I am working on an assignment that involves understanding how the variables in a cash flow testing model move. I have Asset book value as an Asset, STAT reserve and Interest Maintainence Reserve as liabilities, and two cash flows, Maintainence Expense and Annuity benefits. I am looking for some resources to better guide me in understanding how the different pieces move in conjunction with one another. Does anyone know of any articles that would be useful, or have any thoughts?
The most critical elements in a cash flow testing model for deferred annuities are the crediting rate and surrender benefit rate. You definitely need to be able to model what renewal rate the company will credit, which will depend on future interest rates. My (now retired) impression is that in very few companies is the company’s renewal rate just new-money (earned rate) at renewal less a fixed spread. It likely gives some weight to the new-money rate (at renewal), but also gives consideration to the current credited rate on the contract and consideration to the rate the company is earning on the assets already backing the product.
Then you need to model policyholder behavior, which is quite interest sensitive. The higher the credited rate, the lower the lapses and the higher the renewal premiums (if additional premiums are possible). That policyholder behavior will also be influenced by other opportunities the policyholder has. That is, for any given future interest scenario, lapses will be lower if you credit 6% than if you credit 4%. However, lapses on annuities crediting 6% will be lower if the 5-year treasury is at 3% than if it is at 5%.
Not specific to annuities (I don’t think), but the AAA’s practice note on Asset Adequacy Analysis should be part of your review before you get too deep:
And the ASOP on this topic is #22:
Chapter from an Actex text:
That should get you through Monday