards Board
April 1987

(Doc. No. 004)


TABLE OF CONTENTS

Transmittal Memorandum iii

RECOMMENDATIONS

1. Background 1

2. Scope 1

3. Existing Standards 1

4. Disclosure 1

5. Disclosure of Exceptions 1

6. Sample Disclosure 2

ii
June 1987

TO: Members of the American Academy of Actuaries and Other Persons with an
Interest in Actuarial Calculations with Respect to Statements of Financial
Accounting Standards Nos. 87 and 88

FROM: Pension Committee of the Interim Actuarial Standards Board (IASB)

Enclosed is an IASB Actuarial Standard of Practice, Recommendations for Actuarial


Communications Related to Statements of Financial Accounting Standards Nos. 87 and 88. It
reflects the review by the IASB and its Pension Committee of comments received in response to
an exposure draft issued in January 1987.

In reply to the exposure draft, there were twenty-one responses. In addition to responses from
actuaries, responses were received from a large multinational corporation, the Financial
Executives Institute, and the Financial Accounting Standards Board. The opinions expressed
ranged from suggesting that existing standards sufficed and that the actuary’s role is solely to
technically calculate the numbers, to suggestions for significantly expanded disclosure. The
responses were well thought out, and of help to the IASB.

By far the greatest number of comments were related to the sample disclosure, and to
enumeration there of various items for which SFAS No. 87 results could be inappropriate. The
IASB determined that the language should be made less negative in tone, and has made changes
to reflect that. However, the IASB does not believe that this facet of the disclosure should be
completely deleted, as some suggested. The IASB feels strongly that there is a great risk that
incorrect judgments of benefit security and funding will be made from the SFAS No. 87
numbers, given their ready availability.

For example, plan participants might judge themselves to be adequately protected in the event of
plan termination when this would not be true. Indeed, SFAS No. 87, ¶ 18 says, “The
accumulated benefit obligation and vested benefit obligation provide information about the
obligation the employer would have if the plan were discontinued.” In fact, the IASB can
envision many common circumstances where these items would be very bad indicators of the
asset sufficiency in the event of plan termination, primarily because the calculations are on an
“ongoing plan” basis, and because of the way in which the discount rate is selected. The IASB
strongly believes that the profession’s traditional role of protecting participants would be
compromised if specific references to the inappropriateness of SFAS No. 87 numbers for this
purpose were omitted. However, the other items listed were, in the IASB’s opinion, more related
to good consulting than to professional standards, so those were deleted.

Finally, the IASB incorporated SFAS No. 88 more directly into the proposed standard than it did
in the exposure draft.

iii
Pension Committee of the IASB

Thomas D. Levy, Chairperson


Robert W. Haver Carol W. Proffer
Peter L. Hutchings Harry S. Purnell
Judith E. Latta Richard G. Roeder
Joseph P. Macaulay William C. Spencer
Michael J. Mahoney John A. Steinbrunner
Kenneth W. Porter Howard Young

Interim Actuarial Standards Board

Ronald L. Bornhuetter, Chairperson


E. Paul Barnhart Walter N. Miller
Edwin F. Boynton Thomas E. Murrin
James C. Hickman George B. Swick
Barbara J. Lautzenheiser Jack M. Turnquist

iv
ACTUARIAL STANDARD OF PRACTICE NO. 2

RECOMMENDATIONS FOR
ACTUARIAL COMMUNICATIONS RELATED TO
STATEMENTS OF FINANCIAL
ACCOUNTING STANDARDS NOS. 87 AND 88

1. Background—The Financial Accounting Standards Board (FASB) adopted Statement of


Financial Accounting Standards (SFAS) No. 87, Employers’ Accounting for Pensions,
and SFAS No. 88, Employers’ Accounting for Settlements and Curtailments of Defined
Benefit Pension Plans and for Termination Benefits, in December 1985. They made
major changes in the way pension information is determined and presented in employers’
financial statements. Although much of the information required will have to be fur-
nished by actuaries, the basis for those calculations is prescribed by the FASB.

2. Scope—Pronouncements of the FASB set forth required practices with respect to


calculations for SFAS No. 87 and SFAS No. 88. The recommendations in this actuarial
standard establish disclosure standards for actuarial communications with respect to
SFAS No. 87 and SFAS No. 88.

3. Existing Standards—Interpretative Opinion 3 of the Guides and Interpretative Opinions


as to Professional Conduct of the American Academy of Actuaries, and Pension Plan
Recommendation C, “Pension Actuarial Communications,” apply fully with respect to
SFAS No. 87 and SFAS No. 88 calculations. (Pension Plan Recommendation C was
superseded in 1988 by section 13, Pension Actuarial Communications, of Actuarial
Standard of Practice No. 4, Recommendations for Measuring Pension Obligations.) In
view of the number of potential indirect users of such calculations and the likelihood of
significant variations from generally accepted actuarial principles and practices, the
actuary should carefully evaluate what disclosure is appropriate for communications
related to SFAS No. 87 and SFAS No. 88.

4. Disclosure—An actuarial communication for purposes of SFAS No. 87 and SFAS No. 88
must be identified as such. The results of calculations prepared for other purposes (e.g.,
funding, plan reporting, government requirements, plan terminations, etc.) are likely to be
significantly different; the actuary should disclose this fact.

5. Disclosure of Exceptions—If the calculations conflict significantly with the actuary’s


understanding of SFAS No. 87 and SFAS No. 88, including conflict with respect to the
assumptions utilized, that fact should be disclosed as part of the actuarial communication.

1
6. Sample Disclosure—In the absence of exceptions, application of SFAS No. 88, or other
special circumstances, the following sample disclosure is suggested:

Actuarial computations under Statement of Financial Accounting Standards


(SFAS) No. 87 are for purposes of fulfilling employer accounting requirements.
The calculations reported herein have been made on a basis consistent with our
understanding of SFAS No. 87. Determinations for purposes other than meeting
employer financial accounting requirements may be significantly different from
the results reported herein. Accordingly, additional determinations are needed for
other purposes, such as judging benefit security at termination or adequacy of
funding for an ongoing plan.

2
Actuarial Standard
of Practice
No. 3

Continuing Care Retirement Communities

Revised Edition

Developed by the
Task Force to Revise ASOP No. 3 of the
Health Committee of the
Actuarial Standards Board

Adopted by the
Actuarial Standards Board
September 2007

(Doc. No. 111)


ASOP No. 3⎯September 2007

TABLE OF CONTENTS

Transmittal Memorandum iv
STANDARD OF PRACTICE

Section 1. Purpose, Scope, Cross References, and Effective Date 1


1.1 Purpose 1
1.2 Scope 1
1.3 Cross References 2
1.4 Effective Date 2

Section 2. Definitions 2
2.1 Additional Fee 2
2.2 Actuarial Balance Sheet 2
2.3 Advance Fee 2
2.4 Cash and Investment Balance 2
2.5 Cohort of New Residents 2
2.6 Continuing Care Retirement Community (CCRC) 2
2.7 Fee Structure 3
2.8 Health Care Guarantee 3
2.9 Health Center 3
2.10 Independent Living Unit 3
2.11 Levels of Care 3
2.12 Living Unit 3
2.13 Morbidity Rate 3
2.14 Non-Resident 3
2.15 Periodic Fee 3
2.16 Permanent Transfer 3
2.17 Physical Property 3
2.18 Population Projection 4
2.19 Residency Agreement 4
2.20 Resident 4
2.21 Temporary Transfer 4
2.22 Trend 4
2.23 Withdrawal Rate 4
2.24 Valuation Date 4

Section 3. Analysis of Issues and Recommended Practices 4


3.1 Introduction 4
3.2 Determination of Satisfactory Actuarial Balance 4
3.2.1 Condition 1: Adequate Resources for Current Residents 4
3.2.2 Condition 2: Adequate Fee Structure for a Cohort of New Residents 5
3.2.3 Condition 3: Positive Projected Cash and Investment Balances 5
3.3 Projected Population Movements 5
3.3.1 Closed-Group Projection of Current Residents 6
3.3.2 Closed-Group Projection of a Cohort of New Residents 6
3.3.3 Open-Group Projection 6

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ASOP No. 3⎯September 2007

3.4 Actuarial Balance Sheet 6


3.4.1 Assets 6
3.4.2 Liabilities 6
3.5 Cohort Pricing Analysis 7
3.6 Actuarial Asset and Liability Values 7
3.6.1 Future Periodic Fees 7
3.6.2 Future Additional Fees and Third Party Payments 7
3.6.3 Physical Property for Assets Currently in Service 7
3.6.4 Future Use of Physical Property 8
3.6.5 Future Operating Expenses 8
3.6.6 Future Refunds 8
3.6.7 Value of Long-Term Debt 8
3.7 Cash Flow Projections 8
3.8 Selection of Actuarial Assumptions 9
3.8.1 Mortality, Morbidity, and Withdrawal Assumptions 9
3.8.2 Trend Assumptions for Fees and Expenses 10
3.8.3 Investment Rate and Discount Rate Assumptions 10
3.8.4 Revenue and Expense Allocation Assumptions 10
3.8.5 Going-Concern Assumption 10
3.8.6 Reasonableness of Assumptions 11
3.9 Benevolence Funds and Financial Assistance Subsidies 11
3.10 For-Profit CCRCs 11
3.11 Equity or Cooperative CCRCs 12
3.12 Additional Considerations Affecting a CCRC’s Finances 12
3.13 External Restrictions 12
3.14 Reliance on Data or Other Information Supplied by Others 12
3.15 Documentation 13

Section 4. Communications and Disclosures 13


4.1 Communications and Disclosures 13
4.1.1 Actuarial Data, Assumptions, and Methods 13
4.1.2 Assignments Involving an Opinion on Satisfactory Actuarial Balance 14
4.1.3 Specific Disclosures 15
4.2 Deviation 15
4.2.1 Material Deviations to Comply with Applicable Law 15
4.2.2 Other Material Deviations 15

APPENDIXES

Appendix 1—Background and Current Practices 17


Background 17
Current Practices 17
Illustrative Capital Expense Charge Development and Physical Property Valucation 17
Illustrative Formulas for Expensing and Valuing Physical Property 20

Appendix 2—Comments on the Exposure Draft and Responses 22

iii
ASOP No. 3⎯September 2007

September 2007

TO: Members of Actuarial Organizations Governed by the Standards of Practice of the


Actuarial Standards Board and Other Persons Interested in Continuing Care
Retirement Communities

FROM: Actuarial Standards Board (ASB)

SUBJ: Actuarial Standard of Practice (ASOP) No. 3

This document contains the final version of the revision of ASOP No. 3, now titled Continuing
Care Retirement Communities.

Background

In 1987, the Interim Actuarial Standards Board adopted a document titled Relating to Continuing
Care Retirement Communities (CCRCs). In 1990, the ASB revised and reformatted ASOP No. 3,
Relating to Continuing Care Retirement Communities. In 1994, the ASB adopted another
revision titled Practices Relating to Continuing Care Retirement Communities. In light of the
evolution in practice since then, as well as the adoption of a new format for standards, the ASB
believed it was appropriate to revise this standard in order to reflect current, generally accepted
actuarial practice.

Although parts of the existing ASOP that were considered educational in nature were moved to
the appendix, some educational material was retained in the body of the proposed revision to
reflect the paucity of literature concerning actuarial practice regarding CCRCs.

This revision includes some prescriptive disclosure requirements that the task force believes are
appropriate and are intended to enhance the quality of actuarial communications regarding
CCRCs.

Exposure Draft

The exposure draft of this revision was issued in December 2006 with a comment deadline of
April 30, 2007. The Task Force to Revise ASOP No. 3 carefully considered the eight comment
letters received and made changes to the language in several sections in response. For a summary
of the substantive issues contained in the exposure draft comment letters and the responses,
please see appendix 2.

There were no significant changes from the exposure draft although several clarifications were
made.

The ASB voted in September 2007 to adopt this standard.

iv
ASOP No. 3⎯September 2007

Task Force to Revise ASOP No. 3

Molly J. Shaw, Chairperson


Dave Bond Darryl G. Wagner
Gary L. Brace Gregory T. Zebolsky
Gary Teitel

Health Committee of the ASB

Paul R. Fleischacker, Chairperson


Michael S. Abroe James M. Gutterman
Gary L. Brace John C. Lloyd
Robert G. Cosway John W.C. Stark

Actuarial Standards Board

Cecil D. Bykerk, Chairperson


Albert J. Beer Robert G. Meilander
William C. Cutlip Godfrey Perrott
Alan D. Ford Lawrence J. Sher
David R. Kass Karen F. Terry

v
ASOP No. 3⎯September 2007

ACTUARIAL STANDARD OF PRACTICE NO. 3

CONTINUING CARE RETIREMENT COMMUNITIES

STANDARD OF PRACTICE

Section 1. Purpose, Scope, Cross References, and Effective Date

1.1 Purpose—This actuarial standard of practice (ASOP) provides guidance to the actuary
when performing professional services related to a continuing care retirement community
(CCRC).

1.2 Scope—This standard applies to actuaries when performing professional services,


including giving advice, in connection with CCRCs (including nonprofit and for-profit
entities). These professional services may be performed for owners, operators, financing
entities, current residents, or prospective residents of a CCRC, as well as for other
professionals or regulatory bodies.

Examples of the services covered by this ASOP include, but are not limited to, the
following:

a. testing the financial condition of the CCRC for satisfactory actuarial balance;

b. estimating actuarial values of assets and liabilities;

c. evaluating the fee structure for existing residents or a cohort of new residents;

d. developing population projections, including resident movements, independent


living unit turnover, and health center utilization;

e. projecting future cash flows and cash and investment balances;

f. designing and pricing new residency agreements;

g. estimating the future services obligation under GAAP;

h. assisting in developing financial feasibility studies;

i. performing mortality, morbidity, and withdrawal experience studies; and

j. providing appropriate rates of mortality, morbidity, or life expectancies for the


CCRC’s use.

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ASOP No. 3⎯September 2007

The actuary should comply with this standard except to the extent it may conflict with
applicable law (statutes, regulations, and other legally binding authority). If compliance
with applicable law requires the actuary to depart from the guidance set forth in this
standard, the actuary should refer to section 4 regarding deviation.

1.3 Cross References—When this standard refers to the provisions of other documents, the
reference includes the referenced documents as they may be amended or restated in the
future, and any successor to them, by whatever name called. If any amended or restated
document differs materially from the originally referenced document, the actuary should
consider the guidance in this standard to the extent it is applicable and appropriate.

1.4 Effective Date—This standard is effective for professional services performed in


connection with a CCRC on or after March 1, 2008.

Section 2. Definitions

The terms below are defined for use in this actuarial standard of practice.

2.1 Additional Fee—An amount that may be payable by a resident, in accordance with a
residency agreement, for services made available but not covered by the advance fee and
the periodic fees (such as guest meals, additional meals, barber/beauty shop, use of a
carport, and non-covered health care services).

2.2 Actuarial Balance Sheet—A measure of the assets and liabilities, as of the valuation date,
associated with current residents.

2.3 Advance Fee—An amount payable by a resident at the inception of a residency


agreement. The advance fee is usually specified in the residency agreement and is usually
payable prior to the resident assuming occupancy of a living unit (sometimes referred to
as an entrance fee, endowment fee, entry fee, or founder’s fee).

2.4 Cash and Investment Balance—The value of cash, cash equivalents, and marketable
securities of a CCRC (historically referred to as cash balance by CCRC practitioners).
This excludes the value of the physical property assets of the CCRC.

2.5 Cohort of New Residents—A hypothetical group of new residents assumed to enter the
CCRC over a specified period of time and assumed to have certain demographic
characteristics.

2.6 Continuing Care Retirement Community (CCRC)—A residential facility that provides
stated housekeeping, social, and health care services in return for some combination of an
advance fee, periodic fees, and additional fees.

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ASOP No. 3⎯September 2007

2.7 Fee Structure—A combination of fees that generally includes advance fees, periodic fees,
and additional fees.

2.8 Health Care Guarantee—A clause in a residency agreement guaranteeing access to health
care and defining the type of health care services to be provided to the resident. These
health care services may be offered with or without additional charges to the periodic
fees.

2.9 Health Center—A facility associated with a CCRC where health care is provided to
residents in accordance with the residency agreement. The health center typically
includes some combination of assisted living, special care, and nursing care units. Non-
residents may also live in the health center.

2.10 Independent Living Unit—Living quarters designed for residents capable of living
independently. A resident could receive home health care in the independent living unit,
but a resident who needs full-time health care on either a temporary or permanent basis is
normally transferred to the health center.

2.11 Levels of Care—Varying degrees of care, which are based on a resident’s health status.
Typical levels of care include independent living units, assisted living units, nursing care
units, and special care units. The levels of care may be dictated by state licensure. A
transfer to a different level of care need not involve a transfer to a different type of living
unit.

2.12 Living Unit—The various living quarters of a CCRC, including independent living units
and health center units.

2.13 Morbidity Rate—The probability of incurring an illness or disability requiring the


transfer to a different level of care. The permanent transfer rates and the temporary
transfer rates together comprise the morbidity rates.

2.14 Non-Resident—A person living in the CCRC who has signed an agreement without a
health care guarantee and without a refund guarantee. Non-residents normally pay for all
health care services received on a fee for service basis.

2.15 Periodic Fee—Amounts payable by a resident periodically (usually monthly) during the
existence of a residency agreement. The periodic fees are typically adjusted from time to
time to reflect changes in operating costs.

2.16 Permanent Transfer—A move from one level of care to another level of care without
expectation of returning to the former level of care.

2.17 Physical Property—Physical assets, such as land, building, furniture, fixtures, or


equipment, which belong to the CCRC. These assets, excluding land, are assumed to
depreciate over their respective lifetimes. These assets are also referred to as the fixed
assets of the CCRC.

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ASOP No. 3⎯September 2007

2.18 Population Projection—An estimate of the number of residents expected to live in the
CCRC at various future times.

2.19 Residency Agreement—The contract between one or more individuals and the CCRC
that describes the services to be provided and the obligations of the parties. The contracts
are usually of long duration and may be for the life of the individual or the life of the
survivor of two or more individuals. The residency agreement describes the health care
guarantee, if any, and any portion of the advance fee that would be refundable upon
termination of the residency agreement.

2.20 Resident—A person living in the CCRC who has signed a residency agreement with a
health care guarantee or a refund guarantee.

2.21 Temporary Transfer—A move from one level of care to another level of care with the
expectation of returning to the former level of care.

2.22 Trend—Measure of rates of change, over time, that affects revenues, costs, or actuarial
assumptions.

2.23 Withdrawal Rate—The probability that a residency agreement will be terminated by the
resident’s leaving the CCRC for reasons other than death.

2.24 Valuation Date—The date as of which the values of the assets and liabilities of the CCRC
are determined.

Section 3. Analysis of Issues and Recommended Practices

3.1 Introduction—When providing professional services related to a CCRC, the actuary


should consider the relevant financial items associated with the CCRC, current residents,
new residents, and levels of care provided, as well as relevant residency agreement
provisions and applicable law. The actuary should use methods and assumptions that are,
in the actuary’s professional judgment, appropriate in light of the scope and purpose of
the assignment.

3.2 Determination of Satisfactory Actuarial Balance—In determining whether the CCRC is


in satisfactory actuarial balance as of the valuation date, the actuary should evaluate
whether the CCRC meets all of the following three conditions:

3.2.1 Condition 1: Adequate Resources for Current Residents—The resources


available to the CCRC related to current residents include any existing resources
for the current residents plus the actuarial present value of future resources, such
as periodic fees expected to be paid in the future by such residents.

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ASOP No. 3⎯September 2007

The actuary may consider these resources adequate if they are greater than or
equal to any existing liabilities for the current residents plus the actuarial present
value of the expected costs associated with the obligations to such residents under
their contracts. The actuary should determine if this condition is satisfied through
the use of the actuarial balance sheet (see section 3.4).

A proposed CCRC is not required to meet this condition to be in satisfactory


actuarial balance. The actuary should start evaluating this condition for a new
CCRC when the block of current residents is of sufficient size to make this
determination. For example, the actuary may evaluate this condition at the earlier
of three years after opening or when the CCRC reaches its targeted occupancy.

3.2.2 Condition 2: Adequate Fee Structure for a Cohort of New Residents—For a


cohort of new residents, the expected fees are the sum of the advance fee paid at
or before occupancy plus the actuarial present value at occupancy of the new
residents’ expected future periodic fees. Expected fees may include any future
additional fees and third party payments attributable to the new residents.

The actuary may consider the fee structure adequate if the expected fees are
greater than or equal to the actuarial present value at occupancy of the costs
associated with the obligations assumed by the CCRC for that cohort. The actuary
should determine if this condition is satisfied through the use of the cohort pricing
analysis (see section 3.5).

3.2.3 Condition 3: Positive Projected Cash and Investment Balances—The actuary


should project cash and investment balances over the projection period. This
projection should include revenue and expenses from all known sources,
including current and new residents and non-residents.

The actuary should choose a projection period that extends to a point at which, in
the actuary’s professional judgment, the use of a longer period would not
materially affect the results and conclusions.

The actuary may consider the cash and investment balances adequate if these
balances are positive in each projection year. The actuary should determine if this
condition is satisfied through the use of the cash flow projection (see section 3.7).

3.3 Projected Population Movements—The actuary should base the development of the
actuarial balance sheet (see section 3.4), the cohort pricing analysis (see section 3.5), and
the cash flow projection (see section 3.7) respectively on the three types of population
projections described below, using appropriate assumptions for mortality, morbidity, and
withdrawal. The actuary should project the residents’ movements through various levels
of care, the number of surviving residents by level of care status, and the projected
number of independent living units occupied.

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ASOP No. 3⎯September 2007

3.3.1 Closed-Group Projection of Current Residents—When testing for condition 1 (see


sections 3.2.1 and 3.4), the actuary should use a population projection that is
performed solely with respect to current residents on the valuation date. The
actuary should project the surviving residents’ movements through various levels
of care until contract termination by death or withdrawal. This projection excludes
new residents and non-residents.

3.3.2 Closed-Group Projection of a Cohort of New Residents—When testing for


condition 2 (see sections 3.2.2 and 3.5), the actuary should use a population
projection that is performed solely with respect to a cohort of new residents. The
actuary should project the surviving residents’ movements through various levels
of care until contract termination by death or withdrawal. This projection excludes
non-residents.

3.3.3 Open-Group Projection—When testing for condition 3 (see sections 3.2.3 and
3.7), the actuary should use a population projection that tracks residents in the
CCRC on the valuation date together with expected new residents consistent with
assumed occupancy levels. The actuary should reflect non-residents in this
population projection if they will fill unoccupied units or beds in various levels of
care consistent with assumed occupancy levels.

3.4 Actuarial Balance Sheet—The actuary should consider the guidance below when
developing the actuarial balance sheet.

3.4.1 Assets—The actuary should estimate the following: the actuarial present value of
future periodic fees (described in section 3.6.1), the actuarial present value of
future additional fees and third party payments (described in section 3.6.2), and
the actuarial value of physical property for assets currently in service (described
in section 3.6.3).

The actuary should reflect in the actuarial balance sheet other assets from the
accounting balance sheet as appropriate, in the actuary’s professional judgment.
These assets generally include such items as cash and investment balances,
current receivables, and other items not specifically reflected in the above
guidance.

3.4.2 Liabilities—The actuary should estimate the following: the actuarial present value
of the future use of physical property (described in section 3.6.4), the actuarial
present value of future operating expenses (described in section 3.6.5), the
actuarial present value of future refunds (described in section 3.6.6), and the
actuarial present value of the long-term debt (described in section 3.6.7).

The actuary should reflect in the actuarial balance sheet other liabilities from the
accounting balance sheet as appropriate, in the actuary’s professional judgment.
These liabilities generally include such items as current payables, resident

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ASOP No. 3⎯September 2007

deposits, fees paid in advance, short-term debt obligations, and other items not
specifically reflected in the above guidance.

3.5 Cohort Pricing Analysis—The actuary should develop the cohort pricing analysis based
on the present value of revenues and expenses associated with a cohort of new residents.

The revenues include the advance fees, the actuarial present value of future periodic fees
(described in section 3.6.1), and the actuarial present value of future additional fees and
third party payments (described in section 3.6.2).

The expenses include the actuarial present value of the future use of physical property
(described in section 3.6.4), the actuarial present value of future operating expenses
(described in section 3.6.5), and the actuarial present value of future refunds (described in
section 3.6.6).

The actuary may consider, subject to disclosure, the use of expense levels consistent with
the targeted number of residents when there is expected to be a material change in the
population, such as growth resulting from new construction.

3.6 Actuarial Asset and Liability Values—When developing the actuarial balance sheet or
the cohort pricing analysis, the actuary should develop the following present value items.

3.6.1 Future Periodic Fees—The actuary should estimate the actuarial present value of
future periodic fees by projecting the fees payable by the surviving residents of
the appropriate closed-group population in each level of care in each future year,
and discounting the result back to the valuation date. The estimate of future fees
will usually reflect current rates adjusted for projected future fee increases.

3.6.2 Future Additional Fees and Third Party Payments—The actuary should estimate
the actuarial present value of future additional fees (such as guest meals and
additional meals) and payments to the CCRC from third party payers (such as
Medicare, Medicaid, and other insurance), if applicable, by projecting the
additional revenue payable by, or on behalf of, the surviving residents of the
appropriate closed-group population in each level of care in each future year and
discounting the result back to the valuation date. The estimate of these future
revenues should usually reflect current experience adjusted for projected future
increases to such revenues.

3.6.3 Physical Property for Assets Currently in Service—The actuary should estimate
the actuarial value of physical property for assets currently in service as the
present value of the projected remaining annual capital expense charges
associated with assets in service as of the valuation date.

The actuary should estimate the annual capital expense charge for the use of an
asset for each year using its useful lifetime. The projected annual capital expense
charge consists of the imputed interest charge for the use of the asset plus the

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ASOP No. 3⎯September 2007

change in asset value from one year to the next. In calculating the capital expense
charges, the actuary should use a rate consistent with the cost of capital at the time
the asset was originally put into service or the cost of capital in the current
economic environment.

3.6.4 Future Use of Physical Property—The actuary should estimate the actuarial
present value of the future use of physical property by taking the projected annual
capital expense charges for both the current and replacement fixed assets
allocated to the surviving residents of the appropriate closed-group population in
each future year and discounting the result back to the valuation date. The actuary
should use a methodology to estimate the annual capital expense charges that is
consistent with the methodology used in section 3.6.3.

3.6.5 Future Operating Expenses—The actuary should estimate the actuarial present
value of future operating expenses by taking the operating expenses allocated to
the surviving residents of the appropriate closed-group population in each future
year and discounting the result back to the valuation date. The actuary should
exclude from future operating expenses (a) future capital expenditures, which are
discussed in section 3.6.4; and (b) the future long-term debt interest and principal
payments, which are discussed in section 3.6.7.

When estimating future operating expenses, the actuary should reflect future cost
trends and reflect underlying expense consumption patterns in the allocation. The
actuary should allocate expenses across the various levels of care and within each
level of care on an appropriate basis such as per person, per unit, or per square
foot.

3.6.6 Future Refunds—The actuary should estimate the actuarial present value of future
refunds by estimating the amount of refund due each terminating resident of the
appropriate closed-group population in each future year and discounting the
amounts back to the valuation date. The actuary should base the estimate of the
refund due each terminating resident each future year on the terms of the
residency agreement assumed to be applicable to that resident and the CCRC’s
actual practice, if any, with regard to payment of refunds.

3.6.7 Value of Long-Term Debt—The actuary should estimate the actuarial present
value of long-term debt as the discounted value of the projected remaining
principal and interest payments as of the valuation date. The present value of
long-term debt may be different than the amount on the accounting balance sheet
depending on the relationship between the discount rate and the actual or expected
interest rate on the debt.

3.7 Cash Flow Projections—The actuary should perform cash flow projections over the
projection period using open-group methods and should reflect the projected financial
effects of existing residents, new residents replacing existing residents, and non-residents
to the extent living unit capacity allows. The actuary should select assumptions in the

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ASOP No. 3⎯September 2007

cash flow projections that are consistent with those used in the development of the
actuarial balance sheet and cohort pricing analysis (see sections 3.4 and 3.5).

The actuary should reflect revenues from all known sources (such as advance fees,
periodic fees, additional fees, payments from non-residents, reimbursements from
Medicare or other third party payer, and investment income). The actuary should reflect
expenses from all known sources (such as operating expenses, capital expenditures, debt
interest and principal payments, any cost of using an offsite health facility, and refunds of
advance fees).

The cash flow projection should show the cash and investment balances at the beginning
and end of each projection year.

The actuary should consider the guidance in ASOP No. 7, Analysis of Life, Health, or
Property/Casualty Insurer Cash Flows, when choosing assumptions for cash flow
projections.

3.8 Selection of Actuarial Assumptions—The actuary should consider the guidance below
when selecting assumptions for performing actuarial analyses covered by this ASOP.

3.8.1 Mortality, Morbidity, and Withdrawal Assumptions—In selecting assumptions for


rates of mortality, morbidity and withdrawal, the actuary should consider which
of the following, in the actuary’s professional judgment, are appropriate to reflect
in each of these assumptions:

a. age and gender;

b. health characteristics;

c. permanent and temporary transfer patterns;

d. level of care status and expected differences in experience between residents


in different levels of care;

e. time elapsed since the last change in the level of care;

f. single or multiple occupancy;

g. profile of new residents who are expected to enter the CCRC when
vacancies occur;

h. time elapsed since the resident entered the CCRC;

i. actual experience of the CCRC and the credibility of the experience;

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ASOP No. 3⎯September 2007

j. contractual guarantees, such as health care guarantees and advance fee


refunds; and

k. operational policies and practices of the CCRC, such as transfer policies.

The actuary should consider trend assumptions for rates of mortality, morbidity,
and withdrawal that are reasonable, in the actuary’s professional judgment. In
selecting trend assumptions, the actuary should consider and review appropriate
data. These data may include past trend experience studies, past projections of
trends or appropriate industry studies.

3.8.2 Trend Assumptions for Fees and Expenses—The actuary should set trend
assumptions for periodic fees, advance fees, additional fees, and other revenue
items. The actuary should also set trend assumptions for operating expenses,
capital expenditures, and other expense items. The actuary may use different trend
assumptions, as appropriate, for various categories of revenues and expenses. In
setting trend assumptions for periodic fees, the actuary should also take into
account practical, competitive, and contractual considerations.

The actuary should select assumptions as to future trends in periodic fees that are
consistent with the trend assumptions that are used in projecting future expenses.
If the actuary uses different trend assumptions for periodic fees and operating
expenses, the actuary should disclose this difference in an appropriate actuarial
communication.

3.8.3 Investment Rate and Discount Rate Assumptions—The actuary should select
investment rate and discount rate assumptions that are individually reasonable,
mutually consistent, and reflective of the long-term nature of the contracts.

a. Investment Rate⎯The actuary should consider the past investment


performance, short- and long-term market expectations, and the future
investment strategy of the CCRC to estimate investment income for the
cash flow projection.

b. Discount Rate⎯The actuary should use a discount rate to estimate


actuarial present values that, in the actuary’s professional judgment, is
reasonable and appropriate, and is consistent with the investment rate.

3.8.4 Revenue and Expense Allocation Assumptions—The actuary should assume an


allocation of general revenues and expenses to the various levels of care, and to
current and new residents. The actuary should consider whether the sum of all
allocated expenses reconciles to the total projected expenses of the CCRC.

3.8.5 Going-Concern Assumption—The actuarial balance sheet, the cohort pricing


analysis, and the cash flow projection rely on assumptions predicated on the

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ASOP No. 3⎯September 2007

ongoing financial viability and continuation of the CCRC. This implies that the
CCRC will be able to maintain appropriate occupancy levels by attracting new
residents to replace existing residents as the latter vacate units. The actuary should
consider the ability of the CCRC to attract new residents or any other known,
significant circumstances that, in the actuary’s professional judgment, may affect
the CCRC’s ability to remain a going concern.

3.8.6 Reasonableness of Assumptions⎯The actuary should review the assumptions for


reasonableness. The assumptions should be reasonable, in the actuary’s
professional judgment, in the aggregate and for each assumption individually,
using relevant information available to the actuary.

In reviewing the assumptions for reasonableness, the actuary may consider such
factors as the following:

a. the purpose of the measurement;

b. the frequency with which the projections are expected to be updated;

c. the length of the projection period;

d. the sensitivity of the projections to the effect of variations in key actuarial


assumptions;

e. the potential variability of the assumption;

f. the size of the CCRC’s resident population;

g. the ability to increase fees or decrease expenses in future periods;

h. the level of surplus available to provide for adverse fluctuation; and

i. any significant margins for uncertainty which have been included in the
actuarial assumptions.

3.9 Benevolence Funds and Financial Assistance Subsidies—The actuary should consider
both the funds available and the potential future liabilities for residents who do not pay
the full scheduled fees. For example, some CCRCs may set aside assets or funds from
charitable contributions to assist residents who cannot afford the full scheduled fees, the
periodic fee increases, or advance fees. Other CCRCs may include the costs of any
assistance in the basic fee structure.

3.10 For-Profit CCRCs—When performing professional services with respect to for-profit


CCRCs, the actuary should consider the nature and financial implications of the
ownership arrangement, including owner’s equity, past and possible future equity

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distributions, potential income tax liability, and historical and future capital expenditures
funded by the owner.

3.11 Equity or Cooperative CCRCs—The actuary should consider the nature and financial
implications of any ownership arrangement, including advance fee payments and refunds,
and the value of assets invested in the physical property and the replacement costs of
these fixed assets. For example, in some CCRCs, residents may either own a particular
unit or a membership in the CCRC.

3.12 Additional Considerations Affecting a CCRC’s Finances—The actuary should consider


the scope of the CCRC’s commitments to current and prospective residents and the
nature of its fee structure. The actuary may obtain this knowledge from the applicable
residency agreements and any other reasonable source of information about the CCRC.
When interpreting these documents, the actuary should consider the following:

a. the admission criteria and how they are applied;

b. the terms of the residency agreement and any limitations on the period for which
commitments are made;

c. any known, significant limitations on the CCRC’s ability to change future


periodic fees;

d. any provision for refunding the advance fee;

e. any limitation on the services provided and any requirement of additional charges
for services;

f. any contract provisions for prepaid health care or for additional charges if a
resident receives health care;

g. any affiliation with another entity and the extent to which any such entity would
assume responsibility for the CCRC’s obligations; and

h. any other matter that, in the actuary’s professional judgment, is expected to have a
material effect on the CCRC’s current or future financial statements.

3.13 External Restrictions—The actuary should consider restrictions on the CCRC from
external sources, such as applicable law, regulation, or other binding authority. Examples
include a state’s Medicaid reimbursement policy, regulations restricting the use of health
center beds by non-residents, and any relevant lender-imposed restrictions.

3.14 Reliance on Data or Other Information Supplied by Others—When relying on data or


other information supplied by others, the actuary should refer to ASOP No. 23, Data
Quality, for guidance.

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3.15 Documentation⎯The actuary should prepare and retain appropriate documentation


regarding the methods, assumptions, procedures, and the sources of the data used. The
documentation should be in a form such that another actuary qualified in the same
practice area could assess the reasonableness of the actuary’s work, and should be
sufficient to comply with the disclosure requirements in section 4.

Section 4. Communications and Disclosures

4.1 Communications and Disclosures⎯When issuing actuarial communications under this


standard, the actuary should refer to ASOP No. 23 and ASOP No. 41, Actuarial
Communications. In addition, the actuary should disclose the following items in an
actuarial communication:

4.1.1 Actuarial Data, Assumptions, and Methods—The actuarial communication should


describe, as applicable, the actuarial data, assumptions and methods used in
performing the actuarial analysis, including the following:

a. summary of historical resident data and population statistics for residents


as of the valuation date;

b. historical and current financial data used to produce the actuarial balance
sheet, cohort pricing analysis, and cash flow projections;

c. assumed rates of mortality, morbidity, withdrawal, and occupancy;

d. assumptions and methodology used in performing the population


projections;

e. investment and discount rates;

f. trend rates for revenues and expenses, and the relationship between the
two;

g. assumptions and methodology used to value and depreciate the physical


property;

h. assumptions and methodology used to estimate each actuarial present


value;

i. assumptions and methodology used for any significant margin for


uncertainty, or a similar adjustment or provision, included in the actuarial
valuation, including any significant assumptions affecting the valuation
regarding surplus available to provide for adverse fluctuations;

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j. assumptions and methodology used to allocate general revenue and


expenses; and

k. any material changes in assumptions or methods from the most recent


prior analysis.

4.1.2 Assignments Involving an Opinion on Satisfactory Actuarial Balance—The


actuarial communication should disclose the actuarial balance sheet, the cohort
pricing analysis, and the cash and investment balances at the beginning and end of
each projection year, which were prepared to test the three conditions in section
3.2, and state whether or not each condition is met.

If one or more of the three conditions is not met, the actuary should make
disclosures according to the following:

a. Condition 1: Actuarial Balance Sheet Deficit—If the actuarial balance


sheet shows a deficit (regardless of the results of conditions 2 and 3), the
actuary should state the implications of the deficit. The actuarial
communication should describe management’s plans for handling the
deficit, if known, and the actuary’s comments thereon, if any;

b. Condition 2: Cohort Pricing Analysis Deficit or Inadequacy—If the


cohort pricing analysis indicates a deficit or inadequacy, the actuary
should state the implications of the pricing inadequacy, including the
projected impact on the actuarial balance sheet in the future. The actuarial
communication should describe management’s plans for handling the
pricing inadequacy, if known, and the actuary’s comments thereon, if any;

c. Condition 3: Negative Cash and Investment Balances on the Cash Flow


Projection—If the cash flow projection indicates negative or declining
cash and investment balances over the projection period, the actuary
should state the implications of the projected negative or declining cash
and investment balances. If the cash flow projection indicates negative
cash and investment balances, the actuarial communication should
describe management’s plans for handling the negative cash and
investment balances, including the estimated time before positive cash and
investment balances are achieved, if known, and the actuary’s comments
thereon, if any; and

d. Qualification of Opinion—If the actuary is unable to form the needed


opinion regarding whether the CCRC is in satisfactory actuarial balance,
or if the opinion is adverse (due to failing one or more of the above
conditions), or otherwise qualified, then the statement of actuarial opinion
and the actuarial communication should explain why the actuary is unable
to form an unqualified favorable opinion.

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4.1.3 Specific Disclosures—The actuary should specifically disclose the following in


an actuarial communication:

a. any significant issues regarding the going-concern assumption;

b. any assistance assumed to be derived from dedicated benevolence funds;

c. any significant issues related to for-profit CCRCs;

d. any significant issues regarding equity and cooperative CCRCs;

e. any significant issues regarding proposed CCRCs;

f. any significant issues regarding the reasonableness of the actuarial


assumptions;

g. that actual experience may significantly differ from projected experience;

h. that measurements made at a future date may differ significantly from the
current measurement due to potential volatility in an actuarial assumption
(for example, present value calculations, periodic fee analyses or
population projections);

i. the results of any sensitivity tests performed; and

j. any additional issues not addressed elsewhere in section 4 that, in the


actuary’s professional judgment, are expected to have a material impact on
the actuarial analyses.

4.2 Deviation—If, in the actuary’s professional judgment, the actuary has deviated materially
from the guidance set forth elsewhere in this standard, the actuary can still comply with
this standard by applying the following sections as appropriate:

4.2.1 Material Deviations to Comply with Applicable Law—If compliance with


applicable law requires the actuary to deviate materially from the guidance set
forth in this standard, the actuary should disclose that the assignment was
prepared in compliance with applicable law, and the actuary should disclose the
specific purpose of the assignment and indicate that the work product may not be
appropriate for other purposes. The actuary should use professional judgment to
determine whether additional disclosure would be appropriate in light of the
purpose of the assignment and the intended users of the actuarial communication.

4.2.2 Other Material Deviations—The actuary’s communication should disclose any


other material deviation from the guidance set forth in this standard. The actuary
should consider whether, in the actuary’s professional judgment, it would be
appropriate and practical to provide the reasons for, or to quantify the expected

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impact of, such deviation. The actuary should be prepared to explain the deviation
to a principal, another actuary, or other intended users of the actuary’s
communication. The actuary should also be prepared to justify the deviation to the
actuarial profession’s disciplinary bodies.

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Appendix 1

Background and Current Practices

Note: This appendix is provided for informational purposes, but is not part of the standard of
practice.

Background

Certain contractual obligations of a CCRC are contingent upon the occurrence, timing, and
duration of certain future events. The resident typically pays for such future promised services
through a combination of advance and periodic fees, typically before the services are provided.
Actuarial methods are used to establish the fee structure and to measure the CCRC’s liabilities
for the provision of future promised services.

High occupancy, sound pricing, and effective financial management are keys to the successful
operation of a CCRC. The ability of a CCRC to attract new residents to fill vacancies will
depend on keeping the CCRC competitive as to its physical property, its fee schedule, and the
general attractiveness of its whole environment.

Current Practices

Current actuarial practices for CCRCs are generally now well established. Prior to the release of
the first edition of this ASOP and the release of subsequent educational material by various
entities, actuaries used differing analytical approaches. These approaches included differing
methods to determine closed and open-group resident projections, projected refunds, physical
property valuations, long-term debt, and other items. While historically differences did exist,
these differences have now mostly been eliminated and standardized practices have evolved.

Illustrative Capital Expense Charge Development and Physical Property Valuation

The physical property, or fixed assets, of a CCRC are a significant asset of the CCRC, and also a
significant cost to the residents of the CCRC. In order to provide for equity among generations of
residents, it is necessary to allocate an appropriate part of the cost of the use of physical property
to current residents as of the valuation date, and to the cohort of new residents.

The method described in this appendix for developing and assigning the annual capital expense
charge for asset use, determining the asset’s actuarial value, and determining the liability for
asset use, is one illustrative method designed to provide for equity among generations of
residents. (Illustrative formulas for expensing and valuing physical property are presented at the
end of this appendix.)

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Physical property assets may be valued and depreciated using level, decreasing or increasing
depreciation methodologies based on actuarial principles, the nature of the underlying assets and
other factors.

Capital Expense (Imputed Interest plus Depreciation) Charges—The annual capital expense
charge for physical property consists of the imputed interest for the use of the asset, or
opportunity cost of using cash resources for purchasing a fixed asset (because it is not an
interest-earning investment), plus the change in asset value from one year to the next.

a. Each item of physical property is assigned an assumed useful lifetime and an appropriate
rate of inflation. While GAAP expected lifetimes might be available, alternative lifetimes
may be available from other sources such as engineering studies performed by the client.
In the case of land, the expected useful lifetime may be perpetual.

b. The annual capital expense charge for the use of an asset is developed for each year using
its useful lifetime and is calculated as one of a series of annual amounts. The present
value of this series, discounted to the time of acquisition, equals the cost of the asset. This
series of annual amounts may be decreasing, level, or increasing.

c. In similar fashion, capital expense charges are developed for physical property assumed
to be purchased in future years. It is assumed that each asset will be replaced at the end of
its useful lifetime with a new asset. The cost of the new asset is assumed to equal the
original cost indexed for inflation. The asset is continually replaced at the end of
successive useful lifetimes.

An approximation of these replacement costs that better reflects the expected magnitude
and timing of future capital expenditures may also be used. These approximations reflect
a sufficient level of future capital expenditures necessary to maintain the physical
property for future use.

Capital expense charges are developed for the following items:

a. Actuarial value of physical property for assets currently in service—reflected as


an asset on the actuarial balance sheet;

b. Actuarial present value of future use of physical property consumed by current


residents throughout their respective lifetimes—reflected as a liability on the
actuarial balance sheet; and

c. Actuarial present value for future use of physical property consumed by a


hypothetical group of prospective residents—reflected as a liability on the cohort
pricing analysis.

Value of Physical Property for Assets Currently in Service—The actuarial value of each asset is
the discounted value (without survivorship) of the remaining annual capital expense charges as

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of the valuation date. The sum of these values for all such assets in service as of the valuation
date is reflected as an asset on the actuarial balance sheet.

Value of Future Use of Physical Property for Existing Residents—The actuarial present value of
the future use of physical property for existing residents is the discounted value (with
survivorship) of the annual capital expense charges for the physical property, and its
replacements, allocated to existing residents as of the valuation date.

a. The part of each future year’s capital expense charge that relates to the existing
residents as of the valuation date is determined by estimating the ratio of the
existing resident survivorship group use to total CCRC use. The ratio may be in
proportion to population, to number of CCRC occupied beds or units, to square
footage, or to some other appropriate measure. For years during fill-up or material
change in population, it may be appropriate to substitute a target or ultimate level
of use for the actual estimated level of total use.

b. The current actuarial liability for the promised future use of a physical asset (and
its replacements) with respect to the existing resident closed group is the sum (for
all years) of the part of such capital expense charge in each future year related to
the existing closed group, as determined in (a), discounted to the valuation date.

Value of Future Use of Physical Property for the New Entrant Cohort—The actuarial present
value of the future use of physical property for the new entrant cohort is the discounted value
(with survivorship) of the annual capital expense charges for the physical property, and its
replacements, allocated to the new entrant cohort closed group.

a. The part of each future year’s capital expense charge that relates to the new
entrant cohort is determined by estimating the ratio of the new entrant cohort
survivorship group use to total CCRC use.

b. The current actuarial liability for the promised future use of a physical asset (and
its replacements) with respect to the new entrant cohort is the sum (for all years)
of the part of such capital expense charge in each future year related to the new
entrant cohort closed group, as determined in (a), discounted to the valuation date.

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Illustrative Formulas for Expensing and Valuing Physical Property

Note: These formulas illustrate allocations on a per-resident basis. Other allocation bases such as
units, beds, square footage, etc. may be more appropriate for certain assets.

A. Relationships of Asset Cost, Asset Value, and Open-Group Annual Expense

e = Expected years of the asset’s useful lifetime.

En = Annual expense in year n for use of the asset. For simplicity in these illustrations,
we assume it is payable at the end of the year.

j = Assumed annual rate of increase in E. Note that j could be zero. Setting j = k


makes it possible to anticipate a smooth progression in annual expense at the time
the asset is replaced when its useful lifetime ends. (It is not necessary that En’s
form a geometric series. However, in this example the En’s do form such a series.)

k = Assumed annual rate of increase in replacement cost of A.

i = Assumed annual discount, or cost of capital, rate.

v = 1/(1 + i).

Ao = Acquisition cost of the asset.

Ao = v * E1 + v2 * E2 + ..... + ve * Ee.

From this we obtain

Ao * (i – j)
E1 = , provided i ≠ j
1 – [v * (1 + j)]e

Vn = Value of the current asset at duration n, where n < e.


Vn = v * En+1 + v2 * En+2 + ..... + ve-n * Ee.

From this we obtain

En+1 = i * Vn + (Vn – Vn+1).

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This shows that the annual expense for a physical asset consists of the interest that is forgone
(because it is not an interest-earning investment), plus the change in asset value from one year to
the next. In the case of land, the annual expense consists of only the interest that is foregone,
since there is no assumed change in asset value (lifetime is perpetual).

B. Relationship of Closed-Group Liability with Open-Group Expense

Pn = Projected total population at duration n, determined on an open-group basis.


Depending on the circumstances, a reasonable approximation for P may be a constant
number equaling the current population.

Cn = Projected surviving population at duration n from a specified closed group. The


closed group may be the closed group of current residents, or the closed group for a
cohort of new residents.

If a part of a given CCRC is used for persons not under contract, only the fraction
devoted to those under contract should be considered. One way of accomplishing this
is to include those not under contract in Pn, but not in Cn.

Cn + Cn+1
Rn+1 = , representing the ratio of the projected closed group population to the
Pn + Pn+1 projected total population.

Ln = Liability at duration n for the future use of the asset and its replacements by a specific
closed group.

Ln = v * Rn+1 * En+1 + v2 * Rn+2 * En+2 + ..... + ve-n * Re * Ee


+ ve-n+1 * Re+1 * Ee+1 + ve-n+2 * Re+2 * Ee+2 + ... + v2e-n * R2e * E2e
+ ............................. + until R = 0.

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Appendix 2

Comments on the Exposure Draft and Responses

The exposure draft of this revision to ASOP No. 3, Continuing Care Retirement Communities,
was issued in December 2006 with a comment deadline of April 30, 2007. Eight comment letters
were received, some of which may have been submitted on behalf of multiple commentators,
such as by firms or committees. For purposes of this appendix, the term “commentator” may
refer to more than one person associated with a particular comment letter. The Task Force to
Revise ASOP No. 3 carefully considered all comments received, and the Health Committee and
the ASB reviewed (and modified, where appropriate) the proposed changes to the ASOP.
Summarized below are the significant issues and questions contained in the comment letters and
the responses to each. The term “reviewers” includes the task force, the Health Committee, and
the ASB. Unless otherwise noted, the section numbers and titles used below refer to those in the
final revised ASOP.

GENERAL COMMENTS
Comment One commentator questioned the appropriateness of having a small group develop an ASOP with the
risk that an ASOP can be shaped to benefit special interests without regard to the larger public good, and
that all interests impacted by the results of actuarial practice in the area (such as the residents of a
CCRC) be represented in the formulation of those standards.

Response The purpose of the ASOP is to provide guidance to actuaries practicing in the CCRC environment and
the reviewers believe that the exposure process provides ample opportunity for peer review of the
standards being proposed. Anyone, including all members of the public, is permitted to comment on any
standard. All comments received by the comment deadline are posted online and available for anyone to
review until the ASOP is finalized.
Comment One commentator suggested putting more emphasis on principles and less on prescription and adding
phrasing to the ASOP sufficient to allow actuaries to respond to situations they may confront which call
for actuarial judgment beyond what is indicated in the ASOP.

Response The reviewers believe that the ASOP provides adequate flexibility for actuarial judgment and made no
change.
Comment One commentator suggested there be a discussion of equity among residents and a discussion on the
extent to which CCRC pricing should reflect actuarial principles on a resident-by-resident basis.

Response The reviewers believe the wording should not be prescriptive, and equity and pricing decisions vary
from community to community, and made no change.
Comment The transmittal memorandum of the exposure draft asked if the proposed standard codifies appropriate
actuarial practice, and if not, how should it be changed. One commentator expressed disappointment in
the content because it focused more on reformatting than attempts to codify actuarial practice evolution
since 1994. Another commentator indicated the proposed standard does codify appropriate actuarial
practice.

Response The reviewers believe that the ASOP describes appropriate actuarial practice.

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SECTION 1. PURPOSE, SCOPE, CROSS REFERENCES, AND EFFECTIVE DATE


Section 1.1, Purpose
Comment One commentator suggested there be a statement about the rationale for applying actuarial techniques
that includes more than just prepayment of health care. The reason should state that it is due to the
existence of advance fees which represent a prepayment of some costs be they health care or shelter, and
funding of this prepayment using advance fees depends on estimates of the resident’s longevity which is
the purpose of actuarial projections.

Response The reviewers believe that such a comment belongs in the background section of appendix 1, and that
the background section is sufficiently general to cover the reasons included in the comment.
Section 1.2, Scope
Comment One commentator suggested that the business context for this ASOP be indicated as well as who requires
the actuarial services and why.

Response The reviewers believe that the current wording adequately indicates who potential users are and the
various uses of the actuarial analysis, and made no change.
Comment One commentator suggested adding “financing entities” to the list of entities using the results of an
actuarial communication prepared according to this ASOP.

Response The reviewers agree and added “financing entities” to the list of potential users of an actuarial
communication.
SECTION 2. DEFINITIONS
Comment One commentator suggested there be definitions for the various types of actuarial studies.

Response The reviewers note that the examples cited in section 1.2, Scope, are adequately described and did not
believe that formal definitions were needed. The reviewers added estimating the future services
obligation under GAAP to the examples of services provided in section 1.2.
Comment One commentator asked if mortality rate needed to be defined.

Response The reviewers believe that mortality rate was a term that was well understood in the actuarial community
and that a definition was therefore not needed.
Section 2.2, Actuarial Balance Sheet
Comment One commentator suggested there needs to be a clear distinction between an actuarial balance sheet and
an accounting balance sheet.

Response The reviewers believe that the development of the actuarial balance sheet as described in section 3.4,
Actuarial Balance Sheet, is sufficiently clear in that the actuarial balance sheet is not the same as the
accounting balance sheet.
Section 2.5, Cohort of New Residents
Comment Several commentators suggested revised wording in order to clarify this definition. One commentator
asked if the cohort was real or hypothetical. Another commentator suggested that the definition be
refined to specify the time period over which the cohort of new residents would be expected to occur.

Response The reviewers agree that the definition needed to be clarified, and the definition was revised to indicate
this was a hypothetical distribution over a specified period of time relating to assumed future residents.
Section 2.6, Continuing Care Retirement Community (CCRC)
Comment One commentator asked if some kind of guarantee wasn’t an essential part of the definition of a CCRC.

Response The reviewers note that a CCRC may or may not include a guarantee and made no change.
Section 2.9, Health Center
Comment One commentator suggested that the definition include reference to dementia care.

Response The reviewers consider that the reference to special care is broad enough to include dementia care and
made no change.

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Section 2.13, Morbidity Rate


Comment One commentator suggested that the definition be expanded to note that a transfer to a different level of
care may not require a transfer to a different living unit.

Response The reviewers agree that this is an important clarification, but felt it was better placed in the definition
for Levels of Care and modified section 2.11 accordingly.
Section 2.14, Non-Resident
Comment One commentator questioned how a person living in a CCRC could be “non-resident” and suggested that
this term be changed.

Response The reviewers believe the definition is clear and the distinction between resident and non-resident is an
important concept in CCRC analyses, and made no change.
Section 2.17, Physical Property
Comment One commentator criticized this definition as going too far in restricting the meaning of words of
common understanding.

Response The reviewers consider the definition to be appropriate and made no change.
Section 2.18, Population Projection
Comment One commentator suggested changing the definition to add number, age and status. One commentator
asked if the definition should specify the number of residents by care level expected to live.

Response The reviewers consider the definition to be appropriate and made no change. Section 3.3, Projected
Population Movements, implies that population projections are done in sufficient detail as needed by the
intended use of the population projection.
Section 2.20, Resident
Comment One commentator questioned whether a contractholder should be considered a resident if there is no
health guarantee but there is a substantial refund guarantee.

Response The reviewers agree and revised section 2.14, Non-Resident, and section 2.20, Resident, to incorporate
either a health care guarantee or a refund guarantee.
Section 2.23, Withdrawal Rate
Comment One commentator questioned the need for this definition.

Response The reviewers believe that the definition is needed.


Section 2.24, Valuation Date
Comment One commentator suggested that “at” be changed to “as of.”

Response The reviewers agree and made the change, and a similar change was made to the first sentence of section
3.2, Determination of Satisfactory Actuarial Balance.
SECTION 3. ANALYSIS OF ISSUES AND RECOMMENDED PRACTICES
Section 3.1, Introduction
Comment Two commentators suggested that “policy provisions” was not appropriate when dealing with CCRCs.
One commentator suggested using “contract provisions” instead, while the other commentator suggested
using “residency contract provisions” or “residency agreement provisions.”

Response The reviewers agree that “policy” was not appropriate and changed the reference to “residency
agreement provisions,” which is consistent with terminology used in section 2, Definitions.

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Section 3.2, Determination of Satisfactory Actuarial Balance


Comment The transmittal memorandum of the exposure draft asked if requiring a CCRC to meet all three
conditions for determining satisfactory actuarial balance was appropriate.

One commentator supported this section as written.

One commentator believes meeting all three conditions is appropriate for satisfactory actuarial balance
but noted that it is not clear that the ASOP requires all three conditions be met for the CCRC to be in
satisfactory actuarial balance and made a suggestion to revise the language.

One commentator indicated that the concept of satisfactory actuarial balance does need to include all
three criteria, but guidance should be given to provide flexibility for the actuary to provide a favorable
opinion if only two of the three criteria are initially met using baseline assumptions. This has real world
implications in states where regulations mandate this opinion to avoid fee adjustments to residents that
are not desired or marketable.

One commentator indicated that the requirement to meet all three conditions for satisfactory actuarial
balance was more a matter of actuarial judgment in light of the use which the actuary anticipates will be
made of his/her work than a question appropriate for legislating within the context of an ASOP. The
standard should be that the actuary consider all three elements and justify in writing the basis for
structuring the analysis, including actuarial balance, in the way the actuary has chosen.

One commentator indicated that in the situation where a community is slightly less than 100% funded on
valuation, but shows good surplus in pricing and positive cash flows, this community is not in
satisfactory actuarial balance but may not be considered “impaired.”

Response The reviewers believe that the test for satisfactory actuarial balance includes meeting all three conditions
and made no change. As indicated in section 4.1.2, Assignments Involving an Opinion on Satisfactory
Actuarial Balance, the actuarial communication would discuss the implications of not meeting any of the
three conditions, and the actuary can discuss the projected time frame for meeting all of the conditions
using the baseline assumptions.
Section 3.2.1, Condition 1: Adequate Resources for Current Residents
Comment One commentator indicated that beginning to evaluate this condition after the community has been in
operation three years is arbitrary, and targeted occupancy is not defined. The commentator suggested
that an evaluation be made immediately after the close of the first fiscal year when residents have moved
in, and preferably it could be based on a hypothetical census at projected full occupancy as opposed to
the current census in order to minimize the impact of overhead allocation to a smaller census during fill-
up.

One commentator stated that in terms of time frame, it may be appropriate to provide the actuary with a
defined term for describing the financial state of the facility prior to testing for satisfactory actuarial
balance such as “pre-actuarial balance determination.”

Response The reviewers believe that a first evaluation of this condition is most useful after the community has
achieved a stable occupancy level and once mature annual operating expenses can be determined, which
typically would be after the fill-up period has been completed. The reviewers note that section 3.2.1
gives an example as to when this might occur.

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ASOP No. 3⎯September 2007

Section 3.2.2, Condition 2: Adequate Fee Structure for a Cohort of New Residents
Comment One commentator indicated that as written the analysis does not allow for outside subsidization of the
fee structure, for example, sources such as charitable donations, endowments or from other financial
programs such as LTC insurance or Medicare/Medicaid. Instead, it is limited to amounts paid by the
resident. These third party payments are addressed in section 3.6.2, Future Additional Fees and Third
Party Payments. It also doesn’t allow for consideration of additional fees.

Response The reviewers agree with the suggestion and clarified the wording to include future additional fees and
third party payments attributable to the new residents.
Section 3.2.3, Condition 3: Positive Projected Cash and Investment Balances
Comment The transmittal memorandum of the exposure draft asked if the proposed wording for the time period to
be covered by the cash flow projection was appropriate.

One commentator suggested that the minimum number of years should approximate the average
remaining life expectancy of the current CCRC cohort.

Another commentator suggested 10 years of stabilized operations should be reflected in the cash flow
projection. So for a new community, the projection would reflect the remainder of the fill-up period plus
10 years.

Another commentator indicated that it was unclear as to the value of the second sentence in the middle
paragraph. In the first sentence, it states the actuary should choose a projection period based on his/her
judgment. Adding a sentence to say the actuary “may” consider a minimum period is ineffective. The
commentator recommended that the sentence either read as “should consider” or be eliminated.

Another commentator indicated that the choice of a projection period can be a material aspect of an
actuary’s work. The period should be sufficient to be informative for the users of the actuary’s work,
especially in affecting decisions that may be made in reliance on that work, and projection periods
should never be chosen to conceal deferred elements beyond the chosen period that might be material if
the projection were continued further. Hence, the choice of a particular projection period is a matter of
actuarial judgment, the basis for which the actuary should document in his/her actuarial communication.
For instance, for the purpose of examining a CCRC, it might be decided to use the probable maximum
lifespan of the youngest residents as an appropriate future projection horizon, or the actuary might deem
it desirable to have a projection that spans two or three managerial generations since a change in
leadership might be viewed as a material event. A specific period, whether it is 10 or 20 years, should be
omitted from the ASOP in favor of a more principled approach to this question.

Response The reviewers believe that the first sentence of the second paragraph is the key criteria and expanded
that sentence to indicate that use of a longer time period should not materially affect the results and
conclusions. The second sentence of the second paragraph was deleted.
Section 3.3, Projected Population Movements
Comment One commentator indicated that the notion of “levels of care” implies differences in care that can vary
widely from one community to the next. Some communities are very effective at increasing services as
needed to enable residents to stay in their independent living units. Other communities may have unfilled
beds in a higher area of the community and so may move residents to a higher level before care at that
level is absolutely needed. Consequently, it is important that the experience of the particular CCRC
community which the actuary is concerned be a driver in any calculations. Managerial and medical
decisions relating to care levels may vary widely from community to community, or even from time to
time within a community. Still, the ASOP is silent on this material aspect of actuarial practice relating to
CCRCs.

Response The reviewers believe that the wording here and in section 3.8, Selection of Actuarial Assumptions,
accommodates the potential variation between communities noted above, and made no change.

26
ASOP No. 3⎯September 2007

Section 3.6.1, Future Periodic Fees


Comment One commentator indicated that it may be appropriate to reference consideration of ability of the
resident to pay future periodic fees and any appropriate allowance for bad debt or consideration of
facility practices in the event a resident is unable to pay.

Response The reviewers believe that the wording in section 3.9, Benevolence Funds and Financial Assistance
Subsidies, which discusses the need to consider the impact of residents who do not pay the full
scheduled fees, adequately addresses the issue raised and made no change.
Section 3.6.3, Physical Property for Assets Currently in Service
Comment One commentator asked if the cost of capital is defined.

Response The reviewers note that the cost of capital is described in section 3.6.3 and made no change.
Comment One commentator indicated that the use of cost of capital at the time the asset was originally put into
service is not appropriate in current state of practice since the intent of imputing interest is to provide a
mathematical estimate of earnings on these fixed assets. The commentator doesn’t see using prior year’s
cost of capital as any better than current year’s cost of capital. The commentator suggests that the
assumption made for this value should be that the actuary may use a value consistent with the time the
asset was placed in service or one based on the current economic environment.

Response The reviewers agree with this comment and made the appropriate change.
Comment One commentator indicated that practicing actuaries use one of two methods for defining the level of
depreciation expenses for fixed assets and their corresponding current actuarial value. One method
assumes level dollar depreciation expenses and the other assumes increasing dollar depreciation
expenses. The two methods generate different results. In some cases, the actuarial opinion would be
different depending on the depreciation method used. This can be problematic to regulators as well as to
client CCRCs who switch between actuaries. It is suggested the ASOP should state which method is
preferable after careful consideration of all factors.

Response The reviewers believe this is a matter of actuarial judgment and made no change.
Section 3.6.6, Future Refunds
Comment One commentator questioned the actuarial treatment of refund provisions that are identical but where
payment timing may vary due to legal terminology of the residency agreement such as:
(a) unconditionally refundable and typically paid immediately or within 120 days after contract
termination, (b) refundable contingent upon reoccupancy and the proceeds from the next resident’s
advance fee, or (c) refundable upon resale of resident’s unit as in a cooperative contract. The issue is
whether actuarially the refund liabilities should be the same for all three contract options if the intent and
practice of management in regard to payment of refunds is the same for all provisions, i.e., all are paid
shortly after contract termination regardless of whether the reoccupancy or resale has occurred. In other
words, if three communities offered refunds based on one of the above three provisions, but make
payments in the same manner, the resulting actuarial liabilities should not be different.

Response The reviewers agree with the comment and revised the guidance to also include consideration of the
CCRC’s actual payment procedure for refunds.
Section 3.6.7, Value of Long-Term Debt
Comment One commentator suggested changing the last sentence to the following in order to provide for variable
debt: “The present value of long-term debt may be different than the amount on the accounting balance
sheet depending on the relationship between the discount rate and the actual or expected interest rate of
the debt.”

Response The reviewers agree and changed the sentence as suggested.

27
ASOP No. 3⎯September 2007

Section 3.7, Cash Flow Projections


Comment One commentator questioned including the revenue from non-residents living at the health center. The
influx of residents to the health center means eviction of non-residents and the loss of revenue needs to
be considered. If hospice services will be offered on premises it will call for cost and anticipated revenue
assumptions, and if not, the loss of revenue needs to be considered.

Response The reviewers believe that it is appropriate to include the revenue from non-residents in the health center
since operating expenses include the expense of beds occupied by non-residents. The projected cash
flows follow the projected population movements, so as residents displace non-residents in the health
center, the revenue projections automatically reflect this change.
Comment One commentator disagreed with the inclusion of the last paragraph in this section referring to ASOP
No. 7, Analysis of Life, Health, or Property/Casualty Insurer Cash Flows. The commentator stated that
CCRC practice is so far removed from that of insurance companies that this requirement is unnecessary
and bordering on irrelevant. The commentator states that there are too many differences to recommend
this to actuaries practicing in the CCRC area.

Response While the reviewers agree with the commentator about the limited applicability of ASOP No. 7 to
CCRCs, the reference is appropriate because an actuary would only apply the guidance that is
applicable.
Section 3.8, Selection of Actuarial Assumptions
Comment One commentator indicated that the description of assumptions in section 3.8 appears to focus on static
assumptions and asks if the ASOP should allow for dynamic assumptions and analysis.

Response The reviewers believe the current wording is flexible enough to allow dynamic assumptions if the
actuary chooses to use them and made no change.
Comment One commentator noted that the anticipation of withdrawal trend assumptions should be carefully
thought out as such a notion is contrary to a going concern model.

Response The reviewers agree that the withdrawal assumption, as with any assumption, should be carefully
considered, but believe that a withdrawal trend is not contrary to the going concern model.
Section 3.8.2, Trend Assumptions for Fees and Expenses
Comment One commentator indicated that the last sentence of the second paragraph seems redundant. The
commentator indicates that the first sentence of the second paragraph defines the standard, and if the
actuary does not follow any standard they need to disclose and justify.

Response The reviewers consider using a different trend assumption for the periodic fees versus the operating
expenses as a significant issue and wanted there to be no ambiguity about the need to disclose such a
difference, and made no change.
Comment One commentator disagreed with the use of “trend assumptions” when referencing inflation and fee
increase assumptions in this section. The commentator states that the use of the word “trend” in this
context is confusing. Actuaries must make assumptions regarding future “increases” in monthly and
advance fees. Such increases will be the result of decisions made by management at the CCRC and this
isn’t thought of as a “trend.” Actuaries must also make assumptions regarding expense inflation. The
term “inflation” is much more widely understood than “trend” in the context of future expense increases.

Response The reviewers note that section 2.22, Trend, defines trend as applying to revenues, costs or actuarial
assumptions. Therefore, the reviewers believe the current wording is appropriate and made no change.
Section 3.8.3, Investment and Discount Rate Assumptions (now Investment Rate and Discount Rate
Assumptions)
Comment One commentator suggested that the investment rate assumptions should state that investment
performance includes both earnings as well as appreciation in investment values.

Response The reviewers consider the wording sufficiently flexible to accommodate the actuary’s judgment in
developing an appropriate investment rate and made no change.

28
ASOP No. 3⎯September 2007

Section 3.8.5, Going-Concern Assumption


Comment One commentator indicated that it is presumed that the prevailing assumption should be the “going
concern” model, yet the security of residents’ interests in these lifetime contracts is clearly the
paramount public interest issue. Residents are induced to pay large proportions of their retirement assets
in expectation that they will receive lifetime care in accordance with the terms of their contracts. The
“going concern” standard does not seem adequate to protect the vulnerability of residents from the
specter of the financial failure of the CCRC on which they are dependent, so to the extent that those
dependencies are inherent in the CCRC, an assurance of solvency on a “liquidation” basis should be
interwoven with “going concern” analysis to maximize the probability that the enterprise will endure to
be able to fulfill the contractual expectations of the residents for the full duration of their lives.

Response The reviewers believe the three conditions discussed in section 3.2, Determination of Satisfactory
Actuarial Balance, are the appropriate measures to evaluate the financial condition of a CCRC.
Section 3.8.6, Reasonableness of Assumptions
Comment One commentator indicated that the choice of assumptions is critical to the mathematical modeling
which lies at the core of actuarial practice. Consequently, actuaries are expected to be proficient in
showing, good judgment in the choice of assumptions, including adapting assumption sources, for
example, published mortality tables, to the particulars of a specific case. Accordingly, it is desirable that,
as proposed, actuaries be continuously admonished that all assumptions be reasonable under the
circumstances of their use and actuaries should document in their communications the basis for their
judgments that any particular set of assumptions (or any individual assumption within an assumption set)
is the right choice for the particular application.

Response The reviewers agree and consider that the wording in the ASOP supports the above comments.
Comment The transmittal memorandum of the exposure draft asked if the proposed language asking the actuary to
take into consideration the level of surplus and any margins for uncertainty included in the actuarial
assumptions was appropriate.

One commentator indicated that the consideration of the level of surplus and the margins for uncertainty
seem appropriate. This allows the actuary to consider the impact of assumption refinement as compared
to materiality of outcome.

Another commentator indicated that using “margins for uncertainty” is not appropriate for setting
assumptions for CCRC financial and actuarial projections. Population projections, actuarial cash flow
projections, the actuarial balance sheet, and the new entrant (cohort) pricing analysis should be based on
best-estimate assumptions. The commentator asks how the actuary is to determine which direction to
change a particular assumption to add a “margin for uncertainty.” For example, higher mortality will
produce higher refund liabilities but could also produce lower health care liabilities. So, would the
mortality margin be positive or negative? The use of such margins would result in confusion and
problems in interpretation of the results of key actuarial analyses for CCRCs. All CCRC financial
analyses should be based on best estimate assumptions with no margins added or subtracted. The
mechanism for dealing with uncertainty is surplus on the actuarial balance sheet, surplus on the new
entrant (cohort) pricing analysis, and positive cash flows. The existence of such surpluses and positive
cash flows provides the “margins” for uncertainty. Actuaries routinely recommend that CCRCs achieve
certain target levels of such surpluses. Sensitivity testing may also be performed to determine if there is
adequate surplus or cash flows under particular scenarios.

Response The reviewers believe that the current wording is flexible enough to accommodate using assumptions
with or without margins together with the level of surplus available to provide for adverse fluctuations to
demonstrate satisfactory actuarial balance.

29
ASOP No. 3⎯September 2007

Section 3.9, Benevolence Funds and Financial Assistance Subsidies


Comment One commentator asked what if a client is not able to provide any data relative to anticipated
benevolence.

Response The reviewers believe that the actuary should use professional judgment to reflect any anticipated
benevolence based on the information that is available and disclose what, if any, level of benevolence
was reflected in the analysis.
Section 3.10, For-Profit CCRCs
Comment The transmittal memorandum of the exposure draft asked if the addition of sections 3.9, 3.10, and 3.11
were appropriate. Two commentators responded that they were appropriate.

One commentator suggested combining sections 3.10 and 3.11, Equity or Cooperative CCRCs, into a
single section entitled “Ownership Considerations.”

Response The reviewers believe it is clearer to retain these two issues as separate sections and made no change.
Comment One commentator suggested that a potential income tax liability be stated and included in the
projections.

Response The reviewers agree with the suggestion and added “potential income tax liability” to the list of issues to
be considered.
Comment One commentator indicated that the comment about capital expenditures funded by the owner is unclear.
The commentator asks if this is suggesting that these shouldn’t be a liability for the actuarial balance
sheet and cohort pricing. If so, then they shouldn’t be counted as an asset either. The commentator asks
if this is suggesting they be treated as a gift.

Response The reviewers note that ownership arrangements vary and the handling of capital expenditures may also
vary. The reviewers do not believe there should be one prescribed way of handling capital expenditures
in For-Profit CCRCs and this determination should be left to the actuary’s professional judgment.
Section 3.11, Equity or Cooperative CCRCs
Comment One commentator questioned the meaning of this section. The issue in regard to a cooperative CCRC is
(1) whether they should be handled as a combination of cooperative and service components in actuarial
analysis or (2) whether an actuary can simply review the service component and ignore the cooperative
element. It is suggested that the ASOP include a more detailed statement on the preference in regard to
how this organization should be modeled in an actuarial study.

Response The reviewers note that arrangements of equity and cooperative CCRCs vary. The reviewers do not
believe there should be one prescribed way of handling these arrangements and this determination
should be left to the actuary’s professional judgment.
Section 3.13, External Restrictions
Comment One commentator suggested that the list of external sources be extended to loan covenants.

Another commentator indicated that the meaning of this section is not clear. If such restrictions generate
results that are not in satisfactory actuarial balance, then the actuary cannot give a positive opinion. In
particular, what is anticipated by lender imposed restrictions since condition 3 only requires that cash
balances be positive, and the commentator points out that lenders are likely to require a high cash
balance.

Response The reviewers believe that relevant lender-imposed restrictions should be considered and modified the
language to clarify this point.

30
ASOP No. 3⎯September 2007

SECTION 4. COMMUNICATIONS AND DISCLOSURES


Section 4.1.1, Actuarial Data, Assumptions, and Methods
Comment One commentator indicated that since actuaries serve generally as advisors, all communications should
be sufficiently clear and candid so that any person who may rely on the actuary’s work is able to
examine the actuary’s judgments critically to determining if they are appropriate for the intended use.
This requires a high standard of documentation and requires that actuaries be able to explain their
methods, assumptions, judgments and opinions in terms that non-actuaries readily follow and evaluate.
Section 4 as drafted makes clear that actuaries are to document their work with exemplary completeness.
However, the section omits any requirement that the actuary explain the basis for the choice of
assumptions, methodologies, etc. and such explanation should be part of any complete communication.

Response The reviewers believe that such explanation should not be required as a part of this communication and
note that section 3.15, Documentation, requires the appropriate documentation, and made no change.
Comment One commentator indicated that the specific listing of documentation in section 4.1.1 seems redundant
with ASOP No. 41, Actuarial Communications. In addition, many of the items listed in section 4.1.1
may not be applicable depending on the assignment. For example, an assignment involving only a
population projection would not include the items mentioned in section 4.1.1(b), (e), (f), (g), (h), and (j).

Response The reviewers acknowledge there may be some redundancy with ASOP No. 41 but decided that since
CCRC analysis involves issues that may not be familiar to all actuaries it was preferable to list the key
items that should be discussed. Since the items to be included in the actuarial communication depend on
the purpose of the communication, the reviewers changed the first sentence of section 4.1.1 to refer to
applicable items.
Comment One commentator suggested changing item 4.1.1(k) to “any material changes in assumptions or methods
from the most recent prior analysis.”

Response The reviewers agree and changed the sentence as suggested.


Section 4.1.2, Results of Conditions for Satisfactory Actuarial Balance and Qualification of Opinion (now
Assignments Involving an Opinion on Satisfactory Actuarial Balance)
Comment One commentator suggested changing the title of section 4.1.2 to “Assignments Regarding Opinion of
Satisfactory Actuarial Balance” or something similar, in order to clarify that the section is limited in
scope to specific assignments. As worded, the ASOP would require development of the three tests for
any actuarial communication.

Response The reviewers agree and changed the title for section 4.1.2 to “Assignments Involving an Opinion on
Satisfactory Actuarial Balance.”
Comment One commentator questioned the use and implication of “or declining” in paragraph 4.1.2(c). The
commentator asks over what period would the cash balances need to decline (any two consecutive years
or over the total projection period). The commentator indicates that there may be situations where it may
be perfectly appropriate to have slow declining balances or have temporary declines followed by a
plateau.

Response The reviewers agree that in certain circumstances declining cash and investment balances may not pose
any implications, but believe the actuary should comment on the cause of the decline, and made no
change.
Section 4.3, Deviation from Standard (now Deviation)
Comment One commentator indicated that section 4.3.1, Material Deviations to Comply with Applicable Law,
does not address the obligation that we have as professionals to try to ensure that laws with actuarial
implications are properly crafted.

Response While the reviewers agree with the assertion that laws with actuarial implications should be properly
crafted, the reviewers believe that this issue is outside of the scope of the ASOP.

31
ASOP No. 3⎯September 2007

Comment One commentator questioned the meaning of principal in the next to last sentence of section 4.3.2, Other
Material Deviations. The commentator asks if this is the principal in the actuary’s own firm.

Response The reviewers refer the commentator to section 2.7, Principal, of ASOP No. 41. Principal refers to the
client or employer of the actuary, and the facts and circumstances of the situation will determine which
is the principal.
Appendix 2 (now Appendix 1)
Comment The transmittal memorandum of the exposure draft asked if the material in appendix 2 was appropriate
for inclusion in this ASOP.

One commentator indicated that including appendix 2 was appropriate.

Another commentator suggested that the material in appendix 2 was more appropriate for publication for
peer review and discussion on a standalone basis. An ASOP—which may be used by a skilled trial
lawyer in a deposition or trial to undermine the valid judgments of a qualified actuary—is not the best
forum for such material.

Response The reviewers note that much of this material was included in previous versions of this ASOP and that
the exposure process provided ample opportunity for peer review of the material in appendix 2.
Comment One commentator suggested revising the first sentence referring to “and also a significant cost to the
residents of the CCRC.” Residents don’t typically have ownership of fixed assets, so, it is a cost of
operating the CCRC.

Response The reviewers consider the current wording appropriate and made no change.

32
Actuarial Standard
of Practice
No. 4

Measuring Pension Obligations and


Determining Pension Plan Costs or Contributions

Revised Edition

Developed by the
Pension Committee of the
Actuarial Standards Board

Adopted by the
Actuarial Standards Board
September 2007

(Doc. No. 107)


ASOP No. 4 – September 2007

TABLE OF CONTENTS

Transmittal Memorandum iv

STANDARD OF PRACTICE

Section 1. Purpose, Scope, Cross References, and Effective Date 1


1.1 Purpose 1
1.2 Scope 1
1.3 Cross References 2
1.4 Effective Date 2

Section 2. Definitions 2
2.1 Actuarial Accrued Liability 2
2.2 Actuarial Cost Method 2
2.3 Actuarial Present Value 3
2.4 Actuarial Present Value of Projected Benefits 3
2.5 Actuarial Valuation 3
2.6 Amortization Method 3
2.7 Contribution 3
2.8 Contribution Allocation Procedure 3
2.9 Cost 3
2.10 Cost Allocation Procedure 3
2.11 Expenses 3
2.12 Measurement Date 3
2.13 Normal Cost 3
2.14 Participant 3
2.15 Plan Provisions 3
2.16 Prescribed Assumption or Method 4

Section 3. Analysis of Issues and Recommended Practices 4


3.1 Overview 4
3.2 Prescribed Assumption or Method Selected by the Plan Sponsor 4
3.2.1 Basis for Evaluating Prescribed Assumption or Method 4
3.2.2 Inability to Evaluate Prescribed Assumption or Method 5
3.3 General Procedures 5
3.4 Measurement Date Considerations 5
3.4.1 Information as of a Different Date 5
3.4.2 Events after the Measurement Date 6
3.5 Plan Provisions 6
3.5.1 Adopted Plan Changes 6
3.5.2 Proposed Plan Changes 6
3.6 Data 6
3.6.1 Participants 6

ii
ASOP No. 4 – September 2007

3.6.2 Hypothetical Data 6


3.7 Actuarial Assumptions 7
3.8 Asset Valuation 7
3.9 Interrelationship Among Procedures, Assumptions, and Plan Provisions 7
3.10 Relationship Between Procedures Used for Measuring Assets and Obligations 7
3.11 Actuarial Cost Method 8
3.12 Cost or Contribution Allocation Procedure 9
3.13 Ability to Pay Benefits When Due 9
3.13.1 Actuary Selects Actuarial Cost Method or Amortization Method 9
3.13.2 Actuary Does Not Select Actuarial Cost Method
or Amortization Method 9
3.14 Measuring the Value of Accrued or Vested Benefits 10
3.15 Volatility 10
3.16 Adjustment of Prior Measurement 11
3.17 Approximations and Estimates 11
3.18 Reliance on Data, Plan Provisions, or Other Information Supplied by Others 12
3.19 Documentation 12

Section 4. Communications and Disclosures 12


4.1 Communication Requirements 12
4.2 Disclosure About Prescribed Assumptions or Methods 14
4.3 Deviation 14
4.3.1 Material Deviations to Comply with Applicable Law 14
4.3.2 Other Material Deviations 14

Appendix 1—Background and Current Practices 15


Background 15
Current Practices 16

Appendix 2—Comments on the Third Exposure Draft and Responses 18

iii
ASOP No. 4 – September 2007

September 2007

TO: Members of Actuarial Organizations Governed by the Standards of Practice of the


Actuarial Standards Board and Other Persons Interested in Measuring Pension
Obligations and Determining Pension Plan Costs or Contributions

FROM: Actuarial Standards Board (ASB)

SUBJ: Actuarial Standard of Practice (ASOP) No. 4

This document contains the final version of the revision of ASOP No. 4, now titled Measuring
Pension Obligations and Determining Pension Plan Costs or Contributions.

Background

Pension Plan Recommendations A, B, and C were adopted and amended by the American
Academy of Actuaries (Academy) during the period 1976 to 1983. In 1988, Recommendations
for Measuring Pension Obligations was promulgated as an ASOP by the Interim Actuarial
Standards Board and the Board of Directors of the American Academy of Actuaries. In 1990, the
ASB republished that standard as ASOP No. 4, Recommendations for Measuring Pension
Obligations. In October 1993, ASOP No. 4 was reformatted and published in the uniform format
adopted by the ASB, with a title change, Measuring Pension Obligations.

The original ASOP No. 4 contained general recommendations for selecting economic and
noneconomic assumptions, the actuarial cost method, and the asset valuation method—all key
elements in the valuation of pension obligations. The evolution of actuarial practice in this area
and the adoption of related ASOPs since ASOP No. 4 was adopted have made it necessary to
update the guidance contained in ASOP No. 4.

The ASB has provided coordinated guidance through a series of ASOPs for measuring pension
obligations and determining pension plan costs or contributions:

1. This revision of ASOP No. 4, which ties together the standards below, provides guidance
on actuarial cost methods, and addresses overall considerations for measuring pension
obligations and determining plan costs or contributions;

2. ASOP No. 27, Selection of Economic Assumptions for Measuring Pension Obligations;

3. ASOP No. 35, Selection of Demographic and Other Noneconomic Assumptions for
Measuring Pension Obligations; and

4. ASOP No. 44, Selection and Use of Asset Valuation Methods for Pension Valuations.

iv
ASOP No. 4 – September 2007

ASOP Nos. 27 and 35 originally contained statements to the effect that, in case of a conflict
between the guidance in those standards and ASOP No. 4, those standards would govern. At the
same time that it adopted this standard, the ASB adopted revisions of those standards to make it
clear that in case of conflicts ASOP No. 4 will govern.

This ASOP is intended to accommodate the concepts of financial economics as well as


traditional actuarial practice.

First Exposure Draft

The first exposure draft of this revision was issued in December 2002, with a comment deadline
of June 15, 2003. Twenty-two comment letters were received and considered in developing the
second exposure draft.

Second Exposure Draft

The second exposure draft of this revision was issued in March 2005 with a comment deadline of
October 31, 2005. Eighteen comment letters were received and considered in developing the
third exposure draft.

Third Exposure Draft

The third exposure draft of this revision was issued in August 2006 with a comment deadline of
March 1, 2007. The Pension Committee carefully considered the seven comment letters received.
The key changes made to the final standard in response to these comment letters are as follows:

1. Sections 2.1, Actuarial Accrued Liability, and 2.13, Normal Cost, were revised to
indicate that under certain actuarial cost methods, the actuarial accrued liability and
normal cost depend upon the actuarial value of assets.

2. Section 3.2.2, Inability to Evaluate Prescribed Assumption or Method, was revised.


Instead of considering the actuary’s expertise, the section exempts an actuary from
evaluating a prescribed assumption or method selected by the plan sponsor if the actuary
is unable to do so without performing a substantial amount of additional work beyond the
scope of the assignment.

3. Section 3.5.1, Adopted Plan Changes, was revised to better describe generally accepted
practice among actuaries who practice in the public-plan sector as well as those who
work with corporate pension plans.

v
ASOP No. 4 – September 2007

4. Section 3.9, Interrelationship Among Procedures, Assumptions, and Plan Provisions, was
revised to clarify the intent.

5. Section 4.2, Disclosure About Prescribed Assumptions or Methods, was revised for
consistency with the changes in section 3.2.2. The section does not require the actuary to
disclose the reason for any inability to evaluate a prescribed assumption or method
selected by the plan sponsor.

In addition, a number of clarifying changes were made to the text. Please see appendix 2 for a
detailed discussion of the comments received and the reviewers’ responses.

Note that the section on Prescribed Statement of Actuarial Opinion (formerly section 4.3) has
been deleted due to the amended Qualifications Standards for Actuaries Issuing Statements of
Actuarial Opinion in the United States promulgated by the American Academy of Actuaries.

The Pension Committee thanks everyone who took the time to contribute comments and
suggestions on the exposure drafts.

The Pension Committee thanks former committee members Thomas P. Adams, Arthur J.
Assantes, David L. Driscoll, Bruce C. Gaffney, Lawrence A. Golden, Marilyn F. Janzen, Daniel
G. Laline Jr., John F. Langhans, Michael B. Preston, William A. Reimert, Phillip A. Romello,
and Ruth F. Williams for their assistance with drafting this ASOP.

The ASB voted in September 2007 to adopt this standard.

Pension Committee of the ASB

David R. Fleiss, Chairperson


Mita D. Drazilov A. Donald Morgan
David P. Friedlander Timothy A. Ryor
Peter H. Gutman Frank Todisco

Actuarial Standards Board

Cecil D. Bykerk, Chairperson


Albert J. Beer Robert G. Meilander
William C. Cutlip Godfrey Perrott
Alan D. Ford Lawrence J. Sher
David R. Kass Karen F. Terry

vi
ASOP No. 4—September 2007

ACTUARIAL STANDARD OF PRACTICE NO. 4

MEASURING PENSION OBLIGATIONS


AND DETERMINING PENSION PLAN COSTS OR CONTRIBUTIONS

STANDARD OF PRACTICE

Section 1. Purpose, Scope, Cross References, and Effective Date

1.1 Purpose—This actuarial standard of practice (ASOP) provides guidance to actuaries


when performing professional services with respect to measuring pension obligations and
determining plan costs or contributions. Throughout this standard, the term plan refers to
a defined benefit pension plan. Other actuarial standards of practice address actuarial
assumptions and asset valuation methods. This standard addresses actuarial cost methods
and provides guidance for coordinating and integrating all of these elements of an
actuarial valuation of a plan.

1.2 Scope—This standard applies to actuaries when performing professional services with
respect to the following tasks:

a. measurement of pension obligations. Examples include determinations of funded


status, assessments of solvency upon plan termination, and measurements for use
in cost or contribution determinations;

b. assignment of the value of plan obligations to time periods. Examples include


contributions, accounting costs, and cost or contribution estimates for potential
plan changes;

c. development of a cost allocation procedure used to determine costs for a plan;

d. development of a contribution allocation procedure used to determine


contributions for a plan;

e. determination as to the types and levels of benefits supportable by specified cost


or contribution levels; and

f. projection of pension obligations, plan costs or contributions, and other related


measurements. Examples include cash flow projections and projections of a
plan’s funded status.

1
ASOP No. 4—September 2007

Throughout this standard, any reference to selecting actuarial assumptions, actuarial cost
methods, asset valuation methods, and amortization methods also includes giving advice
on selecting actuarial assumptions, actuarial cost methods, asset valuation methods, and
amortization methods. In addition, any reference to developing or modifying a cost or
contribution allocation procedure includes giving advice on developing or modifying a
cost or contribution allocation procedure.

The actuary should comply with this standard except to the extent it may conflict with
applicable law (statutes, regulations, and other legally binding authority). If compliance
with applicable law requires the actuary to depart from the guidance set forth in this
standard, the actuary should refer to section 4 regarding deviation.

This standard does not apply to actuaries when performing professional services with
respect to individual benefit calculations, individual benefit statement estimates, annuity
pricing, nondiscrimination testing, and social insurance programs as described in section
1.2, Scope, of ASOP No. 32, Social Insurance (unless an ASOP on social insurance
explicitly calls for application of this standard).

This standard does not require the actuary to evaluate the ability of the plan sponsor or
other contributing entity to make contributions to the plan when due.

1.3 Cross References⎯When this standard refers to the provisions of other documents, the
reference includes the referenced documents as they may be amended or restated in the
future, and any successor to them, by whatever name called. If any amended or restated
document differs materially from the originally referenced document, the actuary should
consider the guidance in this standard to the extent it is applicable and appropriate.

1.4 Effective Date—This standard will be effective for any actuarial valuation with a
measurement date on or after March 15, 2008.

Section 2. Definitions

The terms below are defined for use in this actuarial standard of practice.

2.1 Actuarial Accrued Liability—The portion of the actuarial present value of projected
benefits (and expenses, if applicable), as determined under a particular actuarial cost
method, which is not provided for by future normal costs. Under certain actuarial cost
methods, the actuarial accrued liability is dependent upon the actuarial value of assets.

2.2 Actuarial Cost Method—A procedure for allocating the actuarial present value of
projected benefits (and expenses, if applicable) to time periods, usually in the form of a
normal cost and an actuarial accrued liability (sometimes referred to as a funding
method).

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ASOP No. 4—September 2007

2.3 Actuarial Present Value—The value of an amount or series of amounts payable or


receivable at various times, determined as of a given date by the application of a
particular set of actuarial assumptions.

2.4 Actuarial Present Value of Projected Benefits—The actuarial present value of benefits
that are expected to be paid in the future, taking into account the effect of such items as
future service, advancement in age, and anticipated future compensation (sometimes
referred to as the present value of future benefits).

2.5 Actuarial Valuation—The measurement of relevant pension obligations and, when


applicable, the determination of periodic costs or contributions.

2.6 Amortization Method⎯A method under a contribution or cost allocation procedure for
determining the amount, timing, and pattern of recognition of the difference between the
actuarial accrued liability and the actuarial value of assets.

2.7 Contribution⎯A potential payment to the plan determined by the actuary. It may or may
not be the amount actually paid by the plan sponsor or other contributing entity.

2.8 Contribution Allocation Procedure⎯A procedure for determining the periodic


contribution for a plan. It may produce a single value, such as normal cost plus
twenty-year amortization of the unfunded actuarial accrued liability, or a range of values,
such as that from the ERISA minimum required contribution to the maximum
tax-deductible amount.

2.9 Cost⎯The portion of plan obligations assigned to a period for purposes other than
funding.

2.10 Cost Allocation Procedure⎯A procedure for determining the periodic cost for a plan (for
example, the procedure to determine the net periodic pension cost under Statement of
Financial Accounting Standards (SFAS) No. 87, Employers’ Accounting for Pensions).

2.11 Expenses—Administrative or investment expenses expected to be borne by the plan.

2.12 Measurement Date⎯The date as of which the values of the pension obligations and, if
applicable, assets are determined (sometimes referred to as the valuation date).

2.13 Normal Cost—The portion of the actuarial present value of projected benefits (and
expenses, if applicable) that is allocated to a period, typically twelve months, under the
actuarial cost method. Under certain actuarial cost methods, the normal cost is dependent
upon the actuarial value of assets.

2.14 Participant—An individual who satisfies the requirements for participation in the plan.

2.15 Plan Provisions—(a) Relevant terms of the plan document; and (b) relevant
administrative practices known to the actuary.

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2.16 Prescribed Assumption or Method—A specific assumption or method that is mandated or


that is selected from a specified range that is deemed to be acceptable by law, regulation,
or other binding authority. For purposes of this standard, the plan sponsor would be
considered a binding authority to the extent that law, regulation, or accounting standards
give the plan sponsor responsibility for selecting such an assumption or method.

Section 3. Analysis of Issues and Recommended Practices

3.1 Overview—Measuring pension obligations and determining plan costs or contributions


are processes in which the actuary may be required to make judgments or
recommendations on the choice of actuarial assumptions, actuarial cost methods, asset
valuation methods, and amortization methods.

The actuary may have the responsibility and authority to select some or all actuarial
assumptions, actuarial cost methods, asset valuation methods, and amortization methods.
In other circumstances, the actuary may be asked to advise the individuals who have that
responsibility and authority. In yet other circumstances, the actuary may perform
actuarial calculations using assumptions or methods prescribed by applicable law or
selected by others.

ASOP No. 27, Selection of Economic Assumptions for Measuring Pension Obligations,
and ASOP No. 35, Selection of Demographic and Other Noneconomic Assumptions for
Measuring Pension Obligations, provide guidance concerning actuarial assumptions.
ASOP No. 44, Selection and Use of Asset Valuation Methods for Pension Valuations,
provides guidance concerning asset valuation methods. ASOP No. 4 addresses actuarial
cost methods and provides guidance for coordinating and integrating all of these elements
of an actuarial valuation of a plan. In the event of a conflict between the guidance
provided in ASOP No. 4 and the guidance in any of the aforementioned ASOPs, ASOP
No. 4 would govern.

3.2 Prescribed Assumption or Method Selected by the Plan Sponsor⎯The actuary should
evaluate whether a prescribed assumption or method selected by the plan sponsor is
reasonable for the purpose of the measurement, except as provided in section 3.2.2. The
actuary should be guided by Precept 8 of the Code of Professional Conduct, which states,
“An Actuary who performs Actuarial Services shall take reasonable steps to ensure that
such services are not used to mislead other parties.” For purposes of this evaluation,
reasonable assumptions or methods are not necessarily limited to those the actuary would
have selected for the measurement.

3.2.1 Evaluating Prescribed Assumption or Method⎯When evaluating a prescribed


assumption or method selected by the plan sponsor, the actuary should consider
whether the prescribed assumption or method significantly conflicts with what, in
the actuary’s professional judgment, would be reasonable for the purpose of the
measurement. If, in the actuary’s professional judgment, there is a significant

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ASOP No. 4—September 2007

conflict, the actuary should disclose this conflict in accordance with section
4.2(a).

3.2.2 Inability to Evaluate Prescribed Assumption or Method—If the actuary is unable to


evaluate a prescribed assumption or method selected by the plan sponsor without performing a
substantial amount of additional work beyond the scope of the assignment, the actuary should
disclose this in accordance with section 4.2(b).
3.3 General Procedures—When measuring pension obligations and determining plan costs or
contributions, the actuary should perform the following:

a. identify the purpose and nature of the measurement;

b. identify the measurement date (section 3.4);

c. identify plan provisions applicable to the measurement (section 3.5);

d. gather data necessary for the measurement (section 3.6);

e. select actuarial assumptions pertinent to the measurement, if applicable (section


3.7);

f. select an asset valuation method, if applicable (section 3.8);

g. consider the interrelationship among procedures, assumptions, and plan


provisions (section 3.9);

h. consider the relationship between procedures used for measuring assets and
obligations (section 3.10);

i. apply an actuarial cost method to produce a normal cost and actuarial accrued
liability, if applicable (section 3.11);

j. apply a procedure to allocate costs or contributions to past and future periods, if


applicable (section 3.12); and

k. consider whether the actuarial cost method and amortization method are
significantly inconsistent with the plan accumulating adequate assets to make
benefit payments when due, if applicable (section 3.13).

3.4 Measurement Date Considerations—When measuring pension obligations and


determining plan costs or contributions as of a measurement date, the actuary should
consider the following:

3.4.1 Information as of a Different Date—The actuary may estimate asset and


participant information at the measurement date on the basis of information
furnished as of another date. In these circumstances, the actuary should make

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ASOP No. 4—September 2007

appropriate adjustments to the data. Alternatively, the actuary may calculate the
obligations on the date as of which the data were furnished and then adjust the
obligations to the measurement date (see section 3.16 for additional guidance).
The actuary should conclude that any such adjustments are reasonable in the
actuary’s professional judgment, given the purpose and nature of the
measurement.

3.4.2 Events after the Measurement Date—The treatment of events known to the
actuary that occur subsequent to the measurement date and prior to the date of the
actuarial communication should be appropriate for the purpose of the
measurement. Unless the purpose of the measurement requires the inclusion of
such events, they need not be reflected in the measurement.

3.5 Plan Provisions—When measuring pension obligations and determining plan costs or
contributions, the actuary should take into account plan provisions as appropriate for the
purpose and nature of the measurement.

3.5.1 Adopted Plan Changes—The actuary should take into account adopted plan
provisions consistent with the following when determining costs or contributions
for a period, unless contrary to applicable law:

a. Provisions adopted on or before the measurement date should be reflected


for at least the portion of the period during which the provisions are in
effect.

b. Provisions adopted after the measurement date may, but need not, be
reflected.

3.5.2 Proposed Plan Changes—The actuary should reflect proposed plan changes as
appropriate for the purpose and nature of the measurement.

3.6 Data—With respect to the data used for measurements, including data supplied by others,
the actuary should refer to ASOP No. 23, Data Quality, for guidance. In addition, the
actuary should consider the following:

3.6.1 Participants—The actuary should include in the measurement all participants


reported to the actuary, except in appropriate circumstances where the actuary
may exclude persons such as those below a minimum age/service level. When
appropriate, the actuary may include employees who might become participants
in the future.

3.6.2 Hypothetical Data—When appropriate, the actuary may prepare measurements


based on the assumed demographic characteristics of individuals not yet in
covered employment.

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3.7 Actuarial Assumptions—With respect to the selection of actuarial assumptions, the


actuary should also refer to ASOP Nos. 27 and 35 for guidance.

3.8 Asset Valuation—The actuary should also refer to ASOP No. 44 for guidance on the
selection and use of an asset valuation method.

3.9 Interrelationship Among Procedures, Assumptions, and Plan Provisions—Some plan


provisions may create pension obligations that are difficult to measure using
deterministic procedures and assumptions selected in accordance with ASOP Nos. 27 and
35. In such circumstances, the actuary may consider using alternative procedures, such as
stochastic modeling or option-pricing techniques, or alternative assumptions that include
adjustments to reflect the plan provisions that were not explicitly valued.

If, in the actuary’s professional judgment, such plan provisions are significant and have
not been reflected in the measurement, the actuary should so disclose in accordance with
section 4.1(d).

An example of such a plan provision is one that provides future benefits based on the
actual experience of the plan that will vary asymmetrically relative to the estimated
projected benefits based on a particular set of actuarial assumptions, such as the
following:

a. the use of favorable investment returns to provide cost-of-living increases


automatically to retirees; or

b. floor-offset provisions that provide a minimum defined benefit in the event a


participant’s account balance in a separate plan falls below some threshold.

3.10 Relationship Between Procedures Used for Measuring Assets and Obligations⎯The
actuary should measure assets and obligations on a consistent basis as of the
measurement date. Following are some examples of such consistency:

a. if a participant was due a lump sum before the measurement date, but such lump
sum had not been paid from plan assets as of the measurement date, the actuary
should either include the participant’s benefit due in obligations, or exclude it
from the asset value, used in the measurement;

b. if a plan has a dedicated portfolio of non-callable bonds specifically designed so


that emerging interest and principal payments meet specific emerging benefit
payments, the actuary could value the bond portfolio at market value and value
the specific emerging benefit payments using an interest rate equal to the internal
rate of return of the bonds on a market value basis. Alternatively, the actuary
could determine a composite valuation interest rate that reflects a weighted
average of the internal rate of return of the bonds on a market value basis and the
expected return on the remainder of the assets; and

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ASOP No. 4—September 2007

c. if the actuary values bonds at amortized cost, as permitted under ASOP No. 44
when the plan’s investment policy provides that such bonds are expected to be
held to maturity and holding such bonds to maturity is not inconsistent with the
plan’s investment practice and expected cash flow needs, the actuary could value
an appropriate portion of the pension obligation using an interest rate equal to the
internal rate of return of the bonds on an amortized cost basis. Alternatively, the
actuary could determine a composite valuation interest rate that reflects a
weighted average of the internal rate of return of the bonds on an amortized cost
basis and the expected return on the remainder of the assets.

3.11 Actuarial Cost Method—When assigning costs or contributions to time periods in


advance of the time benefit payments are due, the actuary should select an actuarial cost
method that meets the following criteria:

a. The period over which normal costs are allocated for a participant should begin
no earlier than the date of employment and should not extend beyond the last
assumed retirement age. The period may be applied to each individual participant
or to groups of participants on an aggregate basis.

When a plan has no active participants and no participants are accruing benefits, a
reasonable actuarial cost method will not produce a normal cost for benefits. For
purposes of this standard, an employee does not cease to be an active participant
merely because he or she is no longer accruing benefits under the plan.

b. The attribution of normal costs should bear a reasonable relationship to some


element of the plan’s benefit formula or the participants’ compensation or service.
The attribution basis may be applied on an individual or group basis (for example,
the actuarial present value of projected benefits for each participant may be
allocated by that participant’s own compensation or may be allocated by the
aggregated compensation for a group of participants).

c. Expenses should be considered when assigning costs or contributions to time


periods. For example, the expenses for a period may be added to the normal cost
for benefits or expenses may be reflected as an adjustment to the investment
return assumption or the discount rate. As another example, expenses may be
reflected as a percentage of pension obligation or normal cost.

d. The sum of the actuarial accrued liability and the actuarial present value of future
normal costs should equal the actuarial present value of projected benefits and
expenses, to the extent expenses are included in the liability and normal cost. For
purposes of this criterion, under an actuarial cost method that does not directly
calculate an actuarial accrued liability, the sum of the actuarial value of assets and
the unfunded actuarial liability, if any, shall be considered to be the actuarial
accrued liability.

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3.12 Cost or Contribution Allocation Procedure—The cost or contribution allocation


procedure typically combines the normal cost under an actuarial cost method and an
amortization method to determine the cost or contribution for the period. When selecting
an actuarial cost method or an amortization method, the actuary should consider factors
such as the timing and duration of expected benefit payments and the nature and
frequency of plan amendments. In addition, the actuary should consider relevant input
received from the principal, such as a desire for stable or predictable costs or
contributions, or a desire to achieve a target funding level within a specified time frame.

3.13 Consistency Between Contribution Allocation Procedure and the Payment of


Benefits⎯In some circumstances, a contribution allocation procedure selected in
accordance with section 3.12 may not necessarily produce adequate assets to make
benefit payments when they are due even if the actuary uses a combination of
assumptions selected in accordance with ASOP Nos. 27 and 35, an actuarial cost method
selected in accordance with section 3.11 of this standard, and an asset valuation method
selected in accordance with ASOP No. 44.

Examples of such circumstances include the following:

a. a plan covering a sole proprietor with funding that continues past an expected
retirement date with payment due in a lump sum;

b. using the aggregate funding method for a plan covering three employees, in which
the principal is near retirement and the other employees are relatively young; and

c. a plan amendment with an amortization period so long that overall plan


contributions would be scheduled to occur too late to make plan benefit payments
when due.

3.13.1 Actuary Selects Actuarial Cost Method or Amortization Method—When


performing professional services with respect to contributions for a plan, the
actuary should not select an actuarial cost method or amortization method that, in
the actuary’s professional judgment, is significantly inconsistent with the plan
accumulating adequate assets to make benefit payments when due, assuming that
all actuarial assumptions will be realized and that the plan sponsor or other
contributing entity will make contributions when due.

3.13.2 Actuary Does Not Select Actuarial Cost Method or Amortization Method—In
some circumstances, the actuary’s role is to determine the contribution, or range
of contributions, using an actuarial cost method or amortization method
prescribed by applicable law or selected by others. If, in the actuary’s professional
judgment, such an actuarial cost method or amortization method is significantly
inconsistent with the plan accumulating adequate assets to make benefit payments
when due, assuming that all actuarial assumptions will be realized and that the
plan sponsor or other contributing entity will make contributions when due, the
actuary should disclose this in accordance with section 4.1(j).

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ASOP No. 4—September 2007

This standard does not require the actuary to evaluate the ability of the plan sponsor or
other contributing entity to make contributions to the plan when due.

3.14 Measuring the Value of Accrued or Vested Benefits—Depending on the scope of the
assignment, the actuary may measure the value of accrued or vested benefits as of a
measurement date. The actuary should consider the following when making such
measurements:

a. relevant plan provisions and applicable law;

b. the status of the plan (for example, whether the plan is assumed to continue to
exist or be terminated);

c. the contingencies upon which benefits become payable, which may differ for
ongoing- and termination-basis measurements;

d. the extent to which participants have satisfied relevant eligibility requirements for
accrued or vested benefits and the extent to which future service or advancement
in age may satisfy those requirements;

e. whether or the extent to which death, disability, or other ancillary benefits are
accrued or vested;

f. whether the plan provisions regarding accrued benefits provide an appropriate


attribution pattern for the purpose of the measurement (for example, it may not be
appropriate if the plan’s benefit accruals are severely backloaded); and

g. if the measurement reflects the impact of a special event (such as a plant


shutdown or plan termination), the actuary should consider factors such as the
following:

1. the effect of the special event on continued employment;

2. the impact of the special event on employee behavior due to factors such
as subsidized payment options;

3. expenses associated with a potential plan termination, including


transaction costs to liquidate plan assets; and

4. changes in investment policy.

3.15 Volatility—If the scope of the actuary’s assignment includes an analysis of the potential
range of future pension obligations, costs, contributions, or funded status, the actuary
should consider sources of volatility that, in the actuary’s professional judgment, are
significant. Examples of potential sources of volatility include the following:

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ASOP No. 4—September 2007

a. plan experience differing from that anticipated by the economic or demographic


assumptions, as well as the effect of new entrants;

b. changes in economic or demographic assumptions;

c. the effect of discontinuities in applicable cost or funding regulations, such as full


funding limitations, the end of amortization periods, or liability recognition
triggers;

d. the delayed effect of smoothing techniques, such as the pending recognition of


prior experience losses; and

e. patterns of rising or falling cost expected when using a particular actuarial cost
method for the plan population.

In analyzing potential variations in economic and demographic experience or


assumptions, the actuary should exercise professional judgment in selecting a range of
variation in these factors and in selecting a methodology by which to analyze them,
consistent with the scope of the assignment.

3.16 Adjustment of Prior Measurement—The actuary may adjust the results from a prior
measurement in lieu of performing a new detailed measurement if, in the actuary’s
professional judgment, such an adjustment would produce an appropriate result for
purposes of the measurement. To determine whether adjustment is appropriate, the
actuary should consider items such as the following, if known to the actuary:

a. changes in the number of participants or the demographic characteristics of that


group;

b. length of time since the prior measurement;

c. differences between actual and expected contributions, benefit payments,


expenses, and investment performance; and

d. changes in economic and demographic expectations.

For example, when adjusting obligations from a prior measurement date, the actuary
should consider whether the interest rate or other assumptions used to determine the
obligations should be revised.

3.17 Approximations and Estimates—The actuary should use professional judgment to


establish a balance between the degree of refinement of methodology and materiality.
The actuary may use approximations and estimates where circumstances warrant.
Following are some examples of such circumstances:

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ASOP No. 4—September 2007

a. situations in which the actuary reasonably expects the results to be substantially


the same as the results of detailed calculations;

b. situations in which the actuary’s assignment requires informal or rough estimates;


and

c. situations in which the actuary reasonably expects the benefits being valued to
represent only a minor part of the overall pension obligation, cost, or contribution.

3.18 Reliance on Data, Plan Provisions, or Other Information Supplied by Others⎯When


relying on data, plan provisions, or other information supplied by others, the actuary
should refer to ASOP No. 23 for guidance.

3.19 Documentation—The actuary should prepare and retain documentation in compliance


with the requirements of ASOP No. 41, Actuarial Communications. The actuary should
also prepare and retain documentation to demonstrate compliance with the disclosure
requirements of section 4.1.

Section 4. Communications and Disclosures

4.1 Communication Requirements—Any actuarial communication prepared to communicate


the results of work subject to this standard must comply with the requirements of ASOP
Nos. 23, 27, 35, 41, and 44. In addition, such communication should contain the
following elements, where relevant and material:

a. a statement of the intended purpose of the measurement and a statement to the


effect that the measurement may not be applicable for other purposes;

b. the measurement date;

c. a description of adjustments made for events after the measurement date under
section 3.4.2;

d. an outline or summary of the benefits included in the actuarial valuation and of


any significant benefits not included in the actuarial valuation;

e. the date(s) as of which the participant and financial information were compiled;

f. a summary of the participant information;

g. if hypothetical data are used, a description of the data;

h. a description of the actuarial cost method and the manner in which normal costs
are allocated, in sufficient detail to permit another actuary qualified in the same
practice area to assess the material characteristics of the method (for example,

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ASOP No. 4—September 2007

how the actuarial cost method is applied to multiple benefit formulas, compound
benefit formulas, or benefit formula changes, where such plan provisions are
significant);

i. a description of the cost or contribution allocation procedure, including a


description of amortization methods and any pay-as-you-go component (i.e., the
intended payment by the plan sponsor of some or all benefits when due);

j. if applicable in accordance with section 3.13.2, a statement indicating that the


actuarial cost method or amortization method is significantly inconsistent with the
plan accumulating adequate assets to make benefit payments when due;

k. if the actuary measured the value of accrued or vested benefits, a description of


the types of benefits regarded as vested and accrued and, to the extent the
attribution pattern of accrued benefits differs from or is not described by the plan
provisions, a description of the attribution pattern;

l. a statement, appropriate for the intended audience (as defined in ASOP No. 41),
indicating that future measurements (for example, of pension obligations, costs,
contributions, or funded status as applicable) may differ significantly from the
current measurement. For example, a statement such as the following could be
applicable: “Future actuarial measurements may differ significantly from the
current measurements presented in this report due to such factors as the following:
plan experience differing from that anticipated by the economic or demographic
assumptions; changes in economic or demographic assumptions; increases or
decreases expected as part of the natural operation of the methodology used for
these measurements (such as the end of an amortization period or additional cost
or contribution requirements based on the plan’s funded status); and changes in
plan provisions or applicable law.”

In addition, the actuarial communication should include one of the following:

1. if the scope of the actuary’s assignment included an analysis of the range


of such future measurements, disclosure of the results of such analysis
together with a description of the factors considered in determining such
range; or

2. a statement indicating that, due to the limited scope of the actuary’s


assignment, the actuary did not perform an analysis of the potential range
of such future measurements;

m. a description of known changes in assumptions and methods from those used in


the immediately preceding measurement prepared for a similar purpose;

n. a description of adjustments of prior measurements used under section 3.16; and

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ASOP No. 4—September 2007

o. if, in the actuary’s professional judgment, the actuary’s use of approximations or


estimates could result in a significant margin for error relative to the results if a
detailed calculation had been done, a statement to this effect.

An actuarial communication can comply with some, or all, of the specific requirements of
this section by making reference to information contained in other actuarial
communications available to the intended audience (as defined in ASOP No. 41), such as
an annual actuarial valuation report.

4.2 Disclosure About Prescribed Assumptions or Methods—The actuary’s communication


should state the source of any prescribed assumptions or methods. In addition, with
respect to prescribed assumptions or methods selected by the plan sponsor, the actuary’s
communication should identify the following, if applicable:

a. any prescribed assumption or method that significantly conflicts with what, in the
actuary’s professional judgment, would be reasonable for the purpose of the
measurement (section 3.2.1); or

b. any prescribed assumption or method that the actuary is unable to evaluate for
reasonableness for the purpose of the measurement (section 3.2.2).

4.3 Deviation—If, in the actuary’s professional judgment, the actuary has deviated materially
from the guidance set forth elsewhere in this standard, the actuary can still comply with
this standard by applying the following sections as appropriate:

4.3.1 Material Deviations to Comply with Applicable Law—If compliance with


applicable law requires the actuary to deviate materially from the guidance set
forth in this standard, the actuary should disclose that the assignment was
prepared in compliance with applicable law, and the actuary should disclose the
specific purpose of the assignment and indicate that the work product may not be
appropriate for other purposes. The actuary should use professional judgment to
determine whether additional disclosure would be appropriate in light of the
purpose of the assignment and the intended users of the actuarial communication.

4.3.2 Other Material Deviations—The actuary’s communication should disclose any


other material deviation from the guidance set forth in this standard. The actuary
should consider whether, in the actuary’s professional judgment, it would be
appropriate and practical to provide the reasons for, or to quantify the expected
impact of, such deviation. The actuary should be prepared to explain the deviation
to a principal, another actuary, or other intended users of the actuary’s
communication. The actuary should also be prepared to justify the deviation to the
actuarial profession’s disciplinary bodies.

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ASOP No. 4—September 2007

Appendix 1

Background and Current Practices

Note: This appendix is provided for informational purposes, but is not part of the standard of
practice.

Background

Actuarial standard of practice (ASOP) No. 4, Recommendations for Measuring Pension


Obligations, was first adopted by the Interim Actuarial Standards Board in January 1988. This
standard superseded Pension Plan Recommendations A, B, and C, which the American Academy
of Actuaries adopted in the period 1976 to 1983. The Interpretations of those Recommendations
were incorporated as appendices in the standard. The ASB adopted a reformatted version of
ASOP No. 4, renamed Measuring Pension Obligations and incorporating several clarifying
revisions, in October 1993 (prior ASOP No. 4).

Since the prior ASOP No. 4 was adopted, the ASB has adopted the following standards that
provide more detailed guidance regarding specific elements of the process of measuring pension
obligations:

1. ASOP No. 23, Data Quality;

2. ASOP No. 27, Selection of Economic Assumptions for Measuring Pension Obligations;

3. ASOP No. 35, Selection of Demographic and Other Noneconomic Assumptions for
Measuring Pension Obligations;

4. ASOP No. 41, Actuarial Communications; and

5. ASOP No. 44, Selection and Use of Asset Valuation Methods for Pension Valuations.

The prior ASOP No. 4 contained general recommendations for selecting economic and
noneconomic assumptions, actuarial cost methods, and asset valuation method—all key elements
in the measurement of pension obligations. The ASB decided to revise ASOP No. 4 to create an
“umbrella” standard to tie together these existing and proposed standards and address overall
considerations for the actuary when measuring pension obligations. In addition, because the prior
ASOP No. 4 and this revision cover the determination of plan costs or contributions, the name of
the standard was changed to Measuring Pension Obligations and Determining Pension Plan
Costs or Contributions.

Because the prior ASOP No. 4 contained guidance that is now covered in other standards, ASOP
No. 4 has been revised to remove any guidance that is now contained in those standards and to
add references to those standards. Some of the material in the prior ASOP No. 4 was educational

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ASOP No. 4—September 2007

rather than guidance on actuarial practice and consequently was not included in this revised
standard.

The revision of ASOP No. 4 has been written to reflect that at times the actuary may have the
responsibility and authority to select actuarial assumptions, actuarial cost methods, asset
valuation methods, and amortization methods, but in other circumstances the actuary may only
advise, or may not even have an opportunity to advise, the individuals who have that
responsibility and authority. For instance, the actuary may advise the plan administrator or plan
sponsor on selecting an actuarial cost method for purposes of determining minimum funding
requirements under ERISA, but the plan administrator or plan sponsor is ultimately responsible
for selecting the method.

Current Practices

This standard and the related standards listed above cover actuarial practices that are central to
the work regularly performed by actuaries in the pension field. The actuarial tasks covered by the
standards are performed for a number of purposes, examples of which are discussed below:

1. Cost, Contribution, and Benefit Recommendations—Calculations may be performed for


purposes of determining actuarial cost, contribution, and benefit recommendations and
related information. Examples are calculations related to the following:

a. recommendations as to the assignment of costs or contributions to time periods


for defined benefit plans;

b. recommendations as to the type and levels of benefits for specified cost or


contribution levels;

c. contributions required under minimum funding standards imposed by statute or


regulations;

d. maximum contributions deductible for tax purposes;

e. information required with respect to plan design; and

f. determination of progress towards a defined financial goal, such as funding of


vested or accrued benefits.

2. Evaluations of Current Funding Status—Calculations may be performed for purposes of


comparing available assets to the actuarial present value of benefits specified by the plan.
Examples are calculations related to the following:

a. actuarial present value of accrued benefits;

b. actuarial present value of vested benefits;

16
ASOP No. 4—September 2007

c. actuarial present value of benefits payable in the event of plan termination; and

d. information required with respect to plan mergers, acquisitions, spin-offs, and


business discontinuances.

3. Comparison of Actuarial Present Values—Calculations may be performed to compare the


actuarial present values of different pension obligations, such as optional benefit forms or
commencement dates.

17
ASOP No. 4—September 2007

Appendix 2

Comments on the Third Exposure Draft and Responses

The third exposure draft of this proposed ASOP was issued in August 2006 with a comment
deadline of March 1, 2007. Seven comment letters were received, some of which were submitted
on behalf of multiple commentators, such as by firms or committees. For purposes of this
appendix, the term “commentator” may refer to more than one person associated with a
particular comment letter. The Pension Committee carefully considered all comments received,
and the ASB reviewed (and modified, where appropriate) the proposed changes. Summarized
below are the significant issues and questions contained in the comment letters and the responses
to each. The term “reviewers” includes the Pension Committee and the ASB. Unless otherwise
noted, the section numbers and titles used below refer to those in the third exposure draft.

GENERAL COMMENTS
Comment Several commentators suggested various editorial changes in addition to those addressed specifically
below.

Response The reviewers implemented such changes if they enhanced clarity and did not alter the intent of the
section.
SECTION 1. PURPOSE, SCOPE, CROSS REFERENCES, AND EFFECTIVE DATE
Section 1.4, Effective Date
Comment One commentator believed the effective date should be extended until regulations are issued under the
Pension Protection Act of 2006.

Response The reviewers disagree and made no change. Section 1.2 addresses how to reconcile any discrepancies
between applicable law and this standard.
SECTION 2. DEFINITIONS
Section 2.1, Actuarial Accrued Liability, and 2.13, Normal Cost
Comment One commentator pointed out that the definition of normal cost was misleading for actuarial cost
methods in which the normal cost varies with the funded status of the plan.

Response The reviewers agree and revised the definition to indicate that under certain actuarial cost methods, the
normal cost depends upon the actuarial value of plan assets. The reviewers made a corresponding change
to the definition of actuarial accrued liability.

18
ASOP No. 4—September 2007

SECTION 3. ANALYSIS OF ISSUES AND RECOMMENDED PRACTICES


Section 3.2, Prescribed Assumption or Method Selected by the Plan Sponsor
Comment Two commentators opposed the requirement that the actuary consider whether a prescribed assumption
or method selected by the plan sponsor significantly conflicts with what, in the actuary’s professional
judgment, would be reasonable for the purpose of the measurement. They felt that the section
represented an inappropriate expansion of the role of the actuary.

Two commentators supported the general requirement of this section.

Response The reviewers believe that this guidance is appropriate, but edited the section for clarity.
Comment Three commentators wrote that instead of requiring the actuary to evaluate a prescribed assumption or
method, the standard should require disclosure concerning the actuary’s role regarding those prescribed
assumptions or methods.

Two commentators suggested that the actuary be required to disclose the actuary’s role, if any, in
selecting the prescribed assumptions or methods. The third commentator recommended that the actuary
be required to disclose, when appropriate, that the actuary did not review the prescribed assumptions or
methods and expresses no opinion concerning their reasonableness.

Response The reviewers believe these concerns have been addressed with the revision of section 3.2.2, Inability to
Evaluate Prescribed Assumption or Method.
Section 3.2.2, Inability to Evaluate Prescribed Assumption or Method
Comment Two commentators expressed concern that exempting an actuary from evaluating a prescribed
assumption or method if the actuary does not possess the necessary expertise might lead some plan
sponsors to seek less-qualified actuaries and punish actuaries who develop additional expertise. One
commentator wrote that this section would create different requirements for different actuaries,
depending on their skills, for performing the same assignment.

Response The reviewers agree and revised this section. Instead of considering the actuary’s expertise, the section
exempts an actuary from evaluating a prescribed assumption or method if the actuary is unable to do so
without performing a substantial amount of additional work beyond the scope of the assignment.
Consistent with the changes in this section, the reviewers removed from section 4.2 the requirement that
the actuary disclose the reason for any inability to evaluate a prescribed assumption or method selected
by the plan sponsor.
Comment One commentator suggested that the standard exempt an actuary from evaluating a prescribed
assumption or method if the actuary relies on the work of another expert retained by the plan sponsor to
select the assumption or method, so long as the actuary makes appropriate disclosure.

Response With the revision of this section, the reviewers do not believe such an exemption is necessary.
Section 3.5.1, Adopted Plan Changes
Comment One commentator wrote that the phrase “adopted plan provisions” was not clear.

Response The reviewers believe that the actuary should exercise professional judgment when considering which
plan provisions are appropriate to take into account for the purpose and nature of the measurement and
made no change.

However, while reviewing this section the reviewers learned that its guidance was inconsistent with
generally accepted practice among actuaries who practice in the public-plan sector. As a result, the
reviewers revised this section to describe practice among actuaries in both the private and public sectors.

19
ASOP No. 4—September 2007

Section 3.9, Interrelationship Among Procedures, Assumptions, and Plan Provisions


Comment One commentator believed this section was overly broad and suggested that it can be argued that all
pension provisions create contingent pension obligations that are difficult to measure using deterministic
assumptions. The commentator also noted that the term “deterministic assumptions” is not defined.

Response The reviewers revised this section to clarify the intent.


Section 3.13, Ability to Pay Benefits When Due (now Consistency Between Contribution Allocation Procedure
and the Payment of Benefits)
Comment One commentator expressed concern that this section placed the responsibility for a plan’s solvency on
the actuary and would require actuaries to perform cash flow testing. The commentator recommended
that the section be deleted; if it was retained, the commentator suggested that it be limited to assignments
in which the scope explicitly included an assessment of future solvency.

Response The reviewers believe that this section neither places the responsibility for a plan’s solvency on the
actuary nor requires the actuary to perform cash flow testing. However, the reviewers renamed the
section to be more consistent with its content, and re-arranged the text to clarify its intent.

Section 3.15, Volatility


Comment One commentator, concerned about the possibility of after-the-fact litigation, suggested adding a
statement that the standard does not presume that the scope of actuarial services includes considerations
of volatility unless specifically included in the actuary’s assignment.

Response The reviewers believe the section as written is sufficiently clear that analyses about volatility depend
upon the scope of the assignment and made no change.
SECTION 4. COMMUNICATIONS AND DISCLOSURES
Section 4.1, Communication Requirements
Comment One commentator wrote that the phrase “funded in whole or in part on a pay-as-you-go basis” in
paragraph (k) was not clear.

Response The reviewers revised the phrase and added a clarifying parenthetical comment. The reviewers also
moved this disclosure requirement to paragraph (i), where they believe it is more appropriate.
Comment One commentator suggested that the disclosure regarding variability of future measurements in
paragraph (m) (now paragraph (l)) could apply to all areas of actuarial practice and might be more
appropriate in ASOP No. 41, Actuarial Communications, than in a pension standard.

Response The reviewers believe it is appropriate for ASOP No. 4, which ties together the other pension standards,
to require this disclosure and made no change. The comment has been passed on to the General
Committee for its review of ASOP No. 41.
Comment One commentator wrote that the disclosure in paragraph (m) (now paragraph (l)) might not be necessary
in all circumstances and suggested that the actuary should consider the audience in determining whether
such disclosure is necessary.

Response The reviewers agree and changed the wording accordingly.

20
Actuarial Standard
of Practice
No. 5

Incurred Health and Disability Claims

Revised Edition

Developed by the
Health Committee of the
Actuarial Standards Board

Adopted by the
Actuarial Standards Board
December 2000

(Doc No. 076)


TABLE OF CONTENTS

Transmittal Memorandum iv

STANDARD OF PRACTICE

Section 1. Purpose, Scope, Cross References, and Effective Date 1


1.1 Purpose 1
1.2 Scope 1
1.3 Cross References 1
1.4 Effective Date 1

Section 2. Definitions 1
2.1 Block of Business 1
2.2 Capitation 2
2.3 Development (or Lag) Method 2
2.4 Exposure Unit 2
2.5 Health Benefit Plan 2
2.6 Incurral Date 2
2.7 Incurred Claims 2
2.8 Material 2
2.9 Tabular Method 2
2.10 Time Value of Money 3
2.11 Trends 3
2.12 Unpaid Claims Liability 3
2.13 Valuation Period 3

Section 3. Analysis of Issues and Recommended Practices 3


3.1 Introduction 3
3.2 Considerations for Estimating Incurred Claims 3
3.2.1 Health Benefit Plan Provisions and Business Practices 3
3.2.2 Economic Influences 3
3.2.3 Organizational Claims Administration 4
3.2.4 Risk Characteristics and Organizational Practices by Block of Business 4
3.2.5 Legislative Requirements 4
3.2.6 Carve-Outs 4
3.2.7 Special Considerations for Long-Term Products 4
3.3 Analysis of Incurred Claims 4
3.3.1 Unpaid Claims Liability 4
3.3.2 Categories of Incurred Claims 5
3.3.3 Reinsurance Arrangements 5
3.3.4 Large Claim Patterns 5
3.3.5 Coordination of Benefits (COB) or Subrogation 6

ii
3.3.6 Provider Contractual Arrangements 6
3.3.7 Consistency of Basis 6
3.4 Data Requirements and Assumptions 6
3.5 Methods Used for Estimating Incurred Claims 7
3.5.1 Development Method 7
3.5.2 Tabular Method 7
3.5.3 Other Methods 8
3.6 Follow-Up Studies 8

Section 4. Communications and Disclosures 8


4.1 Documentation 8
4.2 Prescribed Statement of Actuarial Opinion 8
4.3 Deviation from Standard 9

APPENDIXES

Appendix 1—Background and Current Practices 10


Background 10
Current Practices 10

Appendix 2—Comments on the Exposure Draft and Committee Responses 11

iii
December 2000

TO: Members of Actuarial Organizations Governed by the Standards of Practice of the


Actuarial Standards Board and Other Persons Interested in Incurred Health and
Disability Claims

FROM: Actuarial Standards Board (ASB)

SUBJ: Actuarial Standard of Practice (ASOP) No. 5

This booklet contains the final version of the revision of ASOP No. 5, now titled Incurred Health
and Disability Claims.

Background

Under direction from the ASB, the Health Committee began revising ASOP No. 5, which in its
prior form (adopted 1991, Doc. No. 028) was titled Incurred Health Claim Liabilities. The
revision of ASOP No. 5 has a number of changes from the 1991 version, including the following:

1. The standard has been reformatted to be consistent with the current ASOP format
adopted by the ASB in May 1996 for all future actuarial standards of practice.

2. This standard discusses incurred health and disability claims in total, rather than just
unpaid health claims liabilities. Thus, the standard addresses the paid portion of incurred
health and disability claims.

3. This standard explicitly discusses long-term claim products, and the knowledge and
considerations for estimating incurred health and disability claims. Such considerations
include provider contracts, reinsurance, and testing of liabilities.

4. Claim settlement expenses are no longer included in this standard and will be addressed
in a standard under development at this time. This standard deals only with incurred
health and disability claims. In the interim, actuaries may look to the guidance in section
5.13 of the previous edition of this standard with respect to claim settlement expenses.

5. This standard explicitly excludes deficiency reserves and policy reserves, which will be
addressed in a standard under development at this time.

Exposure Draft

This standard was exposed in September 1999 with a comment deadline of March 31, 2000.
Thirty comment letters were received. All of the comments received were thoroughly reviewed.
Many of the comment letters showed thoughtful perception of the issues involved, and many
clarifying suggestions were incorporated into the final standard, including the following:

iv
1. The committee clarified several definitions and added the definition of “Exposure Unit.”

2. The definition of “Development (or Lag) Method” was expanded to reflect received
claims as well as paid claims.

3. Sections 2.10 and 3.3.1(d), Time Value of Money, were added.

4. Section 3.3.1(c), Margin for Uncertainty, was expanded to provide guidance on the size
of the margin, if one is included.

5. A reference to provider contractual arrangements not reimbursed through claims


processing was added to section 3.3.6.

6. Section 3.3.7 was added, indicating that the basis for related liabilities and reserves
should generally be consistent.

Appendix 2 contains a detailed discussion of the committee’s responses to the comments.

The Health Committee thanks all those who commented on the exposure draft.

The ASB voted in December 2000 to adopt this standard.

Health Committee of the ASB

David F. Ogden, Chairperson


Janet M. Carstens John M. Friesen
Robert M. Duncan Jr. Robert J. Ingram
Paul R. Fleischacker Mary J. Murley
Alan D. Ford

Actuarial Standards Board

Alan J. Stonewall, Chairperson


Phillip N. Ben-Zvi William C. Koenig
David G. Hartman Heidi Rackley
Ken W. Hartwell James R. Swenson
Roland E. King Robert E. Wilcox

v
ACTUARIAL STANDARD OF PRACTICE NO. 5

INCURRED HEALTH AND DISABILITY CLAIMS

STANDARD OF PRACTICE

Section 1. Purpose, Scope, Cross References, and Effective Date

1.1 Purpose—This actuarial standard of practice (ASOP) provides guidance to actuaries


preparing or reviewing financial reports, claims studies, rates, or other actuarial
communications involving incurred claims within a valuation period under a health benefit
plan as defined in section 2.5 of this standard.

1.2 Scope—This standard applies to actuaries who estimate or review incurred claims under
health benefit plans on behalf of insured or noninsured entities, managed-care entities, health
care providers, government-sponsored plans or risk contracts, or regulatory agencies. This
standard does not provide guidance to actuaries regarding reserves such as policy reserves,
premium reserves, or claim settlement expense reserves, although such reserves may be
required for financial reporting. This standard does not address interpretations of statutory or
generally accepted accounting practices. If a conflict exists between this standard and
applicable law, compliance with applicable law is not considered a deviation from this
standard.

1.3 Cross References—When this standard refers to the provisions of other documents, the
reference includes the referenced documents as they may be amended or restated in the
future, and any successor to them, by whatever name called. If any amended or restated
document differs materially from the originally referenced document, the actuary should
consider the guidance in this standard to the extent it is applicable and appropriate.

1.4 Effective Date—This standard is effective for work performed on or after May 1, 2001.

Section 2. Definitions

The terms below are defined for use in this actuarial standard of practice.

2.1 Block of Business—All policies of a common coverage type (for example, major medical,
preferred provider organization, or capitated managed care); demographic grouping (for
example, size, age, or area, group or individual policies); or other segmentation useful for
estimating incurred claims for actuarial purposes.

1
2.2 Capitation—The amount of money paid to a provider by an exposure-based payment system
to provide certain health care services to any Managed Care Health Provider members. The
payment does not vary on the basis of the number or type of services actually rendered. The
verb “to capitate” is used to indicate the act of entering into such an arrangement. Capitation
is also sometimes used to mean the total medical cost or premium per enrollee, though it is
not used in this manner in this document.

2.3 Development (or Lag) Method—A method under which historical claim data, such as the
number and amount of claims for the subject block of business, are grouped into the time
periods in which claims were incurred and the time periods in which they were processed.
The processing date is typically the date the claim is received, adjudicated, or paid by the
claim payer. The method uses these groupings to create a claims processing or development
pattern, which is used to help estimate the unprocessed portion of incurred claims.

2.4 Exposure Unit—A unit by which the cost for a health benefit plan is measured. For example,
an exposure unit may be a contract, an individual covered, $100 of weekly salary, or $100 of
monthly benefit.

2.5 Health Benefit Plan—A contract providing medical, prescription drug, dental, vision,
disability income, long-term care, or other health-related benefits, whether on a
reimbursement, indemnity, or service benefit basis, regardless of the form of the risk-bearing
organization, including benefit plans provided by self-insured or governmental plan
sponsors.

2.6 Incurral Date—The date a claim is determined to be a liability of the organization in


accordance with the terms of the health benefit plan. For health benefit plans where the claim
must exceed a minimum threshold, for example where there is a deductible or elimination
period, the incurral date may be the date claims begin to accumulate toward the threshold.

2.7 Incurred Claims—The value of all amounts paid or payable under a health benefit plan,
determined by contract to be a liability with an incurral date during the valuation period. It
includes all payments during the valuation period plus a reasonable estimate of unpaid
claims liabilities. For an organization’s income statement, incurred claims equal paid claims
plus the estimate of unpaid claims liabilities at the end of the current valuation period less the
estimate of unpaid claims liabilities at the end of the prior valuation period.

2.8 Material—Resulting in an impact, significant to the interested parties, on the affected


actuarial incurred claim estimate.

2.9 Tabular Method—The application of a factor to a volume measure (for example, number of
individual claims) based on prior experience, in order to estimate unpaid claims liabilities for
reported claims (commonly used for long-term claims).

2
2.10 Time Value of Money—The principle that an amount of money available at an earlier point
in time has different usefulness and value than the same amount of money has at a later point
in time.

2.11 Trends—Measures of rates of change, over time, of the elements affecting incurred claims.

2.12 Unpaid Claims Liability—The value of the unpaid portion of incurred claims includes (1)
unreported claims; (2) reported but unprocessed claims; and (3) processed but unpaid claims.
For an organization’s balance sheet, the unpaid claims liability includes provision for all
current and prior valuation periods.

2.13 Valuation Period—A defined period for which incurred claims are recorded.

Section 3. Analysis of Issues and Recommended Practices

3.1 Introduction—The estimation of incurred health and disability claims is fundamental to the
practice of health actuaries. It is necessary for the completion of financial statements; for the
analysis and projection of trends; for the analysis or development of rates; and for the
development of various management reports, regardless of the type of insurance or managed-
care contract.

3.2 Considerations for Estimating Incurred Claims—The actuary should consider how to
appropriately reflect relevant plan provisions, business practices, and environmental factors
that materially affect incurred claims or trends, such as those highlighted in sections 3.2.1–
3.2.7 below.

3.2.1 Health Benefit Plan Provisions and Business Practices—The actuary should consider
the health benefit plan provisions and business practices, including special group
contract holder requirements and provider payment arrangements, that materially
affect the cost, frequency, and severity of claims. These include elimination periods,
deductibles, preexisting conditions limitations, maximum allowances, and managed-
care restrictions. Payment allowances, incurral dating methods, or benefit
interpretations may be defined by internal business practices, plan provisions, or
both.

3.2.2 Economic Influences—Economic conditions may affect incurred claims. For


example, changes in price levels, unemployment levels, or medical practice will
affect morbidity (including both the incidence and duration of disability). The
actuary should consider items such as relevant changes in managed care contracts,
cost shifting, provider fee schedule changes, medical procedures, epidemics, or
catastrophic events, and elective claims processed in recessionary periods or prior to
contract termination.

3
3.2.3 Organizational Claims Administration—Organizations have various practices for
administering claims, which may cause fluctuations in the rates of completion or lag
factors used by the actuary to determine unpaid claims liability. The actuary should
consider how claims administration practices can be influenced by staffing levels,
process and investigation time for complicated claims, computer system changes or
downtime, seasonal backlogs of claims submitted, governmental influences, and cash
flow considerations.

3.2.4 Risk Characteristics and Organizational Practices by Block of Business—The


actuary should consider how marketing, underwriting, and other business practices
can influence the types of risks accepted. Furthermore, the pattern of growth and
relative maturity of a block of business can influence incurred claims.

3.2.5 Legislative Requirements—Governmental mandates can influence the provision of


new benefits; risk characteristics; rating, reserving and underwriting practices; and
claims processing practices. The actuary should consider relevant legislative and
regulatory changes as they pertain to determination of incurred claims.

3.2.6 Carve-Outs—Carve-outs can represent services such as prescription drugs or dental;


or condition-specific services such as cancer treatment, mental health, or substance
abuse. Carve-outs are often provided by a separate entity specializing in that type of
service. The actuary should consider the pertinent benefits, payment arrangements,
and separate reporting of these benefits in incurred claims determination and trend
analysis.

3.2.7 Special Considerations for Long-Term Products—Certain health benefit plans


provide for long-term medical or disability benefits. Some examples are cancer,
long-term care, and long-term disability policies. The plan’s benefits may not begin
for several years after policy purchase, while claims usually extend over many
valuation periods. The actuary should consider the variety of benefits available in
these policies, such as lump-sum, fixed, or variable payments for services; provisions
such as cost of living adjustments and inflation protection; payment differences
based on institutional or home-based care; social insurance integration; and the
criteria for benefit eligibility.

3.3 Analysis of Incurred Claims—After reviewing the considerations in sections 3.2.1–3.2.7


above, the actuary should follow the relevant procedures highlighted in sections 3.3.1–3.3.7
below.

3.3.1 Unpaid Claims Liability—Using incurral and processing dates, the actuary
determines unpaid claims liabilities for claims incurred during the valuation period.

a. Plan Provisions—The actuary should review the relevant plan provisions to


determine if they create liabilities for services or payments after the valuation
period (for example, completion of medical treatments, deferred maternity

4
benefits, or long-term disabilities). The actuary should determine if these
liabilities are part of the current or future period’s liability, or if these liabilities
make up a separate reserve.

b. Data and Reporting—The actuary should take into account the relevant reporting
systems for processed claims, exposure units, and premium rates, and the various
dating methods the systems use (for example, loss recognition, service rendered,
reporting, or payment status). The actuary should use professional judgment in
estimating the extent to which an adjustment to the reported data is needed, based
on the dating methodology.

c. Margin for Uncertainty—Recognizing the fact that determination of liabilities for


incurred but unpaid health and disability claims is an estimate of the true
liabilities that will emerge, the actuary should consider what margin for
uncertainty, if any, might be appropriately included. If a margin is included, the
unpaid claims liability should be appropriate, in the actuary’s judgment, under
moderately adverse conditions.

d. Time Value of Money—The actuary may consider the time value of money if
doing so will have a material effect in the determination of incurred claims. The
use of any interest discounts depends on the purpose for which incurred claims
are being calculated, and should reflect applicable statutory and accounting
standards.

3.3.2 Categories of Incurred Claims—The actuary should consider separate development


of incurred claims for each category that may exhibit different lag patterns, costs per
exposure unit, trends, or exposure unit growth rates. The actuary should define
categories of incurred claims in a manner that is appropriate to the available data and
to the task being performed. Categories may be defined broadly, such as fee-for-
service claims paid to health care providers, capitation payments to providers, or
disability income paid to insureds. Categories might be further refined to more
accurately analyze or project costs and utilization data, for example, by method of
payment (such as electronic vs. manual), type of contract, place of service, premium
rating method, demographic factors, distribution method, and provider risk-sharing
arrangements.

3.3.3 Reinsurance Arrangement—The actuary should recognize the impact of reinsurance


arrangements on the data and should appropriately reflect the effect of such
arrangements in estimating the incurred claims. In particular, the actuary should
recognize the different lag patterns due to the extended reporting or recovery periods
often associated with certain types of reinsurance.

3.3.4 Large Claim Patterns—The actuary should take into account any relevant change in
the pattern of large claims. Specifically, large claims can distort claim payment
patterns or historical per-unit claim levels that the actuary considers when estimating

5
incurred claim estimates. The actuary should consider how large claims impact the
particular method being employed to determine incurred claim estimates and make
appropriate adjustments. For example, incurred claim estimates may be overstated if
completion factors are applied to processed claims levels that include an unusually
high number or amount of large claims.

3.3.5 Coordination of Benefits (COB) or Subrogation—The actuary should take into


account the relevant organizational practices and regulatory requirements related to
COB or subrogation. In particular, the actuary should consider how these items are
reflected in the data (for example, negative claims or income) and make appropriate
adjustments for COB, subrogation, or other adjustments or recoveries.

3.3.6 Provider Contractual Arrangements—The actuary should take into account the
relevant contractual arrangements with providers and any changes in such
arrangements. These arrangements can affect trends, claim cost levels, and claims
processing. The actuary should consider any relevant variation in these arrangements
by region or product, and any provider contractual arrangements that do not provide
for reimbursement through the claim payment process, for example, capitation.

The arrangements will also typically specify what portion of the risk (if any) has
been shifted to the providers. If the providers bear a substantial portion of the risk,
the actuary should consider the overall ability of the provider to meet its obligations.
Depending on the purpose of the analysis, the actuary should take into account any
statutory limitations on the credits for such transfers of risk.

Additional amounts may be owed to providers for supplemental payments for high-
cost medical treatment beyond capitation, return of payment withholds, or incentive
payments based on financial results. Certain contractual arrangements may also
result in amounts due from providers based on financial results. The actuary should
consider the impact of unpaid medical costs resulting from failed contractors under
capitation or losses incurred by contractors deemed to be related parties.

3.3.7 Consistency of Basis—The actuary should consider the basis for determining related
liabilities and reserves, including those not covered by this standard, such as claim
settlement expense reserves. The basis for these items generally should be consistent.

3.4 Data Requirements and Assumptions—The expansion of health benefit coverages and the
greater variety of organizations offering or administering health benefit coverages have
increased the volume, type, precision, and the frequency of data needs by the actuary.
Consistent with ASOP No. 23, Data Quality, the actuary should make appropriate efforts to
obtain accurate data from claim processing reports, accounting systems, and other relevant
internal organization sources in order to determine incurred claims. External sources may be
needed to provide reasonableness checks on limited data.

6
3.5 Methods Used for Estimating Incurred Claims—Various methods may be used to estimate
incurred claims. Some methods are based on statistical analysis and projection of the costs or
rates at which claims were processed in recent periods. Such projection of the costs is usually
done by category of incurred claims for greater accuracy. However, the adequacy of incurred
claim estimates is determined in the aggregate for financial statements.

Because no single method is necessarily better in all cases, the actuary should consider the
use of more than one method. The actuary should evaluate the method(s) chosen and the
results obtained in light of the credibility of the data. The actuary should also consider the
effect of trends both in previous periods and the current period for estimating incurred
claims. The actuary should choose the outcome that, in the actuary’s professional judgment,
is the most reasonable provision for incurred claims, whether from a single method or a
combination of several methods. Sections 3.5.1–3.5.3 below discuss some of the more
common methods for estimating incurred claims.

3.5.1 Development Method—This method is appropriate and widely used for short-term
benefits having processed claims (i.e., not capitation) and may also be appropriate for
long-term claims. It typically requires monthly (or quarterly) claim summary reports
split by period of incurral and period of processing. There should be similar reports
of earned rates and exposure units for the same periods. With these data, the actuary
estimates the percentage or amount of completion needed to project all future yet
unrecorded claims accruable to the valuation period, for each block of business. The
actuary should consider processing fluctuations due to seasonality, claims processing
practices, inflation, or significant changes in medical practices. The summary of all
the months’ estimates of (1) unreported claims; (2) reported but unprocessed claims;
and (3) processed but unpaid claims represents the unpaid claims liability.

When the estimates are completed and added to known payments for each time
period, the total incurred claims should be matched and compared to earned rates and
exposure units for reasonableness. The actuary should test alternatives to gain
understanding of their use and reliability depending on the block of business or
accuracy desired.

3.5.2 Tabular Method—The tabular method is generally used for known long-term claims
and may be required by regulatory standards to estimate the unpaid claims liability
using life annuity values, continuance probabilities, or commutation function tables.
This method applies factors to items such as individual claims, waived rates, or other
volume measures based on previous experience in order to estimate the unpaid
claims liability for known claims. The factors are often based on the age and sex of
the insured, elimination period, cause of claim, length of disablement on the
valuation date, and remaining benefit period, as appropriate to the coverage.

7
The actuary should take into account specified benefit changes throughout the
lifetime of the claim and the assumptions used to develop the table; and should select
the appropriate table(s) to estimate the unpaid claims liability given the risk
characteristics of the policy.

For long-term disability, the actuary should recognize the specific impacts that
recovery, mortality, and government offsets have on tabular factors.

The tabular method is not appropriate for estimating unknown claims. When the
tabular method is used, the actuary should consider whether an additional adjustment
is necessary to reflect unreported incurred claims.

3.5.3 Other Methods—Other methods the actuary may consider to estimate incurred claims
include (but are not necessarily limited to) multiplying the number of reported claims
by the average size of previously closed claims; multiplying projected cost per unit
by exposure units; multiplying projected cost per service by service counts; and
multiplying earned premium by an estimated loss ratio. Other methods may be
necessary when organizational data are limited or not credible, particularly for new
blocks of business.

3.6 Follow-Up Studies—Follow-up studies involve performing tests of reasonableness of the


prior period incurred claims estimates and the methods used over time. The results are
required in some financial statements and may be required in actuarial reports. The actuary
should, to the extent practicable, acquire the data to perform such studies; perform studies in
the aggregate and for pertinent blocks of business involving rating concerns; and utilize the
results, if appropriate, in preparing current incurred claims estimates.

Section 4. Communications and Disclosures

4.1 Documentation—The actuary should document the methods, assumptions, procedures, and
the sources of the data used. The documentation should be in a form such that another
actuary qualified in the same field could assess the reasonableness of the work. For further
guidance, the actuary is referred to ASOP No. 23, Data Quality; ASOP No. 25, Credibility
Procedures Applicable to Accident and Health, Group Term Life, and Property/Casualty
Coverages; and ASOP No. 31, Documentation in Health Benefit Plan Ratemaking.

4.2 Prescribed Statement of Actuarial Opinion—This ASOP does not require a prescribed
statement of actuarial opinion as described in the Qualification Standards for Prescribed
Statements of Actuarial Opinion promulgated by the American Academy of Actuaries.
However, law, regulation, or accounting requirements may also apply to an actuarial
communication prepared under this standard, and as a result, such actuarial communication
may be a prescribed statement of actuarial opinion.

8
4.3 Deviation from Standard—An actuary must be prepared to justify the use of any procedures
that depart materially from those set forth in this standard and must include, in any actuarial
communication disclosing the results of the procedures, an appropriate statement with
respect to the nature, rationale, and effect of such departures.

9
Appendix 1

Background and Current Practices

Note: This appendix is provided for informational purposes, but is not part of the standard of
practice.

Background

The determination of incurred claims is an integral, fundamental part of the work of most health
actuaries. It is necessary to set proper financial statements for ratemaking, planning, and
projections.

Incurred claims determination has become more challenging with the proliferation of provider
contracts that share risk in different ways. Having accurate data continues to be an issue.

Current Practices

A reformatted version of this standard has been in place since January 1991; the original
standard since March 1988. The committee believes that current practices are generally in
keeping with the current standard. While there is no reason to believe current practices are
inappropriate, the revisions to this standard keep it consistent with the changing times.

10
Appendix 2

Comments on the Exposure Draft


and Committee Responses

The proposed standard was exposed for review in September 1999, with a comment deadline of
March 31, 2000. Thirty comment letters were received. The Health Committee of the ASB
carefully considered all comments received. Summarized below are the significant issues and
questions contained in the comment letters, printed in standard type. The Health Committee’s
responses to these issues and questions appear in boldface.

General Observations

Many helpful ideas and comments were offered in the comment letters and are reflected in this
standard, as appropriate.

Several commentators believed that only unpaid claims liabilities should be addressed. The
committee continues to believe that broadening the definition to include all incurred claims
results in a better overall approach.

One commentator believed the standard was a ratemaking standard. The standard applies to the
estimation of incurred claims. Therefore, it applies to ratemaking only to the extent that
incurred claim estimation is a part of the ratemaking process.

One commentator was concerned that methods, approaches, or formulas should not be
prescribed. The committee believes the standard does not prescribe any of these items.

Several commentators believe the standard should discuss the need for claim settlement expense
liabilities, or the effective date of the standard should be delayed until another standard is written
and approved that includes them. Claim settlement expense liabilities will be covered in a
separate standard, which is under development.

Several commentators believed that the time value of money should be explicitly discussed. The
committee agreed and added sections 2.10 and 3.3.1(d) to discuss it.

One commentator recommended that the standard should discuss using either paid or received
claim data in the development method. The committee agreed and changed several parts of
the standard to refer to processed claims, rather than paid only.

One commentator stated that the descriptions of the development method was too specific and
should be generalized. The committee disagrees, believing that only a broad outline of the
development method is included.

11
Transmittal Memorandum

The committee posed four questions in the transmittal memorandum of the exposure draft:

1. Is the proposed revision too specific or too general with its discussion of background issues
(see section 3.2, Considerations for Estimating Incurred Claims) and specific methods and
practices (see sections 3.3–3.6)? If too specific, what should be deleted? If too general,
what should be added?

2. Is it clear that the proposed revision refers to the determination of incurred health and
disability claims only and does not address practices concerning policy reserves, premium
deficiency reserves, or claim settlement expense reserves—which may be necessary for
statutory reporting? If the standard is not clear, what should be revised?

3. Is it clear that the proposed revision applies to government actuaries?

4. Is it appropriate that the proposed revision does not specifically address the time value of
money, but instead leaves such decisions to the professional judgment of the actuary?

Comments on these four questions and the committee’s responses follow:

Question #1: Several commentators stated that the amount of specificity is about right. Two
commentators believed parts were too general; these comments are discussed in the specific
sections.

Question #2: Four commentators believed the standard was clear.

Question #3: Several commentators believed the standard was clear; one commentator suggested
wording changes to the scope. The committee retained the proposed wording, as it does not
believe the suggestion was a material improvement.

Question #4: As discussed above, the standard has been changed to discuss the time value
of money.

Section 1. Purpose, Scope, Cross References, and Effective Date

Section 1.2, Scope—One commentator suggested the scope specifically include or exclude rate
stabilization reserves. Another commentator believed that the scope could be improved by
defining for what the standard does not provide guidance. The committee revised the definition
to be more general by removing specific reference to accidental death and dismemberment
reserves and changing premium deficiency reserves to premium reserves. The committee

12
does not believe rate stabilization reserves or other reserves need to be noted specifically.

One commentator suggested inclusion of a description of the three different categories of


reserves from the NAIC minimum reserve standard model. The committee believes such a
description is not necessary in this standard.

One commentator suggested that the scope be expanded to specifically include actuaries who
estimate or review incurred claims on behalf of employers who sponsor self-insured health care
and disability plans for employees. The committee believes reference to actuaries performing
this work for non-insured entities is sufficient to include actuaries working for
employer-sponsored plans.

Section 2. Definitions

Section 2.1, Block of Business—One commentator suggested that “expected claim runout
pattern” be added to the list of segmentation criteria. Another commentator suggested inclusion
of “significant benefit variations” (for example, deductibles and coinsurance/copays and
maximum limits) as a criterion for segmentation. The committee believes the current
definition is adequate and additional criteria do not need to be included.

Section 2.3, Development (or Lag) Method—One commentator suggested the definition be
revised for clarity as well as to recognize the use of received date. The committee agreed and
revised the definition based on the commentator’s suggestion.

Another commentator suggested inclusion of the words “or health benefit plan” after “block of
business” to recognize employers. The committee believes the current definition is sufficient
to recognize employers and does not believe this change is necessary.

Section 2.4, Exposure Unit—One commentator suggested including a definition for exposure.
The committee agreed and included a definition for “exposure unit.”

Section 2.5, Health Benefit Plan—Two commentators suggested specific clarification regarding
whether workers’ compensation and auto insurance coverages are intended to be covered.
Another commentator suggested clarification regarding whether associations, MEWAs, and Taft-
Hartley plans are intended to be covered. The committee believes the current definition is
adequate and that these items do not need to be addressed specifically.

One commentator suggested the inclusion of examples of self-insured plan sponsors. The
committee does not believe specific examples are necessary.

Another commentator suggested distinguishing between a contract with an insured and a contract

13
with a provider. The committee believes the current definition includes all these items and
that additional information is not necessary.

Section 2.6, Incurral Date—One commentator suggested the current definition for incurral date is
not appropriate for stop-loss coverage. Another commentator did not believe the definition was
appropriate for disability income. The committee agreed and revised the definition for these
types of accumulation claims.

One commentator suggested that additional information as to how to determine the incurral date
be included. Another commentator suggested providing examples of the documents to be used to
determine the incurral date (including, but not limited to, individual or group insurance policies,
plan documents, managed care contracts, etc.). The committee does not believe that these
types of examples should be included in the definition.

Section 2.7, Incurred Claims—Several commentators noted that the current definition was
confusing and some thought the definition did not include the change in estimated incurred
claims for the current valuation period. The committee agreed that the definition was
confusing and has revised the definition.

One commentator suggested including the words “as defined in [section 2.12] of this standard”
after “unpaid claims liability.” The committee believes the current definition is adequate and
that the additional reference is not necessary.

One commentator suggested changing “incurred claims” to “accounting claims,” “booked


claims,” “reported claims,” or “accrual claims” to be more indicative of accounting terminology.
The committee does not believe this change should be made.

One commentator was concerned with the definition in conjunction with the current definition
for incurral date with respect to stop-loss or other accumulated benefits. The committee believes
this issue has been addressed by changing the definition of incurral date.

Section 2.9, Tabular Method—One commentator suggested changing the definition from
“estimate unpaid claims liability for” to “develop.” Another commentator indicated that the term
“tabular method” is generally used to refer to a subset of the “exposure method,” and that the
tabular method is more limiting since the exposures are claims data. The exposure method would
allow use of exposures other than claims data. The committee believes that the current
definition is consistent with the term listed in the Definitions from ASOPs and ACGs of the
ASB, and made no change to the definition.

Section 2.10, Time Value of Money—Several commentators indicated that the ASOP should
reflect the time value of money. The committee agreed and added a definition of the “Time
Value of Money.”

14
Section 2.11, Trends—One commentator indicated the definition was too vague. The committee
believes the definition is consistent with ASOP No. 31, Documentation in Health Benefit
Plan Ratemaking, and made no change to the definition.

Section 2.12, Unpaid Claims Liability—One commentator suggested that the second sentence in
the definition should read, “For an organization’s balance sheet, the unpaid claims liability
includes provision for all current and prior valuation periods.” The committee agreed with the
suggestion and modified the definition.

One commentator indicated that it might be useful to recognize the separation between claim
liabilities (for amounts due prior to the end of the valuation date) and claim reserves (for
amounts due after the end of the valuation date), given the importance of statutory accounting for
health claims. The committee believes it is clear in the current definition that the unpaid
claims liability includes both and that separate definitions are not necessary.

Section 2.13, Valuation Period—Two commentators indicated that the definition was not clear
that a valuation period could represent a period other than a calendar year. The committee
agreed and modified the definition. One commentator indicated that “accounting period”
should be used instead of “valuation period” when the reference is to a time period rather than to
a point in time. The committee believes that the current definition is clear and made no
change to the definition.

Section 3. Analysis of Issues and Recommended Practices

Section 3.1, Introduction—One commentator indicated that the word “determination” should be
changed to “estimation” since actuaries estimate incurred health and disability claims. The
committee agreed with the suggestion and changed the wording in section 3.1 and other
sections.

One commentator indicated that although section 3 covers “issues,” it does not appear to address
directly the issue of conservatism. The committee believes that the issue of conservatism is
adequately addressed in section 3.3.1(c), Margin for Uncertainty.

One commentator suggested that language be inserted to clarify that the section applies to both
insurers and plan sponsors. The committee believes this is adequately addressed in section
1.2, Scope.

One commentator suggested removal of the parenthetical comment in the first paragraph since it
was somewhat misleading. The committee agreed and removed the parenthetical comment.

15
Two commentators indicated that the paragraph suggesting that the actuary keep current
regarding advances in generally accepted actuarial practice was either duplicative with current
educational requirements, might be used in malpractice litigation, or could be difficult to
ascertain compliance. The committee agreed and removed the paragraph.

Section 3.2, Considerations for Estimating Incurred Claims—One commentator indicated that
the word “determining” should be changed to “estimating” in the title since incurred claims are
estimated. The committee agreed and changed the title.

One commentator indicated that the actuary should not only consider relevant plan provisions,
business practices, and environmental factors that materially affect incurred claims or trends, but
should also reflect the item when it is material. The committee agreed and changed the first
sentence to read, “the actuary should consider how to appropriately reflect.”

One commentator indicated that the list of considerations was not all-inclusive and that a
reference should be made to phenomena on the operations side. The committee agreed and
added the phrase “such as” to refer to the list of considerations.

Section 3.2.1, Health Benefit Plan Provisions and Business Practices—One commentator
indicated that a statement should be included indicating that the actuary should consider how the
claims administrator reports the incurral dates for a series of claims derived from a common
condition or injury. The committee believes that incurral dating methods are adequately
covered in the last sentence but modified the first sentence in 3.2.1 to read, “the actuary
should consider the health benefit plan provisions and business practices” for clarification
purposes.

One commentator indicated that although provider payment arrangements are considerations for
determining incurred claims, they were not mentioned. The committee agreed and inserted the
words “and provider payment arrangements” in the first sentence.

One commentator indicated that the potential for over-insurance, especially as it relates to
disability income, should be covered. The committee believes that the concept of over-
insurance is adequately covered.

Several commentators indicated that the section on benefit characteristics was vague or
overlapping. The committee agreed and removed the section.

Section 3.2.2, Economic Influences—One commentator recommended changing the first


sentence to refer directly to changes in medical practice methods, not just expense levels and
morbidity, since average costs can change even if the overall sickness and price levels remain the
same. The commentator also suggested changing the reference to inflation to a reference to price
levels. The committee agreed with these suggestions and incorporated the changes.

16
One commentator did not like the reference to “claims done in recessionary periods.” The
committee agreed and eliminated the word “done.”

Two commentators suggested adding references to disability incidence and termination rates and
one commentator suggested adding a reference to elective claims. Another commentator
indicated that specific reference to epidemics or catastrophic events should be included. The
committee added a specific reference.

Section 3.2.3, Organizational Claims Administration (formerly titled, Organizational Claim


Processing Methods and Reports)—Several commentators noted that description of claims
processing was limited, and suggested that “internal” did not include third party payor methods.
The committee agreed and modified the wording to refer to administering claims rather
than simply processing and to remove the reference to internal.

One commentator stated that this list of influences did not include management reorganization as
a factor. The committee modified the language to make it clear that the list is not intended
to be exhaustive.

Section 3.2.4, Risk Characteristics and Organizational Practices by Block of Business (formerly
titled, Risk Characteristics and Underwriting Practices by Block of Business)—Several
commentators pointed out that there were other items in addition to marketing and underwriting,
such as competition that could influence the types of risks accepted. The committee agreed and
modified the section to include “other business practices” in order to reflect items that
would include the influence of competitive practices on risk characteristics of a block of
business.

One commentator suggested that the risk characteristics be enumerated, such as age, sex, and
medical conditions. The committee believes that this is common knowledge and that it is not
necessary to include such an enumeration in the standard.

Several commentators pointed out that the term “loss ratio” was introduced in this section and
should either be explained or deleted. The committee chose to replace the term with
“incurred claims” in keeping with the rest of the standard.

Section 3.2.5, Legislative Requirements—One commentator indicated that the statement that the
actuary should consider relevant legislative and regulatory changes was redundant with language
elsewhere in the document. The committee believes that it is appropriate to retain the
sentence in this section.

Section 3.2.6, Carve-Outs—Several commentators noted that this section was not clear as to
what was intended to be included as carve-outs. The committee modified the language to

17
clarify that carve-outs include services such as prescription drug, mental health treatment,
or dental. The list is not intended to be exhaustive.

One commentator noted that capitation might be included here in the case of mixed (partially
capitated) plans. The committee believes that capitation could indeed be considered as a
carve-out in certain circumstances. Capitation is also covered by section 3.3.6, Provider
Contractual Arrangements.

One commentator suggested that this section noted the need to review liability for coverage in
the event of provider failure to perform. The committee believes that this is covered under
section 3.3.6.

Section 3.2.7, Special Considerations for Long-Term Products—Two commentators noted that
the term “factors” was used in two different ways in the section. The first usage was to reference
items influencing incurred claims and the second reference was to reference tabular values. The
committee determined usage of the term was not pertinent to the meaning of the section
and also determined that the reference in the second paragraph to the use of judgment was
not needed in the standard.

Two commentators suggested that additional influences be included in the list. The committee
agreed and added cost-of-living, inflation protection, social insurance integration, and
benefit eligibility criteria to the section.

One commentator suggested that a section on nonrecurring or catastrophic events such as


weather, labor disputes, epidemics, terrorism, or earthquakes be added to the standard. The
committee believes this is not necessary, as these items could be considered economic
influences and are covered by section 3.2. Modifications to this section described elsewhere
broaden the scope of the section to include such factors.

Section 3.3, Analysis of Incurred Claims—Several commentators noted that this “Procedures for
Analyzing Incurred Claims” was not an appropriate title for this section. The committee agreed
and changed the title.

Several comments suggested that a discussion of the time value of money should be included.
The committee agreed and added new section 3.3.1(a) to address the issue.

One commentator noted that certain items such as case management, capitations, and other items
associated with direct delivery of services should be included. The committee agreed but
determined that this should be addressed elsewhere, and modified section 3.3.6 to reference
this.

18
One commentator suggested that reference be made to the practice of commuting long-term
claim payment liabilities with lump-sum settlements. The committee agrees that this practice
has an impact on incurred claims and assumptions used to determine them, but believes
that this level of detail is not appropriate for this standard. Section 3.2.3 briefly addresses
this issue.

Section 3.3.1, Unpaid Claims Liability—One commentator suggested that the section be split
into three parts for clarity. The committee agreed, labeled each of the three sections in the
document separately, and added a fourth section on the time value of money.

One commentator noted that this section seemed to require the use of a lag method, and pointed
out that data to determine an unpaid claims liability on this basis may not always be available.
The committee agreed and modified the draft to incorporate language recognizing that
point.

One commentator also noted that the term “payment date” was limiting and did not allow for the
variety of definitions associated with payment and processing of claims, particularly with respect
to disability claims and hospitalizations. The committee agreed and modified the language to
use the term “processing date” in section 3.3.1, and similar wording in new sections 3.3.1(b)
and 3.3.1(c).

Two commentators suggested that the last sentence in new section 3.3.1(a) be expanded to
describe what to do under each situation. The committee considered this point and concluded
that adequate guidance was provided elsewhere and no modification was necessary.

One commentator noted that the term “enrollment” was undefined. The committee agreed and
substituted the term “exposure units” in new section 3.3.1(b).

One commentator noted that the term “rates” was unclear. The committee agreed and added
the word “premium” before “rates” in new section 3.3.1(b).

Several commentators noted that the paragraph on margin should be expanded to provide more
guidance. One suggested that language similar to ASOP No. 28 be included. The committee
agreed and added some language to the new section 3.3.1(c) for this purpose. It should be
noted that the standard does not require that an actuary include a margin, but rather
defines the level of margin that should be included if a margin is indeed determined.

Section 3.3.2, Categories of Incurred Claims—Two commentators suggested that the categories
of incurred claims should make reference to the different methods of payment, with pharmacy
claims being the example used by both commentators. The committee agreed with the
suggestion and added the phrase “method of payment (for example, electronic vs.
manual).”

19
Section 3.3.3, Reinsurance Arrangements—One commentator expressed the concern that this
section seemed to apply only to reinsurers and another commentator suggested adding the phrase
“stop-loss claim” to the section. The committee believes the original wording does apply to
direct writers as well as reinsurers, including stop-loss coverage.

One commentator suggested that the section was too restrictive with regard to varying actuarial
techniques, if applied to rate making. The committee believes the wording “reflect the effect
of such arrangements in estimating the incurred claims” does not restrict actuarial rating
techniques.

Section 3.3.4, Large Claim Patterns—One commentator suggested that the example used in this
section also should have addressed the possibility of understatement of incurred claims
estimates. Another commentator suggested adding “unusually high” to the phrase “number or
amount of large claims.” The committee agreed and changed the wording to include
“unusually high” to address both comments.

Section 3.3.5, Coordination of Benefits (COB) or Subrogation—One commentator suggested


adding a reference to adjustments or recoveries other than COB or subrogation. The committee
agreed and added the phrase “other adjustments or recoveries.”

One commentator expressed concern about adjustments not overly reducing the level of
conservation otherwise assumed. The committee believes this is adequately addressed in the
revised section 3.3.1(c).

Section 3.3.6, Provider Contractual Arrangements—One commentator believed that a reference


to provider arrangements not reimbursed through the claim payment process, for example,
capitation, should be added. The committee agreed and added a sentence to that effect.

Section 3.3.7, Consistency of Basis—Several commentators believed that a reference to claim


settlement expense reserves should be added to ensure consistency in determining all liabilities
and reserves. The committee agreed and added section 3.3.7.

Section 3.4, Data Requirements and Assumptions—One commentator believed that the variety
of organizations providing administrative services would affect the data needs of the actuary.
The committee agreed and added the phrase “or administering” to address these situations.

Section 3.5, Methods Used for Estimating Incurred Claims—Several commentators expressed
concern about the phrase “not an average of the methods” being too limiting in how to use
alternative methods of estimating incurred claims. The committee agreed and deleted the
phrase.

20
One commentator believed that the phrase “early part of the current valuation period” was
confusing. The committee agreed and deleted the phrase.

One commentator expressed concern that the phrase “most reasonable provision” was not
adequately defined with regard to various levels of conservatism that are appropriate. The
committee believes this is adequately addressed in the revised section 3.3.1(c).

One commentator believed that the concept of credibility should be defined or discussed more
fully as it relates to selection of an appropriate method of estimating incurred claims. The
committee believes that the current wording is adequate for guidance to the actuary.

Section 3.5.1, Development Method—One commentator suggested the possibility of using the
development method for long-term claims. The committee agreed and added the wording
“development methods may also be appropriate for long-term claims.”

One commentator suggested removing the sentence redefining claims lag. The committee
agreed and deleted the sentence.

One commentator suggested changing the wording from “the actuary should analyze” to “the
actuary should consider” as it pertains to fluctuations. The committee agreed and changed the
wording.

One commentator suggested making the wording more stringent about considering fluctuations
by requiring that an adjustment be made if deemed to have a significant impact. The committee
believes the original wording is adequate to provide guidance to the actuary.

One commentator believed that the use of paid loss ratios by incurred period should not be
considered a development method. The committee agreed and deleted the wording.

One commentator expressed the opinion that the references to “paid dates” would be better
referenced as “processed dates.” The committee agreed and changed the wording throughout
the standard of practice.

Section 3.5.2, Tabular Method—Three commentators suggested that the tables might be dictated
by regulations. The committee believes that this is adequately covered under section 3.2.5,
Legislative Requirements.

One commentator suggested that the list of factors included in the last sentence of the first
paragraph be broadened to include cause of claim. The committee agreed with this and also
generalized the list to apply to any type of contract, not just to long-term disability. Also,
the committee added wording to section 3.2.7, Special Considerations for Long-Term
Products, to incorporate these concepts.

21
One commentator requested that wording be added regarding the impacts of recovery, mortality
and government offsets on tabular factors for long-term disability. The committee agreed with
this request and added the suggested wording.

Another commentator suggested expansion of the last sentence of this section to state that “the
actuary should consider whether an additional adjustment is necessary to reflect unreported
incurred claims.” The committee agreed with this and added the wording.

Section 3.5.3, Other Methods—Two commentators suggested that “Other Methods” be expanded
to include methods frequently used by managed care plans, such as hospital logs and pre-
authorization data. The committee agreed with this and expanded the examples to include
these. It should be noted that this list of examples is not intended to be exhaustive.

Section 3.6, Follow-Up Studies—Several commentators suggested expanding the wording in this
section to include other items to study, for example, lag patterns, seasonality patterns, trends, and
duration of unpaid claims liability. The committee believes that the wording used in this
section sufficiently covers these.

One commentator expressed concern that the measures of “reasonableness” seemed to focus on
“accuracy” of prior estimates, which “leaves the actuary open to second-guessing by regulators
and others when the estimates are less than 100% accurate.” The committee disagrees with this
interpretation and thus made no change in this section.

Two commentators stated that the wording implied that “all” financial statements require follow-
up studies. The committee agreed and modified the statement to state “some financial
statements.”

One commentator suggested adding a new section 3.7, Other Considerations; section 3.7.1,
Materiality; and section 3.7.2, Cost Effectiveness. The committee agreed to expand on the
definition and issue of “Materiality” elsewhere in the standard. The committee did not
believe it necessary to add a separate section on “Cost Effectiveness,” since the committee
believes these concepts are adequately addressed elsewhere in the standard.

Section 4. Communications and Disclosures

Section 4.2, Prescribed Statement of Actuarial Opinion (PSAO)—One commentator suggested


eliminating this section since the actuary is required to be familiar with all relevant standards,
and thus this is redundant. The committee believes this section should remain since this
language is included in ASOPs that include a Communications and Disclosures section.

22
Section 4.3, Deviation from Standard—One commentator suggested eliminating reference to
“procedures set forth in this standard” since there are no references to “procedures” in the
standard. The committee made no change in the wording since this is standard wording for
this section used in other ASOPs.

Appendix 1. Background and Current Practices

One commentator stated that under current practice the term “changing times” in the last line
might more appropriately be called “current or changed times.” The committee believes the
current wording is appropriate.

Another commentator suggested adding reference to the NAIC Statutory Reserve Guidance
Manual in the appendix. The committee decided that such reference was not appropriate for
this appendix.

23
Actuarial Standard
of Practice
No. 6

Measuring Retiree Group Benefit Obligations

Revised Edition

Developed by the
Task Force on Retiree Group Benefits of the
Actuarial Standards Board

Adopted by the
Actuarial Standards Board
December 2001

(Doc. No. 084)


TABLE OF CONTENTS

Transmittal Memorandum v

STANDARD OF PRACTICE

Section 1. Purpose, Scope, Cross References, and Effective Date 1


1.1 Purpose 1
1.2 Scope 1
1.3 Cross References 2
1.4 Effective Date 2

Section 2. Definitions 2
2.1 Actuarial Cost Method 2
2.2 Adverse Selection 2
2.3 Contingent Participant 2
2.4 Contributions 2
2.5 Cost Allocation Policy 2
2.6 Covered Population 2
2.7 Dedicated Assets 3
2.8 Dependents 3
2.9 Measurement Date 3
2.10 Measurement Period 3
2.11 Medicare-Eligible Participant 3
2.12 Medicare Integration 3
2.13 Normative Database 3
2.14 Participant 3
2.15 Retiree Group Benefits 3
2.16 Spouse 3
2.17 Stop-Loss Coverage 4
2.18 Survivor 4
2.19 Trend 4

Section 3. Analysis of Issues and Recommended Practices 4


3.1 General Overview 4
3.2 Modeling Plan Provisions 5
3.2.1 Components of the Modeled Plan 5
3.2.2 Historical Practices 6
3.2.3 Reviewing the Modeled Plan 7
3.2.4 Measurement Results by Category 7
3.3 Modeling the Covered Population 7
3.3.1 Census Data 7
3.3.2 Employees Currently Not Accruing Benefits 8
3.3.3 Contingent Participants 8
3.3.4 Spouses and Survivors of Participants 8
3.3.5 Dependents 8

ii
3.3.6 Appropriateness of Pension Plan Data 8
3.3.7 Use of Grouping 9
3.4 Modeling Initial Per Capita Health Care Rates 9
3.4.1 Net Aggregate Claims Data 10
3.4.2 Exposure Data 10
3.4.3 Use of Multiple Claims Experience Periods 11
3.4.4 Credibility 11
3.4.5 Use of Premium Rates 11
3.4.6 Impact of Medicare and Other Offsets 12
3.4.7 Age-Specific Claims Rates 12
3.4.8 Adjustment for Plan Design Changes 12
3.4.9 Adjustment for Administrative Practices 12
3.4.10 Adjustment for Large Individual Claims 13
3.4.11 Adjustment for Trend 13
3.4.12 Adjustment When Plan Sponsor is Also a Provider 13
3.4.13 Use of Other Modeling Techniques 13
3.4.14 Administrative Expenses 13
3.5 Modeling the Cost of Death Benefits 14
3.6 Model Consistency and Data Quality 14
3.6.1 Coverage and Classification Data 14
3.6.2 Consistency 14
3.6.3 Sources of Data 15
3.6.4 Reliance on Data Supplied by Others 16
3.7 Administrative Inconsistencies 16
3.8 Projection Assumptions 16
3.8.1 Economic Assumptions 16
3.8.2 Demographic Assumptions 18
3.8.3 Coverage Assumptions 19
3.8.4 Effect of Plan Changes on Assumptions 20
3.8.5 Assumptions Considered Individually and in Relation to Other Assumptions 21
3.8.6 Reviewing Assumptions 21
3.8.7 Changes in Assumptions 21
3.9 Selecting a Cost Allocation Policy 21
3.9.1 Criteria for Acceptable Actuarial Cost Methods 21
3.9.2 Dedicated Assets 22
3.9.3 Amortization Methods 22
3.9.4 Cash Flow Adequacy 22
3.10 Use of Roll-Forward Techniques 23
3.10.1 Full and Partial Roll-Forward 23
3.10.2 Limitation 23
3.10.3 Appropriateness 23
3.10.4 Disclosure 23
3.11 Prescribed Assumptions, Cost Allocation Policies, or Other Model Components 23
3.12 Reasonableness of Results 23
3.12.1 Modeled Cash Flows Compared to Recent Experience 23
3.12.2 Results Compared to Last Measurement 24

iii
3.13 Sensitivity of Results to Chosen Assumptions 24
3.14 Reliance on a Collaborating Actuary 24

Section 4. Communications and Disclosures 24


4.1 Documentation 24
4.2 Disclosure 25
4.3 Prescribed Statement of Actuarial Opinion 25
4.4 Deviation from Standard 25

APPENDIXES

Appendix 1—Background and Current Practices 26


Background 26
Current Practices 27

Appendix 2—Supplementary Information 29


Normative Databases 29
Measurements Using Premium Rates 29
Health Care Trend Rate 30
Interaction Between Trend and Plan Provisions 31
Participant Contributions 32
Assets 33
Compliance with Other Requirements 34

Appendix 3—Comments on the Exposure Draft and Task Force Responses 35

iv
March 2001

TO: Members of Actuarial Organizations Governed by the Standards of Practice of the


Actuarial Standards Board and Other Persons Interested in Measuring Retiree
Group Benefit Obligations

FROM: Actuarial Standards Board (ASB)

SUBJ: Actuarial Standard of Practice (ASOP) No. 6

This booklet contains the final version of the revision of ASOP No. 6. The original title,
Measuring and Allocating Present Values of Retiree Health Care and Death Benefits, has been
changed to Measuring Retiree Group Benefit Obligations. This standard supersedes Actuarial
Compliance Guideline (ACG) No. 3, For Statement of Financial Accounting Standards No. 106,
Employers’ Accounting for Postretirement Benefits Other Than Pensions, which has been
repealed.

Background

The original ASOP No. 6 was effective October 17, 1988. ACG No. 3 was originally effective
December 1, 1992. During the time these documents were being developed, the Financial
Accounting Standards Board was raising the visibility of financial issues related to retiree group
benefits with its development of Statement of Financial Accounting Standard (SFAS) No. 106,
Employers’ Accounting for Postretirement Benefits Other Than Pensions. Prior to the issuance of
SFAS No. 106, most plan sponsors provided and accounted for retiree group benefits on a pay-
as-you-go basis. The move to accrual accounting necessitated greater actuarial involvement.
ASOP No. 6 and ACG No. 3 were written with a high level of educational content because the
measurement of retiree group benefit obligations was an emerging practice area that would be
new to many actuaries.

In the 1990s, the ASB adopted standards related to data quality (ASOP No. 23), credibility
procedures (ASOP No. 25), documentation in health benefit plan ratemaking (ASOP No. 31),
and the selection of pension assumptions (ASOP Nos. 27 and 35). As provided in this ASOP,
these other ASOPs have application to actuaries measuring retiree group benefit obligations.

Although the measurement of retiree group benefit obligations continues to develop as an


actuarial field within the profession, the ASB believes that practice in this field has developed
sufficiently to permit codification of acceptable current practices in a revised ASOP No. 6. Thus,
in 1999, the ASB convened a special task force of knowledgeable practitioners in the retiree
group benefits field to draft the revision of this standard. The Task Force on Retiree Group
Benefits was charged with (1) updating ASOP No. 6 to provide guidance to actuaries regarding
acceptable practices and to reduce the amount of educational material; (2) determining whether
there was a continuing need for ACG No. 3; and (3) evaluating the applicability to retiree group
benefits of ASOPs written since the original adoption of ASOP No. 6.

v
Key Issues

As discussed in the exposure draft, this standard not only replaces the previous ASOP No. 6, but
also supersedes ACG No. 3. In addition, this revised standard represents the following changes
from the original ASOP No. 6:

1. This standard uses a model-building approach to the measurement of retiree group benefit
obligations, as representative of contemporary practice.

2. The measurement model described in this standard includes the following three key
components:

a. the modeled plan provisions;

b. the modeled population expected to receive retiree group benefits; and

c. the model of current and projected benefit costs.

3. The standard requires that each of these three components be appropriately developed so
as to sustain the integrity of the measurement. This generally requires the following:

a. expertise in both the development of health care claims rates and the long-term
projection of the covered population; and

b. exclusion of very simplified methods or assumptions used in modeling complex


plans and processes.

4. The standard emphasizes the use of the plan’s experience for health care measurements,
but allows for the use of appropriately adjusted premium rates or normative claim
databases when the plan’s experience is not fully credible.

5. The standard requires the actuary(s) issuing the actuarial opinion to take professional
responsibility for overall appropriateness of the analysis, assumptions, and results.

6. The standard requires the actuary to use appropriate age bands if the claim rates are
expected to vary significantly by age.

7. The standard allows the use of roll-forward measurement techniques to measurement


dates that are less than three years after the original measurement date.

8. The standard places increased emphasis on the modeling of participant contributions in


retiree group benefit measurements.

vi
9. The standard calls for the application of ASOP Nos. 25, 27, 31, and 35 to the
measurement of retiree group benefits.

10. The standard requires the actuary to compare projected claims to recent actual claims.

11. The standard includes guidance on the handling of differences between actual
administrative practices and stated plan provisions.

12. The standard places increased emphasis on considering expected changes in plan design
and covered population.

13. The standard requires the actuary to consider using different trend assumptions by line of
coverage.

Exposure Draft

The exposure draft of this standard was issued in October 2000 with a comment deadline of
March 31, 2001. The Task Force on Retiree Group Benefits carefully considered the twenty-two
comment letters received. For a summary of the substantive issues contained in these comment
letters, please see appendix 3.

The changes since the exposure draft that were incorporated into this standard include the
following significant items:

1. The language regarding the appropriateness of the use of premium rates in setting the
initial per capita claim rates was changed to allow more flexibility in using this approach,
and the material on premium rates in appendix 2 was revised.

2. The requirement to use five-year age bands in the initial per capita health care rate was
replaced by a more flexible requirement.

3. The language regarding the actuary’s responsibility when actual administrative practices
are not consistent with stated plan procedures was clarified to remove any apparent
burden on the actuary to audit administrative practices.

4. The effective date of the standard was clarified, especially with respect to roll-forward
measurements.

5. Several subsections of section 3 regarding the use of roll-forward techniques and the use
of prescribed assumptions, methods, and other model components were moved to
different areas of section 3.

The task force thanks all those who commented on the exposure draft. The task force also thanks
John Stenson for his assistance during the drafting of this standard.

vii
The ASB voted in December 2001 to adopt this standard.

Task Force on Retiree Group Benefits

Carl D. Smith, Chairperson


Barbara S. Bald Jeffrey P. Petertil
Joseph K. Beeler Adam J. Reese
Richard F. Fisher Dale H. Yamamoto

Actuarial Standards Board

Alan J. Stonewall, Chairperson


David G. Hartman Michael A. LaMonica
Ken W. Hartwell Heidi Rackley
Roland E. King James R. Swenson
William C. Koenig Robert E. Wilcox

viii
ACTUARIAL STANDARD OF PRACTICE NO. 6

MEASURING RETIREE GROUP BENEFIT OBLIGATIONS

STANDARD OF PRACTICE

Section 1. Purpose, Scope, Cross References, and Effective Date

1.1 Purpose—This actuarial standard of practice (ASOP) provides guidance to actuaries


when measuring obligations under a retiree group benefits plan.

1.2 Scope—This standard applies to actuaries when measuring any type of retiree group
benefit obligation. Included in the scope of this standard are measurements made for the
following purposes:

a. financial reporting, such as measurements made for purposes of compliance with


SFAS No. 106;

b. cash-flow analyses;

c. plan funding, including the determination of participant contributions when such


contributions are based on expected retiree group benefit costs;

d. cost projections, including those made in conjunction with establishing or


modifying the plan’s design; and

e. determinations of actuarial present values.

This standard highlights health and death benefits because they are the most common
forms of retiree group benefits. This standard can provide guidance in situations
involving other types of benefits, but does not apply to measurements of pension
obligations or social insurance programs.

Throughout this standard, any reference to selecting assumptions, selecting a cost


allocation policy, or to modeling also includes giving advice on selecting assumptions,
selecting a cost allocation policy, or modeling. For instance, the actuary may advise the
plan sponsor on selecting assumptions for Statement of Financial Accounting Standards
(SFAS) No. 106, but the plan sponsor is ultimately responsible for selecting these
assumptions. This standard applies to the actuarial advice given in such situations, within
the constraints imposed by the relevant accounting standards.

If applicable law, regulation, or accounting standards contain requirements for a


measurement of retiree group benefit obligations that conflict with this standard, the

1
actuary should comply with the requirements of such applicable law, regulation, or
accounting standards. Compliance with such applicable law, regulation, or accounting
standards is not considered to be a deviation from this standard, provided the actuary
discloses that the measurement was performed in compliance with applicable law,
regulation, or accounting standards. Most of the current applicable laws, regulations, or
accounting standards that may apply to specific measurements of retiree group benefit
obligations are listed in appendix 2 under “Compliance with Other Requirements.”

1.3 Cross References—When this standard refers to the provisions of other documents, the
reference includes the referenced documents as they may be amended or restated in the
future, and any successor to them, by whatever name called. If any amended or restated
document differs materially from the originally referenced document, the actuary should
consider the guidance in this standard to the extent it is applicable and appropriate.

1.4 Effective Date—This standard will be effective for measurements of retiree group benefit
obligations with measurement dates on or after January 1, 2003 or, if roll-forward
techniques are used, three years after the last full measurement before January 1, 2003.

Section 2. Definitions

The definitions below are defined for use in this actuarial standard of practice.

2.1 Actuarial Cost Method—A procedure for allocating the actuarial present value of future
plan costs over time periods.

2.2 Adverse Selection—The actions of plan participants who are motivated directly or
indirectly to take financial advantage of plan provisions, such as the choice of plan.

2.3 Contingent Participant—An individual who is not currently a participant but who may
reasonably be expected to become a participant through his or her future action.

2.4 Contributions—A payment made by a participant to support a retiree group benefit plan.
While plan sponsors and employers will contribute funds to subsidize retiree group
benefits, in this standard contributions refer to periodic payments required from
participants for their plan coverage.

2.5 Cost Allocation Policy—An actuarial cost method combined with defined procedures to
account for plan assets (if any) and amortization of changes in plan obligations (such as
those arising from plan changes, experience gains and losses, assumption changes, or
changes in actuarial cost methods).

2.6 Covered Population—Active and retired participants, participating spouses and surviving
spouses of participants who are eligible for benefit coverage under a retiree group benefit
plan. The covered population may also include dependents and contingent participants.

2
2.7 Dedicated Assets—Assets designated by the plan sponsor for the exclusive purpose of
satisfying the retiree group benefit obligations.

2.8 Dependents—Individuals, other than spouses, who are covered under a retiree group
benefits plan by virtue of their relationship to a participating employee or retiree.

2.9 Measurement Date—The date as of which the retiree group benefit obligation is
determined (sometimes referred to as the valuation date).

2.10 Measurement Period—The period subsequent to the measurement date during which the
chosen assumptions or other model components apply.

2.11 Medicare-Eligible Participant—A participating individual who is entitled to Medicare


benefits.

2.12 Medicare Integration—The approach to determining the portion of a Medicare-eligible


claim that is paid by the plan, after adjustment for Medicare reimbursements for the same
claim. Types of Medicare integration include the following:

a. Full Coordination of Benefits (Full COB)—The plan pays the difference between
total eligible charges and the Medicare reimbursement amount, or the amount it
would have paid in the absence of Medicare, if less.

b. Exclusion—The plan applies its normal reimbursement formula to the amount


remaining after Medicare reimbursements have been deducted from total eligible
charges.

c. Carve-Out—The plan applies its normal reimbursement formula to the total


eligible charges, then subtracts the amount of Medicare reimbursement.

2.13 Normative Database—Data compiled from sources that are expected to be typical of the
retiree group benefit plan, rather than from plan-specific experience. Examples of
normative databases include published mortality and disability tables, proprietary
premium rate manuals, and experience on similar retiree group benefit plans.

2.14 Participant—An individual who (a) is currently receiving benefit coverage under a retiree
group benefit plan, or (b) is reasonably expected to receive benefit coverage under a
retiree group benefit plan upon satisfying the plan’s eligibility and participation
requirements.

2.15 Retiree Group Benefits—Health, death, and other benefits (excluding retirement income
benefits) that are provided during retirement to a group of individuals, on account of an
employment relationship.

2.16 Spouse—A husband, wife, or domestic partner eligible for retiree group benefits.

3
2.17 Stop-Loss Coverage—Insurance protection providing reimbursement of all or a portion
of claims in excess of a stated amount. Stop-loss coverage may be either individual or
aggregate (sometimes referred to as excess loss coverage).

2.18 Survivor—A spouse or dependent who continues as a participant under the retiree group
benefit plan following the death of a participating employee or retiree.

2.19 Trend—A measure of a rate of change, over time, of the per capita health care rates.

Section 3. Analysis of Issues and Recommended Practices

3.1 General Overview—When measuring retiree group benefit obligations, the actuary
should do the following:

a. develop a model that represents the following:

1. known plan provisions as they currently exist and as they are anticipated
in the measurement period (see section 3.2);

2. the population covered by the benefits in question, which should reflect


the current population and the anticipated population in the measurement
period (see section 3.3); and

3. current and projected benefit costs (see sections 3.4 and 3.5).

b. evaluate the quality and consistency of data used in construction of the model, and
make appropriate adjustments (see section 3.6);

c. identify any significant administrative inconsistencies and make appropriate


adjustments in the model or disclose the unresolved inconsistency (see section
3.7);

d. select projection assumptions in addition to the assumptions developed as part of


step (a) above (see section 3.8);

e. measure the obligations and, when allocating costs to time periods, use an
appropriate cost allocation policy (see section 3.9); and

f. review and test the results of the calculations (see sections 3.12 and 3.13).

Additionally, the standard contains guidance on using roll-forward techniques (see


section 3.10), using prescribed assumptions, methods, or other model components (see
section 3.11), and reliance on a collaborating actuary (see section 3.14).

4
Retiree health cost projections generally can be expected to vary within a large range of
reasonableness. Notwithstanding the variability of reasonable results, the actuary should
select each element of the model to sustain the integrity of the measurement.

3.2 Modeling Plan Provisions—In modeling the known provisions of the plan, the actuary
should give appropriate consideration to the written plan documents, historical practices,
administrative practices of the plan sponsor, governmental programs, communications to
participants, and, depending on the purpose of the measurement, plan sponsor decisions
and expected future benefit plan designs, as described in sections 3.2.1 and 3.2.2 below.

3.2.1 Components of the Modeled Plan—The actuary should incorporate the significant
elements of the known plan provisions into the model. The major components of
the modeled plan include, but are not limited to, covered benefits; benefit
limitations, exclusions, and cost-sharing provisions; participant contributions;
health care delivery system attributes; and optional benefits. In some cases, it may
also be appropriate to consider future changes and limits on plan sponsor costs.
These considerations are discussed in more detail below.

a. Covered Benefits—Covered benefits may include reimbursements for


covered services, fixed-dollar payments for covered events (such as death
benefits), and other monetary benefits (such as Medicare premiums or
defined dollar benefits).

b. Benefit Limitations, Exclusions, and Cost-Sharing Provisions—Benefit


limitations and exclusions (such as a lifetime maximum benefit in a
medical plan) may affect plan payments, and such effects will change over
time. The actuary should also consider participant cost-sharing provisions
(such as deductibles, copayments, coinsurance, and out-of-pocket limits).

c. Participant Contributions—Many plans require contributions from


participants as a condition for their continued eligibility for plan coverage.
The actuary should reflect the participant contributions in the model, as
discussed below. In addition, participant contributions may affect both
participation rates and adverse selection, thus affecting per capita claim
rates.

1. Contribution Formula—In modeling the plan, the actuary should


reflect actual contribution levels. There is a wide variation in how
plan sponsors determine participant contributions (examples
include flat amounts, amounts based on credited service at
retirement, amounts based on retiree claims costs, and amounts
based on combined active and retiree costs).

2. Contribution Reasonableness—The actuary should compare for


reasonableness the stated basis for participant contributions to what

5
has been implemented. See section 3.7, Administrative
Inconsistencies, for further guidance.

3. Preretirement Active Employee Contributions—A plan may


require preretirement contributions from active employees for
them to earn eligibility for retiree group benefits. The actuary
should consider how this may affect future benefit eligibility and
plan sponsor costs.

4. Contributions as Defined by Limits on Plan Sponsor Costs—Some


plans place an upper limit on the plan sponsor cost by designating
a maximum average per capita amount to be paid in a year (these
limits are commonly known as “caps”). Other plans limit total plan
sponsor cost in any current or future period. The actuary should
consider whether the limits will have a significant impact on the
obligation. The actuary should consider how the plan sponsor is
expected to implement these limits, when these limits are expected
to be reached, their impact on participant contributions, and, thus,
future participation, and, if appropriate, incorporate these limits
into the modeled plan.

d. Health Care Delivery System Attributes—The actuary should consider


that various health care delivery system attributes can affect costs
differently. For example, certain delivery systems may “lock in” costs for
an extended period of time because of their provider contracts.

e. Optional Benefits—The actuary should consider the effect of optional


benefits. Optional benefits include coverage options (for example, choice
of medical plans) and additional coverages (for example, contributory
dental coverage). Optional benefits may require participant contributions,
but also incur plan sponsor costs.

f. Anticipated Future Changes—After discussion with the plan sponsor, and


depending upon the purpose of the measurement, the actuary may take
into account future changes that the plan sponsor has represented an
intention to implement or that are required by law to be implemented
within a specified period. However, for some purposes, such as for
compliance with SFAS No. 106, the actuary may consider only changes
that have been communicated to plan participants or that result from the
continuation of a historical pattern.

3.2.2 Historical Practices—When appropriate, the actuary should consider historical


practices of the plan in developing the model. Historical practices include the
following:

6
a. Claims Payment Practices—The actuary should consider whether there is
significant inconsistency between the benefits provided and the plan
sponsor’s representation to the actuary of the terms of the plan. See
section 3.7 for further guidance.

b. Cost-Sharing and Contribution Levels—The actuary should consider the


plan sponsor’s past pattern of cost-sharing and participant contributions.

c. Pattern of Plan Changes—The actuary should consider the plan sponsor’s


past practice or a pattern of regular changes in the retiree group benefit
plan (such as benefits, cost-sharing, and participant contribution levels).
Depending on the purpose of the measurement, the continuation of such
past practices or patterns may warrant inclusion in the model.

d. Governmental Programs—For some purposes, to the extent that the plan


integrates with Medicare and other governmental programs, the actuary
should consider the historically enacted legislative and administrative
policy changes in these programs.

3.2.3 Reviewing the Modeled Plan—For each measurement, the actuary should
consider whether the model continues to reflect actual known plan provisions and
practices. If the administration of the plan has significantly deviated from the plan
as modeled, the actuary should consider whether this deviation is temporary or
should be treated as a permanent plan change.

3.2.4 Measurement Results by Category—The actuary should consider whether the


measurement results may need to be examined by category (for example, medical
vs. dental, union vs. nonunion, retiree vs. spouse; plan paid vs. participant paid;
payments before Medicare eligibility age vs. payments after Medicare eligibility
age). This need may arise from either the nature of the assignment or from
assessing the integrity of the measurement model.

3.3 Modeling the Covered Population—The projected size and demographic composition of
the covered population has a significant impact on the measurement. The actuary should
consider the need to model variations in the covered population (for example, when
benefit eligibility varies by type of coverage). This standard does not require the use of
open group measurements, although such measurements may be used when appropriate.
These issues are discussed below.

3.3.1 Census Data—The actuary should collect sufficient census data in order to make a
reasonable estimate of the obligation. In certain circumstances, grouped data may
be appropriate; in others, individual census data are required. For example, to
ascertain the optional benefits elected by the retiree, the actuary may need to
collect individual census data, including retiree contribution amounts.

7
3.3.2 Employees Currently Not Accruing Benefits—Depending on the purpose of the
measurement, the actuary should consider whether some or all of the employees
currently not accruing service toward retiree group benefit eligibility may accrue
service in the future and whether some or all of the employees currently not
making required preretirement contributions may contribute in the future, and
make appropriate allowance for them in the modeled population.

3.3.3 Contingent Participants—The actuary should examine the census data and take
appropriate measures to reflect individuals who are not current participants, but
may reasonably be expected to become participants through their future actions.
For example, the actuary may need to make a reentry assumption in situations
where retirees have opted out of coverage at the time of retirement, but may later
reenter the plan.

3.3.4 Spouses and Survivors of Participants—The actuary should include in the


modeled population participating spouses and survivors who are eligible for
coverage. In doing so, the actuary should take into account that the plan’s
eligibility conditions and benefit levels for spouses and survivors may differ from
the plan’s eligibility conditions and benefit levels for retirees. Benefit coverage
for the spouse of a retiree may continue subject to a contribution, continue for a
limited period (for example, until Medicare eligibility or one year after the death
of the retiree), or cease when the retiree dies. The actuary should generally model
spouses separately from retirees because of differences in the timing of Medicare
eligibility and in mortality between the retiree and spouse.

3.3.5 Dependents—The actuary should consider whether the dependent obligation is


significant and, if so, model dependents appropriately. For example, for plans that
have liberal early retirement eligibility conditions, dependent coverage can
significantly increase the overall number of covered individuals and, therefore,
have a significant effect on the size of the covered population.

3.3.6 Appropriateness of Pension Plan Data—Plan sponsors who do not maintain


separate retiree group benefit plan databases may furnish pension plan data to
represent the retiree group benefit plan covered population. In such cases, the
actuary should make appropriate edits and adjustments. Examples of the types of
edits and adjustments that may be required are discussed below.

a. Retirees Covered for Retiree Group Benefits but Not Receiving Pension
Benefits—Employees may be participants in the retiree group benefits
plan, but may no longer be participants in the pension plan (such as
employees who received lump-sum pension payments). Spouses,
dependents, and survivors of retirees may be eligible for retiree group
benefits, but may not be in the pension plan census data.

b. Retirees Receiving Pension Benefits but Not Covered for Retiree Group
Benefits—Employees may be participants in the pension plan, but may not

8
be covered for retiree group benefits (such as employees who terminated
with vested pension benefits now in payment status). Employees may be
eligible for pension benefits upon retirement or disability, but may not
satisfy the eligibility conditions or may have waived coverage for retiree
group benefits.

c. Provisions Affecting Certain Employees—The pension plan may be


frozen for a certain group of employees or may exclude employees due to
age or service eligibility requirements, which might not affect their
eligibility for other retiree group benefits.

3.3.7 Use of Grouping—The actuary may use grouping techniques when, in the
actuary’s judgment, grouping is not expected to unreasonably affect the
measurement results. One such technique is to group participants based on
common demographic characteristics (for example, age and service), where the
obligation for each participant in the group is expected to be similar for
commonly grouped individuals.

Another technique is to group plans with similar expected costs and features. A
plan sponsor with multiple plan designs (for example, through various collective
bargaining agreements) may not require separate measurement for each individual
plan. Under such circumstances, the actuary, after evaluating the eligibility
conditions and range of benefits provided, may decide it is appropriate to combine
plans that have similar expected costs and group the covered populations of those
plans. The actuary should disclose such combining of plans and grouping of
populations.

3.4 Modeling Initial Per Capita Health Care Rates—The actuary should develop assumed per
capita health care rates to be the basis of the initial annual benefit costs for estimating the
future health care obligations. The accuracy of the measurement model depends in large
part on its ability to forecast annual claims costs for the plan. In the actuarial
development of health care rates, plan experience is generally considered the best
predictor of future claims experience, preferable to sole reliance on normative claims
databases or other measures. Therefore, preferred methods involve development of
annual per capita health care rates from the claim experience of the retiree group benefit
plan. In the absence of credible retiree group benefit plan experience data, the actuary
may use other methods (such as methods that use premium rates and normative claims
databases) to develop the per capita rates.

The ratemaking process generally involves (a) quantifying aggregate claims costs; (b)
quantifying a measure of exposure to risk, usually the count of participants who were
eligible for the plan during the period the claims were incurred; and (c) applying other
information such as normative databases and premium rates as appropriate.

Multiple initial per capita health care rates may be appropriate due to the modeling of
known plan provisions (section 3.2) and covered population (section 3.3) as well as

9
claims experience (for example, different rates by gender, healthy vs. disabled, retirees
vs. spouses or dependents).

The actuary should document the methods and procedures followed in developing the
initial per capita health care rates, such that another actuary qualified in this practice area
could assess the reasonableness of the initial per capita health care rates. The actuary
should also document any significant actuarial judgments applied during the modeling
process. ASOP No. 31, Documentation in Health Benefit Plan Ratemaking, provides
relevant guidance to the actuary.

The sections that follow address aspects of ratemaking that are particularly important
when projecting benefit costs for a long period. The actuary should consider the
following elements, but is not required to include all these elements in the model.

3.4.1 Net Aggregate Claims Data—In most cases, the actuary’s objective is the
development of a net incurred claims rate. The actuary should, however,
recognize the factors involved in distinguishing net claims from gross claims and
incurred claims from paid claims, as discussed below.

a. Paid Claims—Aggregate claims data received by the actuary will usually


be grouped by the dates of payment, not by the dates on which claims
were incurred. The actuary should analyze the data for the likely
difference between the level of paid claims for a period and the level of
incurred claims for the same period. When the differences are significant,
the actuary should make an adjustment, either to the historical paid claims
or to the initial claims assumption, to account for the likely future level of
claims activity. To the extent the difference may be due to the trend or the
time value of money, the significance of the difference to the measurement
of retiree group benefit obligations may be reduced, because the plan
sponsor will usually have the use of the money between the time a claim is
incurred and when it is paid.

b. Gross Claim Components—Aggregate claims data received by the actuary


may show only net payments or may include cost-sharing components
(such as deductibles and copayments), reimbursements, costs not covered,
or other elements of gross claims. The actuary may determine the initial
claims rate assumption from the net payments or the gross amounts.

3.4.2 Exposure Data—In developing an initial per capita health care rate, the actuary
should obtain exposure data for the same time periods as the claims experience
data that will be used. Since exposure data are historical in nature, the exposure
data typically will be different from the census data used in modeling the future
covered population. If the differences are significant, the actuary should review
the data sets for consistency (see section 3.6).

10
It may be appropriate to segment the exposure data by age and gender or by
retiree, spouse, or dependent. The actuary should obtain information to properly
segment the population or employ reasonable assumptions as appropriate.

3.4.3 Use of Multiple Claims Experience Periods—The actuary should consider the use
of multiple claims experience periods and adjust the experience of the various
periods to comparable bases as described in sections 3.4.8, 3.4.10, and 3.4.11.
When combining multiple experience periods, the actuary should consider the
applicability of each period based upon elapsed time and changes required to
adjust to comparable bases.

The actuary may consider smoothing the results to account for historical
irregularities. The actuary may weight the experience periods as appropriate.

3.4.4 Credibility—There will be times when plan data are not available or wholly
credible. In those instances, the actuary should make use of relevant normative
databases or active plan experience on the same group, adjusted for age and
expected differences in such items as utilization and plan design. The actuary may
use these supplementary data and professional judgment to validate, adjust, or
replace the plan experience data.

ASOP No. 25, Credibility Procedures Applicable to Accident and Health, Group
Term Life, and Property/Casualty Coverages, provides guidance to the actuary
when assigning credibility to sets of experience data.

3.4.5 Use of Premium Rates—Although an analysis of the plan sponsor’s actual claims
experience is preferable, the actuary may use premium rates as the basis for initial
per capita health care rates, with appropriate analysis and adjustment for the
premium rate basis. The actuary who uses premium rates for this purpose should
adjust them for changes in benefit levels, covered population, or program
administration. The actuary should consider that the actual cost of health
insurance varies by age (see section 3.4.7), but the premium rates paid by the plan
sponsor may not. For example, the actuary may use a single unadjusted premium
rate applicable to both active employees and non-Medicare-eligible retirees if the
actuary has determined that the insurer would offer the same premium rate if only
non-Medicare-eligible retirees were covered.

If, in the actuary’s professional judgment, the unadjusted premium rate


significantly understates or overstates the expected claim cost for retirees, the
actuary should disclose this possibility in any communication regarding a
measurement using an unadjusted premium rate as an initial per capita health care
rate.

If premium rates, adjusted or unadjusted, are used as the basis for initial per capita
rates in the measurement, the actuary should make an appropriate disclosure and
consider the factors described in other sections of 3.4.

11
3.4.6 Impact of Medicare and Other Offsets—Where Medicare as the primary payer has
a significant impact on the per capita health care rates, the actuary should develop
separate rates for Medicare-eligible participants. Such rates should reflect the
plan’s Medicare integration approach or how the plan supplements Medicare. The
actuary should also adjust for other offsets, such as workers’ compensation and
auto insurance, if their impact is considered to be significant.

The actuary should consider whether there is a significant inconsistency between


the Medicare integration approach being applied by the claims administrator and
the plan sponsor’s representation to the actuary of the terms of the plan. See
section 3.7 for further guidance.

Medicare and other governmental programs are subject to continual legislative


revisions. The actuary should be aware of significant changes and make
adjustments as necessary to fit the purposes of the measurement.

3.4.7 Age-Specific Claims Rates—The actuary should consider the variation in rates by
age for the benefits being modeled and use appropriate age bands if the rates vary
significantly. The age bands should not be overly broad, based on the expected
rate variations within the bands. If rates vary significantly by age, it is
inappropriate to assume a single per capita rate that does not vary by age. The
relationship between the rates at various ages is an actuarial assumption that may
be based on normative databases.

3.4.8 Adjustment for Plan Design Changes—The actuary should adjust the claims rates
to reflect significant differences, if any, between the benefit plan designs in effect
for the experience period and those in effect during the initial year of the
measurement period.

3.4.9 Adjustment for Administrative Practices—Changes in plan administrative


practices affect how costs emerge. The actuary should make appropriate
provisions in the model for changes in administrative matters such as the
following:

a. Claims Adjudication—The actuary should consider how overall costs and


utilization rates may be influenced by the method by which enrollees and
providers submit claims (for example, provider electronic submission vs.
enrollee paper submission of claims) and the manner in which claims are
reviewed.

b. Enrollment Practices—The actuary should consider the effect enrollment


practices (for example, the ability of participants to drop in and out of the
plan) have had on participation and health care costs.

12
3.4.10 Adjustment for Large Individual Claims—The actuary should recognize the
significance that large claims may have with respect to claims experience and
make appropriate adjustments. The actuary should review the frequency and size
of large claims when data are available and consider whether the prevalence of
large claims is expected to be significantly different in the future. Future periods
may have a higher or lower incidence of such claims than past experience periods
under examination. The actuary should review both stop-loss coverage and other
large claims, as described below.

a. Stop-Loss Coverage—The actuary should consider the financial impact of


stop-loss insurance in all projections.

b. Other Large Claims—The actuary should also consider large claims that
may be below the stop-loss coverage level.

3.4.11 Adjustment for Trend—When adjusting earlier claim period experience to the
initial year of the measurement, the actuary should reflect the effect of past trend.
An adjustment of the initial per capita health care rate to reflect recent past trends
may include experience from outside the plan.

The actuary should consider using separate historical trend rates for major cost
components (for example, hospital, physician, drug costs, and plan
administration).

3.4.12 Adjustment When Plan Sponsor is Also a Provider—The retiree group benefits
plan sponsor may also be a provider under the plan, as may happen in cases where
the plan sponsor is a hospital, medical office, clinic, or other health care provider.
In these situations, the plan sponsor pays itself, in effect, for services it provides
its own members. Therefore, the actuary should analyze the charges incurred and
reimbursements received by the plan sponsor-provider and make appropriate
adjustments in the measurement model to properly reflect the underlying
transactions.

3.4.13 Use of Other Modeling Techniques—Health care costs may be modeled and
projected using techniques in addition to those mentioned above. When using an
alternative approach, the actuary should disclose the method used and comment
on its applicability. Examples of alternative approaches include models that
project a distribution of expected claims with an associated probability
distribution and models that assign different claims costs for the last year of life.

3.4.14 Administrative Expenses—In addition to the cost of claims, the plan sponsor is
usually responsible for the cost of administering the retiree group benefit plan.
The actuary should consider administrative expenses when performing the
measurement. The actuary may model administrative expenses in various ways.
For example, administrative expenses may be included in claims rates or
expressed on a per capita basis, as a percentage of claims, or as fixed amounts.

13
3.5 Modeling the Cost of Death Benefits—Death benefits may be provided directly by the
plan sponsor upon the death of a retiree or may be paid by an insurance company through
a life insurance program. The life insurance program may be either participating or
nonparticipating with respect to policy dividends. The modeled death benefit cost should
appropriately reflect the financial arrangement through which the benefits are provided,
including dividends, retiree contributions, carrier administrative expenses, and risk
charges.

When selecting assumptions and measurement methods regarding death benefits, the
actuary should consider that the actual cost of life insurance varies by age, but the
insurance rates paid by the plan sponsor may not. The actuary should reflect appropriate
costs by age in the projection model.

3.6 Model Consistency and Data Quality—Before proceeding with the measurement, the
actuary should review the modeled plan provisions, covered population, per capita health
care rates, and death benefit costs as a whole to evaluate their consistency. The actuary
should evaluate the relevancy of any data received and the significance of all data used
for actuarial purposes. ASOP No. 23, Data Quality, provides guidance on selecting and
reviewing data and making appropriate disclosures regarding the data. Additional data
quality requirements that are particularly applicable to the retiree group benefit area are
mentioned below.

3.6.1 Coverage and Classification Data—The actuary should consider the importance
of coverage distinctions (such as HMO vs. indemnity plans) and classification
distinctions (such as hourly vs. salaried, or benefits that vary among different
groups of retirees) that result in variations in the benefit availability among
participants. The actuary should consider whether such differences are significant
enough to require further refinement of the model. The actuary should document
the coverage and classification distinctions incorporated in the model.

3.6.2 Consistency—If the actuary finds data elements that appear to be significantly
inconsistent with known plan provisions, other data elements, or data used for
prior measurements, the actuary should take appropriate steps to address such
apparent inconsistencies before proceeding with the measurement, as discussed
below. To the extent that significant inconsistencies cannot be reconciled, the
actuary should disclose them.

a. Plan Operations—The actuary should determine whether eligibility and


payment data received conflict significantly with information received
about known plan provisions or administration. See section 3.7 for further
guidance. Examples of inconsistencies include the following:

1. Average claims costs that are secondary to Medicare are very high
in relation to average costs that are primary. This might reveal that
the carve-out method of integration with Medicare may not have

14
been used, despite the sponsor’s indication of that method, or that
the classification of the covered spouse is based on the retiree’s
age.

2. Individual contribution amounts for participation before Medicare


eligibility are so low as to make it unlikely that plan sponsor
subsidies are as limited as the sponsor may indicate.

3. The ratio of spouses to retirees in total or for a subgroup (for


instance, those who are not eligible for Medicare) is inconsistent
with expectations. This might mean that it is unlikely surviving
spouse coverage is as stated, that coding of spouse ages is
inaccurate, or that survivors were coded as “retirees.”

4. Known plan provisions include benefit maximums, but the


actuary’s analysis of claims data indicates a likelihood that claims
are in excess of the maximum.

b. Medicare-Related Data—Data concerning Medicare eligibility and age


may be inaccurately and inconsistently coded for both claims and covered
population. The actuary should make and document any appropriate
adjustments in this regard.

c. Demographic Distinctions—The actuary should consider demographic


breakdowns (such as age, gender, geography, and hourly/salaried
classifications), which may reveal results that are inconsistent with prior
data or the actuary’s prior expectations.

d. Data for Spouses, Survivors, and Dependents—The actuary should


scrutinize coverage and classification information for spouses and
survivors and, if significant, for dependents, with as much care as for
employees and retirees due to the significant impact they may have on the
results of the measurement.

3.6.3 Sources of Data—The actuary should consider the various types and sources of
data available for the covered population, for the coverage and classification of
participants, and for benefit costs, as discussed below.

a. Census Data—In most cases, the plan sponsor or administrator will supply
the eligibility and demographic information about participants in the plan.
A participant census used for underwriting or pension purposes may
contain useful information about the covered population. The actuary
should determine whether these sources represent plan participation with
sufficient accuracy (see sections 3.3.6 and 3.4.2) and, if not, seek more
accurate census information.

15
b. Claims Payment Data—Various sources of data are available for
establishing per capita rates, including normative claims databases and
experience data specific to the plan sponsor. The actuary should review
plan experience relative to normative ranges of value, but also recognize
the legitimacy of plan sponsor experience, to the extent it is credible, and
the limitations of applying normative data to an unrelated situation. ASOP
No. 25 provides guidance in the assignment of credibility values to data.

c. Data Quality at Each Level of Usage—Data that may be of appropriate


quality for determination of certain assumptions within a model may not
be of appropriate quality for determination of other assumptions. When
data are combined or separated, the actuary should review the data for
suitability to the purpose. For example, data from an individual employer
may be sufficient for setting an aggregate per capita health care rate, but
not be of sufficient size to set per capita health care rates by location.

3.6.4 Reliance on Data Supplied by Others—ASOP No. 23 provides guidance


regarding the use, review, and disclosure of reliance on data supplied by others.

3.7 Administrative Inconsistencies—In the course of performing the measurement, the


actuary may find that the plan is being administered in a manner that is inconsistent with
the plan documents, stated plan sponsor policies, or participant communications.
Inconsistencies most often arise with respect to participant contribution determination
(see section 3.2.1(c)(2)), claims payment practices (see section 3.2.2(a)), Medicare
integration (see section 3.4.6), and plan operations (see section 3.6.2(a)). When the
actuary becomes aware of a significant inconsistency between administrative practice and
plan documents, stated plan sponsor policies, or participant communications, the actuary
should do the following:

a. discuss the inconsistency with the plan sponsor or administrator;

b. adjust the model appropriately, consistent with the purposes of the measurement
(in making these adjustments, the actuary may rely on the plan sponsor’s
representations);

c. document the resulting steps taken by the actuary in developing the model; and

d. disclose any significant unresolved inconsistency.

3.8 Projection Assumptions—In selecting projection assumptions, the actuary should


consider the following:

3.8.1 Economic Assumptions—With respect to any particular measurement, each


economic assumption selected by the actuary should be consistent with every
other economic assumption selected by the actuary to be used over the
measurement period. The actuary should reflect the same general economic

16
inflation component in each of the economic assumptions selected by the actuary.
The relationships among economic assumptions should be reasonable relative to
the underlying economic conditions expected throughout the projection period.

The actuary should comply with the guidance contained in ASOP No. 27,
Selection of Economic Assumptions for Measuring Pension Obligations, when
selecting the inflation assumption, discount rate, investment return assumption,
and compensation scale (when needed for benefits such as life insurance) to be
used in measuring retiree group benefit obligations. In applying ASOP No. 27, the
actuary should take into account the purpose and nature of the measurement, and
the differences between the characteristics of retiree group benefit obligations and
the characteristics of pension benefit obligations. For example, the discount rate
selected for measuring pension benefit obligations for purposes of SFAS No. 87
(Employers’ Accounting for Pensions) may not be appropriate for measuring
retiree group benefit obligations for the purposes of SFAS No. 106, because the
payment patterns may be different.

Economic assumptions not covered by ASOP No. 27 that are typically required
for measuring retiree group benefit obligations include the following:

a. Health Care Cost Trend Rate—The health care cost trend rate reflects the
change in per capita health claims rates over time due to factors such as
medical inflation, utilization, plan design, and technology improvements.
The actuary should consider separate trend rates for major cost
components such as hospital, prescription drugs, other medical services,
Medicare integration, and administrative expenses. Even if the actuary
develops one aggregate trend rate, the actuary should consider these cost
components when developing the rate. The actuary should consider the
following key components in setting the health care cost trend rate:
inflation, medical inflation, definition of covered charges, frequency of
services, leveraging caused by plan design features not explicitly modeled,
and plan participation. The actuary should not consider aging of the
covered population when selecting the trend assumption for projecting
future costs.

b. Other Cost Change Rates—The actuary should consider other costs that
may change in the future, such as the cost of life insurance and long-term
care insurance.

c. Participant Contribution ChangesDepending on the modeled plan, the


measurement may require an assumption for the rate of change in
participant contributions. For some plans, this may be a function of health
care trend rate or other economic assumptions. For some other plans, there
may be no contributions currently but plan limits and assumed trend rates
may make it likely that contributions will be required in future years. In
those cases, and depending upon the purposes of the measurement, the

17
actuary should determine when contributions are expected to be required
during the measurement period, and model subsequent increases
accordingly.

d. Adverse Selection and Changing ParticipationWhen a retiree group


benefits plan requires a contribution as a condition of continued
participation, those choosing to participate may have a higher average
benefit cost than those not participating. When a retiree group benefits
program requires a contribution or offers a choice of plans, it can be
expected that, over time, the process of adverse selection will have an
impact on plan costs.

The actuary should consider whether adverse selection will result from
such items as decreasing participation. Because the impact of any adverse
selection is very difficult to quantify over the long periods customary in a
retiree group benefits measurement, this standard does not require the use
of assumptions about adverse selection in measurement models. But if the
measurement assumptions project a significant decrease in the proportion
of eligible retirees who participate, the actuary should consider an upward
adjustment for adverse selection in per capita health care rates, or,
alternatively, moderate the assumed decrease in participants. The actuary
should document any adjustments made for adverse selection.

3.8.2 Demographic Assumptions—With respect to any particular measurement, each


demographic assumption the actuary selects should be consistent with the other
demographic assumptions the actuary selects. For example, if the mortality
assumption anticipates increasing life spans, the actuary should consider whether
the retirement assumption should reflect the fact that individuals may choose to
retire later because they are healthier or because they may not have sufficient
accumulated savings to afford a lengthened retirement period.

The actuary should comply with ASOP No. 35, Selection of Demographic and
Other Noneconomic Assumptions for Measuring Pension Obligations, when
selecting the retirement, termination, mortality, and disability assumptions to be
used in measuring retiree group benefit obligations. In applying ASOP No. 35, the
actuary should take into account the purpose and nature of the measurement and
the differences between the characteristics of retiree group benefit obligations and
the characteristics of pension benefit obligations. More refined demographic
assumptions may be required to appropriately measure retiree group benefit
obligations than are required to measure pension obligations. In determining
whether demographic assumptions developed primarily for pension benefit
measurements are appropriate for retiree group benefit measurements, the actuary
should consider the following:

a. Assumptions Based on Pension-Liability-Weighted Experience—Pension


plan termination and retirement rates may have been developed based on

18
pension-liability-weighted experience, which will reduce the effect of
participants terminating or retiring with smaller pension benefits. The
actuary should determine whether the pension plan termination and
retirement assumptions are appropriate for retiree group benefit plans and,
if not, modify the assumptions appropriately.

b. Disability—Assumptions regarding disability incidence, recovery,


mortality, and eligibility for Social Security disability benefits should be
consistent with the coverage provided to disabled participants under the
plan. When the actuary considers disabled life coverage significant to the
measurement, the actuary should select assumptions that appropriately
reflect when benefits are payable to disabled participants, the definition of
disability, and how the benefits are coordinated with other programs.

c. Retirement—The retirement assumption is critical in retiree health plan


measurements because of the higher level of primary coverage a retiree
receives prior to becoming eligible for Medicare. The actuary should
select explicit age-related retirement rates. A single average retirement age
is generally not appropriate.

d. Mortality—When the per capita health care rates are expected to increase
during the projection period, the results of the measurement may be
sensitive to the mortality assumption. Because of this sensitivity and the
observation that life expectancies have increased significantly over the
recent past, the actuary should consider reflecting future mortality
improvements. Pension benefit measurements may use unisex mortality
tables. Use of gender-specific mortality tables, however, may be more
appropriate for retiree group benefit measurements, depending on the
levels of retiree, spouse, and surviving spouse benefits as well as the
demographic composition of the covered population.

3.8.3 Coverage Assumptions—In addition to covering eligible retirees, many plans also
cover the spouse and dependents of retirees. Also, plans may offer some or all
participants a choice of coverages such as HMOs, PPOs, and POS plans. The
magnitude of the retiree group benefit obligation can vary significantly as a result
of the coverage assumption. The actuary should therefore consider historical
participation rates and trends in coverage rates when selecting the coverage
assumptions.

a. Plan Participation—For plans that require some form of contribution to


maintain coverage, some eligible individuals may not elect to be covered,
particularly if they have other coverage available. Empirical data on plan
participation, where available and credible, should be considered when
selecting the participation assumption for future retirees. When developing
the participation rates, the actuary should consider how plan eligibility
rules, plan choices, or retiree contribution rates have changed over time.

19
Furthermore, plan participation may be different in the future due to
participants’ response to changes in retiree contribution levels and plan
choices (for example, Medicare+Choice). For plans that anticipate changes
in retiree contributions the actuary should consider the appropriateness of
participation rates that vary over the projection period for both current and
future retirees. The actuary should consider plan eligibility rules governing
dropping coverage and subsequent reenrollment when selecting
participation rates.

b. Spouse and Dependent Coverage—The actuary should consider who is


eligible for coverage under the plan and make appropriate assumptions
regarding the coverage of spouses and dependents. The actuary should
also consider the impact of plan rules governing changes in coverage after
retirement, such as remarriage, if significant. The actuary should review
historical data on spouse and dependent coverage rates when selecting the
assumption to be used in the projection. If the gender mix of future retirees
and retired plan participants differs, the actuary should consider
developing separate spouse coverage rates for males and females.

c. Spouse and Dependent Age—Wherever practical, the actuary should use


actual data for the age of the spouse and dependents of retired participants.
If actual data is not available for all retired participants the actuary should
review the empirical data and develop an appropriate assumption for the
spouse age difference and dependents’ ages. The spouse and dependents
of an active employee today may not be the same spouse and dependents
covered at retirement, therefore the actuary should generally select an
assumed spouse age difference for purposes of projecting future spouse
coverage and assumed dependents’ ages for projecting dependent
coverage.

3.8.4 Effect of Plan Changes on Assumptions—When selecting projection assumptions,


the actuary should consider the impact of relevant plan design changes during the
measurement period. Whenever a plan design change is being modeled, the
actuary should consider whether or not assumptions, which in combination are
appropriate for measuring overall plan costs, are also appropriate for valuing the
element under study. For example, if a plan sponsor adds or advises the actuary of
its intent to add HMO coverage for a portion of its retiree group, the actuary
should consider how that affects the cost of current coverage, future cost trends,
and participation (including changes in coverage between plans).

Assumptions selected for purposes of estimating short-term cost increases or


decreases arising from a plan change may not be appropriate for developing the
long-term cost implications. For example, a change to the contribution level may
change participation in the plan, which may, in turn, have an impact on per capita
health care rates due to adverse selection after the change. A change in benefits or
cost-sharing may have a similar impact for a plan requiring participant

20
contributions. The actuary should exercise professional judgment about the
impact on long-term assumptions, but this standard does not require explicit
assumptions about changing participation rates or adverse selection.

Many plan sponsors have reserved the right to unilaterally change or terminate
their retiree welfare plans. When appropriate for the purpose of the measurement,
the actuary may include assumptions in the measurement model that attempt to
quantify the probability that the current plan will change significantly in the
future, beyond the changes already included in the modeled plan. For example,
the actuary might assume a probability of plan termination or assume a discount
rate with an additional risk premium that implicitly reflects the participants’
financial risk in receiving benefit coverage that is not guaranteed. The actuary
should disclose that such an assumption has been used. Such assumptions are not
appropriate for all measurement purposes. For example, SFAS No. 106 requires
that the actuary assume that the substantive plan will continue indefinitely.

3.8.5 Assumptions Considered Individually and in Relation to Other Assumptions—


The actuary should consider the reasonableness of each actuarial assumption
independently on the basis of its own merits and its consistency with the other
assumptions selected by the actuary. When selecting assumptions, the actuary
should consider the degree of uncertainty, the potential for fluctuation, and the
consequences of such fluctuation.

3.8.6 Reviewing Assumptions—The actuary is not required to do a complete


assumption study at each measurement date. However, at each measurement date
the actuary should consider whether the selected assumptions continue to be
reasonable. If the actuary determines that one or more of the previously selected
assumptions are no longer reasonable, the actuary should select reasonable new
assumptions in accordance with this section.

3.8.7 Changes in Assumptions—Whenever a change in an assumption is considered,


the actuary should review other assumptions to assess whether they remain
consistent with the changed assumption. For example, if the actuary is
anticipating more disabled participants due to recent experience, consideration
should be given to the impact on plan costs of the health risk of this group.

3.9 Selecting a Cost Allocation Policy—When the measurement involves the allocation of an
obligation to different time periods (including measurements that take into account plan
assets, plan amendments, or actuarial gains and losses), the actuary should select a cost
allocation policy, based on the following considerations:

3.9.1 Criteria for Acceptable Actuarial Cost Methods—The actuary should select an
actuarial cost method that meets the following requirements:

a. Limits on Allocation Period—The period over which the allocation is


made for an active participant should begin no earlier than the date of

21
employment and should not extend beyond the last assumed retirement
age. This period may be determined for each participant individually or for
the active participant group as a whole.

b. Reasonableness of Allocation Basis—The allocation basis should be


reasonable and produce an orderly allocation of the actuarial present value
of future plan benefit costs.

3.9.2 Dedicated Assets—In measuring the unfunded obligation and allocating costs to
time periods, the actuary should take into account dedicated plan assets, if any.

a. The actuary should collect data regarding the amounts and types of
dedicated assets held.

b. In general, the actuary should value the dedicated assets using a method
that takes into account market value, unless constrained to use an asset
valuation method prescribed by law or regulation. Asset valuation
methods include market value; market-related methods that smooth out the
effects of short-term volatility in market value; and methods that discount
the future cash flow of the underlying investments. The use of book or
cost value may be prescribed for some specific purposes (for example, in
determining tax on trust income under Section 512 of the Internal Revenue
Code).

c. The actuary should obtain sufficient details regarding insurance polices


held as dedicated assets to determine an appropriate value, reflecting the
nature of the contractual obligations upon early termination of the policies,
as well as the costs of continued maintenance of the policies. If the cash
surrender value of the policies is not readily determinable, the actuary
should rely on his or her professional judgment to develop an appropriate
value, depending on the purpose of the measurement.

3.9.3 Amortization Methods—Unless already reflected in the actuarial cost method, the
actuary should select a reasonable and systematic amortization method to
recognize changes in plan obligations arising from plan amendments (including
plan initiation), actuarial gains and losses, changes in assumptions, or changes in
the actuarial cost method.

3.9.4 Cash Flow Adequacy—Absent regulatory or legal restrictions, where a cost


allocation policy is used to determine funding requirements, the actuary should
select a policy that accumulates assets such that, absent experience losses,
adequate funds are on hand to pay benefits included in the measurement when
due.

Notwithstanding the above criteria, the actuary may be required to use a prescribed cost
allocation policy for a particular purpose (for example, for financial reporting purposes
under SFAS No. 106 the actuary is required to use the Projected Unit Credit Cost Method

22
and a defined approach to recognize changes in obligation arising from plan amendments
and actuarial gains or losses (see section 3.11)).

3.10 Use of Roll-Forward Techniques—The actuary may determine that it is appropriate to


use prior measurement results, using a roll-forward technique, rather than conduct a new
measurement.

3.10.1 Full and Partial Roll-Forward—Roll-forward techniques include full roll-forwards


of both claims and census data, as well as partial roll-forward techniques. For
example, the actuary may use partial roll-forward techniques that use health care
claim rates developed for the prior measurement trended forward to the current
measurement date coupled with updated census data.

3.10.2 Limitation—The actuary may use roll-forward techniques to reduce the frequency
of full measurements. In general, the actuary should not rely on prior
measurement results if the measurement date is three or more years earlier than
the current measurement date. For example, a January 1, 2000 measurement could
be used to develop roll-forward results as of January 1, 2001 and 2002, but should
not be relied upon for measurements or cost allocations after December 31 , 2002.

3.10.3 Appropriateness—Generally, the actuary should not use full roll-forward


techniques when the population, plan design, or other key model component has
changed significantly since the last full measurement.

3.10.4 Disclosure—Whenever the actuary uses a roll-forward technique, the actuary


should disclose such use in the actuarial communication.

3.11 Prescribed Assumptions, Cost Allocation Policies, or Other Model Components—When


the actuary uses assumptions, cost allocation policies, or other model components
prescribed by the plan sponsor or other binding authority, the actuary’s communication
should state the source of the prescribed elements. Examples are the initial per capita
health care rates prescribed by the plan sponsor and the discount rate basis and cost
allocation policy prescribed by SFAS No. 106.

3.12 Reasonableness of Results—The actuary should review the measurement results for
reasonableness. For example, the actuary could compare the overall measurement results
to benchmarks such as measurement of similar plans, or could review the results for
sample participants for reasonableness.

3.12.1 Modeled Cash Flows Compared to Recent Experience—The actuary should


compare the expected claims produced by the model for the first year from the
measurement date to actual claims over a recent period of years. If the expected
and actual claims are significantly different, the actuary should consider the likely
causes of such differences (for example, cost trends, large claims, a change in the
demographics of the group, or the volatility of experience in small plans), and
consider the impact of those differences on the reasonableness of the
measurement results.

23
3.12.2 Results Compared to Last Measurement—The actuary should compare the overall
results to the last measurement’s results when available and applicable. If the
results are significantly different from results the actuary expected based on the
last measurement, the actuary should consider the likely causes of such
differences. If another actuary performed the prior measurement, some allowance
may be made for differences due to different actuarial techniques or modeling.
The actuary should, if practicable, review the prior actuary’s documentation and,
if necessary, seek further information.

3.13 Sensitivity of Results to Chosen Assumptions—There can be a broad range of reasonable


results when measuring the present value of retiree health benefit obligations because
projected benefit payments are often uncertain and based on assumptions about future
claims. The combination of different present value factors applied to projected future
benefit payments produces wide variations in present values. For example, if a 1%
change in the discount rate produces a 20% change in the present value, and a 20%
change in initial per capita health care rates produces a 20% change in present value, then
changing both assumptions could produce a 44% change in the present value, or a 4%
change.

In light of the sensitivity of the results to key assumptions, the actuary should consider
the purpose of the measurement and use professional judgment when advising the plan
sponsor and presenting present values. In some instances the actuary may develop
alternative results using a range of reasonable assumptions.

3.14 Reliance on a Collaborating Actuary—The various elements of a retiree group benefit


measurement require expertise in the two different actuarial fields of health data analysis
and long-term projections. In recognition of the complexities involved, two or more
actuaries with complementary qualifications in the health and pension practice areas may
collaborate on a project. While each actuary may concentrate on his or her area of
expertise during the project, the actuary (or actuaries) issuing the actuarial opinion must
take professional responsibility for the overall appropriateness of the analysis,
assumptions, and results.

Section 4. Communications and Disclosures

4.1 Documentation—The actuary should maintain appropriate documentation regarding the


analysis of the known plan provisions, covered population, and claims and expenses, as
well as documenting the measurement model and the use of the model output.
Documentation should demonstrate how the actuary has met the requirements of sections
3.2–3.14 above. The methodology and assumptions used in the measurement should be
documented and, in some cases, made available for disclosure. In particular, ASOP No.
31 provides guidance on documenting the work of section 3.4 and 3.6–3.8 as applied to
ratemaking.

24
4.2 Disclosure—The actuary’s communication of the results of the measurement should
identify the data, assumptions, and methods used in the measurement with sufficient
clarity that another actuary qualified in this practice area could make an objective
appraisal of the reasonableness of the actuary’s work. In particular, this standard calls for
disclosure of the following:

a. information about known significant plan provisions, including anticipated future


changes (section 3.2.1(f)), any combining of plans (section 3.3.7) for
measurement purposes, and a description of any known significant plan
provisions not reflected in the model;

b. significant information about the covered population;

c. the initial per capita health care rate assumptions (including the use of normative
data or premium rates), assumed future trends, and all other significant projection
assumptions;

d. significant modeling techniques and methods, such as those mentioned in sections


3.4.12, 3.4.13, 3.8.4, and 3.10;

e. identification, including the source, of any assumptions, methods, or other model


components prescribed by the plan sponsor or other binding authority;

f. significant and unresolved inconsistencies in data or administration, such as those


mentioned in sections 3.6 and 3.7; and

g. information significant to interpreting measurement results.

To the extent the disclosures identified above have been described in a previous actuarial
communication available to the intended audience, such disclosures, if appropriate for the
circumstances, may be incorporated by reference.

4.3 Prescribed Statement of Actuarial Opinion—This ASOP does not require a prescribed
statement of actuarial opinion (PSAO) as described in the Qualification Standards for
Prescribed Statements of Actuarial Opinion promulgated by the American Academy of
Actuaries. However, law, regulation, or accounting requirements may also apply to an
actuarial communication prepared under this standard, and as a result, such actuarial
communication may be a PSAO.

4.4 Deviation from Standard—An actuary must be prepared to justify the use of any
procedures that depart materially from those set forth in this standard and must include,
in any actuarial communication disclosing the results of the procedures, an appropriate
statement with respect to the nature, rationale, and effect of such departures.

25
Note: The following appendixes are provided for informational purposes, but are not part of the
standard of practice.

Appendix 1

Background and Current Practices

Background

Actuarial Standard of Practice (ASOP) No. 6, originally titled Measuring and Allocating
Actuarial Present Values of Retiree Health Care and Death Benefits, was adopted by the ASB in
October 1988. Because measuring retiree health and death benefits was a new and emerging field
and because it would become a new practice area for many actuaries, this standard was needed to
provide guidelines regarding what was acceptable actuarial practice. The original ASOP No. 6,
however, purposely provided a high degree of flexibility to allow for emerging understanding in
this developing practice area.

In December 1990, the Financial Accounting Standards Board issued Statement of Financial
Accounting Standards (SFAS) No. 106, Employers’ Accounting for Postretirement Benefits
Other Than Pensions. SFAS No. 106 generally requires plan sponsors to recognize the cost of
providing retiree group benefits over an employee’s service period. Before the implementation of
SFAS No. 106, most plan sponsors accounted for retiree group benefits on a pay-as-you-go
basis. Therefore, at the time SFAS No. 106 was implemented, few actuaries had any experience
measuring retiree group benefit obligations and practices for performing such measurements
were not consistent.

Actuarial Compliance Guideline No. 3, For Statement of Financial Accounting Standards No.
106, Employers’ Accounting for Postretirement Benefits Other Than Pensions, was adopted in
October 1992. ACG No. 3 was written with a great level of detail and with a high level of
educational content for the same reasons as ASOP No. 6.

Since the adoption of ASOP No. 6, ACG No. 3, and SFAS No. 106, both the design of retiree
group benefits and the actuarial practices for measuring retiree group benefit obligations have
evolved. Faced with the recognition of large unfunded liabilities for retiree health care benefits,
many plan sponsors have taken steps to reduce their retiree group benefit obligations. Often, this
has meant introducing or increasing participant contributions (including placing fixed dollar
limits on the average plan sponsor obligation per person, with the balance to be paid by
participant contributions). Participant contributions have not always been implemented
consistent with the plan sponsor’s objectives. For example, participant contributions may, in
practice, have been set based on combined active and retiree claims, resulting in “hidden” plan
sponsor subsidies (see “Participant Contributions” in appendix 2 for more detail).

Other types of plan design changes intended to reduce plan sponsor obligations include
restricting eligibility for plan benefits (including requiring preretirement contributions), reducing

26
annual or lifetime benefit limits, and changing the way the plan integrates with Medicare. But
here again, actual plan operation may not be fully consistent with the plan sponsor’s intent. For
example, the claims payer may not have the data or systems necessary to implement lifetime
limits on plan benefits.

The actuary may be in the best position to identify such discrepancies between the plan sponsor’s
stated intent and actual plan operation. Often the plan sponsor has divided internal responsibility
for administration of the retiree group benefit plan between different departments. The actuary
may be the only person to have seen data elements and plan provisions as a whole. Plan sponsor
policy may not have considered subsequent changes in future eligibility, cost levels, medical
practice, health care delivery systems, or other plan elements that have a significant effect on
financial obligations. Written provisions regarding aspects of dependent coverage, contribution
levels required from participants, and integration with Medicare may be absent. As a result, data
that the actuary receives may conflict significantly with information received about known plan
provisions or administration.

Current Practices

Actuarial practices for measuring retiree group benefit obligations have evolved since
SFAS No. 106 was implemented. As noted above, actuaries have recognized the importance of
evaluating information about plan operations (including actual participant contribution levels,
participation rates, and retiree claims data) as well as plan documents and plan sponsor policies
to resolve any inconsistencies. As a result of the trend toward greater retiree cost-sharing, the
modeling of participant contributions has become increasingly important. This includes
appropriately reflecting the effect of increased participant contributions on plan participation and
per capita health claims rates of those electing to participate.

Measuring retiree group benefit obligations generally requires expertise in both the development
and projection of health care claims rates and the long-term projection of the covered population.
Therefore, it is common for two actuaries with complementary qualifications (such as a pension
actuary and a health care actuary) to collaborate on a measurement. In some cases, it may not be
clear which actuary has taken professional responsibility for the overall appropriateness of the
analysis, assumptions, and results.

The models used to value retiree health care benefit obligations have become increasingly
sophisticated. Models commonly use age-specific initial per capita health care rates within the
retired population (for example in individual age brackets). Some of these models are based on
net incurred claims, while other models are based on gross expenses incurred reduced by
amounts paid outside the plan or not covered by the plan. Some models project a distribution of
expected claims with an associated probability distribution, while other models use separate age-
specific per capita claim rates for the last year of life and for survivors.

Despite the development of these more sophisticated approaches, some actuaries continue to use
highly simplified models. Examples include using pension census data as the basis for the
measurement, using only two initial per capita health care rates (for Medicare eligible

27
participants and for participants who are not yet eligible for Medicare), and developing initial per
capita health care rates based solely on premiums or normative databases. Such simplified
approaches may result in significantly understated or overstated retiree group benefit obligations
for the following reasons:

1. Retiree group benefit eligibility requirements are often different from pension benefit
eligibility requirements, so pension census data may not appropriately reflect retiree
group benefit plan participation;

2. Significant discrepancies between the plan sponsor’s stated policy and actual plan
operation may not be identified and “hidden” subsidies may not be valued;

3. Normative databases may be applied inappropriately, or may be outdated;

4. The effects of aging of the retired population on future per capita claim rates may not be
appropriately taken into account; or

5. The impact of expected future participant contribution increases on future participation


and projected per capita claim rates of participants may not be appropriately reflected.

28
Appendix 2

Supplementary Information

Normative Databases

In the absence of credible plan experience, a normative database can provide support for
assumptions about the probability of future events or likely relationships between variables.
Examples of normative databases include published mortality and disability tables, proprietary
rate manuals, and experience on similar retiree group benefit plans. However, normative
databases also have limitations, including the following:

1. normative databases lose relevancy over time;

2. a normative database may not be appropriate for the particular situation at hand; and

3. many normative databases have not been subject to rigorous development and review.

Measurements Using Premium Rates

A premium is the price charged by a risk-bearing entity, such as an insurance or managed care
company, to provide risk coverage. The premium usually has a basis in the expected value of
future costs, but the premium will also be affected by other considerations, such as marketing
and profit goals, competition, and legal restrictions. Because of these other considerations, a
premium for a coverage period is not the same as the expected cost for the coverage period.

The demographics of the group for which the premium was intended may be different from the
demographics of the group being valued. When these two groups are different, the premiums are
unlikely to reflect the expected health care costs for the group being valued, even if it is a subset
of the total group for which the premium was determined. In particular, the expected value of
future costs for a group of retirees is unlikely to be the same as for a group consisting of actives
and the same retirees. Examples of this are shown in the “Participant Contributions” section
below.

This standard notes numerous ways the demographics of two groups can differ, but a difference
that is quite likely to have an effect on rates is a difference in average age, or age distributions, of
two groups. This, of course, is particularly likely to occur when one group contains retirees and
active employees while a second group consists only of retirees. But differences can also be
significant within a group made up entirely of retirees, even retirees who are all eligible for
Medicare. When a rate applies over a broad age range, it may misrepresent the average cost at
applicable ages much older or younger than the central age of the range to which the rate applies.
Consequently, many actuaries use a separate initial per capita health care rate assumption for
each age within a range where there are wide variations, such as rates that differ for every age

29
from 60 to 75 or from 55 to 80. (This also may have an effect on costs in future years and is
addressed again below in the “Health Care Trend Rate” section.)

The term “premium rate” is used for both insured group plans and self-insured group plans. In
the case of self-insured plans, the “premium rates” may also be referred to as “budget rates” or
“phantom premiums.” Future changes in insured premiums are frequently affected by the
experience of the insured group. When they are not directly affected by the experience of any
one group, but rather by experience of a community of groups, the plans are referred to as
“community-rated.” Further comments about these common types of retiree group benefit plan
premiums follow:

1. Self-Insured Premiums—Some self-insured plans have expenditures that the plan sponsor
refers to as “premium rates.” These rates may reflect the experience of retirees, active
employees, or both. Also, the rates may reflect only expected claims experience, or may
include other adjustments (such as administrative expenses and stop-loss claims and
premiums). Furthermore, the rates may reflect the effect of the plan sponsor's
contribution or managed care strategy.

2. Community-Rated Premiums—In some regulatory jurisdictions, community-rated


premium rates are required by statute for some fully insured plans. There is variation in
the structure of community-rated premium rates. For example, retirees not eligible for
Medicare may be included with active employees in a community-rated premium
category, while retirees eligible for Medicare may be included in a separate community-
rated premium category. There are also different community-rating methodologies, some
incorporating group-specific characteristics. Note that a community-rated premium
including both retirees not eligible for Medicare and active employees probably
understates the expected claim cost for the retirees alone. If the insurer appears to be
committed to continuing such subsidy for the retirees, there is some justification for
valuing future retiree costs for the postretirement plan sponsor with the community rate
as the basis, although the plan sponsor may want to know of the apparent subsidy and the
possibility that it might not be available in the future. There is also some justification for
valuing future retiree costs with the higher expected claim cost for retirees as the basis,
since the subsidy may disappear.

3. Other Fully Insured Plans—In addition to community-rated plans, there are other types of
fully insured plans and there can be some variation in how actual plan experience affects
the premiums. The same comments mentioned above for self-insured premiums apply
here.

Health Care Trend Rate

The health care trend rate reflects the change in per capita health claims cost over time. The trend
rate may differ by major cost components such as hospital, prescription drugs, other medical
services, Medicare offsets, and administrative expenses. The health care trend rate is affected by
the following interdependent factors:

30
1. Inflation—General economic inflation defined as price changes over the whole economy.

2. Medical Inflation—Changes in the per-unit prices of medical supplies and services


covered by the plan.

3. Covered Charges—The definition of charges that are covered by the plan will determine
how inflation and medical inflation affect per capita health care claims cost. For example,
if the plan pays benefits based on a fixed schedule of benefits, the cost of services is
controlled by the plan’s schedule. If the services on the schedule and the dollar amounts
are not changed, the underlying cost inflation of the plan will be zero.

4. Utilization of Services—This factor considers the change in frequency of health care by


type of services over time, as well as the nature of services due to changes in medical
practice and technology.

5. Leveraging Caused by Plan Design Features—The net plan cost under health plan
designs with fixed-dollar cost-sharing will increase faster than the total costs. For
example, for a prescription drug costing $50 today and a plan design with a $20 copay
per prescription, a 20% increase in the cost of the drug (from $50–$60) will increase the
net plan cost by 33%, from $30 ($50–$20) to $40 ($60–$20).

6. Aging—The aging of the covered population may have contributed to historical health
care cost changes. The use of age-graded per capita health care rates for projecting future
health care costs removes this aging component from the future trend assumption.

7. Participation—If a lower percentage of eligible individuals elect coverage (for example,


because of increasing participant contribution rates or competing plans such as HMOs),
per capita health care claims costs may increase due to adverse selection.

Interaction Between Trend and Plan Provisions

Plan provisions and health care trend rates in combination impact the projected net per capita
health care rates. Examples of the interaction of plan provisions and health care trend rates
include the following:

1. Covered charges can be affected by limits on allowable provider fees and the plan’s
Medicare integration approach. Benefit plan provisions may help in identifying these
limits, as well as what services are covered.

2. Health plan deductibles may or may not be set at a fixed-dollar amount. Health care trend
will, over time, erode the relative value of a fixed-dollar deductible.

3. Coinsurance payments may be expressed as a percentage or fixed-dollar amount. Again,


over time, trend will erode the relative value of a fixed-dollar coinsurance.

31
4. The Medicare program provides coverage for most U.S. retirees over age 65; however,
the retiree group benefits plan may cover a different mix of services than Medicare.
Trend rates may differ between Medicare-covered services and the retiree group benefit.

5. Other payments or offsets may exist, such as subrogation recoveries or plans other than
Medicare. These payments or offsets may change in the future.

6. Lifetime and other maximum dollar limits also affect claims costs, and the effect can
change over time.

Participant Contributions

Participant contributions are very important to the financial understanding of how retiree health
plans work. Plan sponsors must advise participants and plan administrators as to the specific
dollar amounts of currently required contributions. Plan sponsors usually have administrative
policies for determining future contributions (formulas, subsidy limits, or overall contribution
philosophy). Based on the required contributions, an individual will decide whether to
participate, which may result in adverse selection.

Formulas, subsidy limits, and the contribution philosophy of the plan sponsor are subject to
different interpretations about what data and techniques are to be used in deriving the current
monthly contribution used in the measurements of retiree group benefit obligations. Here are two
examples:

1. The plan sponsor’s stated policy is that retirees who are not yet Medicare eligible will
contribute 50% of the cost of their health care benefits. However, the plan sponsor
determines a retiree contribution of $100 per month ($1,200 per year) based on average
annual per capita health care claims of $2,400 for active employees and pre-Medicare
retirees combined. When the actuary evaluates the claims experience of pre-Medicare
retirees separately from that of the active employees, the actuary determines that the
average annual claim per retiree is $4,000. So the plan sponsor subsidy is really $2,800 or
70%, not the stated 50%.

2. A “defined dollar benefit” plan sponsor will pay $2,000 annually toward retiree health
care coverage for retirees who are not Medicare eligible. The plan sponsor determines an
annual retiree contribution of $500 based on average per capita claims of $2,500 for
active employees and pre-Medicare retirees combined. However, when the actuary
evaluates the claims experience for pre-Medicare retirees, the average annual claims per
retiree is determined to be $4,500. The actual plan sponsor subsidy is $4,000 ($4,500
average claims per retiree less $500 retiree contribution)—double the “defined dollar
benefit” of $2,000.

Once the contribution is determined for the current year, future increases can then be
incorporated into the model. The contribution increase assumption is often a function of the

32
claims trend assumption. If the model assumes contributions increase at the same trend as
assumed for age-specific claims rates, the projected contributions will not have a constant
relationship to projected claims, due to the aging of the population.

Some plans impose conditions such that contributions will begin a certain pattern at some
triggering point in the future. This can happen in a number of ways, but the most common may
be the use of “cost caps,” where the sponsor has limited its subsidy to an annual amount per
capita that has not yet been reached. Participant contributions may or may not be required
currently, but after the cap is reached participant contributions are to absorb all the additional
costs. After the caps have been reached, this design is akin to the defined dollar approach, but
before that point, the plan sponsor’s costs will increase. The assumptions about future health care
trend rates (interacting with the cost caps) will increase projected costs to a time when the caps
are reached, and thereafter participant contributions will increase.

Finally, participation rates may be lower when contributions are required. Assumptions about
lower participation rates can vary by small amounts and yet result in large differences in present
values. Furthermore, lower participation may result in adverse selection on the part of
participants. The combination of lower participation and adverse selection assumptions may or
may not be significant in a measurement model.

Assets

Retiree group benefits are generally not subject to minimum funding requirements; however, a
number of plan sponsors have, for various reasons, accumulated assets dedicated to fund the
retiree group benefits. These assets provide some measure of financial security for the
participants and reduce the plan sponsor's unfunded obligation, thereby reducing the future
funding needs.

1. Dedicated Assets—Certain assets set aside to provide for the plan sponsor’s modeled
benefit may partially or completely offset the retiree group benefit obligation. Examples
include the following:

a. whole life insurance policies held by the plan sponsor to cover some of the plan
sponsor’s retiree death benefits;

b. welfare benefit trusts (for example, VEBAs in the U.S.); and

c. section 401(h) accounts in a qualified pension plan in the U.S.

2. Non-Dedicated Assets—Several plan sponsors have purchased life insurance policies (so
called corporate-owned life insurance or COLI policies) with the intent that the proceeds
of the policies will “fund” emerging retiree welfare benefits. Even though these policies
may have been “earmarked” for funding retiree group benefits, they remain corporate
assets and are not taken into account in measuring the plan sponsor’s unfunded
obligations.

33
Compliance with Other Requirements

The following provide guidance for the measurement of retiree group benefit obligations
performed for specific purposes. The list represents rulemaking bodies and specific references as
of the publication date of this standard, and is not intended to be exhaustive.

1. Financial Accounting Standards Board (FASB)—Accounting for financial statements for


companies that comply with U.S. generally accepted accounting principles (GAAP).
Current standards applicable to retiree group benefits include SFAS Nos. 88, 106, 132,
and 135.

2. American Institute of Certified Public Accountants (AICPA)—The AICPA provides


audit and accounting guidelines for its members. Current guidelines include the AICPA
Audit and Accounting Guide, Audits of Employee Benefit Plans, and Statements of
Position (SOP) 01-2, Accounting and Reporting by Health and Welfare Plans, and 94-6,
Disclosure of Certain Significant Risks and Uncertainties.

3. U.S. Internal Revenue Code (IRC)—Various sections of the IRC govern the funding of
retiree group benefits, including sections 401(h), 404, 419, 419A, 420, and 512, and the
regulations and other rulings that interpret the code.

4. Cost Accounting Standards Board (CASB)—The CASB is responsible for developing


accounting standards for U.S. government contracting. Current applicable standards are
CAS 412, 413, 416, and the proposed CAS 419.

5. Federal Acquisition Regulations (FAR)—The FAR are regulations governing the


acceptability of costs for U.S. government contracts. FAR 31.205-6 provides guidance
for retiree group benefit costs.

6. Government Accounting Standards Board (GASB)—The GASB promulgates accounting


standards for state and municipal governments. GASB 26 provides rules for disclosure of
retiree group benefit obligations.

7. National Association of Insurance Commissioners (NAIC)—The NAIC provides model


regulations for insurance company accounting that individual states may use directly or
modify for their particular circumstances. The NAIC has issued Statement of Statutory
Accounting Principles No. 14 that addresses rules for insurance companies with retiree
group benefits.

8. International Accounting Standards Committee (IASC)—The IASC issues international


accounting standards that each country’s accounting profession may use as its GAAP.
IAS 19 provides guidelines for retiree group benefit plans.

34
Appendix 3

Comments on the Exposure Draft and Task Force Responses

The exposure draft of this actuarial standard of practice was issued in October 2000, with a
comment deadline of March 31, 2001. (Copies of the exposure draft are available from the ASB
office.) Twenty-two comment letters were received. The Task Force on Retiree Group Benefits
of the ASB carefully considered all comments received. Summarized below are the significant
issues and questions contained in the comment letters and the task force’s responses.

GENERAL COMMENTS

Comment Some commentators requested the reorganization of various sections and appendixes.

Response The task force incorporated some suggestions into the standard. Other suggestions were inconsistent
with ASB standard format and thus not implemented.
Comment Several commentators suggested slight changes to the wording in nearly all sections of the standard.

Response The task force implemented such suggestions if they enhanced clarity and did not alter the intent of the
section.
Comment Some commentators requested language to deal with specific SFAS No. 106 or SOP 92-6 accounting
issues.

Response The task force directs all readers to the accounting profession for clarification of specific accounting
issues.
TRANSMITTAL MEMORANDUM
In the transmittal memorandum of the exposure draft, the task force solicited comments on the key issues contained
in the draft. These comments and the task force’s responses to them have been incorporated in the applicable sections
below.
Comment Some commentators requested that ACG No. 3 not be replaced by this revision due to the perceived
need for the material pertaining specifically to SFAS No. 106 that is not retained in this revision.

Response The ASB’s current policy is to avoid publishing as a standard any material that is largely educational in
nature, such as ACG No. 3. Educational material is included where appropriate in the appendixes. The
task force understands the commentators’ concern and wants to encourage the further development of
educational material related to all aspects of retiree group benefits; however, we agreed with the ASB
that such material should not be codified as a professional standard.
SECTION 1. PURPOSE, SCOPE, CROSS REFERENCES, AND EFFECTIVE DATE

Section 1.2, Scope


Comment One commentator asked whether plan design projects should be included in the standard’s scope.

Response The task force recognizes that not all plan design projects involve the measurement of obligations; those
that do would be within the scope of this standard. Therefore, the task force modified section 1.2(d) to
expand that part of the definitions to explicitly include plan design projects that are cost-based.

35
Section 1.4, Effective Date
Comment One commentator requested a later effective date; other commentators pointed to the need to clarify the
effective date language.

Response The task force clarified the language regarding the effective date of the standard; however, the primary
effective date was not changed.
SECTION 2. DEFINITIONS

Section 2.1, Actuarial Cost Method


Comment One commentator suggested the deletion of the “more than one” phrase.

Response The task force agreed and modified the definition accordingly.
Section 2.2, Adverse Selection (previously titled “Antiselection”)

Comment One commentator suggested that “Antiselection” was a misnomer and that it be replaced with “Adverse
Selection.”

Response The task force agreed and modified the name.


Section 2.7, Dedicated Assets (previously section 2.4)
Comment One commentator stated that the definition should be expanded to include assets held in trust.

Response The task force modified the definition to broaden the scope.
Section 2.11, Medicare-Eligible Participant (previously section 2.8)
Comment One commentator thought this definition had extraneous wording.

Response The task force agreed and removed the extraneous wording.
Section 2.12, Medicare Integration (previously section 2.9)
Comment Two commentators suggested that Medicare Supplement Plans be included in this definition.

Response The task force agreed that Medicare Supplement Plans are prevalent; however, these plans are a
supplement to Medicare and do not integrate with Medicare.
Section 2.14, Participant (previously section 2.11)
Comment Several commentators suggested that the definition of participant was too broad.

Response The task force agreed and modified the definition. The task force also added a sentence to section 3.3 to
clarify that open group measurements are permitted but not required.
Section 2.15, Retiree Group Benefits (previously section 2.12)
Comment Two commentators suggested changes to this definition. One was concerned that the definition was not
clear that death benefits paid from a retirement income plan are not retiree group benefits.

Response The task force believed that the definition was sufficiently clear and made no modifications.

36
Comment One commentator questioned whether a plan is a retiree group benefits plan if all it provides is that
participants are allowed to self-pay for coverage from their retirement date until Medicare eligibility.

Response The task force intended such a plan to be a retiree group benefits plan, covered broadly in the definition,
and did not believe a change in the definition was needed to convey that intent.
Section 2.19, Trend (previously section 2.16)

Comment Several commentators were concerned that the definition did not exclude aging or age-related morbidity.

Response The task force chose not to narrow the definition, although it recognizes that “trend” can be defined to
include or exclude age-related morbidity. The task force shares the commentators’ concern that
demographic changes due to the changing makeup of a population should not be included in a trend
factor used to project the future cost when age-specific rates are being projected. Section 3.8.1(a) states
that for the purposes of projection assumptions, trend should not include the effects of aging. For the
purposes of determining the initial per capita health care rate from claim experience (section 3.4),
however, the effect of aging in past trend is difficult to separate from other factors. The task force did
not believe this standard should mandate the use of age-specific trend factors in analyzing past
experience.
SECTION 3. ANALYSIS OF ISSUES AND RECOMMENDED PRACTICES
Section 3.2.1, Components of the Modeled Plan
Comment One commentator thought the list of major plan provisions should be expanded. Another thought that the
list should not be included and that the actuary should determine the major plan provisions. A third
commentator was concerned that the section contradicted the SFAS No. 106 requirement that no
assumption with regard to future changes in government programs be made.

Response The task force did not intend for the list to be all-inclusive; however, the task force believed that these
are the minimum components that should always be modeled. In regard to the third commentator’s
concerns, the task force refers the commentator to section 3.2.1(f).
Comment One commentator was concerned that section 3.2.1(a) required that a “gross claim” model be used.

Response The task force modified the wording to remove such a requirement.
Comment With respect to section 3.2.1(b), one commentator suggested that the standard should provide more
discussion pertaining to the modeling of lifetime maximums.

Response The task force believes that this is not a practice area where appropriate guidance has emerged.
Comment One commentator expressed concern that section 3.2.1(c)(2) required the actuary to act as the auditor.

Response The task force agreed and modified the section heading and wording accordingly.
Comment With respect to section 3.2.1(c)(4), one commentator expressed concern about requiring the actuary to
determine the year the limit is reached and the implications of reaching it.

Response The task force disagreed with the commentator on the necessity of knowing when the limit will be
reached. Such information is crucial to appropriately determining the obligation associated with such a
cap. The task force, however, did agree that the “implications” wording was not clear and removed this
language.

37
Comment One commentator suggested that section 3.2.1(c)(5) be deleted since participation rates are covered in
section 3.8.3(a).

Response The task force agreed that participation rates are more appropriately addressed in the later section and
deleted the paragraph.
Comment With respect to section 3.2.1(f), two commentators stated that SFAS No. 106 allows for recognition of
changes other than those that have been communicated.

Response The task force agreed and modified the wording of this section to include changes that are the result of
the continuation of a historical pattern.
Section 3.2.2, Historical Practices
Comment One commentator thought that section 3.2.2(a) was too onerous and that the actuary needs to establish
only “a reasonable level of comfort” that the benefits provided are consistent with major plan provisions.

Response The task force agreed and modified the language.


Comment With respect to section 3.2.2(c), one commentator stated, “[I] do not believe it is the actuary’s
responsibility to determine whether a past practice or a pattern of regular changes indicates a
commitment by the plan sponsor to make future changes to the plan.”

Response The task force agreed that the actuary should not be responsible for determining the plan sponsor’s
“commitment.” The actuary, however, may include the continuation of such past practices in the model.
Comment One commentator thought that section 3.2.2(d) did not belong in the “Historical Practices” section.

Response The task force believed that the language on “Government Programs” was appropriately placed in the
“Historical Practices” section, but it clarified the language.
Section 3.3, Modeling the Covered Population
Comment Several commentators noted that no mention was made of open group valuations, while others were
concerned that the standard required the use of open group valuations.

Response The task force revised the text to indicate that while the standard does not require the use of open group
measurements, they may be used when appropriate.
Comment A commentator suggested that the term “covered population” be included in the set of definitions.

Response The task force agreed and added a definition.


Section 3.3.2, Employees Currently Not Accruing Benefits
Comment One commentator suggested section 3.3.2 be clarified to distinguish between employees who are not
accruing service and never expected to do so, and those who, while not currently accruing service, are
expected to do so in the future.

Response The task force agreed and modified the language.


Section 3.3.3, Contingent Participants
Comment One commentator questioned the need to develop reentry assumptions when measuring contingent
participants. The commentator suggested that the actuary should determine if any significant obligation
exists and only when this is so should the obligation be reflected in the measurement. Otherwise, the
actuary should disclose that reentry possibilities were left out of the measurement.

Response The task force modified the language to clarify that appropriate measures should be taken when
individuals may reasonably be expected to become participants. The task force believes that additional
disclosures on this element of the model are not needed.

38
Section 3.3.4, Spouses and Survivors of Participants (previously titled “Spouses and Surviving Spouses of
Participants”)
Comment One commentator expressed concern about including spouses in the modeled population, when, based
on the commentator’s experience, these data often are not available.

Response While the task force understands that complete information on spouses may not be available for all
measurements, the importance of the spousal obligation to the measurement requires that the actuary
model spouses and surviving spouses in the covered population. The task force believes the current
language is sufficiently broad to allow the actuary to use both empirical data, where available,
supplemented by reasonable assumptions where necessary.
Section 3.3.5, Dependents
Comment Several commentators found this section confusing.

Response The task force redrafted the section to clarify the intent.
Section 3.3.6, Appropriateness of Pension Plan Data
Comment Several commentators suggested alternative language and additional examples of edits and adjustments
to pension plan data to represent the retiree group plan covered population.

Response The task force considered these suggestions and incorporated them in the revised text.
Section 3.3.7, Use of Grouping
Comment One commentator raised a concern about the requirement to disclose the use of grouping, which the
commentator did not see as standard practice. Another commentator was concerned that the requirement
to disclose the use of grouping techniques may be interpreted to imply that some imprecision results
from grouping.

Response The task force incorporated suggested text changes to clarify that grouping techniques may be
appropriate when, in the actuary’s judgment, this is not expected to unreasonably affect the
measurement results.
Section 3.4, Modeling Initial Per Capita Health Care Rates
Comment One commentator suggested that the initial paragraph of section 3.4 include the word “credible” before
“plan experience” in the third sentence.

Response The task force made no change since it believes the last sentence of the paragraph appropriately
addresses the issue of credibility.

Comment Two commentators requested guidance on the use of plan experience for small plans. One commentator
remarked that even if detailed claim information were available for small plans, it generally would not
be credible.

Response The task force did not revise the standard to address small plans specifically, but did expand the
discussion of premium rates in appendix 2. The task force also notes that while plan experience for a
small plan may not be fully credible, that does not mean the plan experience has no credibility. ASOP
No. 25 is recommended for guidance in regards to assigning credibility to experience data.
Comment One commentator noted that ASOP No. 31 also had relevance to ratemaking aspects of sections of the
standard other than section 3.4.

Response The task force agreed and modified that reference accordingly.

39
Comment The task force received several comments regarding the development of the initial per capita health care
rate and the actuary’s responsibility to document that development.

Response The task force addresses those comments below in relation to section 4.1. The task force believes
development of per capita claim rates for measuring retiree health benefit obligations should be subject
to a ratemaking process, whether the purpose is cost projections, financial reporting, or other actuarial
work within the scope of this standard. The task force also notes that ASOP No. 31 is not a standard on
ratemaking, but rather provides “guidance on documentation in the process of health benefit plan
ratemaking.”
Comment One commentator suggested that the standard address situations where another person or organization
gives the actuary the rates.

Response The task force believes the standard addresses this by noting the handling of premium rates in section
3.4.5 and reliance on a collaborating actuary in section 3.12. The development of initial per capita health
care rates for measuring retiree health obligations is an actuarial responsibility. Others will furnish
information during the measurement process and tasks in the development process may be delegated to
non-actuaries, but the professional judgment of an actuary is necessary in determining the initial per
capita health care rates (section 3.4) and ensuring its consistency with the rest of the model (sections 3.6
and 3.12).
Comment One commentator suggested that gender be added to the list of elements the actuary should consider.
Another commented that spouse rates and disabled rates should be considered.

Response The task force expanded the third paragraph to indicate examples of when multiple rates may be
appropriate. The task force also notes that section 3.4.2 mentions gender.
Comment One commentator suggested the section include material on expenses.

Response The task force made no changes, noting that the first sentence mentions benefit costs rather than claim
costs, and section 3.4.14 covers administrative costs.
Comment One commentator disagreed that the second paragraph of section 3.4 outlined a process generally used,
citing the use of actual-to-expected studies.

Response The task force believes the standard accommodates other methods, which would include the use of
normative databases and actual-to-expected studies, when plan experience is not sufficiently credible.
The task force is aware there may be differences of opinion as to when, and to what extent, plan
experience should be tempered with normative data. The task force believes this should be left to the
actuary’s judgment but that there should be a bias towards plan experience. Appendix 2 notes some of
the limitations of normative databases. The second paragraph of section 3.4 was intended to outline the
process, however, and not establish a requirement, so the task force deleted “the actuary should follow”
from the opening sentence in this paragraph. Similarly, other wording in the first two paragraphs was
modified to clarify the preference for credible historical plan claims experience and the use of alternative
methods.

40
Section 3.4.1, Net Aggregate Claims Data
Comment Two commentators questioned whether the last sentence of section 3.4.1(a) implied that differences
between paid claims and incurred claims for the same time period were always insignificant or that
factors of trend and discount always offset each other.

Response The task force believes the full paragraph adequately addresses the likely significance of the differences.
The task force also recognizes that, while the usual objective of claims analysis is the development of an
incurred rate, a valuation of future paid claims may be valid, since determination of the present value of
long-term obligations is based on the principles of discounted cash flow. The standard guides the actuary
reviewing past aggregate claims to acknowledge differences in paid and incurred claims, as well as the
effects of trend and the time value of money, and make adjustments to enhance the ability to forecast
likely future claims levels.

Comment One commentator suggested the first sentence of section 3.4.1(b) was not clear.

Response The task force clarified the language.


Comment One commentator suggested that, “To the extent that net claims are used, the actuary should consider the
effect of their use on other assumptions, (e.g., trend assumption).”

Response The task force agrees that the actuary should consider the effect of trend assumption and other
assumptions, regardless of whether the initial per capita health care rate is based on net or gross claims.
The task force believes the issue is addressed in section 3.8, particularly in section 3.8.1(a), which
mentions leveraging caused by plan design features that are not explicitly modeled.
Section 3.4.2, Exposure Data
Comment Three commentators suggested the need to compare exposure data and the census even though they are
not expected to match exactly.

Response The task force agreed and modified the language accordingly.
Section 3.4.3, Use of Multiple Claims Experience Periods
Comment Three commentators noted that more recent experience is not always more reliable.

Response The task force agreed and modified the language accordingly.

Section 3.4.4, Credibility


Comment One commentator suggested that credibility adjustments should include those for differences in plan
design.

Response The task force agreed and modified the language accordingly.
Section 3.4.5, Use of Premium Rates
Comment One commentator noted that the second sentence of the section did not add clarifying value to the
section.

Response The task force agreed and combined the important elements of the sentence with the initial sentence.

41
Comment One commentator suggested that section 3.4.5 pertain only to self-insured plans and that fully insured
plans need not be subject to this section, particularly if they consist solely of reimbursing insurance
premiums.

Response The task force believes there is consensus among actuaries performing retiree group benefit
measurements about the almost universal need for adjustments when using premiums as the basis for
projected future cost, regardless of whether the plan is fully insured or self-insured. The “Measurements
Using Premium Rates” section of Appendix 2 provides additional comments on this issue.
Comment The same commentator suggested that the impact of aging is often effectively included in the trend rates.

Response The task force believes that the future impact of aging on health care costs of a given population of
actives and retirees does not have a strong enough correlation to trend to be effectively included in the
trend assumption. The standard requires a separation of the impacts of age and trend through the use of
age-specific per capita claims rates (see section 3.4.7).
Comment Several comments were received about the second paragraph concerning community rates.

Response The task force discontinued the use in the standard of the concept of community-rated premium after
recognizing that the term was unlikely to have a satisfactory common definition. The task force
modified the language concerning the use of premium rates as the basis for an initial per capita health
care rate assumption to clarify the significance of age differences in determining rates and to exemplify
the limited circumstances under which an unadjusted premium rate might be used and the disclosures
appropriate for such use.
Comment One commentator raised a question about a per capita rate that had been approved by an accounting
firm.

Response The task force notes that section 3.11 (previously section 3.8.8) and section 4.4 may be relevant to this
question and that section 3.4.5 covers actuarial aspects of the use of premium rates.
Section 3.4.6, Impact of Medicare and Other Offsets
Comment Several comments were received regarding the requirement to confirm the Medicare integration
approach.

Response The task force did not intend this to be an audit requirement and deleted the confirmation wording,
believing that recognition of the Medicare integration approach and need for consistency in section 3.7
adequately address the issue.
Comment A commentator noted that while section 3.4.6 urged adjustments if Medicare changed, it was not clear
on the timing or purpose of adjustments.

Response The task force believes that adjustments for scheduled or proposed changes in Medicare are somewhat
contingent upon the purpose of the measurement and modified the standard accordingly, while leaving
to the actuary’s judgment whether to anticipate changes before they become law.
Comment A commentator noted that the requirement to develop separate rates for Medicare eligible participants
may apply to benefits unaffected by Medicare and to those eligible for Medicare before age 65 by reason
of eligibility.

Response The task force agreed and modified the language to recognize these differences.

42
Section 3.4.7, Age-Specific Claims Rates
Comment Several commentators questioned the appropriateness of requiring, at a minimum, five-year age bands
for claims rates. Most agreed with the general practice of age grading but some noted instances, such as
dental care or medical benefits above age 90, where age grading was relatively flat and five-year age
bands would not be appropriate.

Response The task force withdrew the requirement that initial per capita health care rate assumptions use claims
rates in age ranges not to exceed five years and substituted language requiring age bands that are
appropriate and not overly broad.
Comment Two commentators seemed to believe the standard required analysis of the specific claims experience to
determine the rates at each age or age band.

Response The task force clarified that the intent is not to subject claims experience to analysis by age bands but
rather to ensure that rate projections account appropriately for the possibility of significant utilization
and cost differences within small age bands. This will most likely be demonstrated by normative data.
Comment Three commentators thought it was sufficient to have only two different claims rates, for non-Medicare
eligible versus Medicare eligible ages, or for pre-age-65 and post-age-65 ages.

Response The task force disagrees that a medical benefits model is likely to be sufficient with only two different
claims rates for non-Medicare eligible versus Medicare eligible ages, or pre-age-65 and post-age-65
ages, since such wide bands would be overly broad for the likely age variation in claim rates for a retiree
group with lifetime coverage.
Comment One commentator thought that a defined dollar benefit would fall outside this requirement. Another
believed that for a premium reimbursement plan only the premium rate experience would be relevant.

Response The task force disagrees that this section will be irrelevant to the measurement process for these specific
instances and notes that other sections, such as 3.2.1(c), 3.7, 3.8.1(c), and the “Participant
Contributions” portion of appendix 2, offer guidance when sponsor financing has defined limits.
Section 3.4.8, Adjustment for Plan Design Changes
Comment A commentator suggested that this section be expanded to include plan design changes effective in the
future.

Response The task force agreed that, for some purposes, adjustment for future changes might be appropriate, but
made no changes to the requirements of this section, feeling the matter is covered adequately in section
3.2.1(f) and 3.8.4.
Section 3.4.9, Adjustment for Administrative Practices
Comment Three commentators pointed out that these adjustments were most relevant when there had been changes
in the administrative practice.

Response The task force agreed that changes in administrative practice are the relevant concern for rate
development, for both claims adjudication and enrollment practices, and changed the language
accordingly.

43
Section 3.4.10, Adjustment for Large Individual Claims
Comment Three commentators were concerned about the plan sponsor’s ability to supply large claim information,
due to privacy concerns or other reasons, or whether the additional workload was justified by additional
accuracy.

Response The task force modified the language to clarify the actuary’s duties but does not believe privacy laws
will preclude the minimum duties.
Section 3.4.11, Adjustment for Trend
Comment A commentator noted that initial per capita claim rates were not always exactly congruent with the first
year of the measurement period and suggested that language about trend adjustments should reflect that
possibility.

Response The task force agreed and modified the first sentence accordingly.
Comment One commentator indicated the effect of trend on the plan’s historic experience might not be credible.

Response The task force agreed and clarified the language.


Section 3.4.12, Adjustment When Plan Sponsor is Also a Provider
Comment Three commentators asked for additional guidance on this topic.

Response The task force believed this was not a part of the practice where appropriate guidance had emerged in
succinct form, but did add consideration for reimbursements, such as Medicare, which might be received
by the plan sponsor.
Section 3.5, Modeling the Cost of Death Benefits
Comment Two commentators pointed out that group term life premium rates often do not vary by age, which
produces a reconciliation problem between accounting charges and the true cost of coverage.

Response The task force believes that the model should still accurately measure true costs and that the accounting
issues are not within the scope of this standard.
Section 3.6.1, Coverage and Classification Data
Comment One commentator suggested the phrase “merit further refinement” be changed to “require further
refinement.”

Response The task force agreed and modified the language.


Section 3.6.2, Consistency
Comment Several commentators believed the requirement to “evaluate the operations of the plan” went well
beyond the duties of the actuary, and that the actuary should be able to assume that the provisions are
being properly administered unless data suggests otherwise.

Response The task force did not intend the actuary to “audit” the plan operations, and has therefore amended the
requirements on plan operations. The task force believes the actuary is in a unique position to observe
the plan operations, and thus may discover inconsistencies in plan operations that affect the
measurement. In such circumstances, the actuary is directed to section 3.7 for the appropriate actions.
Comment One commentator suggested an additional example of situations where average claims costs that are
secondary to Medicare are high in relation to average costs that are primary.

Response The task force expanded the example to include the classification of covered spouses based on the
retiree’s age.

44
Comment One commentator suggested the phrase “if significant” in section 3.6.2(d) should not apply just to
dependents.

Response The task force disagreed. While the obligation for spouses and surviving spouses can generally be
expected to have a significant impact on the results, the obligation for dependents would do so only if
the dependent coverage was extensive and dependents made up a significant proportion of the total
covered population.
Section 3.7, Administrative Inconsistencies
Comment One commentator suggested that disclosure include “an illustration of the effects of recognizing such
inconsistency on either the anticipated level of future claims or the determination of any special
one-time cost.”

Response The task force did not believe this was a requirement for all measurements, although it may be
appropriate for some.
Comment One commentator suggested that section 3.7(c) be separated into two points.

Response The task force agreed and modified the structure.


Comment Four commentators were concerned that the language required an audit of the plan’s administration.

Response The task force agreed that was not its intent and modified the language of the first sentence to indicate
that it addressed guidelines for an actuary who might come across administrative inconsistencies during
the course of the measurement process.
Section 3.8.1, Economic Assumptions
Comment One commentator stressed that the consistent use of a general inflation component in each of the
economic assumptions is a necessary but not sufficient condition so as to have consistent overall
economic assumptions.

Response The task force agreed and modified the wording of the first paragraph accordingly.
Comment Another commentator suggested that since most employers have a consistent discount rate assumption
for their SFAS No. 87 and SFAS No. 106 measurements, the new standard should mandate the use of
the same discount rate for the pension and retiree welfare valuations.

Response The task force believes that such a mandate would be excessively stringent and that there are certainly
cases where varying the discount rates is quite reasonable, taking into account differences in duration
between pension benefits and retiree group benefits.
Comment One commentator suggested that educational material pertaining to health care cost trend rates be added
to this standard.

Response Actuarial standards of practice typically do not include educational material in the body of the standard,
the task force included material in appendix 2 that provides commonly used definitions and illustrations
of the factors that can affect health care cost trend rates.
Comment Three commentators suggested that practitioners be allowed to utilize a single composite trend rate
assumption.

Response The task force agreed and added the following sentence to section 3.8.1(a): “Even if the actuary
develops one aggregate trend rate, the actuary should consider these cost components when developing
the rate.”

45
Comment One commentator suggested that there be separate recognition in the actuarial model of the health care
trend rate and the plan design elements that may modify the trend.

Response The task force appreciates the commentator’s concern, but believes that the leveraging caused by plan
design features can be reflected in the health care cost trend rate if it is not explicitly modeled.
Comment One commentator suggested that there were two opposing statements in section 3.8.1(d)—that “this
standard does not require the use of explicit assumptions about antiselection” and that “the actuary
should consider an upward adjustment for antiselection.”

Response The task force modified some of the wording, but stresses that the second sentence to which the
commentator referred should be read in its entirety. The task force agrees that the standard should not
require the use of specific assumptions for adverse selection. If the actuary changes assumptions for
adverse selection such as the participation assumption, however, the actuary should be aware that other
assumptions (per capita health care rates) should be modified appropriately.
Comment Another commentator expressed concern that section 3.8.1(d) allows the actuary to reflect possible
antiselection through an implicit assumption.

Response The task force modified the wording of this section to remove any ambiguity about assumptions for
adverse selection.
Section 3.8.2, Demographic Assumptions
Comment One commentator suggested that it would be helpful to include some discussion about the potential
interdependence of the various demographic assumptions. The commentator also suggested that
discussion of the other factors that should be considered in choosing a retirement assumption be added.

Response The task force agreed and modified sections 3.8.2 and 3.8.2(c).
Comment One commentator questioned whether the ASB is mandating the use of disability assumptions.

Response The task force directs the commentator to the second sentence of section 3.8.2(b), which states that the
actuary should select disability assumptions if the actuary considers the disabled life coverage
significant to the measurement.
Comment One commentator believed that the definition of disability (and issues surrounding how it should be
reflected) is amply handled in section 3.5.4(a) of ASOP No. 35.

Response The task force agrees and notes that section 3.8.2 refers actuaries to ASOP No. 35 for guidance when
selecting any of the demographic assumptions.
Comment One commentator stated that the actuary may decide to use different mortality assumptions for medical
(i.e., annuity) and life benefits.

Response The task force agreed, but believed that no change was needed in section 3.8.2(d) to address this. The
task force did, however, add wording to suggest that gender-specific mortality rates may be more
appropriate for retiree group benefit obligation measurements rather than unisex mortality rates.
Comment Another commentator suggested that projecting future mortality improvements could be overstating
realistic expectations.

Response The task force made no change since the second sentence of section 3.8.2(d) states “the actuary should
consider.” If, after consideration, the actuary determines that future mortality improvements are
negligible, he or she should reflect this in the choice of mortality assumptions.

46
Section 3.8.3. Coverage Assumptions
Comment One commentator suggested that the guidance could include some consideration of future availability of
options, particularly the reduction in availability of Medicare Risk HMO options. This commentator also
stated that the actuary could be directed to consider the impact of plan rules on whether a spouse or
dependent could be added after retirement.

Response The task force agreed with both comments and modified the section accordingly.
Comment One commentator stated that section 3.8.3(a) seems to assume a large group with credible experience
while in many cases this will not be the situation.

Response The task force added wording to stress that group-specific data be used in selecting assumptions when
such data are available and credible.
Comment Another commentator suggested that variations in participation may occur after retirement and thus may
affect current retirees as well as future retirees.

Response The task force agreed and modified sections 3.8.3(a) and (b) accordingly.
Comment One commentator questioned whether some of the material in this section should be covered in section
3.3.

Response The task force believes that these assumptions are relevant to future years and are appropriately
discussed here.
Comment One commentator believed that section 3.8.3(a) should be clarified to state that participation can vary by
type of coverage when more than one type are available.

Response The task force agreed and modified the language accordingly.
Comment Another commentator suggested that, in addition to appropriate age assumptions for covered spouses,
appropriate age assumptions should be made for non-spouse dependents.

Response The task force agreed and modified section 3.8.3(c) accordingly.
Section 3.8.4, Effect of Plan Changes on Assumptions
Comment One commentator believed that the concept of the additional risk premium in the discount was not clear.

Response The task force agreed and modified the language accordingly.
Comment Another commentator expressed concern about the context in which the advice in this section is given.

Response The task force agreed and modified the language of the second paragraph.
Comment One commentator believed that the use of the term “professional judgment” in the second paragraph
implies that actuaries should never allow anticipated plan change savings to continue into the future.

Response The task force believes that the second sentence of the second paragraph does not restrict the actuary in
recognizing plan change costs/savings in future years. The sentence does require the actuary to exercise
judgment before making such a decision.
Comment Two commentators questioned whether the assumption of the probability of plan termination is an
acceptable practice.

Response The task force believes that there are certain limited circumstances where the use of an assumption of
the probability of plan termination should be permitted.

47
Section 3.8.6, Reviewing Assumptions
Comment Two commentators stated that the setting of assumptions for the measurement of costs does not always
rest with the actuary (for example, SFAS No. 106 measurements).

Response The task force agrees and refers the commentators to section 3.11, Prescribed Assumptions, Methods, or
Other Model Components.
Section 3.8.7, Changes in Assumptions
Comment One commentator believed that this section should be modified to restrict consideration to other
assumptions selected by the actuary, and that no such consideration is required for a change in
assumptions not selected by the actuary.

Response The task force believes that the actuary should review all assumptions, including client prescribed
assumptions, where the actuary was asked to give advice, for continued reasonableness.
Section 3.9, Selecting a Cost Allocation Policy (previously titled “Selecting Actuarial Cost Methods”)
Comment Several commentators suggested the section heading should be changed, as the amortization of plan
amendments and actuarial gains and losses are not necessarily part of the actuarial cost method.

Response The task force agreed, modified the section heading and wording accordingly, and added a definition of
“cost allocation policy” in section 2.
Comment One commentator suggested that cash flow adequacy criteria for selecting an appropriate cost allocation
policy should be limited to apply solely to situations where only the existing assets will be used to pay
benefits.

Response The task force disagreed.


Section 3.9.2, Dedicated Assets (previously section 3.9.3)
Comment One commentator suggested that a different example be developed for section 3.9.2(b).

Response The task force believes the example of a prescribed asset valuation method is relevant.
Section 3.10, Use of Roll-Forward Techniques (previously section 3.9.2)
Comment One commentator agreed with the limitation that roll-forwards should be limited to no more than two
years after a prior measurement. Another questioned the selection of two years, and several
commentators believed this was too restrictive, interpreting the standard to prohibit the use of a 1/1/2000
measurement for SFAS No. 106 12/31/2002 disclosures. A survey of one commentator’s firm’s clients
found that, in addition to biennial re-measurements, triennial measurements were used for a fair number
of clients. The survey did not find any situations where a measurement was performed less frequently
than once every three years.

Response The task force had intended the use of roll-forward techniques with triennial re-measurements and
modified the text and example in section 3.10.2 (previously section 3.10(b)) to clarify this.
Comment One commentator questioned the restriction on the length of the roll-forward period when the
accounting standard to which the work applies has a requirement for an actuarial study that must, at a
minimum, be updated every five years.

Response The task force recognized that special circumstances could apply and modified the language
accordingly.

48
Comment One commentator interpreted the restriction on roll-forward techniques to imply that a complete
experience analysis of every assumption and claim rate must be preformed at each re-measurement.

Response The task force refers the commentator to section 3.8.6, which states, in part, that the actuary is not
required to do a complete assumption study at each measurement date.
Comment One commentator suggested the example in section 3.10.1 (previously section 3.10(a)) be clarified so
that claim rates used at a prior measurement are trended forward.

Response The task force agreed and modified the language accordingly.
Comment One commentator noted that the term “significantly” in section 3.10.3 (previously section 3.10(c)) may
cause debate among actuaries as to what is significant.

Response The task force recognizes this issue, but did not modify the language, as it believes it is appropriate for
the actuary to decide, based on professional judgment, whether a key model component has changed
significantly since the last full measurement.
Section 3.11, Prescribed Assumptions, Cost Allocation Policies, or Other Model Components (previously
Section 3.8.8, Prescribed Actuarial Assumptions)
Comment One commentator stated that this section should discuss what implications the prescribed assumptions
have on the need for the actuary to use consistent assumptions.

Response The requirement to use consistent assumptions, set forth in section 3.8.5, applies only to assumptions
selected by the actuary.

Comment Another commentator was pleased with the elimination of the language regarding disclosure of
exceptions (ACG No. 3, section 6.2) and suggested that this point be more emphatically stated.

Response The task force believes that the issue is adequately addressed in the fourth paragraph of section 1.2.
Comment One commentator noted that an actuary cannot be responsible for assumptions prescribed by others or be
responsible for the overall appropriateness of results where the prescribed assumption might not be
considered appropriate. This commentator cited section 3.8.8, Prescribed Actuarial Assumptions (now
section 3.11, Prescribed Assumptions, Methods, or Other Model Components).

Response The task force agreed that this may be an important distinction in some cases and modified this section
to acknowledge exceptions due to section 3.11.
Section 3.12, Reasonableness of Results (previously section 3.10)
Comment One commentator suggested the language regarding sample participants be clarified.

Response The task force agreed and modified the language.


Comment With respect to the requirement to compare expected claims with actual claims, several commentators
believed that the requirement was excessive, that actual claims may not be credible, and that only
significant differences should be evaluated.

Response The task force agreed that the actuary should evaluate only significant differences, which may include
the volatility of experience in small plans. In response to one commentator, the task force added the
word “available.”
Section 3.13, Sensitivity of Results to Chosen Assumptions (previously section 3.11)
Comment Three commentators pointed out that a 20% increase plus a 20% decrease produces a 4% decrease, not
0%.

Response The task force agreed and made the change.

49
Section 3.14, Reliance on a Collaborating Actuary (previously section 3.12)
Comment Three commentators questioned the implications of this section. One wanted a statement to the effect
that each of two actuaries could issue an actuarial opinion with respect to the part of the valuation for
which he or she was responsible. Another wanted a statement on the role of the non-actuary who might
be qualified by the nature of his or her professional experience, education and training. A third said that
the standard implied that one actuary must have expertise in all aspects of the project.

Response The task force recognizes in section 3.14 that two or more actuaries may collaborate on a project. One
may have an expertise in health data analysis and another in long-term projections. Nothing in the
standard prevents each from issuing an actuarial opinion with respect to his or her responsibility. Each
of these expertises, however, is an actuarial expertise. Neither the task force nor the ASB is aware of any
other profession where a practitioner is qualified by the nature of his or her professional experience,
education and training to perform the health data analysis or long-term projections that are key to the
measurement of retiree group benefit obligations. For an actuary to issue a professional opinion on such
measurement and meet this standard, that actuary must take responsibility that all significant aspects
meet this standard or disclose the deviation from standard. The standard does not require that one of the
actuaries must have expertise in each and every aspect of the measurement, but does require at least one
of the actuaries to take responsibility that the results of the health data analysis used for initial rate and
other health care assumptions mesh appropriately with the assumptions and model used for long-term
projections.
SECTION 4. COMMUNICATIONS AND DISCLOSURES
Section 4.1, Documentation
Comment The task force received several comments regarding documentation of health care rate development. A
commentator questioned the applicability of ASOP No. 31 to retiree health benefits, particularly since
there seems to be a specific exemption in ASOP No. 31 for work related to SFAS No. 106.

Response The sentence referred to in ASOP No. 31 contains a contingent exemption. It states, “The standard does
not apply to work done in connection with [SFAS No. 106] unless ASOPs pertaining to SFAS No. 106
specifically call for application of this standard.” That sentence is followed by the statement, “A task
force is being created to address issues related to SFAS 106.”

The task force that was created recommended the revision of ASOP No. 6 and also believed it was
appropriate for ASOP No. 31 to apply to SFAS No. 106, as well as other retiree group benefit
measurements. The current task force agrees that ASOP No. 31 should apply to SFAS No. 106. The
ASB affirms that ASOP No. 31 does apply to work performed in connection with SFAS No. 106. The
contingent exemption in ASOP No. 31 relating to SFAS No. 106 is now erased.

Documentation is an essential component of actuarial practice. ASOP No. 31 provides guidance on


important aspects of documenting health benefit plan ratemaking. Not every issue covered by ASOP No.
31, however, applies to every development of rates. The actuary developing or using rates for a retiree
health valuation should comply with those aspects of ASOP No. 31 relevant to the case at hand.
Comment A commentator suggested that claim rates used in retiree health valuations differ from other actuarially
derived claim rates and are not subject to the same outside review as the ratemaking covered under
ASOP No. 31.

Response The task force believes this may be a misreading of the purpose of ASOP No. 31, which is not a
standard on ratemaking, but rather provides “guidance on documentation in the process of health benefit
plan ratemaking.” The task force believes development of per capita claim rates for measuring retiree
health benefit obligations clearly falls within the ratemaking process, whether the purpose is plan
design, cost projections, or financial reporting. ASOP No. 31 also clearly states that it is not a standard
on pricing, which may be subject to extensive regulatory review.

50
Comment Another commentator suggested this standard should include a requirement that documentation
regarding development of health care rates be made available to another actuary upon the client’s
request and that it not be withheld as proprietary.

Response ASOP No. 31 states that “Documentation should be available to the actuary’s client or employer, and it
should be made available to other persons when the client or employer so requests and provided such
availability is not otherwise improper.” The task force believes this accurately states the actuary’s need
to cooperate with others who have an appropriate role in determining the rationale for a particular
assumption about per capita health care rates. While there may be software that is proprietary, the
actuary’s cooperation should encompass source data and methods. Differences of opinion on what is
proprietary might be referred to the Actuarial Board for Counseling and Discipline (ABCD).
Comment One commentator noted that ASOP No. 31 also had relevance to ratemaking aspects of sections of the
standard other than section 3.4.

Response The task force agreed and modified that reference accordingly.
Comment Several commentators objected to the documentation requirements of the standard as being “excessive,”
“inappropriate,” “severe,” or “burdensome.” One commentator suggested that the proposed
requirements were beyond the normal documentation requirements.

Response Upon review, the task force believes that the extent of the documentation required by this standard is
consistent with other, contemporaneous standards. In addition, the documentation required seems to be
the minimum level necessary “so that another actuary qualified in the same field could assess the
reasonableness of the work.” Furthermore, the task force notes that some commentators appear to have
confused documentation with disclosure requirements, which is the difference between one’s work
papers and the communication of one’s work product.
Section 4.2, Disclosure
Comment One commentator questioned the meaning of the word “significant” throughout this section.

Response The task force identified the items subject to disclosure, but leaves it to the professional judgment of the
actuary to decide the appropriate extent of such disclosure, given the purpose of the measurement and
the expected use of the disclosure material.
Comment Two commentators requested a clarification of terms used in section 4.2(a).

Response The task force added references to sections in the standard.


Comment One commentator said that the last paragraph was too restricting, in that it limits external references to
only actuarial communications.

Response This paragraph is intended to reduce the repetition of previously disclosed actuarial material in a current
document; it should not be seen as limiting any other external references to commonly available
documents.

51
Actuarial Standard
of Practice
No. 7

Analysis of Life, Health, or Property/Casualty


Insurer Cash Flows

Revised Edition

Developed by the
Cash Flow Testing Task Force of the
Actuarial Standards Board

Adopted by the
Actuarial Standards Board
June 2002

(Doc. No. 089)


TABLE OF CONTENTS

Transmittal Memorandum iv

STANDARD OF PRACTICE

Section 1. Purpose, Scope, Cross References, and Effective Date 1


1.1 Purpose 1
1.2 Scope 1
1.3 Cross References 2
1.4 Effective Date 2

Section 2. Definitions 2
2.1 Applicable Law 2
2.2 Asset 2
2.3 Asset Risk 2
2.4 Cash Flow 2
2.5 Cash Flow Analysis 2
2.6 Cash Flow Testing 2
2.7 Derivative Contract 3
2.8 Health Benefit Plan 3
2.9 Insurer 3
2.10 Investment Rate-of-Return Risk 3
2.11 Liability 3
2.12 Notional Asset Portfolio 3
2.13 Other Liability Cash Flows 3
2.14 Policy Cash Flow Risk 3
2.15 Policy Cash Flows 3
2.16 Scenario 3

Section 3. Analysis of Issues and Recommended Practices 4


3.1 Analysis of Insurer Cash Flows 4
3.2 Determining the Level of Analysis of Cash Flows 4
3.2.1 Reasons for Cash Flow Testing 4
3.2.2 Cash Flow Testing is Not Always Necessary 4
3.2.3 Use of Analyses or Data Predating the Analysis Date 5
3.3 Identification of Assets 5
3.3.1 Choice of Asset Subsets to Use 5
3.3.2 Notional Asset Portfolios 5
3.3.3 Other Assets 5
ii
3.4 Projection of Asset Cash Flows 5
3.4.1 Asset Characteristics 6
3.4.2 Investment Strategy 6
3.5 Projection of Policy Cash Flows 7
3.5.1 Policy Cash Flow Characteristics 7
3.5.2 Management Policy 8
3.6 Other Liability Cash Flows 8
3.7 Materiality 8
3.8 Reinsurance 8
3.9 Separate Accounts 8
3.10 Modeling and Data 8
3.10.1 Scenarios 9
3.10.2 Sensitivity Testing 9
3.10.3 Internal Consistency 9
3.10.4 External Requirements 9
3.10.5 Projection Period 10
3.10.6 Limitations of Models, Assumptions, and Data 10
3.11 Negative Interim Earnings 10

Section 4. Communications and Disclosures 10


4.1 Reliance on Others for Data, Projections, and Supporting Analysis 10
4.2 Actuarial Report 10
4.3 Documentation 10
4.4 Conflict with Applicable Law 12
4.5 Retention 12
4.6 Prescribed Statement of Actuarial Opinion 12
4.7 Deviation from Standard 12

APPENDIXES

Appendix 1—Background and Current Practices 13


Background 13
Current Practices 13

Appendix 2—Comments on the Exposure Draft and Task Force Responses 15

Appendix 3—Comments on the Revised Standard as Adopted in September 2001


and ASB Responses 19

iii
June 2002

TO: Members of the American Academy of Actuaries and Other Persons Interested in the
Analysis of Life, Health, or Property/Casualty Insurer Cash Flows

FROM: Actuarial Standards Board (ASB)

SUBJ: Actuarial Standard of Practice (ASOP) No. 7

This booklet contains the final version of ASOP No. 7. The original title, Performing Cash Flow
Testing for Insurers, has been changed to Analysis of Life, Health, or Property/Casualty Insurer
Cash Flows. This standard, along with a revision of ASOP No. 22, now titled Statements of Opinion
Based on Asset Adequacy Analysis by Actuaries for Life or Health Insurers, supersedes ASOP
No. 14, When to Do Cash Flow Testing for Life and Health Insurance Companies, which has been
repealed effective April 15, 2002.

Background

Development of actuarial standards of practice in the cash flow testing area was originally undertaken
separately for the life and health and the property and casualty specialties. The first to be published was
ASOP No. 7, Concerning Cash Flow Testing for Life and Health Insurance Companies. This was
developed by the American Academy of Actuaries’ Committee on Life Insurance Financial Reporting in
conjunction with the Life Committee of the ASB, and was adopted by the ASB in October 1988.

Subsequently, the Casualty Committee of the ASB, through its Valuation Subcommittee, developed a
proposed standard titled Cash Flow Testing for Property and Casualty Insurers. This draft was
presented to the ASB in April 1990. The ASB decided that the document should be revised so that
there would be one broad standard that would apply to life and health insurers as well as to prop-
erty/casualty (P/C) insurers. A Joint Casualty/Life Cash Flow Testing Task Force was appointed by the
ASB to accomplish this. The resulting standard was adopted in July 1991.

Further revisions to ASOP No. 7 are now being made for several reasons. First, practice in this area
has evolved and this proposed revised standard reflects this evolution. Second, the National Association
of Insurance Commissioners (NAIC) adopted two new model regulations, Synthetic Guaranteed
Investment Contracts Model Regulation, and Separate Accounts Funding Guaranteed Minimum
Benefits Under Group Contracts Model Regulation. These two model regulations contain language
requiring that life insurers submit an actuarial opinion and memorandum

iv
related to cash flow testing. Finally, the ASB has adopted a new format for standards, and this standard
has been rewritten to conform to that new format.

In addition to ASOP No. 7, as part of the project to look at all cash flow testing standards of practice,
ASOP No. 14 and ASOP No. 22 were also reviewed. Relevant portions of ASOP No. 14 were
incorporated within the 2001 revisions of ASOP No. 7 and ASOP No. 22.

At its September 2001 meeting, the ASB voted to adopt the revised ASOP No. 7 and ASOP No. 22
and to repeal ASOP No. 14. In April 2002, the ASB voted to defer the effective date of ASOP No. 7
to July 15, 2002 while it reviewed concerns raised by the Academy’s Casualty Practice Council
regarding the standard’s applicability to property/casualty practice. At its June 2002 meeting, the ASB
amended the scope to conform to generally accepted casualty actuarial practice. Please see appendix 3
for further information.

Exposure Draft

The exposure draft of this revised standard was issued in September 2000 with a comment deadline of
March 31, 2001. The Cash Flow Testing Task Force carefully considered the twenty-one comment
letters received. For a summary of the substantive issues contained in these comment letters, please see
appendix 2.

The most significant changes from the exposure draft were as follows:

1. In section 3.10.1, Scenarios, and 3.10.3, Internal Consistency, a few changes were made for
similar reasons to both sections to clarify the actuary’s responsibilities. In 3.10.1(a), the actuary
is now required to determine whether the tested scenarios reflect a range of conditions
consistent with the purpose of the cash flows, and, if not, the actuary should disclose any
material inconsistency in any report or communication. Similarly, in 3.10.3, the actuary is now
required to determine whether the actuarial assumptions within each scenario are consistent
where appropriate, and, if not, the actuary should disclose any material inconsistency in any
report or other communication.

2. In section 3.10.2, Sensitivity Testing, a sentence was added noting that the further into the future
that asset and policy cash flows are projected, the more potential there is for variability in future
cash flows.

3. In section 4.3, Documentation, wording was added noting that the degree of documentation of
the actuary’s cash flow analysis will vary with the complexity and purpose of the job.

v
The task force thanks all those who commented on the exposure draft. The task force also thanks
Susan Witcraft for her assistance in drafting this standard.

The ASB voted in June 2002 to adopt this standard.

Cash Flow Testing Task Force

Marc A. Cagen, Chairperson


Michael A. Cioffi Thomas A. Phillips
Owen M. Gleeson David K. Sandberg
David J. Jungk Herbert S. Wolf
Lew H. Nathan

Life Committee of the ASB

Godfrey Perrott, Chairperson


John W. Brumbach (2001) Robert G. Meilander
Marc A. Cagen (2001) Thomas A. Phillips
Charles Carroll Alan W. Ryan
Michael Cioffi Barry L. Shemin

Actuarial Standards Board

William C. Koenig, Chairperson


David G. Hartman (2001) Alan J. Stonewall
Ken W. Hartwell James R. Swenson (2001)
Roland E. King Karen F. Terry
Michael A. LaMonica William C. Weller
Heidi Rackley Robert E. Wilcox

vi
ACTUARIAL STANDARD OF PRACTICE NO. 7

ANALYSIS OF LIFE, HEALTH,


OR PROPERTY/CASUALTY
INSURER CASH FLOWS

STANDARD OF PRACTICE

Section 1. Purpose, Scope, Cross References, and Effective Date

1.1 Purpose—This actuarial standard of practice (ASOP) provides guidance to actuaries who perform
professional services involving the analysis of asset, policy, or other liability cash flows for life,
health, or property/casualty insurers.

1.2 Scope—This standard applies to actuaries when performing the analysis of part or all of an
insurer’s asset, policy, or other liability cash flows for life or health insurers (including health benefit
plans). The standard also applies to actuaries when performing the analysis of cash flows involving
both invested assets and liabilities for property/casualty insurers.

Cash flow analysis subject to this standard should be considered in connection with professional
services such as the following:

a. determination of reserve adequacy;

b. determination of capital adequacy;

c. product development or ratemaking studies;

d. evaluations of investment strategy;

e. financial projections or forecasts;

f. actuarial appraisals; and

g. testing of future charges or benefits that may vary at the discretion of the insurer (for
example, policyholder dividend scales and other nonguaranteed elements of the insurer’s
liabilities).

1
This standard does not apply to actuaries when performing cash flow analysis for entities other than
life, health, or property/casualty insurers, such as pension plans, retiree group benefit plans, or
social insurance programs.

When applicable law conflicts with this standard, compliance with such applicable law shall not be
deemed a deviation from this standard, provided the actuary discloses that the cash flow analysis
was performed in accordance with the requirements of such applicable law.

1.3 Cross References—When this standard refers to the provisions of other documents, the reference
includes the referenced documents as they may be amended or restated in the future, and any
successor to them, by whatever name called. If any amended or restated document differs
materially from the originally referenced document, the actuary should consider the guidance in this
standard to the extent it is applicable and appropriate.

1.4 Effective Date—This standard of practice is effective for actuarial work performed after July
15, 2002.

Section 2. Definitions

The definitions below are defined for use in this actuarial standard of practice.

2.1 Applicable Law—Federal, state, and local statutes, regulations, case law, and other binding
authority that may govern analysis of insurer cash flows.

2.2 Asset—Any resource that can generate revenue or reduce disbursement cash flows.

2.3 Asset Risk—The risk that the amount or timing of items of cash flow connected with assets will
differ from expectations or assumptions for reasons other than a change in investment rates of
return. Asset risk includes delayed collectibility, default, or other financial nonperformance. This has
been commonly referred to in actuarial literature as the C-1 risk or credit risk.

2.4 Cash Flow—Any receipt, disbursement, or transfer of cash.

2.5 Cash Flow Analysis—Any evaluation of the risks associated with the timing or amount of cash
flows.

2.6 Cash Flow Testing—A form of cash flow analysis involving the projection and comparison of the
timing and amount of cash flows resulting from economic and other assumptions.

2
2.7 Derivative Contract—Any security that derives its value from an underlying financial instrument.
Examples include interest rate swaps, futures, and options.

2.8 Health Benefit Plan—A contract providing medical, dental, vision, disability income, accidental
death and dismemberment, long-term care, and similar benefits, whether on a reimbursement,
indemnity, or service benefit basis, regardless of the form of the risk-bearing organization, including
benefit plans provided by self-insured plan sponsors.

2.9 Insurer—An entity that accepts the risk of financial losses or, for a specified time period, guarantees
stated benefits upon the occurrence of specific contingent events, in exchange for a monetary
consideration.

2.10 Investment Rate-of-Return Risk—The risk that investment rates of return will differ from
expectations or assumptions, causing a change in the amount or timing of asset, policy, or other
liability cash flows. This has been commonly referred to in actuarial literature as the C-3 risk or
asset/liability mismatch risk.

2.11 Liability—Any commitment by, or requirement of, an insurer that can reduce revenue or generate
disbursement cash flows.

2.12 Notional Asset Portfolio—A portfolio of assets, not owned by the insurer, which changes the risk
characteristics of either the assets or the liabilities of the insurer.

2.13 Other Liability Cash Flows—Cash flows not specifically associated with asset or policy cash flows.
Examples are corporate expenses, payables, surplus notes, shareholder dividends, or balance sheet
items that result from litigation.

2.14 Policy Cash Flow Risk—The risk that the amount or timing of cash flows under a policy or contract
will differ from expectations or assumptions for reasons other than a change in investment rates of
return or a change in asset cash flows. This has been commonly referred to in actuarial literature as
the C-2 risk.

2.15 Policy Cash Flows—All premiums and other amounts paid by policyholders or contract holders to
the insurer and all benefits, expenses, and other amounts paid to policyholders or others as required
by policy or law.

2.16 Scenario—A set of economic and other assumptions used in performing cash flow analysis.

3
Section 3. Analysis of Issues and Recommended Practices

3.1 Analysis of Insurer Cash Flows—The actuary may perform the analysis of part or all of an insurer’s
asset (including off-balance sheet asset), policy, or other liability cash flows.

3.2 Determining the Level of Analysis of Cash Flows—In deciding the level of analysis of insurer cash
flows, if any, appropriate for the circumstances, the actuary should consider the type of asset,
policy, or other liability cash flows and the severity of risks associated with those cash flows. As
part of that consideration, the actuary should consider those risks and options embedded in the
asset, policy, or other liability cash flows that the actuary judges to be material. In addition, the
actuary should consider the risks that are being undertaken and determine what types of deviations
from expected experience should be taken into account, if any, given the purpose of the analysis.

3.2.1 Reasons for Cash Flow Testing—The actuary should consider cash flow testing when
variations in the underlying risks are likely to have a material impact on the expected
cash flows in certain products, certain lines of business, or on the company. Situations that
might indicate a need for cash flow testing include the following:

a. where there are material asset risks (for example, below investment grade bonds,
assets with payment timing risks such as CMOs or mortgage-backed securities,
mortgages concentrated in certain regions of the country, and large illiquid assets
such as real estate);

b. where there are liabilities that have cash flows far out into the future (for example,
structured settlement annuities with a significant reinvestment
rate-of-return risk);

c. where a company has a new or rapidly growing line of business; and

d. where options have been granted to policyholders or borrowers and the likelihood
of antiselection in the exercise of these options is significant (for example, an
annuity contract holder’s option to surrender the annuity for cash at book value).

3.2.2 Cash Flow Testing is Not Always Necessary—Insurers are subject to different types and
degrees of risk. The actuary may decide that the type or degree of risk does not warrant
cash flow testing. Following are examples of situations where other types of analyses might
be sufficient.

a. If the risks to be analyzed are products with short-term liabilities (for example, the
vast majority of cash flows occurring within a few years) supported by short-term

4
assets, these risks may be more appropriately analyzed through other means. The
risks may involve a small number of large individual claims over a short-term period
and may be better addressed using risk theory techniques.

b. If, in the actuary’s judgment, a block of business, taken together with its policy
term and the associated investment strategy, is relatively insensitive to influences
such as changes in economic conditions or interest-rate scenarios, the actuary may
determine that cash flow testing is not necessary to support the opinion, report, or
recommendation, and other methods may be sufficient.

c. If the risk being evaluated is unanticipated sources of significant claims (examples in


the past include AIDS and asbestos), these risks may be analyzed with methods
other than cash flow testing.

3.2.3 Use of Analyses or Data Predating the Analysis Date—If appropriate, the actuary may use
analyses performed prior to the valuation date, an analysis performed at the time of policy
issue, modeling based on data taken from a time that predates the analysis date, or other
methods.

The actuary should document the reasonableness of such prior period data, studies,
analyses, or methods, that key assumptions are still appropriate, and that no material events
have occurred prior to the valuation date that would invalidate the analysis on which the
actuary’s opinion is based.

3.3 Identification of Assets—The actuary should identify which assets are included in the cash flow
analysis.

3.3.1 Choice of Asset Subsets to Use—The same assets should not be improperly used to
support different blocks of policy cash flows.

3.3.2 Notional Asset Portfolios—If the liability of the insurer is based on the performance of a
notional asset portfolio, such as in the case of synthetic guaranteed investment contracts, the
actuary should include the notional asset portfolio creating this liability in this analysis.

3.3.3 Other Assets—The actuary should consider whether policy loans, deferred premiums, and
other policy-related assets should be included in the cash flow analysis.

3.4 Projection of Asset Cash Flows—In projecting an insurer’s asset cash flows for a given scenario,
the actuary should consider the assets of the insurer and the insurer’s investment strategy.

5
3.4.1 Asset Characteristics—The characteristics of an asset affect the timing and amounts of its
cash flows. The cash flows of some assets are relatively immune to external factors and can
be predicted on the basis of asset structure alone (for example, high-quality noncallable
bonds). The cash flows of other assets (for example, callable bonds, mortgage-backed
securities, common stocks, derivative contracts, or premium receivables) are more sensitive
to external events, and their analysis should be based on a combination of their structure
and external factors. The actuary should consider the following issues in making cash flow
projections:

a. the sensitivity to economic factors, such as interest rates, equity, or other market
returns, and inflation rates on the insurer’s asset cash flows;

b. any limitations on the ability to use asset cash flows to support policy or other
liability cash flows, such as when a block of assets is specifically held in support of
a particular block of business by contract or regulation;

c. the impact on cash flow associated with asset quality as it relates to the risk of a
delay in asset cash flows being collected, asset default, or other financial non-
performance;

d. the associated costs of maintaining the assets or of converting the assets into cash
when necessary;

e. the historical experience of similar assets, to the extent such experience is credible
and relevant to the projection of future asset cash flows; and

f. other known factors that are likely to have a material effect on asset cash flows,
particularly those factors that are likely to have an effect on asset risk or investment
rate-of-return risk.

3.4.2 Investment Strategy—The actuary should consider the following in performing the cash
flow analysis:

a. the insurer’s strategy regarding the sale of assets prior to maturity;

b. asset segmentation in support of the insurer’s policy cash flows;

c. the insurer’s strategy regarding the sale of assets with a declining market value;

d. the insurer’s strategy for the investment of future positive or negative cash flows;

6
e. to the extent the insurer’s investment strategy contemplates borrowing to cover
negative cash flows, whether the funds borrowed pursuant to the strategy are
reasonable in relation to the insurer’s existing indebtedness, borrowing capacity,
and cost of borrowing funds;

f. the insurer’s use of derivative contracts, including strategies to mitigate asset,


policy, or other liability cash flow risk;

g. to the extent the insurer’s investment strategy contemplates capital contributions


from a parent or other source, whether the capital contributions can be sustained
and are appropriate for the type of analysis;

h. the costs or gains due to asset, policy, or other liability cash flows denominated in
foreign currencies; and

i. any other known factors that are likely to have a material effect on investment
strategy or the insurer’s ability to execute its investment strategy.

3.5 Projection of Policy Cash Flows—In projecting an insurer’s expected policy cash flows, the
actuary should consider the policy’s cash flow characteristics as well as the insurer’s policies
concerning the management of its policy cash flows.

3.5.1 Policy Cash Flow Characteristics—The characteristics of a policy affect the timing and
amounts of its cash flows. The actuary should consider the following factors in projecting
policy cash flows:

a. the risk of insolvency or other nonperformance by providers of services, including


reinsurers and other counter-parties;

b. the associated costs of maintaining, collecting, or paying out the policy cash flows;

c. the historical experience of similar policy cash flows, to the extent such experience
is credible and relevant to the projection of future cash flows;

d. the effect of external factors such as interest rates, equity or other market returns,
unemployment rates, and inflation rates on the insurer’s policy cash flows;

e. the ability of the policyholder or other party to exercise options under the policy
that have an effect on policy cash flows (for example, put options

7
subject to a predefined event occurring, or allowing the transfer of funds between
contracts or funding vehicles);

f. the effect of changes in premium (for example, rate increases) or changes in other
policy charges (for example, cost of insurance charges in universal life contracts);
and

g. other known factors that are likely to have a material effect on policy cash flows,
including off-balance sheet items.

3.5.2 Management Policy—The actuary should consider management policy concerning the
settlement or payment of liabilities, and the effect that this management policy may be
reasonably expected to have on the projection of policy cash flows. Considerations that
might affect the projection include claim settlement and benefit payment practices, expense-
control strategies, company philosophy relative to the determination of policyholder
dividends, and charges or benefits that vary at the discretion of the company, as well as
significant relationships between management policy and the scenarios analyzed.

3.6 Other Liability Cash Flows—The actuary should consider whether other liability cash flows should
be included in the analysis being conducted.

3.7 Materiality—The actuary may determine that certain asset, policy, or other liability cash flows will
not be analyzed if these asset, policy, or other liability cash flows may be reasonably expected not
to have a material impact on the overall results. The analysis need not be refined if, in the judgment
of the actuary, further refinement would not result in a materially different actuarial opinion, report,
or recommendation.

3.8 Reinsurance—The actuary should consider whether reinsurance receivables will be collectible when
due, and any terms, conditions, or other aspects that may be reasonably expected to have a
material impact on the cash flow analysis.

3.9 Separate Accounts—The actuary should consider the effect of separate account asset, policy, or
other liability cash flows on the general account. For example, the actuary should consider general
account guarantees, recoverability of unamortized expense allowances, and allowable transfers
between the separate account and the general account.

3.10 Modeling and Data—The actuary should select an appropriate model for the analysis being
performed. When the asset, policy, or other liability cash flows being analyzed are represented by
sample or hypothetical data, the cash flows used for modeling should be representative of the block
of asset, policy, or other liability cash flows being analyzed and should be consistent with the

8
intended purpose and use of the analysis.

3.10.1 Scenarios—The scenario is a key element in the analysis of cash flows. Depending on the
purpose of the analysis, more than one scenario may be used. Scenarios may be generated
by either deterministic or stochastic methods.

a. Range of Scenarios Consistent with Purpose of Analysis—The scenario(s) to be


analyzed may be specified by the client or employer, by applicable law, or by the
actuary. The actuary should determine whether the scenarios analyzed reflect a
range of conditions consistent with the purpose of the analysis of cash flows. If not,
the actuary should disclose any material inconsistency in any actuarial report
prepared pursuant to section 4.2, or in any other communication of the actuary’s
findings.

b. Number of Scenarios—Consistent with the purpose of the analysis, the actuary


should consider a sufficient number of scenarios to reasonably represent the
underlying variability of the asset, policy, or other liability cash flows.

3.10.2 Sensitivity Testing—The actuary should consider and appropriately address the sensitivity
of the model to the effect of variations in key assumptions. For example, the further into the
future that asset and policy cash flows are projected, the more potential there is for
variability in the future cash flows. In determining whether sensitivity has been appropriately
addressed, the actuary should consider the intended purpose and use of the analysis and
whether the results reflect a reasonable range of variation in the key assumptions, consistent
with that intended purpose and use.

3.10.3 Internal Consistency—The actuary should determine the following:

a. whether actuarial assumptions within each of the interest rate and other scenarios
being analyzed are consistent where appropriate; and

b. that the actuarial assumptions, methods, or models used for different segments of
business are materially consistent, and that any significant interdependencies are
modeled appropriately.

If not, the actuary should disclose any material inconsistency in any actuarial report
prepared pursuant to section 4.2 or in any other communication of the actuary’s findings.

3.10.4 External Requirements—The actuary should consider how applicable law, and other
external requirements relating to such things as financial statements and operating ratios,

9
federal income taxes, insurer capitalization, and distribution of an insurer’s earnings to
policyholders or shareholders are likely to affect future cash flows or constrain the range of
possible scenarios. These factors should be appropriately reflected in the analysis.

3.10.5 Projection Period—The time period over which cash flows are projected should be
consistent with the purpose of the analysis. Different blocks of business may require
different projection periods. If the objective is to analyze cash flows over the entire life of
the block of business, then the actuary should choose a time period over which the
underlying asset, policy, or other liability cash flows are material. If the objective is to
analyze cash flows over a period shorter than the entire life of the block of business, then
the actuary should disclose the existence of possible material cash flows beyond such a time
period in analyzing results.

3.10.6 Limitations of Models, Assumptions, and Data—Cash flow estimates can vary
considerably as a result of the model used, the assumptions selected, and the data. When
results are highly volatile, additional analysis may be appropriate.

3.11 Negative Interim Earnings—The actuary should consider the impact of any negative interim earnings
during the cash flow projection period, if it is appropriate for the purpose of the analysis.

Section 4. Communications and Disclosures

4.1 Reliance on Others for Data, Projections, and Supporting Analysis—The actuary may rely on data,
projections, and supporting analysis supplied by others. In doing so, the actuary should disclose
both the fact and the extent of such reliance. Such disclosure may follow the forms prescribed in the
applicable NAIC model laws and regulations. The accuracy and comprehensiveness of data,
projections, or supporting analysis supplied by others are the responsibility of those who supply the
data, projections, or supporting analysis. When practicable, the actuary should review the data,
projections, and supporting analysis for reasonableness and consistency, and disclose such a
review. For further guidance, the actuary is directed to ASOP No. 23, Data Quality.

4.2 Actuarial Report—If appropriate, given the purpose for which the cash flow analysis was
performed, the actuary should issue a written actuarial report as a means of documenting the data,
assumptions, techniques, and conclusions reached.

4.3 Documentation—The degree of documentation of the actuary’s cash flow analysis will vary with the
complexity and purpose of the analysis. The documentation should be more complete for more
significant assignments such as regulatory cash flow testing than for other assignments such as
periodic income projections.

10
The actuary should document the following, as appropriate, for the cash flow analysis being
conducted:

a. whether any analyses performed prior to the valuation date were used, and, if so, the
reasonableness of the prior period data, studies, analyses, or methods;

b. the purpose of the analysis and the risks analyzed;

c. the type of analysis performed (i.e., whether cash flow testing or some other method of
analysis) for each block of business analyzed;

d. the results of the analysis;

e. the actuary’s conclusions or recommendations, if any;

f. any conclusions or recommendations related to sensitivity testing; and

g. the data, assumptions, and methods used with sufficient clarity that another actuary qualified
in the same practice area could evaluate the reasonableness of the actuary’s work. The
actuary should consider whether the documentation should contain the following:

1. the asset characteristics;

2. any limitations on the ability to use asset cash flows to support policy and other
liability cash flows;

3. the insurer’s investment strategy;

4. how the policy cash flow characteristics are reflected in the analysis, including the
insurer’s policies concerning the management of its policy cash flows;

5. any cash flows not attributable to specific asset, policy, or other liability cash flows;

6. whether any off-balance sheet items were included in the analysis;

7. relevant cash flows within the scope of the analysis that were specifically excluded
from the cash flow analysis due to immateriality;

8 the characteristics of any reinsurance agreements, and how these were reflected in
the analysis;

11
9. the effect of separate account asset, policy, or other liability cash flows on the
general account, such as general account guarantees;

10. the model used, including the sources of data and key assumptions;

11. the scenarios used, and the rationale supporting the methodology used to choose
and develop the scenarios;

12. how any external factors were included in the analysis;

13. the time period over which cash flows are projected;

14. the existence of negative interim earnings and its effect on the analysis;

15. whether the actuary relied on asset cash flow projections or other analyses of
assets supplied by others, and the extent of such reliance; and

16. any other data, assumptions, or other methods that are known to materially impact
the analysis.

4.4 Conflict with Applicable Law—When applicable law conflicts with this standard, compliance with
such applicable law shall not be deemed a deviation from this standard, provided the actuary
discloses that the opinion was rendered in accordance with the requirements of such applicable law.

4.5 Retention—The actuary, to the extent practicable, should take reasonable steps to ensure that the
documentation will be retained for a reasonable period of time (and no less than the length of time
necessary to comply with any statutory, regulatory, or other requirements). The actuary need not
retain the documentation personally; for example, it may be retained by the actuary’s employer.

4.6 Prescribed Statement of Actuarial Opinion—This ASOP does not require a prescribed statement
of actuarial opinion (PSAO) as described in the Qualification Standards for Prescribed
Statements of Actuarial Opinion promulgated by the American Academy of Actuaries. However,
law, regulation, or accounting requirements may also apply to an actuarial communication prepared
under this standard, and as a result, such actuarial communication may be a PSAO.

4.7 Deviation from Standard—The actuary must be prepared to justify the use of any procedures that
depart materially from those set forth in this standard and must include, in any actuarial
communication disclosing the results of the procedures, an appropriate statement with respect to the
nature, rationale, and effect of such departures.

12
Appendix 1

Background and Current Practices

Note: This appendix is provided for informational purposes, but is not part of the standard of practice.

Background

Actuaries have been performing financial projections for many years. Various cash flow elements have
often been an integral part of these projections. The large increase in the level and volatility of investment
rates of return since the 1970s caused significant swings in asset, policy, or other liability cash flows and
present values. The sophistication of insurance products has increased during this time. In addition,
fluctuating operating results have led to increased attention to improving the measurement of the financial
security of insurers. As a result of these changes, cash flow analysis has become an increasingly
important aspect of actuarial work.

Current Practices

Common approaches to cash flow analysis typically follow these steps:

1. identify which asset, policy, or other liability cash flows are to be included in the cash flow
analysis;

2. select and validate models for asset, policy, or other liability cash flows;

3. select an appropriate scenario or set of scenarios, either deterministic or stochastic;

4. project the selected asset, policy, or other liability cash flows under each selected scenario; and

5. develop conclusions based on analysis of the cash flow projections.

There are variations on this process. For example, if cash flow analysis is used to analyze the effects of
changes in investment strategy, specific assets may not be identified in the initial step of the process. It
may be sufficient instead to analyze variations in asset portfolio characteristics such as yield and
duration.

Cash flow analysis can be used in a variety of ways, such as analyzing the performance of a particular
asset or product under certain specified scenarios or evaluating the solvency of the entire company. A

13
common current use of cash flow analysis is to meet the requirements of the NAIC’s Actuarial
Opinion and Memorandum Regulation (AOMR), including any variations to this regulation passed by
a state in adopting the model.

14
Appendix 2

Comments on the Exposure Draft and Task Force Responses

The exposure draft of this revised actuarial standard of practice was issued in September 2000 with a
comment deadline of March 31, 2001. (Copies of the exposure draft are available from the ASB
office.) Twenty-one comment letters were received. The Cash Flow Testing Task Force of the Life
Committee of the ASB carefully considered all comments received. Summarized below are the
significant issues and questions contained in the comment letters and the task force’s responses.

SECTION 1. PURPOSE, SCOPE, CROSS REFERENCES, AND EFFECTIVE DATE


Section 1.2, Scope
Comment A number of commentators asked for clarification whether the analysis can be for part of an insurer’s asset,
policy, or other liability cash flows. One commentator did not want the standard to allow testing of only
assets or liabilities.

Response The revised ASOP No. 7 allows testing of asset, policy, or other liability cash flows individually or only
in part, as appropriate. The task force added wording in section 1.2 to clarify the point.
Comment A few commentators believed that section 1.2 should specifically mention items that are relevant in today’s
practice, namely determination of capital adequacy (such as the C-3 RBC tests that were required for some
companies for the first time in 2000) and determination of fair value.

Response The task force agreed that capital adequacy is relevant for today’s practice, but believed that fair value is
not defined well enough, so the task force added only capital adequacy to the list of items.
Comment A few commentators asked whether ASOP No. 7 was appropriate for property/casualty insurance and
health benefit plans.

Response The task force notes that a joint property/casualty and life task force originally developed ASOP No. 7,
which continues to be appropriate for certain property/casualty work and for health benefit plans.
Comment One commentator questioned the relevance of ASOP No. 7 for non-U.S. work.

Response Annotation 3-1 of the Code of Professional Conduct requires the actuary to observe applicable standards
of practice promulgated by a recognized actuarial organization for the jurisdiction in which the actuary
renders actuarial services. ASOPs promulgated by the Actuarial Standards Board apply to actuarial
services rendered in the United States. Actuarial services rendered in a non-U.S. jurisdiction would be
subject to actuarial standards of practice promulgated by such jurisdiction’s recognized actuarial
organization, if any. Therefore, the task force made no change as a result of this comment.
SECTION 2. DEFINITIONS
Section 2.2, Asset, and 2.11, Liability
Comment Many commentators offered suggestions for changing these definitions.

Response The task force believes the definitions are appropriate. The definitions are consistent with those found in
other standards, where practical. The definitions in ASOP No. 7 are for just this standard and are
appropriate for this standard.

15
Section 2.5, Cash Flow Analysis, and 2.6, Cash Flow Testing
Comment One commentator did not like the distinctions made between “cash flow analysis” and “cash flow testing.”

Response The task force believes the definitions are appropriate, since ASOP No. 7 is now designed to make a
hierarchy of types of analysis, with “cash flow analysis” being the most general term, and “cash flow
testing” being one type of cash flow analysis.
Section 2.12, Notional Asset Portfolio
Comment A number of commentators suggested changes to this definition.

Response The task force revised the definition in response.


Section 2.13, Other Liability Cash Flows
Comment One commentator noted that the term “other liability cash flows” was used, but not defined, in the exposure
draft of ASOP No. 22. A commentator on ASOP No. 22 thought that the definition should include surplus
notes.

Response The task force agreed and added a definition of “other liability cash flows,” which includes a reference to
surplus notes, to both ASOP No. 7 and No. 22.
Section 2.15, Policy Cash Flows (previously section 2.14)
Comment One commentator noted that the definition did not treat premium taxes properly, as premium taxes are not paid
on behalf of policyholders, but rather are paid as required by law.

Response The task force agreed with this comment and changed the definition accordingly.
SECTION 3. ANALYSIS OF ISSUES AND RECOMMENDED PRACTICES
Section 3.2.1, Reasons for Cash Flow Testing, and 3.2.2, Cash Flow Testing is Not Always Necessary
Comment A few commentators questioned the use of the phrases “long duration” and “short-term,” and noted that
these can have meaning in a GAAP context.

Response The task force agreed that the use of those phrases could cause confusion in that regard and changed
the wording.
Section 3.2.2, Cash Flow Testing is Not Always Necessary
Comment One commentator asked that the phrase “policy term” be included as part of what the actuary should
consider as to whether a block is relatively insensitive to changes in economic conditions.

Response The task force agreed and added words to accomplish this.
Section 3.2.3, Use of Analyses or Data Predating the Analysis Date
Comment One commentator believed that the actuary should consider future material events in the analysis.

Response The task force disagreed, believing such a thing is beyond the scope of cash flow analysis.
Section 3.5.1, Policy Cash Flow Characteristics
Comment One commentator asked that the issue of changes in the premium scales be included explicitly.

Response The task force added section 3.5.1(f), which specifically identifies changes in premiums and other charges
as items for the actuary to consider.

16
Section 3.7, Materiality
Comment A few commentators wanted further guidance on materiality. Several asked that materiality be mentioned
in specific sections.

Response The task force believes that more detailed guidance on materiality is beyond the scope of this standard.
The task force notes that the guidance in section 3.7 is applicable to the entire standard, so it did not add
specific mentions in other sections.
Section 3.8, Reinsurance
Comment One commentator asked whether section 3.8 differed from section 3.5.1(a).

Response Section 3.5.1(a) specifically deals with policy cash flows, while section 3.8 is broader than that. The task
force made no changes to either section.
Section 3.9, Separate Accounts
Comment A few commentators wanted more detailed guidance on treatment of flows between the general account and
the separate account.

Response The task force believes that the level of guidance in this section is appropriate. However, the task force
agreed with a comment that the actuary should consider whether certain cash flows between the general and
separate accounts were allowable, and changed the wording accordingly.
Section 3.10.1, Scenarios
Comment A number of commentators questioned the use of the word “often” in the sentence, “Often, more than one
scenario will be analyzed.”

Response The task force removed the word “often” and substituted the words “depending on the purpose of the
analysis.”
Comment Regarding 3.10.1(b), Number of Scenarios, one commentator wanted more detailed guidance on the number of
scenarios. Another commentator wanted words that put less emphasis on the investment rate of return being
the key item of interaction with asset, policy, or other liability cash flows.

Response The task force believes that the level of guidance on the number of scenarios is appropriate. The task force
did change this section to put less emphasis, when choosing the number of scenarios, on whether asset,
policy, or other liability cash flows vary with investment rates of return.
Section 3.10.2, Sensitivity Testing
Comment A few commentators noted the issue of cash flows being more uncertain the further into the future a
projection is done.

Response The task force agreed and added words to section 3.10.2, noting more potential for variability the further into
the future the cash flows are projected.
Section 3.11, Negative Interim Earnings
Comment One commentator mentioned that negative interim earnings were an accounting issue and that, therefore, this
section should be eliminated.

Response The task force disagreed. This section emphasizes the point that, if appropriate for the purposes of the
analysis (for example, an asset adequacy test), the actuary should consider whether negative earnings in
some years (the typical concern being the early projection years) affect whether future positive earnings in
other (typically, later projection) years can be realized; i.e., the block tested may require the infusion of
additional funds before the positive earnings years start. The task force agreed that in some types of
analyses (for example, pricing and analyzing a new block of business where the company has significant
surplus) the consideration of negative earnings may not be appropriate.

17
SECTION 4. COMMUNICATIONS AND DISCLOSURES
Section 4.1, Reliance on Others for Data, Projections, and Supporting Analysis
Comment One commentator noted that wherever the term “data” was mentioned in terms of an actuary reviewing and
using the work of others, it was more appropriate to use the more comprehensive terminology “data,
projections, or supporting analysis.”

Response The task force agreed and made the recommended change.
Section 4.3, Documentation
Comment Some commentators believed that section 4.3 should be more general and not contain a list of items needing
documenting, while others liked the guidance a list gave.

Response The task force agreed to keep the list, but shortened the descriptions of some of the items.
Comment A few commentators noted that the amount of disclosure should vary based on the complexity of the project.

Response The task force agreed and added wording to note this.
Comment One commentator noted that a disclosure item should be added for analyses performed prior to the valuation
date.

Response The task force agreed and added what is now section 4.3(g).
Comment One commentator noted that section 4.3(g)(15) (previously section 4.3(u)) on documentation of negative
interim earnings should be modified to note that this should be done only if appropriate for the analysis.

Response The task force believes this issue is covered by other wording in section 4.3, which notes that documentation
should be appropriate for the analysis being done.
Section 4.5, Retention
Comment One commentator noted that there should be a section on document retention.

Response The task force agreed and added a new section 4.5, Retention.

18
Appendix 3

Comments on the Revised Standard as Adopted


in September 2001 and ASB Responses

As appendix 2 indicates, the exposure draft of this revised actuarial standard of practice was issued in
September 2000 with a comment deadline of March 31, 2001. The Cash Flow Testing Task Force of
the Life Operating Committee of the ASB, after carefully considering all comments received, presented
a proposed final revised standard to the ASB for adoption. At its September 2001 meeting, the ASB
adopted the revised standard (with minor edits) with an effective date of April 15, 2002.

In March of 2002, representatives of the Casualty Practice Council of the American Academy of
Actuaries identified concerns regarding the application of the revised standard to property and casualty
practice. Specifically, they expressed concern that the scope of the revised standard went beyond
generally accepted actuarial practice in the property and casualty area and, arguably, called for casualty
actuaries to consider cash flow testing in settings where they typically would not do so and where, in
their view, cash flow testing would not be needed.

In light of these concerns, the Casualty Practice Council formally requested that the ASB defer the
effective date of the revised standard to July 15, 2002, in order to provide the Council with an
opportunity to present its concerns and offer one or more suggested remedies. The ASB carefully
considered the Casualty Practice Council’s request and agreed to defer the effective date of the revised
standard to July 15, 2002.

Representatives of the Casualty Practice Council attended the ASB’s June 2002 meeting and presented
the Council’s concerns. The chairperson of the Life Operating Committee of the ASB was also present.
After considerable discussion and consideration, the ASB agreed that it would be appropriate to do the
following:

1. amend the scope of the revised standard to conform more closely to current, generally accepted
practice among property and casualty actuaries;

2. proceed with such amended scope without re-exposure to the membership since the scope and
content of the revised standard (as adopted at the September 2001 meeting) with respect to life
and health practice remained unaltered; and

3. inform the membership and all interested parties of these developments and the effective date of
July 15, 2002.

19
The Casualty Practice Council representatives also opined that section 3.2, Determining the Level of
Analysis of Cash Flows, in requiring the actuary to consider “all material risks and options embedded in
the asset, policy or other liability cash flows,” was unclear as to what is or is not “material.” The ASB
agreed a clarification was appropriate for all practice areas, and modified the section to require the
actuary to consider only those risks and options that the actuary believes to be material.

20
Actuarial Standard
of Practice
No. 8

Regulatory Filings for Health Plan Entities

Revised Edition

Developed by the
Task Force to Revise ASOP No. 8 of the
Health Committee of the
Actuarial Standards Board

Adopted by the
Actuarial Standards Board
December 2005

(Doc. No. 100)


ASOP No. 8—December 2005

TABLE OF CONTENTS

Transmittal Memorandum iii

STANDARD OF PRACTICE

Section 1. Purpose, Scope, Cross References, and Effective Date 1


1.1 Purpose 1
1.2 Scope 1
1.3 Cross References 2
1.4 Effective Date 2

Section 2. Definitions 2
2.1 Financial Projection 2
2.2 Health Benefit Plan 2
2.3 Health Filing 2
2.4 Health Plan Entity 3
2.5 Regulatory Benchmark 3
2.6 Time Value of Money 3

Section 3. Analysis of Issues and Recommended Practices 3


3.1 Introduction 3
3.2 Issues and Recommended Practices for Health Filings 3
3.2.1 Purpose of Filing 3
3.2.2 Assumptions 3
3.2.3 Use of Business Plans to Project Future Results 4
3.2.4 Use of Past Experience to Project Future Results 4
3.2.5 Recognition of Plan Provisions 5
3.2.6 New Plans or Benefits 5
3.2.7 Projection of Future Capital and Surplus 5
3.2.8 Regulatory Benchmark 5
3.2.9 Reasonableness of Assumptions 5
3.3 Reliance on Data or Other Information Supplied by Others 6
3.4 Documentation 6

Section 4. Communications and Disclosures 6


4.1 Communications and Disclosures 6
4.2 Prescribed Statement of Actuarial Opinion 6
4.3 Deviation from Standard 6

APPENDIXES

Appendix 1—Background and Current Practices 8


Background 8
Current Practices 8

Appendix 2—Comments on the Exposure Draft and Responses 9

ii
ASOP No. 8—December 2005

December 2005

TO: Members of Actuarial Organizations Governed by the Standards of Practice of the


Actuarial Standards Board and Other Persons Interested in Regulatory Filings for
Health Plan Entities

FROM: Actuarial Standards Board (ASB)

SUBJ: Actuarial Standard of Practice (ASOP) No. 8

This booklet contains the final version of the revision of ASOP No. 8, now titled Regulatory
Filings for Health Plan Entities.

Background

The ASB originally adopted ASOP No. 8, Regulatory Filings for Rates and Financial
Projections for Health Plans (Doc. No. 010), in 1989. Under the guidance of the ASB Health
Committee, the Task Force to Revise ASOP No. 8 has prepared this revision to be consistent
with the current ASOP format and to reflect current, generally accepted actuarial practices with
respect to regulatory filings for health plan entities.

Exposure Draft

The exposure draft of this ASOP was issued in September 2004 with a comment deadline of
March 31, 2005. Fourteen comment letters, showing thoughtful insight of the issues, were
received and considered in developing the final ASOP. For a summary of the substantive issues
contained in the exposure draft comment letters and the responses, please see appendix 2.

The most significant changes since the exposure draft were as follows:

1. The language on applicable law in section 1.2 was updated to be consistent with current
boilerplate language to be used in other ASOPs and removed from section 2.1.

2. The task force modified the language regarding section 3.2.2, Consistency with Business
Plans (now section 3.2.3, Use of Business Plans to Project Future Results), to address
commentators’ concerns regarding the actuary’s use of any relevant information from any
business plan(s) as part of the process of setting assumptions and methodologies used in the
filing. The task force also removed the requirement of consistency in assumptions between
the business plan and the filing.

3. The task force modified section 3.2.3, Reasonableness of Assumptions, in the exposure draft
and moved it to the last section within 3.2, Issues and Recommended Practices for Health

iii
ASOP No. 8—December 2005

Filings. The language clarifies the requirements when the actuary reviews the reasonableness
of assumptions.

4. The task force modified the language in section 3.2.6, New Plans or Benefits, to address the
issues regarding data raised by the commentators.

5. The task force modified section 3.3, Reliance on Others (now Reliance on Data or Other
Information Supplied by Others), to use language consistent with other recent ASOPs.

6. The task force changed the language in section 4.3, Deviation from Standard, to be consistent
with that used in other recent ASOPs.

The Health Committee thanks all those who commented on the exposure draft.

The ASB voted in December 2005 to adopt this standard.

Task Force to Revise ASOP No. 8

Paul R. Fleischacker, Chairperson


Timothy D. Courtney Julia T. Philips
John M. Friesen William H. Phillips
Michael R. Gross William R. Sarniak
James M. Gutterman John W.C. Stark

Health Committee of the ASB

Alan D. Ford, Chairperson


Michael S. Abroe John M. Friesen
Gary L. Brace James M. Gutterman
Robert G. Cosway Mary J. Murley
Paul R. Fleischacker John W.C. Stark

Actuarial Standards Board

Michael A. LaMonica, Chairperson


Cecil D. Bykerk William A. Reimert
William C. Cutlip Lawrence J. Sher
Lew H. Nathan Karen F. Terry
Godfrey Perrott William C. Weller

iv
ASOP No. 8—December 2005

ACTUARIAL STANDARD OF PRACTICE NO. 8

REGULATORY FILINGS FOR HEALTH PLAN ENTITIES

STANDARD OF PRACTICE

Section 1. Purpose, Scope, Cross References, and Effective Date

1.1 Purpose⎯This actuarial standard of practice (ASOP) provides guidance to actuaries


when performing professional services with respect to preparing or reviewing required
regulatory filings for health plan entities and health benefit plans provided by health plan
entities.

1.2 Scope⎯This standard applies to actuaries when performing professional services with
respect to preparing or reviewing health filings, as defined in section 2.3, required by and
made to state insurance departments, state health departments, the federal government,
and other regulatory bodies. Health filings require projection of future contingent events
and can be categorized into two broad categories: rate or benefit filings and financial
projection filings. Some of these filings are made on behalf of health plan entities, such
as filings made in conjunction with applications for licensure. Other filings are required
for health benefit plans provided by health plan entities, such as filings for approval of
rates. Such filings may be required for new and existing health plan entities, for new
health benefit plans, and for revisions to existing health benefit plans.

The filings covered by this standard do not include filings to certify compliance with
rating methods and other actuarial practices applicable to carriers for small employer
health benefit plans (see ASOP No. 26, Compliance with Statutory and Regulatory
Requirements for the Actuarial Certification of Small Employer Health Benefit Plans);
statements of actuarial opinion relating to statutory financial statements of health plan
entities (see ASOP No. 22, Statements of Opinion Based on Asset Adequacy Analysis by
Actuaries for Life and Health Insurers, and ASOP No. 28, Compliance with Statutory
Statement of Actuarial Opinion Requirements for Hospital, Medical, and Dental Service
or Indemnity Corporations, and for Health Maintenance Organizations); and filings that
are solely experience reports and do not require projection of future contingent events.

This standard is not meant to provide a complete set of recommended practices for the
determination of health rates, financial projection entries, or other numerical information
required to be included in health filings. It represents areas of inquiry and analysis that an
actuary should consider when preparing or reviewing a required health filing for purposes
of compliance with applicable law.

The actuary should satisfy the requirements of applicable law (statutes, regulations, case
law, and other legally binding authority) and this standard. However, to the extent

1
ASOP No. 8—December 2005

applicable law conflicts with this standard, compliance with such applicable law shall not
be deemed a deviation from this standard, provided the actuary discloses that the actuarial
assignment was performed in accordance with the requirements of such applicable law.

1.3 Cross References⎯When this standard refers to the provisions of other documents, the
reference includes the referenced documents as they may be amended or restated in the
future, and any successor to them, by whatever name called. If any amended or restated
document differs materially from the originally referenced document, the actuary should
consider the guidance in this standard to the extent it is applicable and appropriate.

1.4 Effective Date—This standard is effective for all applicable filing work performed on or
after May 1, 2006.

Section 2. Definitions

The terms below are defined for use in this actuarial standard of practice.

2.1 Financial Projection⎯A projection of covered lives, premiums, claims, expenses, capital
and surplus, or other financial quantities that may be required by applicable law.

2.2 Health Benefit Plan⎯A contract or other financial arrangement providing hospital,
medical, prescription drug, dental, vision, disability income, accidental death and
dismemberment, long-term care, or other health-related benefits, whether on a
reimbursement, indemnity, or service benefit basis, irrespective of the type of health plan
entity that provides the benefits.

2.3 Health Filing⎯A required regulatory filing, at least one element of which requires
projection of future contingent events, for rates or benefits, or financial projections.

Rate or benefit filings include, but are not limited to, the following:

a. filings of manual rates and rating factors;

b. filings of rating methodology, such as experience rating formulas and factors;

c. statements of actuarial soundness or rate adequacy, as may be defined by the


regulatory body, for future rating periods;

d. certification of benefit values; and

e. other filings of similar nature as may be required by the regulatory body.

Financial projection filings include, but are not limited to, any filings in which the
financial projections are a stand-alone requirement, such as those for licensure

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ASOP No. 8—December 2005

requirements, or are a requirement of a broader filing, such as a rate filing or projections


of future capital and surplus or other regulatory benchmark requirements.

2.4 Health Plan Entity⎯An insurance company, health maintenance organization, hospital or
medical service organization, self-insured health benefit plan sponsor, governmental
health benefit plan sponsor, or any other health benefit plan sponsor from which health
filings are required.

2.5 Regulatory Benchmark⎯A measurement, such as a loss ratio or capital ratio, specified
by applicable law, which is used by the regulatory authority as a basis upon which to
evaluate a health filing.

2.6 Time Value of Money⎯The principle that an amount of money available at an earlier
point in time has different usefulness and value than the same amount of money has at a
later point in time.

Section 3. Analysis of Issues and Recommended Practices

3.1 Introduction—Many jurisdictions require health filings that demonstrate compliance with
applicable law, which may vary considerably as to the requirements and procedures for
these filings. In many cases, such law may be silent as to the assumptions and
methodology to be used, thus giving the actuary significant discretion to exercise
professional judgment in preparing and reviewing the filings.

3.2 Issues and Recommended Practices for Health Filings—The actuary should consider the
following:

3.2.1 Purpose of Filing⎯When preparing a filing, the actuary should include in the
filing a statement of its purpose, identifying the applicable law it is intended to
comply with. For example, the actuary might state, “The only purposes of this rate
filing are to document the rates and to demonstrate that the anticipated loss ratio
of this product with those rates meets the minimum requirements of Section XX
of the statutes of [name of state]. This filing may not be appropriate for other
purposes.”

If, in the actuary’s professional judgment, applicable law is ambiguous, the


actuary should describe how the actuary interpreted the requirements when
preparing the filing. For example, the statute may say, “Provide a business plan
demonstrating future solvency.” The actuary then might state, “This projection of
financial results is intended to demonstrate that the business plan reasonably
anticipates surplus exceeding $XX million for the following Y years.”

3.2.2 Assumptions—The actuary should consider which assumptions are necessary for
the filing. Such assumptions may include the following:

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ASOP No. 8—December 2005

a. premium levels and future rate changes;

b. enrollment projections;

c. morbidity, mortality, and lapsation levels and trends;

d. expenses, commissions, and taxes;

e. investment earnings and the time value of money;

f. health cost trends;

g. expected financial results, such as profit margin, surplus contribution, and


surplus level;

h. expected impact of contractual arrangements with health care providers


and administrators; and

i. expected impact of reinsurance and other financial arrangements.

3.2.3 Use of Business Plans to Project Future Results⎯The actuary should request and
review any existing and relevant business plans for the health plan entity or health
benefit plan that is the subject of the filing. The actuary should consider the
information therein along with any other information relevant to the business plan
as a part of the setting of the assumptions and methodologies used in the filing.

3.2.4 Use of Past Experience to Project Future Results⎯When setting assumptions, the
actuary should adjust past experience for any known or expected changes that, in
the actuary’s professional judgment, are likely to materially affect expected future
results. These may include, but are not limited to, changes in the following:

a. selection of risks;

b. demographic and risk characteristics of the insured population;

c. policy provisions;

d. business operations;

e. premium rates, claim payments, expenses, and taxes;

f. trends in mortality, morbidity, and lapse; and

g. administrative procedures.

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ASOP No. 8—December 2005

The actuary should make adjustments to past experience based on earned


premiums and incurred claims, as appropriate, in a way that reasonably matches
claim experience to exposure. For example, the actuary should not use ratios of
paid claims to collected premiums to project future incurred loss ratios except
with appropriate adjustment.

The actuary should update prior earned premium and incurred claim estimates to
reflect premium and claim development experience to date when, in the actuary’s
professional judgment, the difference is material.

The actuary may express past experience in terms of aggregate premium, claim,
and reserve amounts, or in terms of unit results, such as incidence rates and
average premium and claim amounts.

The actuary should consider the applicability and statistical credibility of the data
and make appropriate modifications, if necessary.

3.2.5 Recognition of Plan Provisions⎯The actuary should consider pertinent plan


documents or contracts and, as described to the actuary, established administrative
procedures, any plan interpretations that are not written in the plan documents,
and any arrangements with providers of health care.

3.2.6 New Plans or Benefits⎯The actuary should consider available data relevant to
new plans or benefits. If using a model (for example, in the absence of sufficient
data), the actuary should use a model that is reasonable and consistent with
similar benefits or plans of coverage, if any, and that, if appropriate for the plan or
benefit, takes into account the general characteristics of the health care delivery
system.

3.2.7 Projection of Future Capital and Surplus⎯As part of a health filing, the actuary
may be called upon to project future capital and surplus for the entire health plan
entity or a portion of it, such as a business unit. In doing so, the actuary should
base the projection on reasonable assumptions that take into account any internal
or external future actions as described to the actuary that, in the actuary’s
professional judgment, are likely to have a material effect on capital or surplus.

3.2.8 Regulatory Benchmark⎯The actuary may be called upon to project results in


relation to a regulatory benchmark for the entire health plan entity or a portion of
it, such as a line of business. The actuary should base the projection on
appropriate available information about the relevant book of business.

3.2.9 Reasonableness of Assumptions⎯The actuary should review the assumptions


employed in the filing for reasonableness. The assumptions should be reasonable
in the aggregate and for each assumption individually. The support for
reasonableness should be determined based on the actuary’s professional
judgment, using relevant information available to the actuary. This information

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ASOP No. 8—December 2005

may include, but is not limited to, business plans; past experience of the health
plan entity or the health benefit plan; and any relevant industry and government
studies that are generally known and reasonably available to the actuary. The
actuary should make a reasonable effort to become familiar with such studies.

3.3 Reliance on Data or Other Information Supplied by Others⎯When relying on data or


other information supplied by others, the actuary should refer to ASOP No. 23, Data
Quality, for guidance.

3.4 Documentation—The actuary should prepare and retain documentation in compliance


with the requirements of ASOP No. 31, Documentation in Health Benefit Plan
Ratemaking, if applicable, and ASOP No. 41, Actuarial Communications. The actuary
should also prepare and retain documentation to demonstrate compliance with the
disclosure requirements of section 4.1.

Section 4. Communications and Disclosures

4.1 Communications and Disclosures⎯When issuing actuarial communications relating to


regulatory filings for health plan entities, the actuary should refer to ASOP No. 23 and
ASOP No. 41. In addition, such actuarial communications should disclose the following:

a. the sources of information;

b. any material information supplied by others and the extent of the actuary’s
reliance on such information;

c. any unresolved concerns the actuary may have about the information that could
have a material effect on the actuarial work product;

d. limitations on the use of the actuarial work product;

e. any conflicts arising from applicable law; and

f. any assumptions or methods prescribed by applicable law.

4.2 Prescribed Statement of Actuarial Opinion—This ASOP does not require a prescribed
statement of actuarial opinion as described in the Qualification Standards for Prescribed
Statements of Actuarial Opinion promulgated by the American Academy of Actuaries.
However, law, regulation, or accounting requirements may also apply to an actuarial
communication prepared under this standard, and as a result, such actuarial
communication may be a prescribed statement of actuarial opinion.

4.3 Deviation from Standard—The actuary must be prepared to justify to the actuarial
profession’s disciplinary bodies, or to explain to a principal, another actuary, or other
intended users of the actuary’s work, the use of any procedures that depart materially

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ASOP No. 8—December 2005

from those set forth in this standard. If a conflict exists between this standard and
applicable law or regulation, compliance with applicable law or regulation is not
considered to be a deviation from this standard.

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ASOP No. 8—December 2005

Appendix 1

Background and Current Practices

Note: This appendix is provided for informational purposes but is not part of the standard of
practice.

Background

Many jurisdictions require the filing of actuarial memoranda or similar documents in connection
with health plan entities. An actuary may be involved in the preparation or review of these
filings. The applicable laws differ as to their content, scope, and requirements. Many laws are
silent as to procedures and assumptions to be employed, thus giving the actuary significant
discretion to exercise professional judgment in these areas.

Current Practices

The previous ASOP No. 8 had been in place since 1989. Although the task force believes that the
previous standard represented generally accepted practice, this revision more accurately reflects
current practices.

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ASOP No. 8—December 2005

Appendix 2

Comments on the Exposure Draft and Responses

The exposure draft of this revised actuarial standard of practice (ASOP), Regulatory Filings for
Health Plan Entities, was issued in September 2004, with a comment deadline of
March 31, 2005. Fourteen comment letters were received, some of which were submitted on
behalf of multiple commentators, such as by firms or committees. For purposes of this appendix,
the term “commentator” may refer to more than one person associated with a particular comment
letter. The Task Force to Revise ASOP No. 8 carefully considered all comments received.
Summarized below are the significant issues and questions contained in the comment letters and
responses to each, which may have resulted from ASB, Health Committee, or task force
discussion. Unless otherwise noted, the section numbers and titles used below refer to those in
the exposure draft.

GENERAL COMMENTS
Comment One commentator questioned whether credit disability filings were subject to ASOP No. 8 since
typically such filings require only that the actuary conform to the state’s published “prima facie” rates
and, thus, the filings are not “projections of future contingent events.” The commentator questioned
whether ASOP No. 8 should exclude credit disability in these situations.

Response The task force did not think such a specific exclusion was appropriate and believed the general
description of inclusions and exclusions was sufficient.
Comment One commentator noted that some other standards (for example, ASOP Nos. 26 and 28) describe
specific “regulatory filings for health plan entities” and that, either the relationship between these
standards and ASOP No. 8 needed to be clarified in the latter, or that the name of the proposed standard
was too broad and needed to be replaced.

Response The task force noted that these filings are already specifically excluded in the second paragraph of
section 1.2 and that these exclusions should adequately address these concerns.
Comment One commentator was concerned that the scope of the proposed ASOP was too broad, stating individual
health insurance carriers are often asked by regulators about the benefit cost(s) of mandates and that,
depending on what the definition of a benefit filing is, almost every request could require more work or
even an actuarial memorandum. Also, in many cases, the regulatory entity has a prescribed form that
does not lend itself to many of the proposed requirements. For example, many states have electronic
forms that allow for entering only a number or a few numbers; in most cases, there is not room to
provide all of the qualifications or caveats that could be included. In addition, there is often no means to
follow up with a full report.

Response The task force believes that the definition of section 2.4 adequately addresses these concerns. The task
force does not believe requests for information regarding, for example, benefit cost(s) of mandates
would fall under the category of required filings.
Comment One commentator suggested adding materiality criteria in the section that discusses reasonableness of
assumptions.

Response The task force chose not to make a distinction between levels of materiality of assumption. The task
force did not want to include a formal definition of materiality in this standard, as materiality is a
subjective concept and often depends on professional judgment.

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ASOP No. 8—December 2005

SECTION 1. PURPOSE, SCOPE, CROSS REFERENCES, AND EFFECTIVE DATE


Section 1.1, Purpose
Comment One commentator stated that “required regulatory filings” is less clear than the language in the prior
standard. One of the most common types of filings is a filing for a rate increase. Most often, the filing
is made to increase rates, not to meet a regulatory requirement to file. The commentator suggested
striking the work “required” and striking it in the second to last paragraph of section 1.2.

Response The task force noted that it had previously considered this issue and concluded purposely to insert the
word “required” to differentiate between filings that are required by regulatory authorities, such as
those required when filing for a rate increase, and other information that actuaries may submit to
health regulators, such as a regulator’s request for an estimate of the cost impact of a proposed
regulation.
Section 1.2, Scope
Comment The transmittal memorandum of the exposure draft asked whether the scope was appropriate. One
commentator agreed it was but believed that the second sentence could be clearer if worded as
follows: “Health filings covered by this standard are filings that require projection of future
contingent events in order to meet the given regulatory requirements. These health filings can be
categorized into two broad categories: rate or benefit filings and financial projection filings.”

Response The task force believes that these concerns are adequately covered in sections 1.2 and section 2.3.
The task force noted that most of the commentators on the first three questions asked in the
transmittal memorandum agreed that the scope was appropriate and that the ASOP was clear as to
whom it applied and to what types of health filings were covered.
Comment The transmittal memorandum of the exposure draft asked whether the ASOP was clear that it applies
to projections relating to capital and surplus requirements, which would include, for example,
minimum risk-based capital and surplus requirements in states that have adopted the NAIC Risk-
Based Capital (RBC) for Health Organizations Model Act. One commentator stated that, if the ASB
wishes to further emphasize application to projections related to capital and surplus requirements,
then it could include the example given above.

Response The task force believed the descriptions were sufficiently clear to provide guidance on which filings
were subject to the standard, noting that two other commentators agreed with this.
Comment One commentator was concerned with the last paragraph regarding conflict with applicable law and
believed that the last phrase should be strengthened to require the actuary to disclose items such as
the nature of the departure from the requirements of the standard, the financial effects thereof, and the
specific provisions of the applicable law.

Response The task force updated the wording to be consistent with the current language to be used in other
ASOPs and believed the revised language more closely addressed some of the commentator’s
concerns. The task force did not agree that the standard should specify what the actuary’s disclosure
should contain in the event of the standard conflicting with applicable law and believed that the
revised wording, in combination with section 4, Communications and Disclosures, provided adequate
guidance.
Comment One commentator was concerned that including “case law” and “statutes” in a definition of
applicable law might unreasonably require the actuary to be knowledgeable about court
interpretations or even require the unauthorized practice of law.

Response The definition of “applicable law” was deleted since it is now defined in “boilerplate” language in
section 1.2. The task force does not believe the definition puts actuaries in the position of
unauthorized practice of law, but the standard does require actuaries to be knowledgeable of
applicable law germane to the actuarial assignment.

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ASOP No. 8—December 2005

Comment One commentator suggested that a discussion of any conflict between the standard and applicable law
should be placed in the body of the standard rather than in the scope.

Response The task force believed the current placement was appropriate and consistent with other ASOPs.
SECTION 2. DEFINITIONS
Section 2.2, Financial Projection (now section 2.1)
Comment One commentator suggested inserting “covered” before “expenses.”

Response The task force believed that, if this word were added, the actuary could interpret it to mean expenses
covered, for example, by premiums. Financial projections should include all expenses, which may or
may not be covered by premiums. As such, the task force concluded not to add this word.
Comment One commentator stated that a projection of covered lives in the absence of financial quantities was
not considered a “financial projection” and that “covered lives” should be removed from the list. The
commentator also suggested changing “administrative expenses” to “expenses” since claims are
expenses too and noted that in other places in the standard “expenses” means “administrative
expenses.”

Response The task force believed that covered lives often are included in financial projections and should be
included in the projection. The task force also believed that “expenses” as a general term provided
adequate guidance, particularly since claims are mentioned as a separate item.
Section 2.3, Health Benefit Plan (now section 2.2)
Comment One commentator expressed concern that “health benefit plan” is a defined term in numerous state
insurance laws, but the ASOP defines it differently. The commentator suggested substituting a term
such as “health coverage plan.”

Response The task force believed that the definition needed to be sufficiently broad and inclusive to cover all
states’ requirements and that definition contained in the exposure draft was sufficiently clear to avoid
confusion with statutory language. The task force noted that terms in section 2 are defined only for
their use within this standard and may depart from definitions used in other actuarial literature.
Comment One commentator suggested adding “hospital” before “medical” and adding this sentence to the end
of the paragraph: “A discount-only plan is not a health benefit plan.”

Response The task force agreed and made the first suggested change. On the second suggestion, the task force
noted that, at this time, this type of product would not be subject to this ASOP since it would not
require a health filing as defined under section 2.4 and believed it was unnecessary to add this
sentence.
Section 2.4, Health Filing (now section 2.3)
Comment One commentator suggested that a definition of “manual rates” be included and that ASOP No. 8
should be expanded to cover the derivation and proper use of manual rates.

Response The task force believed the term “manual rates” was well enough understood in the context of health
filings and did not need to be defined in this ASOP. The task force did not believe that a discussion
of the derivation or use of manual rates was an appropriate subject for this ASOP.

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ASOP No. 8—December 2005

Comment One commentator was concerned that the definition was too restrictive and questioned whether the
phrase “certification of benefit values” includes filings where an actuary certifies that two sets of
benefits are equivalent, which would not always require a projection into the future and may be
strictly based on the current experience.

Response The task force intends that, for a filing to be subject to this ASOP, the filing be required by a
regulatory authority and that at least one element of the filing requires projection of future contingent
events. If the filing does not have both of these requirements, the filing is not subject to this ASOP. In
the example given by the commentator, if the benefit equivalence calculation requires a projection of
future contingent events, and the actuary chooses to use current experience with zero trend, and the
filing is required by a regulatory authority, the filing would be subject to this ASOP.
Comment One commentator suggested striking the phrase “as may be defined by the regulatory body” because
it does not help to strengthen the section and may in fact do harm, as applicable law can define
anything as “actuarial soundness” or “rate adequacy.” The power of the “regulatory body” should not
be defined to dictate unsound practice.

Response The task force noted that it had previously considered this issue and had intentionally concluded to
add this language. The task force had discussed including a definition of “actuarial soundness” in this
ASOP but concluded that “actuarial soundness” is a broader industry issue and decided to limit its
inclusion to cover those situations in which states have specific requirements, for example, that the
actuary opine that the rates are reasonable in relation to the benefits provided or that the rates meet
mandated minimum loss ratio requirements.
Comment One commentator recommended replacing the last paragraph of the section with the following: “A
financial projection or business plan filing includes, but is not limited to, any filings in which the
financial projections are a stand-alone requirement, such as those for licensure requirements, or are a
requirement of a broader filing, such as a rate filing or projections of future capital and surplus or
other regulatory benchmark requirements.”

Response The task force noted that the suggested wording was basically the same as that contained in the
exposure draft except adding the wording about business plan. The task force did not believe the
reference to business plan in this paragraph was necessary.
Comment One commentator stated that the term “health filing” is based on the undefined term “required
regulatory filing.” As a result, the scope of the definition is left unclear. No distinction is made
between a legal requirement and an administrative request that is unsupported by statute or
regulation. The commentator suggested adding the following definition of a required regulatory
filing: “A required regulatory filing is a filing required by statute or regulation.”

Response The task force believed the definition of “health filing” in the exposure draft provided adequate
guidance and that the proposed definition was circular.
Section 2.7, Time Value of Money (now section 2.6)
Comment One commentator suggested dropping the phrase “usefulness and” and leaving the term defined in
terms of value only, perhaps by adding the word “monetary” before “value.” Another commentator
believed the definition and references to “earlier” and “later” in particular were not clear.

Response The task force considered the wording in light of the comments but concluded that the definition,
which is used in other ASOPs, was sufficiently clear.

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ASOP No. 8—December 2005

SECTION 3. ANALYSIS OF ISSUES AND RECOMMENDED PRACTICES


Section 3.2.1, Purpose of Filing
Comment One commentator noted that the example in the second paragraph appeared to provide more precision
than appeared to be implied by the requirement in the first sentence of this paragraph, which required
the actuary only to “describe” the interpretation of the regulatory requirements. The commentator
questioned what level of precision is appropriate for the description and believed that “describe” does
not provide any notion of the degree of completeness needed.

Response The task force believed the wording was appropriate and did not believe the standard should be too
prescriptive.
Section 3.2.2, Consistency With Business Plan (now section 3.2.2, Assumptions, and section 3.2.3, Use of
Business Plans to Project Future Results)
Comment One commentator suggested alternative language that would require assumptions to be consistent
with contemporaneous health filings relating to the health benefit plan subject to the current filing;
one commentator suggested strengthening the requirement that “the actuary should use assumptions
and methodologies that are consistent with the business plan….”

Response Section 3.2.2 from the exposure draft was reorganized into new sections 3.2.2, Assumptions, and
3.2.3, Use of Business Plans to Project Future Results, to better address these different but connected
issues.
Comment One commentator noted that the term “persistency” appears without definition. While the term has an
unambiguous meaning in an individual life insurance setting, it could have multiple applications in
the health insurance arena.

Response The task force considered this and believed that the meaning should be clear within the context of
each filing. The task force did not believe a definition was necessary.
Comment One commentator stated that, in any given filing, certain assumptions may not be material and that
this should be so noted in the ASOP.

Response The task force did not believe such a statement was necessary. As noted in the task force’s response
to the last comment under General Comments, the task force chose not to make a distinction between
levels of materiality of assumptions and did not want to include a formal definition of materiality in
this standard, as materiality is a subjective concept and often depends on professional judgment.
Comment Several commentators expressed concerns and raised important issues and questions on the opening
paragraph of this section, including the following:

One commentator found that certain terms such as “business plan,” “sales results,” and “overall” in
“overall business results” were undefined.

One commentator questioned whether the relevant sections of the business plan should be disclosed
in the actuarial communication.

One commentator believed the phrase “as known to the actuary” was too lenient and that the actuary
should review the components of the business plan that are relevant to the determination of
reasonable assumptions.

One commentator noted that business plans developed by health plans to support the internal plan
management serve a different purpose than the projections used to support pricing and regulatory
filings. For example, they are often intended to set challenging performance goals rather than most
likely outcome. The commentator stated that it would be inappropriate to base pricing assumptions on
such projections, as there is no guarantee that they represent a reasonable expectation of future
experience. Further, the commentator suggested that business plans subject to regulatory filing and
review should be included in the definition of a health filing.

13
ASOP No. 8—December 2005

Response The task force agreed with many of the comments and renamed the title and rewrote the section to
address these issues. It is recognized there are many types of business plans, ranging from formal
written documents to informal verbal discussions. To avoid being prescriptive, the language was
changed to require the consideration of relevant information from whatever business plan exists and
included wording about requesting such plan, although obvious. The task force removed references to
consistent assumptions. The task force believed that the issue regarding documentation is adequately
covered in sections 3.4 and section 4.1.
Comment One commentator found that sections 3.2.2 and 3.2.3 of the exposure draft when read together were
troublesome. Section 3.2.2 would have required consistency with the business plan. Section 3.2.3.
would have described a review for reasonableness versus, among other factors, the business plan. The
commentator proposed several changes to both sections, including a proposed redraft of section 3.2.2.

Response The task force substantially rewrote sections 3.2.2 and 3.2.3, (now sections 3.2.2, 3.2.3, and 3.2.9,
Reasonableness of Assumptions) and believes that these revisions adequately address the concerns
mentioned.
Section 3.2.3, Reasonableness of Assumptions (now section 3.2.9)
Comment One commentator questioned whether the actuary should state the extent to which the assumptions
are the actuary’s own or that he or she is reviewing those of some other technician (who may or may
not be an actuary) and perhaps assessing them to meet only the lower standard of “not unreasonable”
or “in a reasonable range.” The commentator stated that two aspects should be reported: (a) the
applicable standard of reasonableness; and (b) who the author is. The commentator noted that, in
assessing anything prepared by an actuary, the actuary’s assessment is going to be strongly affected
by whether the assumptions were devised by the signing actuary or by someone else and, for that
matter, whether the actuary was independent or employed by the organization from which the
assumptions came and questioned whether that should be the case.

Response The task force rewrote this section and believes that this revision addresses many of the
commentator’s concerns.
Comment One commentator stated that two ideas seem important here. First, the model chosen can be important
because some models make assumptions explicit while other models make the same assumptions
implicit. Second, it seems inappropriate to exempt implicit assumptions from the same scrutiny as the
explicit assumptions. The commentator suggested renaming the section “Reasonableness of
Projection Model and Assumptions.”

Response The task force believed that no change was necessary since this section applies to all assumptions,
both implicit and explicit.
Comment Two commentators raised the issue regarding materiality of assumptions and suggested wording
changes to the effect that “each material assumption should be reasonable.”

Response The task force believed that it was important that all assumptions be identified and that the support
for reasonableness of the assumptions be based on the actuary’s professional judgment. As noted in
the task force’s response to the last comment under General Comments, the task force chose not to
make a distinction between levels of materiality of assumptions and did not want to include a formal
definition of materiality in this standard, as materiality is a subjective concept and often depends on
professional judgment.
Comment One commentator recommended retaining the old language in this section requiring assumptions to
be reasonable based on all information available to the actuary and suggested replacing the last two
sentences with the following: “The support for reasonableness should be determined based on the
actuary’s professional judgment, using relevant information available to the actuary. This information
may include, but is not limited to, past experience of the health plan entity or the health benefit plan,
and any relevant industry and government studies.”

Response The task force substantially agreed with most of the commentator’s comments and made appropriate
changes to this section while adding another sentence outlining the actuary’s duty to make a
reasonable effort to become familiar with relevant studies.

14
ASOP No. 8—December 2005

Section 3.2.4, Use of Past Experience to Project Future Results


Comment One commentator suggested striking “in the actuary’s professional judgment,” citing it extraneous.

Response The task force believed that decisions about materiality often depend on the actuary’s professional
judgment and, as such, concluded not to strike those words.
Comment One commentator suggested that, in 3.2.4(d) the comma between “benefit” and “expense” be
replaced with the word “and.”

Response The task force clarified this section (now section 3.2.4 (e)) with revised wording.
Comment One commentator recommended including the concept of “known” changes in the first paragraph and
noted that there may be changes that have taken place between the end of the experience period and
the date of the filing that are known and will materially affect expected future results.

Response The task force agreed and made the change.


Comment One commentator noted the wording of item 3.2.4(e) is potentially confusing and recommended using
either “trends in mortality and morbidity” or “trends in mortality and in the utilization and cost of
services.”

Response The task force agreed and revised the section (now section 3.2.4(f)) for clarity.
Comment One commentator stated that the discussion in the second paragraph refers to paid and incurred
“claims” and to “earned premiums,” etc., and yet the principles are more general and extend beyond
premiums and claims to any financial flows with similar characteristics, for example, capitation
income and payments, government subsidy or “reinsurance” payments, risk adjustments, state risk
pool assessments, etc. The commentator asked whether more general language should be used.

Response The task force believed that more general language was not necessary. The items mentioned are, for
the most part, an element of premiums or incurred claims, for example, capitation income would be
part of earned premiums and capitation payments are a part of incurred claims.
Section 3.2.5, Recognition of Plan Provisions
Comment One commentator stated that the phrase “as described to the actuary” in this context should be
acceptable only if such descriptions are carefully documented with sufficient specificity to designate
the contract provisions precisely.

Response The task force believed that this is adequately covered with the requirements in sections 3.4 and
section 4.1.
Comment One commentator found the meaning “plan documents” unclear and questioned whether it could
include employer contracts, employee certificates, group administration manuals, provider contracts,
etc.

Response The task force believed that plan documents and unwritten procedures, such as those mentioned by
the commentator, can provide useful information about the plan. The task force believed that further
clarification was not necessary.

15
ASOP No. 8—December 2005

Section 3.2.6, New Plans or Benefits


Comment One commentator suggested that the first sentence could be shortened to say, “The actuary should
consider available relevant data,” because the wording as it stands almost limits the paragraph to an
actuary on the filing end and excludes the actuary on the reviewing end.

Response The task force agreed and rewrote this sentence to clarify the language.
Comment One commentator recommended rewording the second sentence of this section as follows: “In the
absence of such data, the actuary should use a reasonable model that is consistent with similar
benefits or plans of coverage offered by the health plan entity and that, if appropriate for the plan or
benefit, takes into account the general characteristics of the health care delivery system.”

Another commentator believed that the second sentence was incomplete in that the model, by itself,
does nothing and that the standard should state what to do with the model. The commentator believed
that the standard meant that the actuary should consider the elements of the new benefits, find other
existing coverages that have matching benefits to the new plan, see if the experience would apply to
the new plan, and, if it does not, keep looking until a match is found.

Response This section was rewritten. Although the wording is very similar, the phrasing has been rearranged
somewhat for clarification. With regards to the second comment, the task force means that the
actuary is to select a model that is intended to develop data that can be used for estimating the value
of new plans or benefits from data on existing plans, when directly relevant data on the new plan are
not available. The language does not require that the benefits and the experience match exactly. As
with all other items under section 3.2, the results of such a model would be considered for the health
filing.
Section 3.2.7, Projection of Future Capital and Surplus
Comment One commentator stated that the phrase “as described to the actuary” should not be used without a
requirement to document what was described to the actuary.

Response The task force believes that this is adequately covered with the requirements in sections 3.4 and
section 4.1.
Section 3.2.8, Investment Income
Comment One commentator recommended revising section 3.2.8 of the exposure draft by substituting
“reasonable earnings rates” for “a reasonable earnings rate.” This would (a) allow for earnings rates
varying by the average duration of liabilities; and (b) leave room for stochastic interest rate studies
(admittedly rare at present, but a concern for very long-term products such as LTC). The present
wording seems to require use of a single rate.

Response This section was deleted but the term “investment earnings” has been included without further
description in the list of assumption in new section 3.2.2, Assumptions.
Section 3.2.9, Regulatory Benchmark (now section 3.2.8)
Comment One commentator believed that the second sentence was a general statement that applied to any filing
and, thus, belonged in section 3.2.4. The commentator suggested that, if it is desirable to mention
regulatory benchmark in the standard, it should be done in section 3.2.1.

Response The task force believed that sections 3.2.4 and 3.2.6 already provide for the use of appropriate
relevant information in their respective descriptions. The task force considered the commentator’s
second suggestion regarding having regulatory benchmark be a part of section 3.2.1. The task force
concluded to keep it as a separate subsection under section 3.2 because of the importance and relative
uniqueness of these types of projections.

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ASOP No. 8—December 2005

Section 3.3, Reliance On Others (now Reliance on Data or Other Information Supplied by Others)
Comment One commentator recommended that the word “descriptions” be included so that it would read,
“…on information, including data and descriptions….”

Another commentator expressed concern about the reliance on information supplied by others and
any due diligence the actuary should perform on that information.

Response The task force revised this section to be consistent with language used in other current ASOPs and
notes that ASOP No. 23, Data Quality, provides expanded guidance on these issues.
SECTION 4. COMMUNICATIONS AND DISCLOSURES
Section 4.1, Communication and Disclosures
Comment One commentator expressed concern with item 4.1(b), stating actuaries will adopt blanket boilerplate
statements that absolve them of the responsibility to inform the employer or client who may rely on
their judgments and what they relied on.

Response The task force agreed and modified the language.


Comment One commentator expressed a concern about whether the actuary has been required to estimate the
extent that adopting an assumption dictated by laws or regulations has changed the results of the
calculations. The commentator suggested that one way to do this would be to make section 4.1(e)
more explicit, for example, by stating, “any conflicts arising from applicable law or regulations and
their effects on the calculations.”

Response The task force decided not to change the language from that contained in the exposure draft. The task
force believed that this suggested requirement would put a greater burden on the actuary and does not
necessarily reflect generally accepted practice. It may be a good thing to know but would not be part
of a required regulatory filing.

17
Actuarial Standard
of Practice
No. 9

Documentation and Disclosure


in Property and Casualty Insurance
Ratemaking, Loss Reserving, and Valuations

Revised Edition

Developed by the
Casualty Committee of the
Actuarial Standards Board

Adopted by the
Actuarial Standards Board
January 1991

(Doc. No. 027)


TABLE OF CONTENTS

Transmittal Memorandum iii

PREAMBLE

Section 1. Purpose, Scope, and Effective Date 1


1.1 Purpose 1
1.2 Scope 1
1.3 Effective Date 1

Section 2. Definitions 1
2.1 Actuarial Report 1
2.2 Actuarial Work Product 1
2.3 Required Actuarial Document 1
2.4 Statement of Actuarial Opinion 2
2.5 Statement of Actuarial Review 2

Section 3. Background and Historical Issues 2

Section 4. Current Practices and Alternatives 2

Section 5. Analysis of Issues and Recommended Practices 3


5.1 Introduction 3
5.2 Extent of Documentation 3
5.3 Prevention of Misuse 3
5.4 Disclosure of Conflict with Professional Judgment, and of Advocacy 3
5.5 Availability of Documentation 4
5.6 Conflicting Interests 4
5.7 Signature on Work Product 4
5.8 Reliance on Another 4
5.9 Waiver of Fee 4

Section 6. Communications and Disclosures 4


6.1 Deviation from Standard 4

APPENDIXES

Appendix 1—Statement of Principles Regarding Property and Casualty Insurance


Ratemaking 5

Appendix 2—Statement of Principles Regarding Property and Casualty Loss and Loss
Adjustment Expense Reserves 10

Appendix 3—Statement of Principles Regarding Property and Casualty Valuations 19

ii
January 1991

TO: Members of the American Academy of Actuaries (AAA) and Other Persons
Interested in Property and Casualty Insurance Ratemaking, Loss Reserving, and
Valuations

FROM: Actuarial Standards Board (ASB)

SUBJ: Actuarial Standard of Practice No. 9

This booklet contains the final version of Actuarial Standard of Practice (ASOP) No. 9,
Documentation and Disclosure in Property and Casualty Insurance Ratemaking, Loss Reserving,
and Valuations.

Background

This booklet contains an actuarial standard of practice concerning documentation and disclosure
in property and casualty insurance ratemaking, loss reserving, and valuations. This standard has
been prepared jointly by the Subcommittee on Ratemaking, the Subcommittee on Loss
Reserving, and the Subcommittee on Valuation of the Casualty Committee of the ASB, and it
has been reviewed by the full Casualty Committee. The standard relies heavily on Interpretative
Opinion 3 of the Guides and Interpretative Opinions as to Professional Conduct of the AAA.

The Casualty Committee is one of six operating committees of the ASB; it is charged with
drafting actuarial standards of practice relating to property and casualty insurance.

The Casualty Committee acknowledges that the professional practice of actuaries varies widely.
In some property and casualty areas, there may be significant differences of opinion as to what is
generally accepted actuarial practice. The enclosed standard sets forth recommended practices
for documentation and disclosure that actuaries must consider in property and casualty
ratemaking, reserving, and valuations. They are intended to guide actuaries in performing their
professional responsibilities.

The standard was originally drafted to apply only to ratemaking and loss reserving. This draft
was exposed to the members of the AAA and to other interested persons in August 1988;
comments were received into October 1988. In addition, the standard was discussed at a session
on this subject at the Casualty Actuarial Society (CAS) meeting in November 1988. The
Casualty Committee considered these comments in preparing a revised standard for adoption by
the ASB. A detailed report of comments received and the committee’s disposition of them
appears below.

iii
Change in Format

After the exposure draft was distributed, the ASB adopted, at its October 1988 meeting, a new,
uniform format for standards of practice. At the ASB’s direction, this standard was reformatted
to conform to the new format. In addition, the standard was given a number (9) in the standards
of practice series, and was reprinted (Document No. 011).

Extension to Cover Valuations

In 1990, the standard was amended to apply to property and casualty insurance company
valuation as well as to ratemaking and loss reserving. The amended version (Document No. 027)
was approved by the Casualty Committee and by the ASB, effective May 1, 1991.

Responses to Comments on 1988 Exposure Draft

The Casualty Committee is grateful to the respondents who submitted comments in 1988 on the
exposure draft. A total of nine individuals responded, and additional comments were made at a
special session on this topic at the November CAS meeting. All comments were carefully
considered by the Casualty Committee, and a number of changes were made to the exposure
draft as a result.

Four respondents commented on the fact that this standard limited its application to ratemaking
and loss reserving, rather than to all facets of actuarial work. The committee agreed in principle
that disclosure and documentation are equally appropriate for other work products. However, the
standard was designed to be in support of established statements of principles of the CAS. At the
time of its original drafting, two such statements had been promulgated, in ratemaking and in
loss reserving. The standard was, therefore, appropriate as written. In 1989, the CAS
promulgated a Statement of Principles Regarding Property and Casualty Valuations, and the
standard was subsequently amended to be in support of that statement as well.

One respondent to the exposure draft commented that the loss reserving principles do not
specifically refer to documentation and disclosure. The committee believed that this standard of
practice is equally applicable to those principles and that the principles need not be revised. Also,
the last sentence of the first paragraph under section 3 (Background and Historical Issues) was
revised to make clear that this standard, not the statements of principles, states the criteria for
documentation and disclosure.

Several other respondents raised a question as to whether this standard requires actuaries to take
positive action if they believe their work is being relied upon inappropriately. This question was
raised in response to appendix 1 in the exposure draft containing “Casualty Committee
Comments,” which specifically stated that this responsibility exists. The standard requires that
actuaries take reasonable steps to ensure that actuarial work products are presented fairly in order

iv
to minimize the risk of misquotation, misinterpretation, or other misuse of the product’s actuarial
aspects. The standard does not in and of itself require positive action on the actuary’s part if the
actuary is aware of any such misuse. Such an intent is beyond the purpose of this standard.
Rather, it is more an issue related to the guides to professional conduct, or normal work ethics.
The appendix containing the comments was not included with the final standard of practice. The
committee also added wording at the end of section 5.3 (Prevention of Misuse) to clarify what
was intended by the phrase, presented fairly.

In section 4 (Current Practices and Alternatives), last sentence, the clause, “as there have been no
formal standards of practice,” was deleted, since it would be inappropriate to imply causality in
this statement.

In section 5.2 (Extent of Documentation), the standard was revised to incorporate a “minimal”
criterion. This was done by moving the word appropriate to modify records, worksheets, and
other documentation, and by specifying that documentation should be sufficient for another
actuary practicing in the same field to evaluate the work. Documentation is required—whether or
not there is a legal or regulatory requirement for documentation—and the standard defines what
that documentation should entail.

One respondent questioned whether the word must should have been used instead of should in
several instances. The committee did not make this change because it believed that the word
should expresses obligation and propriety, but also allows for deviation, in some cases. (See
section 6.)

One respondent commented on the roles of standards of practice, relative to the Guides and
Interpretative Opinions as to Professional Conduct, which are standards of professional conduct.
He commented that this standard could raise questions and perhaps cause confusion unless
guidance is provided as to whether the standard of practice or the standard of professional
conduct applies. The committee has written this standard to be complete and sufficient, so that
the standard will provide specific guidance on documentation and disclosure in ratemaking, loss
reserving, and valuations, within the general framework provided by Interpretative Opinion 3.

Other changes of a grammatical or editorial nature were adopted, many in response to comments
received.

v
Casualty Committee of the ASB

Charles A. Bryan, Chairperson 1988


Michael J. Miller, Chairperson 1989–

Subcommittee on Ratemaking

LeRoy A. Boison Jr., Chairperson

Subcommittee on Reserving

James A. Faber, Chairperson

Subcommittee on Valuation

Douglas J. Collins, Chairperson

Members of the Casualty Committee, Past and Present

Martin Adler Gary Grant


James R. Berquist James A. Hall III
Richard Beverage Bertram A. Horowitz
Richard S. Biondi Eldon J. Klaassen
Randall E. Brubaker Michael R. Lamb
Douglas J. Collins Stephen P. Lowe
Robert V. Deutsch Robert A. Miller III
Daniel J. Flaherty Gary K. Ransom
David P. Flynn Alfred O. Weller
Spencer M. Gluck Paul E. Wulterkens
David J. Grady

Actuarial Standards Board

Walter N. Miller, Chairperson


Edward E. Burrows Frederick W. Kilbourne
Gary Corbett Harry L. Sutton Jr.
Willard A. Hartman Jack M. Turnquist
James C. Hickman P. Adger Williams

vi
ACTUARIAL STANDARD OF PRACTICE NO. 9

DOCUMENTATION AND DISCLOSURE


IN PROPERTY AND CASUALTY INSURANCE
RATEMAKING, LOSS RESERVING, AND VALUATIONS

PREAMBLE

Section 1. Purpose, Scope, and Effective Date

1.1 Purpose—The purpose of this standard of practice is to define the documentation and
disclosure required of an actuary in property and casualty insurance ratemaking, loss
reserving, and valuations.

1.2 Scope—This standard of practice is limited to the practices that relate to the Statement of
Principles Regarding Property and Casualty Insurance Ratemaking, the Statement of
Principles Regarding Property and Casualty Loss and Loss Adjustment Expense
Reserves, and the Statement of Principles Regarding Property and Casualty Valuations
as adopted by the Casualty Actuarial Society (CAS).

1.3 Effective Date—This standard became effective July 14, 1989, for documentation and
disclosure in ratemaking and loss reserving. Its effective date for valuations was May 1,
1991.

Section 2. Definitions

2.1 Actuarial Report—A document, or other presentation, prepared as a formal means of


conveying the actuary’s professional conclusions and recommendations, of recording and
communicating the methods and procedures, and of ensuring that the parties addressed
are aware of the significance of the actuary’s opinion or findings.

2.2 Actuarial Work Product—The result of an actuary’s work. The term applies to the
following actuarial communications, whether written or oral: statements of actuarial
opinion, actuarial reports, statements of actuarial review, and required actuarial
documents.

2.3 Required Actuarial Document—An actuarial communication of which the formal content
is prescribed by law or regulation.

1
2.4 Statement of Actuarial Opinion—A formal statement of the actuary’s professional
opinion on a defined subject. It outlines the scope of the work but normally does not
include descriptive details.

2.5 Statement of Actuarial Review—A formally communicated appraisal of actuarial work


done by another person.

Section 3. Background and Historical Issues

Professional documentation and communication are essential components of actuarial practice.


In the absence of specific standards of practice, the amount of documentation and disclosure has
varied. As the nature of casualty actuarial work has become more complex and more open to and
available for public review, the need to formalize standards has increased. The CAS has adopted
a Statement of Principles Regarding Property and Casualty Insurance Ratemaking, a Statement
of Principles Regarding Property and Casualty Loss and Loss Adjustment Expense Reserves, and
a Statement of Principles Regarding Property and Casualty Valuations. Those statements serve
as guides to this standard. This standard states that the methodology and material assumptions
utilized in ratemaking, reserving, and valuations should be documented and, in some cases,
available for disclosure.

This standard addresses the following issues:

1. the extent to which an actuarial work product should be documented,

2. the persons to whom that documentation should be available,

3. the extent to which deviations from standards of practice should be documented,

4. the requirement that actuaries sign work products within their responsibility, and

5. the requirement that actuaries disclose the names of others upon whose work they have
relied.

Section 4. Current Practices and Alternatives

Current practices have been governed by the Guides and Interpretative Opinions as to
Professional Conduct promulgated by the American Academy of Actuaries, the CAS, the
Conference of Actuaries in Public Practice, and the Society of Actuaries. Current practices have
varied with individual interpretations of those Guides and Opinions.

2
STANDARD OF PRACTICE

Section 5. Analysis of Issues and Recommended Practices

5.1 Introduction—Ratemaking, loss reserving, and valuations take place in a variety of


settings depending upon the legal and regulatory environment involved. The form and
content of any actuarial communication should meet the needs of the particular
circumstances, taking into account the knowledge and understanding of the users and the
actuary’s relationship to the users. Users may be either direct or indirect. A client or
employer is the direct user of the actuary’s service, as distinguished from an indirect user.
The direct user selects the actuary and communicates directly with the actuary about
qualifications, work, and recommendations.

5.2 Extent of Documentation—This standard requires documentation of an actuarial work


product whether or not there is a legal or regulatory requirement for the documentation.
Appropriate records, worksheets, and other documentation of the actuary’s work should
be maintained by the actuary and retained for a reasonable period of time. Documentation
should be sufficient for another actuary practicing in the same field to evaluate the work.
The documentation should describe clearly the sources of data, material assumptions, and
methods. Any material changes in sources of data, assumptions, or methods from the last
analysis should be documented. The actuary should explain the reason(s) for and describe
the impact of the changes.

5.3 Prevention of Misuse—Information prepared by an actuary may be used by another


person in a way that may influence the actions of a third party. If someone other than an
actuary might convey such information to any such indirect users, the actuary should
recognize the risk of misquotation, misinterpretation, or other misuse of its actuarial
aspects. The actuary should take reasonable steps to ensure that an actuarial work product
is presented fairly, that the presentation as a whole is clear in its actuarial aspects, and
that the actuary is identified as the source of the actuarial aspects and as the individual
who is available to answer questions. An actuarial report is customarily considered to be
presented fairly if it describes the data, material assumptions, methods, and material
changes in these with sufficient clarity that another actuary practicing in the same field
could make an appraisal of the reasonableness and validity of the report.

5.4 Disclosure of Conflict with Professional Judgment, and of Advocacy—If the service
requested by a client or employer produces a result that conflicts materially with the
actuary’s professional judgment, the actuary should advise the client or employer of the
conflict and should include appropriate qualifications or disclosures in any related
actuarial communication. When an actuary acts, or may seem to be acting, as advocate
for a client or employer, the nature of that relationship should be disclosed to directly
interested parties.

3
5.5 Availability of Documentation—Documentation should be available to the actuary’s
client or employer, and it should be made available to other persons when the client or
employer so requests, assuming appropriate compensation, and provided such availability
is not otherwise improper. Ownership of documentation is normally established by the
actuary and the client or employer, in accordance with law.

5.6 Conflicting Interests—The actuary does not normally have an obligation to communicate
with any person other than the client or employer. If aware of any significant conflict
between the interests of indirect users and the interests of the client or employer, the
actuary should advise the client or employer of the conflict and should include
appropriate qualifications or disclosures in any related actuarial communication.

5.7 Signature on Work Product—When required by law or regulation or when called upon by
the client or employer to provide documentation of work, the actuary should provide such
disclosure in writing. Any such disclosure must be signed with the name of the actuary
responsible for the work. The name of an organization with which the actuary is affiliated
may be incorporated into the signature. The actuary’s responsibilities to comply with this
standard are not affected by the form of the signature.

5.8 Reliance on Another—An actuary who makes an actuarial communication assumes


responsibility for it, except to the extent the actuary disclaims responsibility by stating
reliance on another person. Reliance on another person means using that person’s work
without assuming responsibility therefor. A communication should define the extent of
any such reliance.

5.9 Waiver of Fee—The waiving of a fee for professional services, either partially or totally,
does not relieve the actuary of the need to observe professional standards.

Section 6. Communications and Disclosures

6.1 Deviation from Standard—An actuary who uses a procedure which differs from this
standard must include, in the actuarial communication disclosing the result of the
procedure, an appropriate and explicit statement with respect to the nature, rationale, and
effect of such use.

4
Appendix 1

Statement of Principles Regarding


Property and Casualty Insurance Ratemaking

(Adopted by the Board of Directors of the CAS May 1988)

The purpose of this Statement is to identify and describe principles applicable to the
determination and review of property and casualty insurance rates. The principles in this
Statement are limited to that portion of the ratemaking process involving the estimation of costs
associated with the transfer of risk. This Statement consists of four parts:

I. DEFINITIONS
II. PRINCIPLES
III. CONSIDERATIONS
IV. CONCLUSION

The principles contained in this Statement provide the foundation for the development of
actuarial procedures and standards of practice. It is important that proper actuarial procedures be
employed to derive rates that protect the insurance system’s financial soundness and promote
equity and availability for insurance consumers.

Although this Statement addresses property and casualty insurance ratemaking, the principles
contained in this Statement apply to other risk transfer mechanisms.

I. DEFINITIONS

Ratemaking is the process of establishing rates used in insurance or other risk transfer
mechanisms. This process involves a number of considerations including marketing goals,
competition and legal restrictions to the extent they affect the estimation of future costs
associated with the transfer of risk. This Statement is limited to principles applicable to the
estimation of these costs. Such costs include claims, claim settlement expenses, operational and
administrative expenses, and the cost of capital. Summary descriptions of these costs are as
follows:

—Incurred losses are the cost of claims insured.

—Allocated loss adjustment expenses are claims settlement costs directly assignable to specific
claims.

—Unallocated loss adjustment expenses are all costs associated with the claim settlement
function not directly assignable to specific claims.

5
—Commission and brokerage expenses are compensation to agents and brokers.

—Other acquisition expenses are all costs, except commission and brokerage, associated with
the acquisition of business.

—Taxes, licenses and fees are all taxes and miscellaneous fees except federal income taxes.

—Policyholder dividends are a non-guaranteed return of premium charged to operations as an


expense.

—General administrative expenses are all other operational and administrative costs.

—The underwriting profit and contingency provisions are the amounts that, when considered
with net investment and other income, provide an appropriate total after-tax return.

II. PRINCIPLES

Ratemaking is prospective because the property and casualty insurance rate must be developed
prior to the transfer of risk.

Principle 1: A rate is an estimate of the expected value of future costs.

Ratemaking should provide for all costs so that the insurance system is financially sound.

Principle 2: A rate provides for all costs associated with the transfer of risk.

Ratemaking should provide for the costs of an individual risk transfer so that equity among
insureds is maintained. When the experience of an individual risk does not provide a credible
basis for estimating these costs, it is appropriate to consider the aggregate experience of similar
risks. A rate estimated from such experience is an estimate of the costs of the risk transfer for
each individual in the class.

Principle 3: A rate provides for the costs associated with an individual risk transfer.

Ratemaking produces cost estimates that are actuarially sound if the estimation is based on
Principles 1, 2, and 3. Such rates comply with four criteria commonly used by actuaries:
reasonable, not excessive, not inadequate, and not unfairly discriminatory.

Principle 4: A rate is reasonable and not excessive, inadequate, or unfairly


discriminatory if it is an actuarially sound estimate of the expected value of all future
costs associated with an individual risk transfer.

6
III. CONSIDERATIONS

A number of ratemaking methodologies have been established by precedent or common usage


within the actuarial profession. Since it is desirable to encourage experimentation and innovation
in ratemaking, the actuary need not be completely bound by these precedents. Regardless of the
ratemaking methodology utilized, the material assumptions should be documented and available
for disclosure. While no ratemaking methodology is appropriate in all cases, a number of
considerations commonly apply. Some of these considerations are listed below with summary
descriptions. These considerations are intended to provide a foundation for the development of
actuarial procedures and standards of practice.

Exposure Unit—The determination of an appropriate exposure unit or premium basis is


essential. It is desirable that the exposure unit vary with the hazard and be practical and
verifiable.

Data—Historical premium, exposure, loss and expense experience is usually the starting
point of ratemaking. This experience is relevant if it provides a basis for developing a reasonable
indication of the future. Other relevant data may supplement historical experience. These other
data may be external to the company or to the insurance industry and may indicate the general
direction of trends in insurance claim costs, claim frequencies, expenses and premiums.

Organization of Data—There are several acceptable methods of organizing data including


calendar year, accident year, report year and policy year. Each presents certain advantages and
disadvantages; but, if handled properly, each may be used to produce rates. Data availability,
clarity, simplicity, and the nature of the insurance coverage affect the choice.

Homogeneity—Ratemaking accuracy often is improved by subdividing experience into


groups exhibiting similar characteristics. For a heterogeneous product, consideration should be
given to segregating the experience into more homogeneous groupings. Additionally,
subdividing or combining the data so as to minimize the distorting effects of operational or
procedural changes should be fully explored.

Credibility—Credibility is a measure of the predictive value that the actuary attaches to a


particular body of data. Credibility is increased by making groupings more homogeneous or by
increasing the size of the group analyzed. A group should be large enough to be statistically
reliable. Obtaining homogeneous groupings requires refinement and partitioning of the data.
There is a point at which partitioning divides data into groups too small to provide credible
patterns. Each situation requires balancing homogeneity and the volume of data.

Loss Development—When incurred losses and loss adjustment expenses are estimated,
the development of each should be considered. The determination of the expected loss
development is subject to the principles set forth in the Casualty Actuarial Society’s Statement of
Principles Regarding Property and Casualty Loss and Loss Adjustment Expense Reserves.

7
Trends—Consideration should be given to past and prospective changes in claim costs,
claim frequencies, exposures, expenses and premiums.

Catastrophes—Consideration should be given to the impact of catastrophes on the


experience and procedures should be developed to include an allowance for the catastrophe
exposure in the rate.

Policy Provisions—Consideration should be given to the effect of salvage and


subrogation, coinsurance, coverage limits, deductibles, coordination of benefits, second injury
fund recoveries and other policy provisions.

Mix of Business—Consideration should be given to distributional changes in deductibles,


coverage limitations or type of risks that may affect the frequency or severity of claims.

Reinsurance—Consideration should be given to the effect of reinsurance arrangements.

Operational Changes—Consideration should be given to operational changes such as


changes in the underwriting process, claim handling, case reserving and marketing practices that
affect the continuity of the experience.

Other Influences—The impact of external influences on the expected future experience


should be considered. Considerations include the judicial environment, regulatory and legislative
changes, guaranty funds, economic variable, and residual market mechanisms including
subsidies of residual market rate deficiencies.

Classification Plans—A properly defined classification plan enables the development of


actuarially sound rates.

Individual Risk Rating—When an individual risk’s experience is sufficiently credible, the


premium for that risk should be modified to reflect the individual experience. Consideration
should be given to the impact of individual risk rating plans on the overall experience.

Risk—The rate should include a charge for the risk of random variation from the
expected costs. This risk charge should be reflected in the determination of the appropriate total
return consistent with the cost of capital and, therefore, influences the underwriting profit
provision. The rate should also include a charge for any systematic variation of the estimated
costs from the expected costs. This charge should be reflected in the determination of the
contingency provision.

Investment and Other Income—The contribution of net investment and other income
should be considered.

Actuarial Judgment—Informed actuarial judgments can be used effectively in


ratemaking. Such judgments may be applied throughout the ratemaking process and should be
documented and available for disclosure.

8
IV. CONCLUSION

The actuary, by applying the ratemaking principles in this Statement, will derive an estimation of
the future costs associated with the transfer of risk. Other business considerations are also a part
of ratemaking. By interacting with professionals from various fields including underwriting,
marketing, law, claims, and finance, the actuary has a key role in the ratemaking process.

9
Appendix 2

Statement of Principles Regarding


Property and Casualty
Loss and Loss Adjustment Expense Reserves

(Adopted by the Board of Directors of the CAS, May 1988)

The purpose of this Statement is to identify and describe principles applicable to the evaluation
and review of loss and loss adjustment expense reserves. Because of their size and the
uncertainties in the estimation process, the evaluation of these reserves requires the use of proper
actuarial and statistical procedures. The financial condition of a property and casualty insurer
cannot be assessed accurately without sound reserve estimates.

This Statement consists of three parts:

I. DEFINITIONS
II. PRINCIPLES
III. CONSIDERATIONS

The definitions in the next section apply to both loss reserves and loss adjustment expense
reserves. For the purpose of this statement the terms loss and claim are used interchangeably, and
the term insurer is meant to represent any risk bearer for property and casualty exposures,
whether an insurance company, self-insured entity, or other.

I. DEFINITIONS

A loss reserve is a provision for its related liability. A total loss reserve is composed of five
elements, although the five elements may not necessarily be individually quantified:

—case reserve

—provision for future development on known claims

—reopened claims reserve

—provision for claims incurred but not reported

10
—provision for claims in transit (incurred and reported but not recorded)

Before these five elements are discussed, certain key dates and terms need to be defined.

—The accounting date is the date that defines the group of claims for which liability may exist,
namely all insured claims incurred on or before the accounting date. The accounting date may be
any date selected for a statistical or financial reporting purpose.

—The valuation date is the date through which transactions are included in the data base used in
the evaluation of the liability, regardless of when the analysis is performed. For a defined group
of claims as of a given accounting date, reevaluation of the same liability may be made as of
successive valuation dates. A valuation date may be prior to, coincident with or subsequent to the
accounting date.

—The carried loss reserve is the amount shown in a published statement or in an internal
statement of financial condition.

—An indicated loss reserve is the result of the application of a particular loss reserving
evaluation procedure. An indicated loss reserve for a given accounting date likely will change
from one valuation date to another.

—A division is often required between reserves for known claims and reserves for claims which
have been incurred but not reported (IBNR). The reserve for known claims represents the
amount, estimated as of the valuation date, that will be required for future payments on claims
that already have been reported to the insurer. (The reserve for known claims is also sometimes
referred to by other labels such as the reported reserve, the reserve for claims adjusted or in the
process of adjustment, or the reserve for unpaid losses excluding IBNR.) The IBNR reserve
represents the amount that must be provided for future payments on insured losses that have oc-
curred but that have not been reported.

—The case reserve is defined as the sum of the values assigned to specific known claims
whether determined by claims adjusters or set by formula. (The term case reserve is sometimes
used in place of the reserve for known claims. However, as defined, the case reserve does not
include the provision for future development on known claims.) Adjusters’ estimates are the
aggregate of the estimates made by claims personnel for individual claims, based on the facts of
the particular claims. Formula reserves are reserves established for groups of claims for which
certain classifying information is provided. Formula reserving may be applied to individual
claims or to aggregations of claims with similar characteristics through use of average claim
values or factors applied to representative statistics (for example, premiums in force or earned
premiums).

—Development is defined as the change between valuation dates in the observed values of
certain fundamental quantities that may be used in the loss reserve estimation process. For
example, the observed number of reported claims associated with losses occurring within a
particular calendar period often will be seen to increase from one valuation date to the next until

11
all claims have been reported. The pattern of accumulating claims represents the development of
the number of claims.

In a similar fashion, the amount of claim payments for losses occurring within a specific calendar
period also will be seen to increase at succeeding valuation dates. In this case the pattern of
accumulating payments represents the development of claim costs and is usually referred to by
the term paid development. The concept of development also applies to incurred losses. Incurred
development is defined as the difference between estimates of incurred costs at two valuation
dates for a defined group of claims.

—The provision for future development on known claims relates to incurred development on
those claims reported to an insurer on or before a specific accounting date that are still open on
that accounting date. Incurred development on such claims can be either increasing or
decreasing.

—The reopened claims reserve is a provision for future payments on claims closed as of the
accounting date that may be reopened due to circumstances not foreseen at the time the claims
were closed. In some instances, post-closing payments or recoveries for claims not actually
reopened may be included with the development on known claims.

For many insurers a claim is considered to be reported when it is first recorded in the accounting
records of the insurer. Conceptually, two elements form the IBNR reserve. The first of these
elements is the provision for claims incurred but not reported, referred to as the “pure” IBNR.
This provision results from the normal delay that occurs in reporting losses. The second element
is the provision for claims in transit, which are incurred and reported but not recorded. This
provision represents the additional time consumed by the insurer’s recording procedures. As a
practical matter it is not always feasible to measure these two elements separately, but it is
important to understand the effect reporting procedures can have on the amount of IBNR reserve.
For some insurers claims in transit are considered known claims. The IBNR reserve must
provide for the ultimate value of IBNR claims including the development which is expected to
occur on these claims after reporting.

—Loss adjustment expenses include allocated loss adjustment expenses and unallocated loss
adjustment expenses. Allocated loss adjustment expenses are those expenses, such as attorneys’
fees and other legal costs, that are incurred in connection with and are assigned to specific
claims. Unallocated loss adjustment expenses are all other claim adjustment expenses and
include salaries, utilities and rent apportioned to the claim adjustment function but not readily
assignable to specific claims. The definition of allocated and unallocated loss adjustment
expenses for reserving purposes varies among insurers, and an individual insurer’s practice for
reserving may not always conform to its definition for statistical reporting or ratemaking
purposes.

Since allocated expenses are assigned to specific claims, all of the analyses performed on loss
data can also be performed on allocated loss expense data. Thus, the allocated loss adjustment
expense reserve can be divided into known and IBNR components. All of the concepts discussed

12
in the preceding paragraphs, as well as each of the five elements of the loss reserve, have similar
meanings with regard to the allocated loss adjustment expense reserve.

Although the same statistical procedures normally do not apply to unallocated expenses, the
unallocated loss adjustment expense reserve can still be divided into known reserve and IBNR
components, and the concept of a particular valuation date is meaningful.

II. PRINCIPLES

1. An actuarially sound loss reserve for a defined group of claims as of a given valuation date is
a provision, based on estimates derived from reasonable assumptions and appropriate
actuarial methods for the unpaid amount required to settle all claims, whether reported or not,
for which liability exists on a particular accounting date.

2. An actuarially sound loss adjustment expense reserve for a defined group of claims as of a
given valuation date is a provision, based on estimates derived from reasonable assumptions
and appropriate actuarial methods, for the unpaid amount required to investigate, defend, and
effect the settlement of all claims, whether reported or not, for which loss adjustment expense
liability exists on a particular accounting date.

3. The uncertainty inherent in the estimation of required provisions for unpaid losses or loss
adjustment expenses implies that a range of reserves can be actuarially sound. The true value
of the liability for losses or loss adjustment expenses at any accounting date can be known
only when all attendant claims have been settled.

4. The most appropriate reserve within a range of actuarially sound estimates depends on both
the relative likelihood of estimates within the range and the financial reporting context in
which the reserve will be presented.

Although specific reserve requirements may vary, the same basic principles apply in each
context in which the reserves are stated, including statutory balance sheets, statements of opinion
on loss reserves, and reports to shareholders or securities regulators. Guidance in the application
of these principles is provided in the Considerations section of this statement.

III. CONSIDERATIONS

Understanding the trends and changes affecting the data base is a prerequisite to the application
of actuarially sound reserving methods. A knowledge of changes in underwriting, claims
handling, data processing and accounting, as well as changes in the legal and social environment,
affecting the experience is essential to the accurate interpretation and evaluation of observed data
and the choice of reserving methods.

A knowledge of the general characteristics of the insurance portfolio for which reserves are to be
established also is important. Such knowledge would include familiarity with policy provisions

13
that may have a bearing on reserving, as well as deductibles, salvage and subrogation, policy
limits, and reinsurance.

Data Organization—The categorization of claims by time unit is extremely important. The


successful organization of a data base for reserving revolves around five key dates:

—accident date, which is the date on which the loss occurred, or for those losses that cannot be
identified with a single isolated event, the date on which the loss is deemed to have occurred

—report date, which is the date on which the loss is first reported to the insurer (in practice it is
often taken to be the recorded date)

—recorded date, which is the date on which the loss is first entered in the statistical records of
the insurer

—accounting date

—valuation date

Commonly, insurers compile claim data by accident periods (accident year, accident quarter,
accident month, etc.), which group together all claims with accident dates falling within
particular fiscal periods; or by policy periods, which group all claims relating to policies written
during particular fiscal periods. Claim information by accident year is required for various
financial reporting schedules. Many insurers also compile claim data by report periods, which
group together all claims with report dates falling within specified fiscal periods.

Claims with report dates equal to or prior to a particular accounting date would be classified as
known or reported claims with respect to the accounting date, but claims with report dates later
than a particular accounting date and with accident dates equal to or earlier than the accounting
date would be classified as IBNR with respect to the accounting date.

The preceding paragraph gives the precise definition of IBNR claims. In practice a broader
definition is sometimes used in which the IBNR reserve denotes the provision for late reported
claims, development on known claims, and a provision for reopened claims.

The ambiguity regarding the definition of IBNR can result from the differing strategies insurers
may employ in approaching loss reserving. The two common strategies are the report period
approach and the accident period approach. In the report period approach the adequacy of
existing reserves on reported claims is estimated on the basis of the historical results. Further
analysis is required in order to measure the emergence of IBNR claim. In a pure accident period
approach, the ultimate cost of all claims, both reported and unreported, arising from each
accident period is estimated. This approach results in an estimate of the loss reserve without
segregation of claims incurred but not reported. The estimated loss reserve is then apportioned
between reserves for IBNR and known claims on a suitable basis. Because accident period

14
techniques do not necessarily require separate treatment of reported and unreported claims, their
use can lead to a broader definition IBNR as mentioned above.

The method of assigning report dates to reopened claims can also affect the IBNR reserve.
Because reopened claims are generated from claims previously reported and closed, there is
general agreement that the provision for this liability should be included in the reserve for known
claims. Some insurers, however, establish new report dates for reopened claims and thereby
consider the provision for these claims as a component of the IBNR reserve.

Homogeneity—Loss reserving accuracy often is improved by subdividing experience into


groups exhibiting similar characteristics, such as comparable claim experience patterns,
settlement patterns or size of loss distributions. For a heterogeneous product, such as commercial
multi-peril or miscellaneous liability insurance, consideration should be given to segregating the
experience into more homogeneous groupings. Other example applications concern the
distinctions between personal and commercial risks and between primary and excess coverage.
Additionally, subdividing or combining the data so as to minimize the distorting effects of
operational or procedural changes should be fully explored.

Credibility—Credibility is a measure of the predictive value that the actuary attaches to a


body of data. The degree to which consideration is given to homogeneity is related to the
consideration of credibility. Credibility is increased by making groupings more homogeneous or
by increasing the number of claims analyzed within each group. A group of claims should be
large enough to statistically reliable. Obtaining homogeneous groupings requires refinement and
partitioning of the total data base. There is a point at which partitioning divides data into cells too
small to provide credible development patterns. Each situation requires a balancing of the
homogeneity and amount of data in each grouping. Thus, line and coverage definitions suitable
for the establishment of reserves for large insurers can be in much finer detail than in the case of
small insurers. Where a very small group of claims is involved, use of external information such
as industry aggregates may be necessary.

Data Availability—Data should meet requirements for the proper evaluation of reserves.
Existing information systems may impose constraints while more suitable data are being
developed. Whatever data are used in analysis of reserves, they must reconcile to the insurer’s
financial records. If reserves are established in less detail than necessary for reporting
requirements, procedures for properly assigning the reserves to required categories must be
developed.

Emergence Patterns—The delay between the occurrence of claims and the recording of
claims depends upon both the line of business and the insurer’s practices. In general, property
claims are reported quickly, whereas the reporting of liability claims may be substantially
delayed.

A review of the insurer’s claims practices should be made to assure that assumptions regarding
the claims process are appropriate. If a change in claims procedures is identified, its impact on
emergence patterns should be evaluated.

15
Settlement Patterns—The length of time that it normally takes for reported claims to be
settled will affect the choice of the loss reserving methods. Lines of business for which claims
settle quickly generally are less subject to reserve uncertainty. A claim arising under collision
coverage, for example, tends to be settled quickly, and the amount of settlement is usually close
to the original estimate. Conversely, a bodily injury liability claim often requires a long time to
settle. Moreover, the amount of settlement often varies considerably from the original estimate,
since it depends on the interaction of complex variables such as the type and severity of the
injury and the intricacies of the judicial process.

Development Patterns—The pattern of development on known claims should be carefully


reviewed. An insurer’s claims procedures will affect the manner in which the case reserves
develop for any group of claims, and changes in claims practices may affect the consistency of
historical developments. Further, the length of time to settlement may affect the observed
development.

If reserves have been established at present values, the payments of claims, by themselves, cause
an appearance of upward development apart from development due to other factors. To interpret
development patterns correctly, the development history should be restated to remove the effect
of discounting.

Frequency and Severity—The same total dollars of losses may arise from a few very large
claims or from many small claims. Reserve estimates will tend to be more accurate for losses
resulting from a high frequency/low severity group of claims than from a low frequency/high
severity group of claims. Therefore, the evaluation of reserves for low frequency/high severity
groups of claims will ordinarily require more extensive analysis. If the exposure for the group of
claims being considered includes the potential for claims of a magnitude not present in historical
data, adjustments should be made to reflect the expectation of such claims.

Reopened Claims Potential—The tendency for closed claims to reopen varies substantially
among lines of business. Judicial opinions and legislation can affect the reopening of claims, as
can changes in an insurer’s procedures.

Claims-Made—Some coverages may be provided on a policy form covering claims reported


during a certain period rather than claims arising out of occurrences during that period. Claims-
made data should be segregated from experience on occurrence policies. It may be necessary to
augment claims-made statistics with appropriate report period statistics generated under
occurrence programs.

Certain provisions may modify the claims-made policy upon fulfillment of conditions stipulated
in the contract. Review of the contract wording is necessary to determine the appropriate reserve,
if any, for occurrences prior to the policy effective date or claims reported after the policy
expiration.

16
Aggregate Limits—For certain insurance coverages, such as products and professional
liability, aggregate policy limits may act to restrict total potential incurred losses and therefore
reserve requirements. In the review of groups of claims where aggregate limits apply, modeling
techniques or audit tests of the data will reveal to what extent limit ceilings have been reached
and assist in determining how reserve projections may have to be modified.

Salvage, Subrogation, and Collateral Sources—For a proper evaluation of an insurer’s total


reserve position, the potential impact of salvage and subrogation on the group of claims under
consideration should be evaluated even though statutory accounting may prohibit a deduction
from loss reserves. In addition, the impact of coinsurance, deductibles, coordination of benefits,
second injury fund recoveries, as well as any other collateral sources, should be considered.

Generally Accepted Accounting Principles—Reports to shareholders and to securities


regulators are governed by generally accepted accounting principles (GAAP). GAAP reserves
may be defined differently from statutory reserves. For example, GAAP reserves are ordinarily
reduced by anticipated salvage and subrogation. The same principles of analysis used for
statutory estimates can be applied to GAAP reserve estimates.

Reinsurance—Reserves are affected by the types of reinsurance plans and retentions that
were and are in force, and the impact of changes in net retentions should be evaluated. To
determine the effect of reinsurance it may be appropriate to analyze direct and ceded experience
separately. The recoverability of ceded reinsurance is a further consideration; generally, it is
addressed separately from the reserve evaluation process.

Portfolio Transfers, Commutations, and Structured Settlements—Portfolio transfers,


commutations, and structured settlements generally recognize the time value of money. Such
transactions should be evaluated for their impact on the loss reserves and the development
patterns.

Pools and Associations—The loss liabilities of an insurer depend to some degree on forces
beyond its control, such as business obtained through participation in voluntary and non-
voluntary underwriting pools and associations. The operating and reserving policies of these
organizations vary, and adjustments to reserves reported by the pools and associations may be
warranted.

Operational Changes—The installation of a new computer system, an accounting change, a


reorganization of claims responsibility or changes in claims handling practices or underwriting
programs are examples or operational changes that can affect the continuity of the loss
experience. The computation of the reserves should reflect the impact of such changes.

Changes in Contracts—Changes in contract provisions, such as policy limits, deductibles, or


coverage attachment points, may alter the amounts of claims against an insurer. Such contractual
changes may affect both the frequency and severity of claims.

17
External Influences—Due regard should be given to the impact of external influences.
External influences include the judicial environment, regulatory and legislative changes, residual
or involuntary market mechanisms, and economic variables such as inflation.

Discounting—There are circumstances where loss reserves are stated on a present value
basis. To calculate or evaluate such reserves, it is generally appropriate to perform an analysis on
an undiscounted basis and then apply the effect of discounting.

Provision for Uncertainty—A reserve estimate should take into account the degree of
uncertainty inherent in its projections. A reserve stated at its ultimate value may include an
implicit provision for uncertainty due to the time value of money. If a reserve is to be stated at a
present value, it may be appropriate to include an explicit provision for uncertainty in its
undiscounted amount. Further, an explicit provision for uncertainty may be warranted when the
indicated ultimate reserve value is subject to a high degree of variability.

Reasonableness—The incurred losses implied by the reserves should be measured for


reasonableness against relevant indicators, such as premiums, exposures, or numbers of policies,
and expressed wherever possible in terms of frequencies, severities, and loss ratios. No material
departure from expected results should be accepted without attempting to find an explanation for
the variation.

Loss-Related Balance Sheet Items—The loss reserve analysis may have implications for
other loss-related balance sheet items. These include contingent commissions, retrospective
premium adjustments, policyholder dividends, premium deficiency reserves, minimum statutory
reserves and the deduction for unauthorized reinsurance.

Loss Reserving Methods—Detailed discussion of the technology and applicability of current


loss reserving practices is beyond the scope of this statement. Selection of the most appropriate
method of reserve estimation is the responsibility of the actuary. Ordinarily the actuary will
examine the indications of more than one method when estimating the loss and loss adjustment
expense liability for a specific group of claims.

Standards of Practice—This statement provides the principles of loss reserving. The actuary
should also be familiar with standards of practice, which address the application of these
principles.

18
Appendix 3

Statement of Principles Regarding


Property and Casualty Valuations

(Adopted by the Board of Directors of the CAS September 22, 1989)

The purpose of this Statement is to identify and describe principles applicable to property and
casualty valuations. The Statement establishes fundamental concepts for research and education
regarding valuation techniques. The principles in this Statement provide the foundation for
actuarial procedures and standards of practice regarding valuations. These principles apply to
valuations regarding any risk bearer of property and casualty contingencies.

This Statement consists of three parts:

I. DEFINITIONS
II. PRINCIPLES
III. DISCUSSION

I. DEFINITIONS

—Valuation is the process of determining and comparing, for the purpose of assessing a risk
bearer’s financial condition as of a given date, called the valuation date, the values of part or all
of a risk bearer’s obligations and the assets and considerations designated as supporting those
obligations.

A valuation is carried out in accordance with specified rules or assumptions selected or


prescribed in accordance with the purpose of the valuation.

—A risk bearer is a person or other entity that is exposed to the risk of financial losses that may
arise out of specified contingent events during a specified period of exposure.

—Cash flows are receipts or disbursements of cash.

—An asset is cash held or any other resource that can generate receipts or reduce disbursements.

—An obligation is a commitment by or requirement of a risk bearer to make disbursements with


respect to financial losses arising out of specified contingent events or with respect to any type of
other expense or investment commitment.

19
—A consideration is a receipt or a reduction in disbursements in exchange for accepting the risk
of financial losses that may arise out of specified contingent events during a specified period of
exposure.

II. PRINCIPLES

1. Every obligation, consideration or asset, with the exception of cash held, is associated with
one or more items of cash flow.

2. The value of every item of cash flow depends upon the following valuation variables, each of
which may involve uncertainty:

a. the occurrence of the item of cash flow,

b. the amount of the item of cash flow,

c. the interval of time between the valuation date and the date of occurrence of the item of
cash flow, and

d. a rate of interest related to the interval of time between the valuation date and the date of
occurrence of the cash flow.

3. The degree of uncertainty affecting each valuation variable for any item of cash flow
associated with a given asset, obligation or consideration depends upon:

a. the nature of the asset, obligation or consideration,

b. the various environments (e.g. regulatory, judicial, social, financial and economic
environments) within which the valuation is being performed, and

c. the predictive value of the data used to estimate the valuation variables associated with
each item of cash flow.

4. In general, the values of items of cash flow associated with a given asset, obligation or
consideration, and the values of assets, obligations and considerations themselves are not
only uncertain, they are also not independent of each other. Consequently, the degree of
uncertainty relative to the combined value of items of cash flow or of assets, obligations and
considerations reflects the uncertainties affecting the underlying valuation variables and
arising out of the interaction of those variables in the process of combination.

5. The value of an asset, obligation or consideration is equal to the combined values of its
constituent items of cash flow.

20
6. The result of a valuation is the combined value of the assets, obligations and considerations
involved in the valuation with due recognition of the offsetting characteristics of receipts and
disbursements.

7. These valuation principles apply to any valuation whether it involves a risk bearer’s total
assets, obligations and considerations as of a given valuation date or only identified segments
of the risk bearer’s assets, obligations and considerations including:

a. commitments made on or before the valuation date, or

b. the commitments in (a) and commitments projected to be made after the valuation date,
or

c. only those commitments projected to be made after the valuation date.

III. DISCUSSION

Although no valuation methodology is appropriate in all situations, a number of considerations


commonly apply. Some of these considerations are discussed in this section. These discussions
are intended to provide a foundation for the development of actuarial procedures and standards
of practice.

Data—Data to be used in valuation include descriptions of the characteristics of the risk


bearer’s assets, obligations and considerations. The descriptions should be sufficiently detailed to
permit reasonable projections of cash flows from these assets, obligations and considerations.

The actuary may use a risk bearer’s own experience relative to its assets, obligations and
considerations if this provides a basis for developing a reasonable indication of the future.
Moreover, the actuary may use external data drawn from relevant experience of the insurance
industry, other financial institutions or surrounding environments.

Organization of Data—Organization of data for valuation is affected by the characteristics of


the assets, obligations and considerations involved and the characteristics of the valuation
variables connected with them.

Much of the data organizational work relative to obligations and considerations begins with data
used in connection with the reserving and ratemaking processes. However, it may be necessary
to adjust the results of those processes so as to take into account differences between cash flow
dates and the various dates used in those processes. It may also be necessary to identify any
relevant expenses that fall outside the data used in the reserving and ratemaking processes and
reflect them in the valuation process. It is important, too, to identify potential adjustments to
considerations like retrospective premiums or audit premiums that may be received or paid in the
future.

21
If a valuation deals with detailed analyses of cash flows, data organization relative to assets
involves principally the work of classifying the assets and developing projections of contractual
or anticipated cash flows from them. It is also often necessary to divide assets into classes of
investment by such things as time to maturity or quality and to project flows of anticipated
receipts into particular classes of investment in accordance with an assumed investment strategy.

Homogeneity—Valuation accuracy is often improved by dividing the data on assets,


obligations and considerations into groups exhibiting similar characteristics. Homogeneous
groupings recognize, when appropriate, the interrelationships between those assets, obligations
and considerations.

Credibility—Credibility is a measure of the predictive value attached to a body of data.


Credibility is increased by defining groups of assets, obligations or considerations so as to
increase their homogeneity or to increase the volume of data relative to the groups. Increasing
homogeneity may fragment the groups to such an extent that their predictive value is reduced to
an unacceptable level. Each situation requires balancing homogeneity and the volume of data.

Operating Conditions—Operating conditions should be reflected in valuation. Operating con-


ditions include mix of business, underwriting, claims handling, marketing, accounting, premium
processing, portfolio of investments, investment strategy, and reinsurance programs.

Environmental Conditions—Environmental conditions should be reflected in valuation. The


regulatory, judicial, social, financial, and economic environments are some of the major ones to
be considered.

Losses and Loss Adjustment Expenses—The major obligations of a risk bearer are usually
those relating to the future payment of losses and loss adjustment expenses. When these
obligations are estimated for purposes of a valuation, their future development may be a factor
for consideration. Development of losses and loss adjustment expenses is defined in the Casualty
Actuarial Society’s Statement of Principles Regarding Property and Casualty Loss and Loss
Adjustment Expense Reserves.

Rules and Assumptions—The objective of a valuation is to produce an assessment of a risk


bearer’s financial condition that will be useful for the purpose for which the valuation is
performed. The purpose of the valuation affects the rules and assumptions used.

Cash flow analyses produce projections of receipts and disbursements. These analyses are
conceptually the most fundamental of the forms of valuation. The other forms of valuation can
be derived from cash flow analysis by suitable selection of rules and assumptions relative to the
valuation variables.

Balance sheets and income statements are often produced internally by a risk bearer using rules
and assumptions established by its management to assess financial strength and earning
performance.

22
Appraisals are intended to help determine the value of all or a part of a risk bearer’s assets,
obligations and considerations related to property and casualty contingencies, taking into account
not only financial statement items but also off-balance-sheet items such as investment in staff,
leases and so on. Appraisals are usually made in connection with mergers and acquisitions and
the sale of parts of a risk bearer’s business.

GAAP accounting rules or assumptions are intended to produce financial statements that the
financial community believes are useful for assessing a risk bearer’s earning capacity.

Statutory accounting rules or assumptions are intended to produce financial statements that
regulators believe are useful for assessing whether an insurer’s financial condition warrants its
being allowed to write insurance.

The value of any of the valuation variables with respect to a given set of items of cash flow may
be determined on the basis of any set of rules and assumptions that is appropriate to the purpose
of the valuation. Rules and assumptions relative to different classes of assets, obligations or
considerations need not necessarily be consistent with each other as long as the differences are
consistent with the purpose of the valuation, or the effect of the inconsistencies is not great
enough to invalidate the valuation.

23
Assumptions are based on a reasonable review of whatever appropriate facts are available
supplemented by the actuary’s experience and judgement as necessary. Rules are helpful to the
assurance of appropriately consistent treatment of facts and assumptions in valuation. Both rules
and assumptions can be helpful to achieving a result with a degree of refinement consistent with
the purpose of the valuation. Anticipated changes in operating and environmental conditions
should be reflected in the rules and assumptions applied to a valuation.

Valuation Variables—The valuation variables of occurrence, amount, interval of time and


rate of interest describe the quantitative characteristics of all cash flows for purposes of financial
analysis. All of the valuation variables are conceptually involved in the determination of the
values of all assets, obligations and considerations. The roles of the valuation variables in the
determination of values may be limited by the selection of rules or assumptions.

The value of any item of cash flow changes with the passage of time. This implies that valuations
of the same sets of items of cash flow performed at different valuation dates will in general
produce different results. It further implies that a valuation of one set of items of cash flow
performed as of a given valuation date will produce a result that is not directly comparable with
that of a second valuation of the same or a different set of items of cash flow performed as of a
different date.

Uncertainty—The result of a valuation involves uncertainty because of the uncertainty


connected with the valuation variables themselves and because the result of combining valuation
variables is affected by whatever relationships may exist among them.

Valuation Risks—The risks associated with valuation can be summarized into the following
three broad classes:

1. Asset Risk—The risk that the occurrence, amount or timing of items of cash flow
connected with assets will differ from that anticipated as of the valuation date for reasons
other than a change in the interest environment.

There are several factors that affect asset risk:

a. Type—This factor relates to whether the asset is, for example, a bond, a mortgage, a
preferred or common stock, an agent’s balance, a recoverable reinsurance item or
interest accrued but not paid. It also relates to such things as whether a bond is callable
and, if so, at what premiums; whether a bond has a sinking fund provision; or whether
prepayments can be made on a mortgage and, if so, what penalty may apply.

b. Quality—This factor relates to the financial strength of the entity from which the cash
flow is to be received and the relative standing of the type of asset in the hierarchy of
financial instruments.

24
c. Deferred Acquisition Expenses, Goodwill and Similar Assets—This factor relates to
the valuation question of whether any asset of these or similar types involves cash
flows that are not explicitly or implicitly recognized elsewhere in the valuation.

d. Investment Strategy—This factor relates to plans for investment of receipts in various


types of security, taking into account such things as the insurer’s needs for funds to
meet obligations as they mature, market conditions at the time the investments are
made, and the overall condition of the insurer’s investment portfolio at the time the
investments are made.

e. Trends—This factor relates to changes over time in the valuation variables other than
interest, insofar as they affect assets, and in the degree of uncertainty affecting them.

2. Obligation and Consideration Risk—The risk that the occurrence, amount or timing of
items of cash flow connected with obligations and considerations will differ from that
anticipated as of the valuation date for reasons other than a change in the interest
environment.

There are several factors that affect obligation and consideration risk:

a. Coverage—This factor relates to the riskiness of the coverage involved.

b. Type—This factor relates to whether the obligation is, for example, a loss or loss
adjustment reserve, an unearned premium reserve, a contingent commission reserve, a
retrospective premium adjustment reserve, a policyholder or shareholder dividend
reserve, a premium deficiency reserve, an income tax liability, an investment
commitment or an account payable for something such as expenses, taxes, licenses,
fees and assessments.

c. Commitment Provisions—This factor relates to the extent to which the range of the
valuation variables may be effectively limited by terms of the commitments out of
which the obligations arise. Examples of such commitment provisions are basic limits,
increased limits, aggregate limits, claims made, salvage and subrogation, coinsurance,
deductibles, coordination of benefits and second injury fund recoveries.

d. Reinsurance Programs—This factor relates to the extent to which the range of the
valuation variables may be effectively limited by the terms of reinsurance programs
applicable to the commitments out of which the obligations arise. Examples of such
programs are those involving surplus, excess of loss and catastrophe reinsurance.
Frequency and severity of losses, attachment points and upper limits of reinsurance are
features of the programs relating to their limiting effect. On the other hand, reinsurance
programs also involve uncertainty as to whether reinsurance will be collectible.

e. Exposure—This factor relates to the uncertainty involved in measuring or projecting


levels of exposure, and for periods beginning after the valuation date, the

25
considerations for those periods and the obligations to arise out of them. Obligations
and considerations related to these periods of exposure may be offset against each
other in recognition of the fact that the obligations would not arise if the considerations
were not received. Determination of whether obligations and considerations relative to
such periods should be recognized in a valuation depends upon the timing relative to
the valuation date of the commitments to accept risks for those periods.

f. Loss Development—This factor relates to the uncertainty arising out of changes over
time in patterns of emergence, development, reopening, settlement and payment of
claims.

g. Trends—This factor relates to changes over time in the valuation variables other than
interest, insofar as they affect obligations and considerations, and in the degree of
uncertainty affecting them.

h. Large Latent Losses—This factor relates to the treatment of identifiable classes of very
serious potential losses for which probable frequency and severity can not be
reasonably estimated for a considerable period of time.

i. Off-Balance-Sheet Items Such as Long-Term Leases and Commitments to Buy


Securities—This factor relates to the valuation question of whether any obligation of
these or similar types involve cash flows that are not explicitly or implicitly recognized
elsewhere in the valuation.

3. Interest Risk—The risk that different amounts of change in the anticipated values, and the
degree of uncertainty therein, of obligations and of the assets and considerations with
which the obligations are being compared will occur:

i. simply because of a change in the interest environment, or

ii. because a change in the interest environment brings about a change from expected
experience as to the occurrence, amount or timing of items of cash flow connected
with assets, obligations or considerations.

There are several factors that affect interest risk:

a. Mismatch of Asset and Obligation Cash Flows—This factor relates to the


development of an excess of a risk bearer’s receipts over its required disbursements
or vice versa.

If an excess of receipts over required disbursements develops, the risk bearer may
not be able to invest the excess cash at yields that will produce future cash flows
large enough to meet its obligations as they mature. This is “reinvestment” risk.

26
If an excess of required disbursements over receipts develops, the risk bearer may
have to borrow or liquidate assets with yields below then current market rates to
make up the difference. Borrowing at a relatively high interest rate, or inability to
invest the difference at then current market rates produces a reduction in the risk
bearer’s future profits. This is “market” risk.

b. Changes in the Timing of Receipts and Disbursements—This factor relates to the


preference of borrowers to prepay debt carrying high rates of interest when rates go
down and to defer repayments of debt carrying low rates of interest when rates go
up. For risk bearers of property and casualty contingencies, this risk affects mainly
their assets.

c. General Economy—This factor relates to the way in which things such as liquidity,
inflation, demand for cash to fund expansion, government debt, trade imbalances
and distortions in the yield curve affect the general level of interest rates.

d. Trends—This factor relates to changes over time in the interest valuation variable
and in the degree of uncertainty affecting it and how those changes affect the other
asset and obligation valuation variables.

Interaction with Other Professionals—The uncertainties that affect other actuarial fields, such
as ratemaking and reserving, also affect valuation. In addition, valuation is affected by
uncertainties met in other fields, such as marketing, underwriting, finance, regulation, risk
management and so on. This implies that professionals working in other fields can be helpful in
gathering information and developing rules and assumptions to be used in valuation.

Actuarial Judgment—It is important to apply actuarial judgment based on education and


experience in selecting and organizing data and making rules and assumptions to be used in the
valuation process and in assessing the reasonableness of the results.

27
Actuarial Standard
of Practice
No. 10

Methods and Assumptions for Use in Life Insurance Company


Financial Statements Prepared in Accordance with GAAP

Revised Edition

Developed by a Task Force of the


Life Committee of the
Actuarial Standards Board

Adopted by the
Actuarial Standards Board
March 2000

(Doc. No. 068)


TABLE OF CONTENTS

Transmittal Memorandum iv

STANDARD OF PRACTICE

Section 1. Purpose, Scope, Cross References, and Effective Date 1


1.1 Purpose 1
1.2 Scope 1
1.3 Cross References 1
1.4 Effective Date 1

Section 2. Definitions 2
2.1 Costs 2
2.2 Deferred Policy Acquisition Cost 2
2.3 GAAP Net Premium 2
2.4 Gross Premium 2
2.5 Indeterminate Premium Policies 2
2.6 Investment Contracts, Limited-Payment Contracts, and Universal Life-Type
(UL-Type) Contracts 2
2.7 Lock-In 2
2.8 Net GAAP Liability 2
2.9 Participating Policy 2
2.10 Policy Benefit Liability 2
2.11 Risk of Adverse Deviation 3

Section 3. Analysis of Issues and Recommended Practices 3


3.1 The Role of the Actuary 3
3.2 Preparation of Financial Statements 3
3.3 Categories of Assumptions 3
3.4 Best-Estimate Assumptions 3
3.4.1 Items to Be Considered 3
3.4.2 Internal Consistency 3
3.4.3 Sources of Data 4
3.5 Provision for Risk of Adverse Deviation 4
3.5.1 Degree of Risk 4
3.5.2 Relationship to Best-Estimates 4
3.6 Methods 4
3.6.1 Lock-In/Adjustment 5
3.6.2 Recognition of Loss 5
3.6.3 Recognition of Premiums 5
3.7 Special Situations 5
3.7.1 Participating Policies That Are Subject to SFAS No. 60 6
3.7.2 Indeterminate Premium Policies 6
3.8 Materiality 6

ii
Section 4. Communications and Disclosures 7
4.1 Documentation 7
4.2 Prescribed Statement of Actuarial Opinion (PSAO) 7
4.3 Deviation from Standard 7

APPENDIXES

Appendix 1Background and Current Practices 8


Background 8
Current Practices 9

Appendix 2Comments on the Exposure Draft and Committee Responses 10

iii
March 2000

TO: Members of Actuarial Organizations Governed by the Standards of Practice of the


Actuarial Standards Board and Other Persons Interested in Life Insurance
Company Financial Reporting According to Generally Accepted Accounting
Principles (GAAP)

FROM: Actuarial Standards Board (ASB)

SUBJ: Revision of Actuarial Standard of Practice (ASOP) No. 10

This booklet contains the revision of Actuarial Standard of Practice No. 10, Methods and
Assumptions for Use in Life Insurance Company Financial Statements Prepared in Accordance
with GAAP (formerly titled Methods and Assumptions for Use in Stock Life Insurance Company
Financial Statements Prepared in Accordance with GAAP).

Development of the Standard

This booklet contains an updated and expanded version of ASOP No. 10, originally adopted by
the ASB in 1989. The 1989 standard was developed by the American Academy of Actuaries
(AAA) Committee on Life Insurance Financial Reporting for the Life Committee of the ASB.

In 1992, ASOP No. 10 was expanded. The purpose of the expansion was to incorporate portions
of the AAA’s Financial Reporting Recommendation (FRR) 1, Actuarial Methods and
Assumptions for Use in Financial Statements of Stock Life Insurance Companies Prepared in
Accordance with Generally Accepted Accounting Principles; FRR 5, Recognition of Premiums;
FRR 6, Participating Policies Sold by Stock Life Insurance Companies; and AAA Interpretation
1-I, Nonparticipating Guaranteed Renewable Life and Accident and Health Insurance Policies.
The standard was also reformatted. On adoption of the revised ASOP No. 10 in 1992,
Recommendations 1, 5, and 6 and their accompanying interpretations were eliminated.

In 1995, the Financial Accounting Standards Board (FASB) issued Statement of Financial
Accounting Standards (SFAS) No. 120, Accounting and Reporting by Mutual Life Insurance
Enterprises and by Insurance Enterprises for Certain Long-Duration Participating Contracts,
which extended the requirements of SFAS No. 60, Accounting and Reporting by Insurance
Enterprises, and SFAS No. 97, Accounting and Reporting by Insurance Enterprises for Certain
Long-Duration Contracts and for Realized Gains and Losses from the Sale of Investments, to
mutual life insurers. SFAS No. 120 also established accounting for certain participating life
insurance contracts of mutual life insurance enterprises (and stock life insurance subsidiaries of
mutual life insurance enterprises). In the same year, the American Institute of Certified Public

Accountants (AICPA) issued Statement of Position (SOP) No. 95-1, Accounting for Certain
Insurance Activities of Mutual Life Insurance Enterprises.

iv
This revision of ASOP No. 10 provides guidance in light of these pronouncements, and includes
other minor revisions in the text, as well.

Exposure Draft

An exposure draft of this revision was issued in June 1999 with a comment deadline of
December 1, 1999. Nine comment letters were received. For a detailed summary of the
substantive issues contained in the comment letters and the committee’s responses to such,
please see appendix 2.

The key change from the exposure draft was the modification of sections 1.2, 3.1, and 3.2 to
clarify that the standard applies to actuaries reviewing historical life insurance company GAAP
financial statements, as well as to actuaries preparing such statements.

The Task Force on Revision of ASOP No. 10 and the Life Committee would like to thank
everyone who contributed comments and suggestions on the exposure draft.

The ASB adopted this revision at its March 2000 meeting.

Task Force on Revision of ASOP No. 10

Mark Freedman, Chairperson


John W. Brumbach Godfrey Perrott

Life Committee of the ASB

Lew H. Nathan, Chairperson


John W. Brumbach Godfrey Perrott
Marc A. Cagen Thomas A. Phillips
Mark J. Freedman Barry L. Shemin
Stephen G. Hildenbrand Timothy J. Tongson

Actuarial Standards Board

Alan J. Stonewall, Chairperson


Phillip N. Ben-Zvi Roland E. King
Heidi R. Dexter William C. Koenig
David G. Hartman James R. Swenson
Ken W. Hartwell Robert E. Wilcox

v
ACTUARIAL STANDARD OF PRACTICE NO. 10

METHODS AND ASSUMPTIONS FOR USE IN


LIFE INSURANCE COMPANY
FINANCIAL STATEMENTS
PREPARED IN ACCORDANCE WITH GAAP

STANDARD OF PRACTICE

Section 1. Purpose, Scope, Cross References, and Effective Date

1.1 Purpose—The purpose of this actuarial standard of practice (ASOP) is to provide


guidance to the actuary in establishing appropriate actuarial methods and assumptions for
life insurance companies’ financial statements prepared in accordance with generally
accepted accounting principles (GAAP).

1.2 Scope—This standard applies to actuaries selecting or reviewing methods or assumptions


used in the preparation of historical life insurance company GAAP financial statements.
The standard does not apply in purchase accounting situations. For investment contracts
(as defined in Statement of Financial Accounting Standards (SFAS) No. 97, Accounting
and Reporting by Insurance Enterprises for Certain Long-Duration Contracts and for
Realized Gains and Losses from the Sale of Investments, promulgated by the Financial
Accounting Standards Board (FASB)) that are issued by insurance companies, GAAP
requires accounting as for other interest-bearing obligations. To the extent that the ac-
counting treatment for these contracts does not involve actuarial methods or assumptions,
such contracts are specifically excluded from the scope of this standard.

1.3 Cross References—When this standard refers to the provisions of other documents, the
reference includes the referenced document as it may be amended or restated in the
future, and any successor to it, by whatever name called. If the amended or restated
document differs materially from the originally referenced document, the actuary should
consider the guidance in this standard to the extent it is applicable and appropriate.

1.4 Effective Date—This revision of ASOP No. 10 will be effective for work on life
insurance company financial statements for fiscal periods ending on or after October 15,
2000.

1
Section 2. Definitions

The terms below are defined for use in this actuarial standard of practice:

2.1 Costs—All benefit payments and expenses associated with issuing and maintaining a
company’s policies, with no explicit provision for profit.

2.2 Deferred Policy Acquisition Cost (DPAC)—The unamortized portion of those policy
acquisition expenses that vary with, and are primarily related to, the acquisition of new
and renewal insurance contracts and coverages.

2.3 GAAP Net Premium—The portion of gross premium that provides for costs.

2.4 Gross Premium—Amounts contractually required to be paid or anticipated to be


contributed by the policyholder.

2.5 Indeterminate Premium Policies—Life and health insurance policies under which the
insurer is obligated to provide coverage for an extended period of time, and under which
premiums may vary at the discretion of the insurer.

2.6 Investment Contracts, Limited-Payment Contracts, and Universal Life-Type (UL-Type)


Contracts—As each is defined in SFAS No. 97, ¶ 6–14.

2.7 Lock-In—A GAAP concept that requires the continuing use of original basis assumptions
(issue, acquisition, or prior redetermination). This concept is further discussed in SFAS
No. 60, Accounting and Reporting by Insurance Enterprises, SFAS No. 97, and in the
American Institute of Certified Public Accountants (AICPA) Statement of Position (SOP)
No. 95-1, Accounting for Certain Insurance Activities of Mutual Life Insurance
Enterprises.

2.8 Net GAAP Liability—The GAAP policy benefit liability for a book of business less any
associated DPAC.

2.9 Participating Policy—An insurance or annuity policy under which the policyholder is
entitled to participate in the distributable surplus of the company.

2.10 Policy Benefit Liability—An accrued obligation to policyholders that relates to insured
events, such as death or disability. This financial statement liability includes amounts
accrued for deferred revenues under SFAS No. 97 and maintenance expenses under
SFAS No. 60. The amount accrued for deferred revenue, known as the deferred revenue
reserve, may or may not be shown separately in the company’s financial statements, but
is, in any case, included in the policy benefit liability for purposes of this standard.

2
2.11 Risk of Adverse Deviation—The risk that actual experience may differ from best-
estimate assumptions in a manner that produces costs higher than assumed or revenues
less than assumed.

Section 3. Analysis of Issues and Recommended Practices

3.1 The Role of the Actuary—Applicable accounting literature suggests, but does not require,
that the actuary select the methods and assumptions used to establish net GAAP
liabilities. To the extent the actuary selects or reviews such methods or assumptions, the
actuary should be guided by this standard.

3.2 Preparation of Financial Statements—An actuary who selects or reviews methods or


assumptions used in a life insurance company GAAP financial statement should be
familiar with relevant accounting and actuarial literature, including, but not limited to,
SFAS No. 60, SFAS No. 97, SFAS No. 120, Accounting and Reporting by Mutual Life
Insurance Enterprises and by Insurance Enterprises for Certain Long-Duration
Participating Contracts; and the AICPA’s Audits of Stock Life Insurance Companies
(Audit Guide), Practice Bulletin 8, and SOP No. 95-1.

3.3 Categories of Assumptions—Two general types of actuarial assumptions are used in the
preparation of GAAP financial statements. Best-estimate assumptions as of the financial
statement date are required in certain instances. In others, assumptions that provide for
the risk of adverse deviation are required. Relevant accounting standards call for best-
estimate assumptions to be periodically reviewed and updated to reflect emerging
experience, whereas assumptions with provision for risk of adverse deviation are subject
to lock-in until a loss recognition situation arises. The actuary should exercise care to
ensure that the proper category of assumptions is used.

3.4 Best-Estimate Assumptions—In instances where GAAP requires best-estimate


assumptions, the actuary should choose assumptions that, in his or her judgment, reflect
the most likely outcome of events. Best-estimate assumptions selected by the actuary
should be reasonable. Except in a loss recognition situation, accounting practice usually
follows the convention that, given two choices that are deemed equally likely, the one
that should be selected is the one that produces the larger liability or smaller asset.

3.4.1 Items to Be Considered—In selecting best-estimate assumptions, the actuary


should consider the characteristics and magnitude of the company’s business; the
maturity of the company and its rate of growth; the prior experience of the
company, to the extent considered relevant, and the trends in that experience; and
medical, economic, social, and technological developments that might affect
future experience.

3.4.2 Internal Consistency—The actuary should select best-estimate assumptions that,


when taken together, reflect all pertinent areas of expected future experience and

3
are specific to the particular product, line of business, or block of business being
valued. These assumptions should be comprehensive and internally consistent.

3.4.3 Sources of Data—In forming a judgment as to the appropriate assumptions, the


actuary should consider available pertinent data. To the extent possible and
appropriate, the actuary should consider data specific to the company for which
the assumptions are being made. Where such data are not available or are not
credible, the actuary should consider industry data or data from other similarly
situated companies, modified as appropriate. ASOP No. 23, Data Quality, gives
further guidance to the actuary on issues related to the selection of data, use of
imperfect data, and reliance on data supplied by others.

3.5 Provision for Risk of Adverse Deviation—In certain instances GAAP requires a
provision for the risk of adverse deviation in actuarial assumptions.

3.5.1 Degree of Risk—In selecting assumptions that include provision for the risk of
adverse deviation, the actuary should consider the degree to which the assumption
is subject to such risk in total and at each future duration. Provision for the risk of
adverse deviation should be reasonable in the actuary’s judgment.

3.5.2 Relationship to Best-Estimates—In selecting assumptions that include provision


for the risk of adverse deviation, the actuary should consider whether such
assumptions bear a reasonable relationship to the best-estimate assumptions.
Under GAAP, the provision for the risk of adverse deviation should not increase
the resulting GAAP net premium above the gross premium. The resulting GAAP
net premium may be less than the gross premium, provided that due provision has
been made for the risks of adverse deviation. Note that the GAAP net premium
prior to provision for the risk of adverse deviation may be greater than the gross
premium.

The actuary should establish that the aggregate net GAAP liability determined
using assumptions that include provision for the risk of adverse deviation equals
or exceeds a similarly determined net liability determined using best-estimate
assumptions without provision for the risk of adverse deviation.

3.6 Methods—One purpose of GAAP is to achieve matching of revenue and expenses. This
matching is accomplished primarily through establishing policy benefit liabilities and
DPAC assets. Methods used to determine policy benefit liabilities and DPAC assets will
vary according to whether SFAS No. 60, SFAS No. 97, or SOP No. 95-1 applies. The
actuary should use the methods that are appropriate to the type of contract.

For contracts subject to the requirements of SFAS No. 60, premiums are included in
revenues, while benefits and other expenses are included in expenses. Matching is
achieved by accruing costs against premiums.

4
For UL-type contracts subject to SFAS No. 97, amounts assessed against the policyholder
are included in revenue; benefits in excess of the policy value and other expenses are
included in expenses. Matching is achieved by amortizing deferrable acquisition
expenses and unearned revenue against margins.

For contracts subject to SOP No. 95-1, premium and benefit recognition is identical to the
requirements of SFAS No. 60, but amortization revenue is analogous to that used for UL-
type contracts subject to SFAS No. 97.

3.6.1 Lock-In/Adjustment—Unless loss recognition or a significant difference between


actual and expected persistency exists, policy benefit liabilities and DPAC for
insurance contracts subject to SFAS No. 60 are subject to lock-in. Where lock-in
is applicable under SFAS No. 60, the actuary should base the amortization on the
same assumptions as those underlying the calculation of the GAAP policy benefit
liability.

The actuary should adjust DPAC and the amortization thereof for UL-type
contracts, investment contracts, and participating contracts subject to SOP
No. 95-1 as conditions warrant.

3.6.2 Recognition of Loss—GAAP requires the recognition of a loss when it is


probable and can be reasonably estimated (SFAS No. 5, Accounting for
Contingencies). This is further discussed in SFAS No. 60, SFAS No. 97, and SOP
No. 95-1. When asked to perform a loss recognition analysis, the actuary should
use best-estimate assumptions.

3.6.3 Recognition of Premiums—The actuary should use appropriate methods to rec-


ognize premiums in income. These are determined by the applicable accounting
standards and vary by the type of contract. The recognition of GAAP net
premiums in the GAAP benefit liability and DPAC computations should be
consistent with the treatment of gross premiums in the income statement.

When deferred premiums are appropriate, any excess of gross premium over net
premium should not be recognized in net GAAP income until the related gross
premium is due. This applies to life and health contracts (except credit) under
SFAS No. 60 and SOP No. 95-1 if it is expected that the policy may be renewed
for more than one year with reasonably predictable persistency. For credit
insurance, or where persistency is such that a term of one year or less is expected,
gross premiums should be recognized as revenue over the premium period by
means of an unearned gross premium liability.

3.7 Special Situations—In preparing GAAP financial statements, the actuary will encounter
circumstances that require significant interpretation of the general considerations already

5
addressed in this standard. Two of these situations are sufficiently common to be
addressed in this standard.

3.7.1 Participating Policies That Are Subject to SFAS No. 60—GAAP requires that
only the portion of profits that inures to the benefit of stockholders is reflected in
reported results. Profits that are derived from participating policies and inure to
the benefit of stockholders may be restricted (by law, regulation, company
practice, or otherwise) or may be unrestricted. The actuary should use the
appropriate methods and assumptions for each of the following two
circumstances.

a. Restricted Stockholder Profits—Profits in excess of the amount inuring to


the benefit of stockholders should be accumulated in a participating
policyholder account. Assumptions, including provision for the risk of
adverse deviation, may be established at a level consistent with those
underlying gross premiums or may be comparable to those used for the
company’s nonparticipating business. Policyholder dividends would
generally be treated as disbursements of predividend profits, not as
disbursements in the liability calculation.

b. Unrestricted Profits—Policyholder dividends should be treated as


disbursements in the liability calculation. Assumptions may include a
somewhat smaller provision for the risk of adverse deviation, given the
flexibility provided by the dividend scale.

3.7.2 Indeterminate Premium Policies—Provided the policy is not, in substance, a UL-


type contract, SFAS No. 60 is applicable to indeterminate premium policies. The
premium flexibility associated with these policies may affect the application of
SFAS No. 60, such as the use of a smaller provision for the risk of adverse
deviation. The ability and willingness of the insurer to change premiums may be
anticipated in performing loss recognition. Assumptions may be “unlocked” at
gross premium change dates. If assumptions are adjusted, it should be done
prospectively, without a change in the liability as of the valuation date.

3.8 Materiality—It may be appropriate to use assumptions and techniques (for example,
models) that simplify the calculation of policy benefit liabilities and DPAC amortization.
For example, it may be appropriate to assume that policy anniversaries occur on July 1 of
each calendar year. Another example is that statutory reserves might be deemed a proxy
for net GAAP reserves on small or old blocks of business. Simplification and
approximations are acceptable only if the results can reasonably be expected not to differ
materially from the results of detailed calculations. The actuary may seek guidance from
accounting professionals on the issue of materiality.

6
Section 4. Communications and Disclosures

4.1 Documentation—The actuary should maintain adequate documentation of the


assumptions selected and methods used, such that another actuary qualified in the same
practice area could assess the reasonableness of the work.

4.2 Prescribed Statement of Actuarial Opinion (PSAO)—This ASOP does not require a
prescribed statement of actuarial opinion (PSAO) as described in the Qualification
Standards for Prescribed Statements of Actuarial Opinion promulgated by the American
Academy of Actuaries (AAA). However, law, regulation, or accounting requirements
may also apply to an actuarial communication prepared under this standard, and as a
result, such actuarial communication may be a PSAO.

4.3 Deviation from Standard—An actuary must be prepared to justify the use of any
procedures that depart materially from those set forth in this standard and must include,
in any actuarial communication disclosing the results of the procedures, an appropriate
statement with respect to the nature, rationale, and effect of such departures.

7
Appendix 1

Background and Current Practices

Note: This appendix is provided for informational purposes, but is not part of the standard of
practice.

Background

Determination of generally accepted accounting principles (GAAP) is the responsibility of the


accounting profession. The American Institute of Certified Public Accountants (AICPA)
developed Audits of Stock Life Insurance Companies (Audit Guide) in 1972 with the cooperation
of life insurance company accountants and actuaries. The Audit Guide represented the first effort
by the accounting profession to establish GAAP for the life insurance industry. The Financial
Accounting Standards Board (FASB) is now responsible for the determination of GAAP for
companies whose financial statements are audited. It does so through the promulgation of
Statements of Financial Accounting Standards (SFAS).

GAAP standards for stock life insurance companies are primarily established by SFAS No. 60,
Accounting and Reporting by Insurance Enterprises, and SFAS No. 97, Accounting and
Reporting by Insurance Enterprises for Certain Long-Duration Contracts and for Realized
Gains and Losses from the Sale of Investments. The FASB issued SFAS No. 60, which generally
codified the concepts in the Audit Guide, in 1972. In 1987, the FASB issued SFAS No. 97, which
(1) established GAAP for certain forms of insurance contracts not specifically addressed by
SFAS No. 60, primarily UL-type contracts; (2) established GAAP for investment contracts not
involving a significant insurance component; and (3) revised GAAP for limited-payment
contracts. In November 1990, the AICPA issued Practice Bulletin 8, providing guidance for
certain questions related to SFAS No. 97. In 1995, the FASB issued SFAS No. 120, Accounting
and Reporting by Mutual Life Insurance Enterprises and by Insurance Enterprises for Certain
Long-Duration Participating Contracts, which extended the requirements of SFAS No. 60 and
SFAS No. 97 to mutual life insurers; and established accounting for certain participating life
insurance contracts of mutual life insurance enterprises (and stock life insurance subsidiaries of
mutual life insurance enterprises) in its Statement of Position (SOP) No. 95-1, Accounting for
Certain Insurance Activities of Mutual Life Insurance Enterprises. This statement permits other
stock life insurers to apply its provisions to participating life insurance contracts that meet the
SOP’s conditions. Other standards are also relevant, as is prevailing accounting practice in areas
not specifically addressed by an SFAS. Prior to the issuance of SFAS No. 120, mutual life
insurers’ statutory financial statements were, in practice, described as being in accordance with
GAAP.

8
Current Practices

The AAA had promulgated Financial Reporting Recommendations and Interpretations


applicable to GAAP for insurance companies, thus establishing guidance to actuaries in this area
before the formal appearance of ASOP No. 10 in 1989. Because of changes in GAAP resulting
from SFAS No. 97, SFAS No. 120, and evolution in actuarial practice, it is appropriate once
again to replace certain existing guidance and to promulgate a more generally applicable
standard of actuarial practice with respect to life insurance company GAAP financial statements.

9
Appendix 2

Comments on the Exposure Draft and Committee Responses

The exposure draft of this actuarial standard of practice (ASOP) was issued in June 1999, with a
comment deadline of December 1, 1999. (Copies of the exposure draft are available from the
ASB office.) Nine comment letters were received, which the Life Committee carefully
considered. Summarized below are the significant issues and questions contained in the comment
letters, printed in standard type. The Life Committee’s responses to these issues and questions
appear in boldface.

Section 1. Purpose, Scope, Cross References, and Effective Date

Section 1.2, Scope—One commentator suggested that actuaries are not only involved in the
preparation of financial statements, but that some review historical GAAP financial statements.
The committee agreed and modified the wording to reflect the role of some actuaries to
review historical GAAP financials. In addition, the committee modified wording in section
3.1, The Role of the Actuary, and section 3.2, Preparation of Financial Statements, to
reflect this role.

The same commentator also suggested the inclusion of Purchase GAAP in the scope. The
committee believes that Purchase GAAP should be excluded from the standard. Many
changes in the ASOP would have to be made to accommodate Purchase GAAP. In
addition, industry practice varies considerably. Nonetheless, in many cases, Purchase
GAAP requires either best-estimate assumptions or provisions for the risk of adverse
deviation. In these instances, even though Purchase GAAP is excluded from this ASOP, it
might still be reasonable for an actuary to apply the spirit of this ASOP.

Section 2. Definitions

Section 2.1, Costs, and section 2.3, GAAP Net Premium—One commentator suggested that it
would be more logical to exclude profits from the definition of costs instead of from the
definition of GAAP Net Premium. The committee agreed and modified the wording.

Section 3. Analysis of Issues and Recommended Practices

Section 3.1, The Role of the Actuary—See the comments under section 1.2, Scope.

Section 3.2, Preparation of Financial Statements—See the comments under section 1.2, Scope.
Two commentators suggested the inclusion of additional accounting guidance. The committee
believes that the accounting guidance listed is the most relevant to this standard, and feels

10
comfortable that the phrase “including, but not limited to” encompasses the other guidance
as necessary.

Section 3.3, Categories of Assumptions—One commentator believed that loss recognition should
be defined. The committee believes that this subject is sufficiently defined in the accounting
literature.

Section 3.4, Best-Estimate Assumptions—Three commentators were uncomfortable with the


phrase most likely outcome and suggested using more defined statistical measures such as mean,
median, or mode. One of the commentators strongly suggested that mean expected value is a
much more appropriate measure, although this commentator acknowledged that accounting
literature uses the phrase most likely.

Although the committee believes that mean expected value has theoretical merit for some
assumptions, the committee does not want to change current practice by requiring its use.
The standard calls for the actuary to use judgment and pick reasonable assumptions.
Therefore, the committee did not modify the wording.

Two commentators suggested that the guidance for assumptions in loss recognition situations
should be clearer. The committee believes that the current language is sufficiently clear.
Therefore, the committee did not modify the wording.

Section 3.6, Methods—One commentator suggested some clarification was necessary in the
phrases describing matching of revenue and expenses. The committee agreed and changed the
phrase in the second paragraph from “amortizing costs against premiums” to “accruing
costs against premiums.”

Section 3.6.3, Recognition of Premiums—One commentator suggested that the guidance for
credit insurance should be slightly different depending upon exactly the type of coverage. For
example, the pro rata method is not commonly used for single premium credit insurance with
decreasing benefits. The committee agreed and made the language more general by deleting
the reference to the pro rata method.

The committee thanks everyone who took the time and made the effort to comment on the
exposure draft. The input was helpful in developing the standard.

11
Actuarial Standard
of Practice
No. 11

Financial Statement Treatment of Reinsurance


Transactions Involving Life or Health Insurance

Revised Edition

Developed by the
Task Force to Revise ASOP No. 11 of the
Life Committee of the
Actuarial Standards Board

Adopted by the
Actuarial Standards Board
June 2005

(Doc. No. 098)


ASOP No. 11—June 2005

TABLE OF CONTENTS

Transmittal Memorandum iii

STANDARD OF PRACTICE

Section 1. Purpose, Scope, Cross References, and Effective Date 1


1.1 Purpose 1
1.2 Scope 1
1.3 Cross References 1
1.4 Effective Date 1

Section 2. Definitions 2
2.1 Health Insurance 2
2.2 Net Statement Liabilities 2
2.3 Nonproportional Feature 2
2.4 Reinsurance Agreement 2
2.5 Reinsurance Assumed 2
2.6 Reinsurance Ceded 2
2.7 Reinsurance Transaction 2

Section 3. Analysis of Issues and Recommended Practices 2


3.1 Financial Features 2
3.2 Cash Flows 2
3.3 Treatment of Reinsurance Ceded 3
3.4 Termination of Reinsurance 3
3.5 Additional Liabilities 3
3.6 Applicable Law 3
3.7 Accounting Guidance 4
3.8 Reliance on Data or Other Information Supplied by Others 4
3.9 Documentation 4

Section 4. Communications and Disclosures 4


4.1 Actuarial Communications 4
4.2 Prescribed Statement of Actuarial Opinion 4
4.3 Deviation from Standard 4

APPENDIXES

Appendix 1—Background and Current Practices 5


Background 5
Current Practices 5

Appendix 2—Comments on the Second Exposure Draft and Task Force Responses 7

ii
ASOP No. 11—June 2005
June 2005

TO: Members of the American Academy of Actuaries and Other Persons Interested in
the Financial Statement Treatment of Reinsurance Transactions Involving Life or
Health Insurance

FROM: Actuarial Standards Board (ASB)

SUBJ: Actuarial Standard of Practice (ASOP) No. 11

This booklet contains the final version of a revision of ASOP No. 11, Financial Statement
Treatment of Reinsurance Transactions Involving Life or Health Insurance.

Background

The Actuarial Standards Board adopted the original ASOP No. 11, then titled The Treatment of
Reinsurance Transactions in Life and Health Insurance Company Financial Statements, in 1989.
Prior to adoption of the standard, Recommendation No. 4 and Interpretation No. 4-A of the
Financial Reporting Recommendations and Interpretations of the American Academy of
Actuaries covered certain aspects of generally accepted accounting principles (GAAP) financial
reporting on reinsurance ceded by life and health insurance companies. The original standard
superseded Recommendation No. 4 and Interpretation No. 4-A.

Since the original actuarial standard was issued, reinsurance practice and related accounting
guidance have evolved significantly. Such accounting guidance includes, for GAAP financial
statements, Statement of Financial Accounting Standard (SFAS) No. 113, Accounting and
Reporting for Reinsurance of Short-Duration and Long-Duration Contracts, issued in 1992;
American Institute of Certified Public Accounts (AICPA) Statement of Position (SOP) 98-7,
Deposit Accounting: Accounting for Insurance and Reinsurance Contracts That Do Not
Transfer Insurance Risk; and, for statutory accounting, Statutory Statement of Accounting
Principles (SSAP) No. 61 and other statutory guidance, including Appendix A-785 (credit for
reinsurance) and Appendix A-791 (risk transfer/in-force accounting) of statutory codification.

The Task Force to Revise ASOP No. 11 included a member of the Casualty Actuarial Society.
However, the task force, the Life Committee, and the ASB agreed that the scope of this standard
would not be expanded to include reinsurance of purely property/casualty insurance at this time.

In the first exposure draft, the scope was changed to apply to reinsurance transactions involving
life (including annuities) and health insurance, rather than to life and health insurance company
financial statements. In the second exposure draft, the scope was further clarified to state that this
standard will apply when life and health insurance is reinsured by property/casualty companies.
Furthermore, should a company enter into a transaction that involves reinsurance of

iii
ASOP No. 11—June 2005

both life/health insurance and property/casualty insurance, it is incumbent on the actuary to


determine whether this standard, ASOP No. 36, Statements of Actuarial Opinion Regarding
Property/Casualty Loss and Loss Adjustment Expense Reserves, or aspects of both are most
appropriate to determine the proper treatment of the transaction.

First Exposure Draft

The first exposure draft of this ASOP was issued in June 2003, with a comment deadline of
December 15, 2003. Eleven comment letters were received. The Task Force to Revise ASOP
No. 11 carefully considered all comments received and made clarifying changes to the language
in several sections. The most significant change from the first exposure draft was the revision of
section 1.2, Scope, to clarify that the standard will apply to the extent that life/health insurance is
reinsured by property/casualty companies. Should a reinsurance transaction involve both
life/health and property/casualty insurance, the actuary should use professional judgment to
determine whether this standard, ASOP No. 36, or aspects of both are most appropriate to
determine the proper treatment of the transaction.

Second Exposure Draft

The second exposure draft of this ASOP was issued in November 2004, with a comment
deadline of March 31, 2005. Nine comment letters were received. The Task Force to Revise
ASOP No. 11 carefully considered all comments received and made clarifying changes to the
language in several sections. For a summary of the substantive issues contained in the second
exposure draft comment letters and the task force’s responses, please see appendix 2. There were
no significant changes from the second exposure draft.

The task force thanks everyone who took the time to contribute comments on the exposure
drafts.

The ASB voted in June 2005 to adopt this standard.

iv
ASOP No. 11—June 2005

Task Force to Revise ASOP No. 11

Allan W. Ryan, Chairperson


Franklin C. Clapper, Jr. Jeremy Starr
Paul J. Kneuer Stephen A. Zonca

Life Committee of the ASB

Robert G. Meilander, Chairperson


Charles Carroll Thomas A. Phillips
Michael A. Cioffi Allan W. Ryan
Stephen N. Patzman Barry L. Shemin

Actuarial Standards Board

Michael A. LaMonica, Chairperson


Cecil D. Bykerk William A. Reimert
William C. Cutlip Lawrence J. Sher
Lew H. Nathan Karen F. Terry
Godfrey Perrott William C. Weller

v
ASOP No. 11—June 2005

ACTUARIAL STANDARD OF PRACTICE NO. 11

FINANCIAL STATEMENT TREATMENT OF REINSURANCE TRANSACTIONS


INVOLVING LIFE OR HEALTH INSURANCE

STANDARD OF PRACTICE

Section 1. Purpose, Scope, Cross References, and Effective Date

1.1 Purpose—This actuarial standard of practice (ASOP) provides guidance to actuaries


when performing professional services relating to financial statements that contain
material reinsurance transactions involving life insurance (including annuities) or health
insurance.

1.2 Scope—This standard applies to actuaries when performing professional services in


connection with preparing, reviewing, or analyzing financial statement items that reflect
reinsurance ceded or reinsurance assumed on life insurance (including annuities) or
health insurance.

To the extent that life/health insurance is reinsured by property/casualty companies, this


standard will apply. If a reinsurance transaction involves both life/health and
property/casualty insurance, the actuary should use professional judgment to determine
whether this standard, ASOP No. 36, Statements of Actuarial Opinion Regarding
Property/Casualty Loss and Loss Adjustment Expense Reserves, or aspects of both are
most appropriate to determine the proper treatment of the reinsurance transaction.

The actuary should satisfy the requirements of applicable law (including regulation and
other binding authority) and this standard. However, to the extent applicable law conflicts
with this standard, compliance with such applicable law shall not be deemed a deviation
from this standard, provided the actuary discloses that the actuarial assignment was
performed in accordance with the requirements of such applicable law.

1.3 Cross References—When this standard refers to the provisions of other documents, the
reference includes the referenced documents as they may be amended or restated in the
future, and any successor to them, by whatever name called. If any amended or restated
document differs materially from the originally referenced document, the actuary should
consider the guidance in this standard to the extent it is applicable and appropriate.

1.4 Effective Date—This standard is effective for actuarial services performed in connection
with financial statements for periods beginning on or after January 1, 2006.

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ASOP No. 11—June 2005

Section 2. Definitions

The terms below are defined for use in this actuarial standard of practice.

2.1 Health Insurance⎯Coverage associated with contract provisions for medical, dental,
vision care, disability income, accidental death and dismemberment, long-term care, and
similar benefits, on either a reimbursement or service-benefit basis, sold by insurance
companies, health maintenance organizations, hospital and medical service organizations,
and other entities subject to insurance regulatory authorities.

2.2 Net Statement Liabilities⎯Reserves (net of reinsurance reserve credits), plus any other
liabilities (such as amounts due reinsurers), less any other assets arising from reinsurance
transactions (such as amounts receivable from reinsurers or deferred acquisition costs),
for the reinsured block of business.

2.3 Nonproportional Feature—A feature of a reinsurance agreement that makes the


reinsurer’s financial experience nonproportional to that of the ceding entity. Examples of
such nonproportional features include aggregate claim limits, deductibles, limited
coverage periods, experience refunds, profit-sharing provisions, separate but related
agreements, i.e., where the results of one agreement affect the operation of the other, and
termination provisions.

2.4 Reinsurance Agreement—An agreement whereby one or more elements of risk contained
in insurance contracts are transferred from a ceding insurance entity to a reinsuring (or
assuming) insurance entity in return for some consideration.

2.5 Reinsurance Assumed—Reinsurance as it affects the entity assuming the risk under a
reinsurance agreement.

2.6 Reinsurance Ceded—Reinsurance as it affects the entity ceding the risk under a
reinsurance agreement.

2.7 Reinsurance Transaction—A transaction made pursuant to a reinsurance agreement.

Section 3. Analysis of Issues and Recommended Practices

3.1 Financial Features—When preparing, reviewing, or analyzing financial statement items,


the actuary should consider the material financial features of relevant reinsurance
agreements. In particular, the actuary should appropriately and consistently recognize the
risks transferred.

3.2 Cash Flows—When preparing, reviewing, or analyzing financial statement items that
reflect reinsurance ceded or reinsurance assumed, the actuary should consider potential

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ASOP No. 11—June 2005

cash flows that may, in the actuary’s professional judgment, have a material impact under
the reinsurance agreement (for example, premiums, allowances, investment income,
expenses, modified coinsurance reserve adjustments, benefits, experience refunds, risk
fees, and volume or other bonuses, including any contingent payments). The actuary
should consider the likely impact of nonproportional features and termination provisions
of the reinsurance agreement.

3.3 Treatment of Reinsurance Ceded—The actuary should determine adjustments for


reinsurance ceded financial statement items using assumptions that are consistent with
those underlying the calculation of the direct items, except as otherwise indicated by the
terms and conditions of the reinsurance agreement, even though the values of the direct
financial statement items (before reinsurance) and adjustments for reinsurance ceded are
generally determined separately.

The actuary should calculate adjustments for reinsurance ceded directly without relying
upon the values of financial statement items held by the reinsurer. Because the ceding
entity and the assuming entity each establish and test statement liabilities and assets
independently, it is possible for the value of the net statement liabilities held by the
ceding entity, plus those held by the reinsurer on a reinsured contract, to be more or less
than the amount that would have been held if the ceding entity had not reinsured the