NAIC Economic Scenario Generator Project

Overview

In 2017, the American Academy of Actuaries advised the NAIC that it no longer had the resources to maintain prescribed Economic Scenario Generators including the Academy Interest Rate Generator (AIRG) for Life and Annuity Reserves and Capital. The NAIC Life and Annuity Task Force (LATF) decided to solicit proposals from Economic Scenario Generator (ESG) vendors to provide, maintain, and support an ESG producing real-world interest and equity scenarios to be prescribed for use in the calculations of Life and Annuity reserves and capital in the US.

In September 2020, the NAIC accepted a proposal by Conning, and contracted with that vendor to:

  • Use their ESG customized with any modifications adopted by State regulators to produce a Basic Data Set of scenarios to be prescribed for statutory reporting. The Basic Data Set would include scenarios of Treasury Yields, Bond Returns and Equity Returns. This Dataset will be available on a public website, and at least initially will be free of charge.
  • Engage in discussions with NAIC staff, state regulators and end users, including insurers and consultants to discuss the ESG, related tools and possible modifications.

The initial agreement calls for the selected vendor to also produce and make available various tools and calibration criteria needed for the ongoing production and usage of these scenarios, including:

  1. A scenario reduction tool to enable the choice of scenario subset from the main 10,000 scenario set;
  2. Calibration criteria to determine whether scenario subsets are sufficiently representative of the full set;
  3. A tool to generate scenarios for the VM-20 Stochastic Exclusion Ratio Test;
  4. A tool to generate the VM-21 Company-specific Market Path method scenarios; and
  5. A tool to generate statistics on the Basic Data Set files to be used for validation reports and to summarize key characteristics to be determined.

The agreement also calls for full documentation on specifications, calibrations and tools, as well as training materials. The NAIC intends to review the long-term behavior of the models over a multi-year period and to approve adjustments in the long-term behavior parameters where necessary. However, on a monthly basis, the vendor is expected to recalibrate the following parameters within the overall ESG model:

  1. Treasury Yield Model - Initial starting yield curve and mean reversion parameter
  2. Equity Return Model - Initial variance and dividend yields
  3. Bond Return Model - Similar to Treasury once the model approach is finalized by regulators

The Intention of the NAIC is for these scenarios in the Basic Data Set to be initially prescribed for use in Principles Based Reserve calculations including VM-20 (Life Insurance) and VM-21 (Variable Annuity). In addition, these scenarios would be prescribed for C3-Phase II Risk Based Capital for Variable Annuities. Subsequently, the application of the scenarios for VM-22 Fixed Annuity reserves and for C3 Phase I Risk Based Capital for Fixed Annuities and Single Premium Life Insurance would be considered.

Early in 2022, the NAIC worked with regulators to finalize the economic scenario models and sensitivities that the industry would test in June 2022 for the impact on reserves (VM-20 and VM-21) and required capital (C3P1 and C3P2). The testing would use the inforce as of 12/31/2021, unless the inforce as of 9/30/2021 was used for year-end reporting. The field test required using the same number of scenarios a company used for reporting at the end of 2021, with some potential adjustments when negative scenarios were encountered during the field test. Some assumption adjustments may be necessary for negative scenarios since there are no negative scenarios in the current American Academy of Actuaries Interest Rate Generator (AIRG).

After reviewing and addressing concerns from the industry with the models, including Moody's Analytics (see Knowledge Base article 2422 - Moody's Analytics on Proposed NAIC ESG Models), the NAIC and regulators decided to test the following models:

Treasury

  1. NAIC original calibration and Generalized Fractional Floor
  2. Alternative Calibration and Shadow Floor

Equity (including linkage to Treasury model)

  1. Baseline calibration aligned with gross wealth factors produced by AIRG Equity model
  2. Original NAIC calibration with significantly lower wealth factors than the AIRG Equity model
  3. Alternative calibration provided by the ACLI

Corporate

  1. NAIC corporate model using undisclosed proprietary vendor assumptions

Additional specific reference materials about the field test are available at the NAIC website.

Also, additional specifics concerning the Treasury model and the need to consider the two alternative models can be found on the SOA website.

The NAIC offered a summary of some qualitative observations from the field test results at the Fall NAIC meeting in December 2022. Final quantitative results and next steps are expected to be published by the NAIC early in 2023. It is expected that a second field test in mid-2023 will be necessary to identify the appropriate model and refine the calibrations. Results of the second field test are expected to be reviewed in 2023 with expected implementation at the end of 2024.

Some potential calibrations anticipated in the agreement with the contracted vendor and proposed to be effective on 1/1/2022 were intended to be field tested in 2021. However, In May 2021, the NAIC confirmed that the anticipated 2021 field tests would not take place and the overall timeline for completion and implementation of the NAIC ESG would be extended to allow more time and effort to be devoted to the process of producing a working ESG that meets the expectations of both regulatory and interested party communities. The NAIC also confirmed their intention to provide regular communications of progress updates and to obtain more meaningful input and expert advice from the industry and the actuarial profession.

It's now expected that the field testing of the initial calibrations will take place in 2022 for initial use in VM-20 (Life Insurance) and VM-21 (Variable Annuity) calculations in 2023, and that these scenarios will be further tested for VM-22 Fixed Annuity reserves and C3-Phase I Risk Based Capital for Fixed Annuities and Single Premium Life Insurance in 2023/2024. Based on successful results from the VM-22/C3P1 field test, these scenarios will be prescribed for use in 2024/2025 and beyond when applying VM-22 to these products.