Actuarial Standards of Practice

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 Section 1. Section 2. Section 3. Section 4. iii

Overview...................................................................................................................1 The Actuarial Standards Board ..................................................................................1 Actuarial Standards of Practice ..................................................................................1 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: FROM: SUBJ: Members of Actuarial Organizations Governed by the Standards of Practice of the Actuarial Standards Board and Other Interested Persons Actuarial Standards Board (ASB) 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 ASBs operations, the content and format of standards, and the ASBs 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 purposeto 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 Boards 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 ASBs 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. 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 ASBs 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

2.2

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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 ASBs 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 2

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 professions 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 ASOPsEach ASOP document contains (1) a transmittal memorandum, (2) the ASOP itself, and (3) one or more supporting appendices.3

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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 3.2.13.2.3 of this Introduction.

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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 principals behalf. In those instances, the ASOP may indicate in its scope to what extent the ASOP addresses the actuarys role in advising the principal. However, the ASOPs are not intended to make the actuary responsible if the principal acts contrary to the actuarys advice. 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. 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.

b.

c.

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 ASOPs 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 actuarys 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 professions counseling and discipline processes. 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. 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 Academys Council on Professionalism publishes advisory Applicability Guidelines to assist actuaries in identifying the ASOPs that may be relevant. 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 actuarys judgment. ASOPs frequently use a few terms that, while not defined within them, are integral to an informed reading of the ASOPs. For example: 5

4.2

4.3

4.4

4.5


4.5.1 KnownASOPs 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 principals 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/PracticableASOPs 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 timeconsuming, elaborate, or costly relative to the principals 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 actuarys professional judgment, are not material to the purpose and nature of the assignment. 4.5.3 Professional judgmentActuaries 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 actuarys 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 ReasonableIn 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 actuarys 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 RelianceThe 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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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. 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.

Response

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. 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.

Response

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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. The reviewers agree and made the change. 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). The reviewers did not feel that this addition was needed and made no change. One commentator suggested adding a modifier to make clear what level of practice is expected in the last sentence of the section. The reviewers agreed that the addition of the modifier would be beneficial to clarify intent, and inserted the word appropriate.

Response Comment Response Comment Response

Section 3.1.3 (Now 3.1.4) Comment Response Comment One commentator suggested adding wording to address the criteria that determine when ASOPs are updated. The reviewers agree and have added a new subsection, 3.1.2, to address this (and renumbered the subsequent subsections accordingly). 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. The reviewers do not believe that this addition is needed and made no change.

Response Section 3.2.3 Comment Response Section 4.6 Comment

One commentator suggested that Code be changed to Code of Professional Conduct in all instances for clarity. The reviewers agree and made the change.

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

Response

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COMMENTS ON OTHER SECTIONS OF THE ASOP Overview 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. The reviewers agree and made the change.

Response

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. The reviewers disagree, and made no change.

Response

Section 3.1.5 (Now 3.1.6) Comment Response One commentator suggested that the last sentence in the section should be modified to excise the phrase must be able to. 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. The reviewers agree and revised the sentence to clarify its meaning. One commentator suggested that the phrase generally accepted practice be changed to a particular ASOP. The reviewers agree and made the change. 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. The reviewers decided that any change of this nature is outside of the scope of this update to the Introduction.

Response Comment Response Comment

Response

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

Response Comment

Response

Section 3.1.8 (Now 3.1.9) Comment Response Comment One commentator pointed out that the Introduction has no discussion on the procedures the ASB uses when reviewing and revising ASOPs. The reviewers agree that this needs to be addressed and added section 3.1.2 to address the issue. 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. The reviewers do not feel such a statement is needed.

Response 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. The reviewers agree and made the change.

Response

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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. 1March 2004 T A B L E OF C O N T E N T S Transmittal Memorandum Section 1. Purpose, Scope, Cross References, and Effective Date 1.1 Purpose 1.2 Scope 1.3 Cross References 1.4 Effective Date Section 2. Definitions 2.1 Anticipated Experience Factor 2.2 Applicable Law 2.3 Determination Policy 2.4 Nonguaranteed Charge or Benefit 2.5 Policy 2.6 Policy Class 2.7 Policy Factor Section 3. Analysis of Issues and Recommended Practices 3.1 Advice on Determination Policy 3.2 Determination of Nonguaranteed Charges or Benefits 3.3 Determination Process 3.4 Policy Classes 3.5 Nonguaranteed Charges or Benefits Used in Illustrations 3.6 Documentation Section 4. Communications and Disclosures 4.1 Actuarial Communication 4.2 Disclosure 4.3 Reliance on Data Supplied by Others 4.4 Prescribed Statement of Actuarial Opinion 4.5 Deviation from Standard APPENDIXES Appendix 1Background and Current Practices Background Current Practices Appendix 2Comments on the Exposure Draft and Task Force Responses 6 6 7 9 iii 1 1 1 1 2 2 2 2 2 2 2 2 2 3 3 3 3 3 4 4 4 4 4 5 5 5

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ASOP No. 1March 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 Actuarial Standards Board (ASB) Actuarial Standard of Practice (ASOP) No. 1

FROM: SUBJ:

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 forces responses, please see appendix 2.

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ASOP No. 1March 2004 The most significant changes from the exposure draft are as follows: 1. 2. 3. 4. The task force revised the standard to utilize the term determination in place of redetermination. The task force modified section 3.1 to clarify that the actuary should consider relevant policy provisions and applicable law. The task force clarified section 3.5, which addresses the actuarys responsibilities with respect to illustrations not subject to ASOP No. 24. 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. The task force changed the term company to insurer throughout the ASOP to recognize that an insurer is not necessarily a company.

5.

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

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ASOP No. 1March 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 PurposeThis 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. ScopeThis 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 ReferencesWhen 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.

1.2

1

ASOP No. 1March 2004 1.4 Effective DateThis 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 FactorAn 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. Applicable LawFederal, state, and local statutes, regulations, case law, and other legal binding authority that may govern the actuarial work being performed. Determination PolicyThe insurers criteria or objectives for determining nonguaranteed charges or benefits for a particular policy class. Nonguaranteed Charge or BenefitAny 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. PolicyExcept 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. Policy ClassA group of policies considered together for purposes of determining a nonguaranteed charge or benefit. Policy FactorA 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.

2.2 2.3 2.4

2.5

2.6 2.7

2

ASOP No. 1March 2004 Section 3. Analysis of Issues and Recommended Practices 3.1 Advice on Determination PolicyWhen advising the insurer on the actuarial aspects of a determination policy, the actuarys advice should be consistent with the insurers stated marketing, financial, and other objectives. The actuary should consider relevant policy provisions and applicable law. Determination of Nonguaranteed Charges or BenefitsThe actuary should recommend nonguaranteed charges or benefits that are consistent with the insurers determination policy. When the determination policy is not provided to the actuary, the actuary should inquire about the insurers intentions for the determination of nonguaranteed charges or benefits and have the insurer confirm those intentions as the determination policy. Determination ProcessThe 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 actuarys advice is based, if the actuary expects such deviations to have a material effect. 3.4 Policy ClassesPolicies 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. b. c. d. e. the similarity of the policy types; the structure of policy factors and nonguaranteed charges or benefits; the similarity of anticipated experience factors; the time period over which the policies were issued; and the underwriting and marketing characteristics of the policies.

3.2

3.3

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

3

ASOP No. 1March 2004 3.5 Nonguaranteed Charges or Benefits Used in IllustrationsThe 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. DocumentationThe 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 CommunicationThe actuary should issue an actuarial communication in accordance with ASOP No. 41 to the insurer stating the actuarys 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. DisclosureThe actuary should disclose the following items when appropriate and available: a. a description of the insurers 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; any known areas in which the recommended nonguaranteed charges or benefits do not follow the insurers determination policy; any material change in the determination policy or in the assumptions the actuary has made about the determination policy since the previous determination; the policy classes involved and any material changes in the assignment of policies to policy classes; 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; the nonguaranteed charges or benefits recommended for the forthcoming period; the significant policy factors used in the determination of nonguaranteed charges and benefits;

3.6

4.2

b. c. d. e.

f. g.

4

ASOP No. 1March 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; any conclusions or recommendations related to sensitivity testing; and applicable law recognized in formulating the actuarys recommendations.

i. j. 4.3

Reliance on Data Supplied by OthersThe 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. Prescribed Statement of Actuarial OpinionThis 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. Deviation from StandardAn 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.

4.4

4.5

5

ASOP No. 1March 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 actuarys essential obligations were (1) to assure the completion 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.

6

ASOP No. 1March 2004 Current Practices The actuary may provide professional services in two principal areas with respect to nonguaranteed 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 determination 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. b. c. to reflect anticipated gains or losses on supplementary benefit riders; to reflect anticipated gains or losses arising from the usage of settlement option guarantees; 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; to smooth the transition from one set of nonguaranteed charges or benefits to another; to smooth the incidence of nonguaranteed charges or benefits between policy durations; and to be consistent with nonguaranteed charges or benefits of other similar products.

d. e. f.

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.

7

ASOP No. 1March 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 nonguaranteed charges or benefits (see section 3.5 of this standard).

8

ASOP No. 1March 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 forces 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 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.

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

Response Comment 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.

9

ASOP No. 1March 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 Comment Response Comment Response The task force clarified the section. One commentator recommended that a statement be added that anticipated experience should not reflect any assumed improvement beyond the current date. 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. One commentator suggested the standard should provide guidance regarding the timing of conducting tests of illustrated nonguaranteed charges or benefits. The task force discussed timing, but decided the actuary should have flexibility in this matter.

10

ASOP No. 1March 2004Comment Response One commentator noted that section 3.5 used the phrase currently anticipated experience while other parts of the standard used anticipated experience.

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 Comment The task force added the phrase when appropriate and available to provide more flexibility in disclosure. 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 actuarys responsibilities, as the company establishes determination policy. The task force agreed and deleted the phrase. Regarding section 4.2(f), a few commentators stated that the documentation of all specific nonguaranteed charges or benefits might be overly burdensome. 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. 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. The task force agreed and changed the wording of section 4.2(i).

Response Comment Response Comment Response

11


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 RECOMMENDATIONS 1. 2. 3. 4. 5. 6. Background Scope Existing Standards Disclosure Disclosure of Exceptions Sample Disclosure 1 1 1 1 1 2 iii

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 Pension Committee of the Interim Actuarial Standards Board (IASB)

FROM:

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 actuarys 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 professions 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 IASBs 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 881. BackgroundThe 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 furnished by actuaries, the basis for those calculations is prescribed by the FASB. ScopePronouncements 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. Existing StandardsInterpretative 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. DisclosureAn 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. Disclosure of ExceptionsIf the calculations conflict significantly with the actuarys 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.

2.

3.

4.

5.

1

6.

Sample DisclosureIn 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


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. 3September 2007 TABLE OF CONTENTS Transmittal Memorandum STANDARD OF PRACTICE Section 1. Purpose, Scope, Cross References, and Effective Date 1.1 Purpose 1.2 Scope 1.3 Cross References 1.4 Effective Date Section 2. Definitions 2.1 Additional Fee 2.2 Actuarial Balance Sheet 2.3 Advance Fee 2.4 Cash and Investment Balance 2.5 Cohort of New Residents 2.6 Continuing Care Retirement Community (CCRC) 2.7 Fee Structure 2.8 Health Care Guarantee 2.9 Health Center 2.10 Independent Living Unit 2.11 Levels of Care 2.12 Living Unit 2.13 Morbidity Rate 2.14 Non-Resident 2.15 Periodic Fee 2.16 Permanent Transfer 2.17 Physical Property 2.18 Population Projection 2.19 Residency Agreement 2.20 Resident 2.21 Temporary Transfer 2.22 Trend 2.23 Withdrawal Rate 2.24 Valuation Date Section 3. Analysis of Issues and Recommended Practices 3.1 Introduction 3.2 Determination of Satisfactory Actuarial Balance 3.2.1 Condition 1: Adequate Resources for Current Residents 3.2.2 Condition 2: Adequate Fee Structure for a Cohort of New Residents 3.2.3 Condition 3: Positive Projected Cash and Investment Balances 3.3 Projected Population Movements 3.3.1 Closed-Group Projection of Current Residents 3.3.2 Closed-Group Projection of a Cohort of New Residents 3.3.3 Open-Group Projection ii 1 1 1 2 2 2 2 2 2 2 2 2 3 3 3 3 3 3 3 3 3 3 3 4 4 4 4 4 4 4 4 4 4 4 5 5 5 6 6 6 iv

ASOP No. 3September 2007 3.4 Actuarial Balance Sheet 3.4.1 Assets 3.4.2 Liabilities 3.5 Cohort Pricing Analysis 3.6 Actuarial Asset and Liability Values 3.6.1 Future Periodic Fees 3.6.2 Future Additional Fees and Third Party Payments 3.6.3 Physical Property for Assets Currently in Service 3.6.4 Future Use of Physical Property 3.6.5 Future Operating Expenses 3.6.6 Future Refunds 3.6.7 Value of Long-Term Debt 3.7 Cash Flow Projections 3.8 Selection of Actuarial Assumptions 3.8.1 Mortality, Morbidity, and Withdrawal Assumptions 3.8.2 Trend Assumptions for Fees and Expenses 3.8.3 Investment Rate and Discount Rate Assumptions 3.8.4 Revenue and Expense Allocation Assumptions 3.8.5 Going-Concern Assumption 3.8.6 Reasonableness of Assumptions 3.9 Benevolence Funds and Financial Assistance Subsidies 3.10 For-Profit CCRCs 3.11 Equity or Cooperative CCRCs 3.12 Additional Considerations Affecting a CCRCs Finances 3.13 External Restrictions 3.14 Reliance on Data or Other Information Supplied by Others 3.15 Documentation Section 4. Communications and Disclosures 4.1 Communications and Disclosures 4.1.1 Actuarial Data, Assumptions, and Methods 4.1.2 Assignments Involving an Opinion on Satisfactory Actuarial Balance 4.1.3 Specific Disclosures 4.2 Deviation 4.2.1 Material Deviations to Comply with Applicable Law 4.2.2 Other Material Deviations APPENDIXES Appendix 1Background and Current Practices Background Current Practices Illustrative Capital Expense Charge Development and Physical Property Valucation Illustrative Formulas for Expensing and Valuing Physical Property Appendix 2Comments on the Exposure Draft and Responses 17 17 17 17 20 22 6 6 6 7 7 7 7 7 8 8 8 8 8 9 9 10 10 10 10 11 11 11 12 12 12 12 13 13 13 13 14 15 15 15 15

iii

ASOP No. 3September 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 Actuarial Standards Board (ASB) Actuarial Standard of Practice (ASOP) No. 3

FROM: SUBJ:

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. 3September 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 Godfrey Perrott William C. Cutlip Alan D. Ford Lawrence J. Sher David R. Kass Karen F. Terry

v


ACTUARIAL STANDARD OF PRACTICE NO. 3

CONTINUING CARE RETIREMENT COMMUNITIES

STANDARD OF PRACTICE Section 1. Purpose, Scope, Cross References, and Effective Date 1.1 PurposeThis actuarial standard of practice (ASOP) provides guidance to the actuary when performing professional services related to a continuing care retirement community (CCRC). ScopeThis standard applies to actuaries when performing professional including giving advice, in connection with CCRCs (including nonprofit and entities). These professional services may be performed for owners, operators, entities, current residents, or prospective residents of a CCRC, as well as professionals or regulatory bodies. services, for-profit financing for other

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Examples of the services covered by this ASOP include, but are not limited to, the following: a. b. c. d. e. f. g. h. i. j. testing the financial condition of the CCRC for satisfactory actuarial balance; estimating actuarial values of assets and liabilities; evaluating the fee structure for existing residents or a cohort of new residents; developing population projections, including resident movements, independent living unit turnover, and health center utilization; projecting future cash flows and cash and investment balances; designing and pricing new residency agreements; estimating the future services obligation under GAAP; assisting in developing financial feasibility studies; performing mortality, morbidity, and withdrawal experience studies; and providing appropriate rates of mortality, morbidity, or life expectancies for the CCRCs use.

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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 ReferencesWhen 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. Effective DateThis 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 FeeAn 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). Actuarial Balance SheetA measure of the assets and liabilities, as of the valuation date, associated with current residents. Advance FeeAn 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 founders fee). Cash and Investment BalanceThe 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. Cohort of New ResidentsA hypothetical group of new residents assumed to enter the CCRC over a specified period of time and assumed to have certain demographic characteristics. 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. 3September 2007 2.7 2.8 Fee StructureA combination of fees that generally includes advance fees, periodic fees, and additional fees. Health Care GuaranteeA 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. Health CenterA 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. Nonresidents may also live in the health center. Independent Living UnitLiving 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. Levels of CareVarying degrees of care, which are based on a residents 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. Living UnitThe various living quarters of a CCRC, including independent living units and health center units. Morbidity RateThe 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. Non-ResidentA 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. Periodic FeeAmounts 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. Permanent TransferA move from one level of care to another level of care without expectation of returning to the former level of care. Physical PropertyPhysical 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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Population ProjectionAn estimate of the number of residents expected to live in the CCRC at various future times. Residency AgreementThe 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. ResidentA person living in the CCRC who has signed a residency agreement with a health care guarantee or a refund guarantee. Temporary TransferA move from one level of care to another level of care with the expectation of returning to the former level of care. TrendMeasure of rates of change, over time, that affects revenues, costs, or actuarial assumptions. Withdrawal RateThe probability that a residency agreement will be terminated by the residents leaving the CCRC for reasons other than death. Valuation DateThe date as of which the values of the assets and liabilities of the CCRC are determined. Section 3. Analysis of Issues and Recommended Practices

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IntroductionWhen 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 actuarys professional judgment, appropriate in light of the scope and purpose of the assignment. Determination of Satisfactory Actuarial BalanceIn 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 ResidentsThe 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. 3September 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 ResidentsFor 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 BalancesThe 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 actuarys 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 MovementsThe 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. 3September 2007 3.3.1 Closed-Group Projection of Current ResidentsWhen 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 ResidentsWhen 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

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