May 31, 2017
Since the Principles-Based Reserving (PBR) regulation has come into effect for new life insurance policies, U.S. actuaries have faced a clash in modeling priorities. In the red corner, projection models should always be flexible and transparent, while in the blue corner, valuation models rely on precision and governance. So, as the worlds of projection and valuation collide under PBR, which kind of modeling system will win out: “open” or “closed”?
Traditionally, the battle lines have been clearly drawn between the transparency of open modeling systems and the control offered by closed systems. With an open system, you effectively gain the flexibility to design models as you see fit, build company-specific tests and incorporate any new product features, management actions or policy holder behavior. And because the open system is so transparent, you get a real-time view of all the formulae and calculations involved. The closed system, on the other hand, brings security to your models, with knowledge that other companies are using (and validating) the same code base on which a model is running.
Given their respective priorities, projections have typically been modeled in open systems and valuations in closed systems. Consequently, insurers have been using a combination of the two system types to meet all their modeling requirements.
But there are major problems with this approach. The more systems you run, the higher the actuarial, vendor, internal IT and infrastructure costs. Also, multiple systems are unlikely to be calibrated consistently, resulting in inconsistent models. Additionally, they make it harder to adopt new products, modify existing products or change assumptions with speed or efficiency.
Above all, traditional, separate systems for valuation and projection are not equipped to take on the new world of PBR with its competing goals for modeling. Ideally, you need the ability to run a valuation model that meets your governance needs, with projection models that use the same valuation code base. Users would then know that there is no difference between the projected reserves and the reported reserves unless they chose to simplify inputs to the projection model. At the same time, you should have the flexibility to model new products however you want, without waiting for a vendor or sacrificing accuracy for the sake of a “generalized” model. This would ensure that all your models are consistent and substantially reduce the overhead necessary to maintain multiple systems and models.
The good news is that a new generation of actuarial platforms can deliver this winning combination of functionality within a single solution: a system that’s neither open nor closed but meets your twin modeling objectives. Most importantly, the modern platform will provide all the tools you need to manage your insurance business, from pricing and valuation to capital management. This will help you achieve transparency and governance not just for PBR compliance, but also across your entire actuarial modeling environment. Why compromise when you can now have the best of both worlds?