Principle-Based System continued
a Short Technical history of u.S. Principle-Based
Efforts and Scenario generators
BY NANCY BeNNe TT
When the National Association of Insurance Commissioners (NAIC) asked work groups of the Academy’s Life Practice
Council to develop economic scenario generators for principle-based
requirements for fixed deferred and
variable annuity products, the generator for variable annuities was designed to reflect long-term equity
returns for stock and bond funds. The
Academy recommended a scenario
generator with parameters based on
historical observations.
NAIC’s regulators instructed the
Academy to reduce the assumed
mean or average return of the scenario distribution below the mean return
based on historical observation. The
effect of reducing the mean return
was to reduce the anticipated spreads
contained in the equity scenarios.
Since 2005, the underlying parameters for the equity generator haven’t
been updated. Please note that an
updated interest-rate generator was
approved by the NAIC for use in regulatory capital calculations in 2007 and
beyond. This interest rate generator
was approved for generating any interest rate scenarios or regenerating
prepackaged fund scenarios for funds
that include the impact of bond yields.
The Academy also developed a
set of calibration criteria to support
the use of an alternative generator in
regulatory calculations. As established
by the NAIC, the risk-based capital
(RBC) formula allows a company to
use either the preapproved scenarios
or scenarios generated from a propri-
etary generator, as long as the sce-
nario set satisfies calibration criteria.
The Academy has encouraged the use
of proprietary scenario generators in
regulatory calculations.
nAncy Bennett is the Academy’s
senior life fellow and chairperson of
the Academy’s economic Scenario
Implementation Work Group.
Solvency II
Unlike the above examples, Solvency II’s implementation isn’t
yet complete. But the risk-measurement production architectures that are being discussed tend to share many of the above
traits. For example, a number of large groups intend to centrally own and develop economic scenarios for application in
the capital assessments of the business units, using a process
similar to their current group EC processes. In some territories,
the local regulator has raised the prospect of the provision of
a standard scenario set that could be used by all businesses in
the principle-based regulatory capital assessment. Both of these
sources of scenarios are arguably examples of external prescription rather than a local, adaptive principle-based process.
The option to use the standard formula in the solvency
capital requirement is unambiguously a prescriptive approach.
That doesn’t mean it’s not appropriate to include the standard
formula as an option for firms where the materiality of risk exposure makes a simpler, prescriptive approach quite reasonable
