PBR adoption in North America

Two days back I saw a screaming headline in reuters: "Regulators advance controversial insurance accounting change". The article was about NAIC adopting Principles Based Regulation for Valuation. NAIC has published a new Valuation manual. The write-up could've been similar to "Earth is NOT flat" article from centuries ago.

The tone of the article demonstrates the lag of NA regulators as compared to the ones in Europe and Asia.

The valuation manual can be accessed at http://www.naic.org/documents/committees_a_related_docs_valuation_manual.pdf.

Assessing the assessment

Aon Hewitt has launched an online "Settlement Readiness Assessment", open to all UK defined benefit pension schemes.

It is a very useful assessment to take as a reality check of the state of scheme management.

The questions deal with Scheme size, an understanding of the Financial and Investment Impact, Decision making powers etc.

Some of the questions deal with whether longevity analysis has been done on the scheme membership, record keeping, benefit projection studies, pension structure with linkages to CPI, tiered insurance of the scheme benefits, and % of pensioners which throw light on the costing parameters.

In particular I was interested on  insuring different elements of the scheme’s benefits (eg. older pensioners vs younger, fixed vs indexed pensions, different member categories, a percentage of all pensioners). This would be an interesting area of pricing trade-offs. It certainly removes any cross-subsidization from an Insurer's perspective while making any such selective hiving off costlier for the scheme sponsors.

You can look up on the internet for this assessment by Aon Hewitt.

"Running out of money" - Risk transfer from plan sponsors to annuitants

The ways companies in the US are trying to cut pension risks:

• Boosting 401K contributions and cutting cash balance plan (pension plan) contributions
• Offering a lump sum in lieu of monthly pension benefit
• Purchasing annuity for older block of pensioners and offering a lump sum for newer retirees which would reduce the cost of single premium for annuity.
• Buying a pension “buy-in” policy from an Insurer who holds the money in a separate account from which the employer can withdraw money each month to pay benefits. This way, the company is shielded from the risk of having to make additional plan contributions if, for example, the value of plan assets falls due to a decline in the equities market or retirees live longer than expected.
• Offering future retirees (current employees) to opt for a lump sum benefit instead of the future annuity.

India is a nascent market in terms of private sector pensions with even the regulator yet to settle down. The lessons here for Indian companies would be

• Increased contribution to PF funds
• Purchase of single premium deferred annuity products every year
• Conservative modeling in case self-managed funds

Some of these have taxation impact and hence government comes into the picture.  From the perspective of managing a country, it pays to prepare for the old age as a society. Australia is a very good example to follow. A government (or its Finance Minister) can consider the following:

• Increasing the tax free ceiling and/or reducing the tax rates on post-tax contributions (both employer & employee) to savings (PF, Superannuation) elements
• Imposing stringent regulations on pricing & funding assumptions and capital requirements rather than enforcing minimum returns & fee regimes. Prevention is better than cure.

The opportunities for Insurance companies are:

• Develop the products & meet the need. Sometimes even the need may not be realized at the societal consciousness as a whole. Just conducting a survey of how much people think they require per month when they retire would reveal this.
• Address the younger segment of the market as the accumulation phase has to be longer in low interest regimes.

Falling off the wagon?

I came across an article in bloomberg, "Insurers Add Risk, Sacrifice Liquidity in Hunt for Yield". It looks like insurers in their efforts to sustain yields to match the long term commitments, have again started looking for high yield low rated instruments.

Hope lessons taught by the 2008/09 crisis are not forgotten.