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Principle-Based Reserving or PBR is a new shift expected in the Reserving approach of US Life Insurance business. National Association of Insurance Commissioners (NAIC) has introduced the Standard Valuation Model Law (SVL) that will enable a change from the standard reserve requirement to the new dynamic methodology of aligning risks on an individual company basis. This method focuses on actual risk profiles considering factors such as age and health of people the insurer insures, company’s investment performance and financial strength. As per SVL, Valuation Manual (VM) provides the details of the methodology and is effective from Jan 1, 2017. Given a 3-year transition period, PBR would become mandatory on Jan 1, 2020.

Insurers have been following a standard formula-based approach towards reserves calculation, i.e., setting aside an amount of reserve fund to cater to the claim payment. This amount has an impact on the cost of the insurance policy since a high reserve may raise the cost of policy while a low reserve may raise the risk of insurer not meeting the claim obligation.

NAIC has introduced a new valuation model to calculate life insurance reserves, which is the PBR approach. Expectation from this approach is to provide a reserve allocation based on products rather than one-for-all approach. This would result in reducing reserves that are too high for certain products and increase the reserves where it is low. As sufficient number of states have enacted laws supporting the new approach, NAIC had brought VM to effect from Jan 1, 2017.

This being an interesting transition for the life insurers, implications can be seen in optimization in reserve provisions and product design, thereby impacting the product profitability and regulatory changes leading to reporting structure and tax considerations. Insurers need to assess the influence of this new requirement to arrive at system implications and become an early adopter in order to reap the benefits earlier.

PBR Framework

PBR framework intends to bring in features and risk profiles of life insurance products into the estimate while still considering an appropriate level for policy reserves. As a result, life insurers should calculate the following three different reserves to derive the minimum reserve:

Principle-Based Reserving

Net Premium Reserve (NPR)

NPR is the existing minimum level reserve that a life insurer estimates for each product, using prescribed formulas and assumptions. However, there is a modification in the NPR formula for term life and ULSG (Universal Life with Secondary Guarantees) products. Estimate made by modified NPR represents the actuarial present value of future benefit payments less the actuarial present value of future net premium payments.

Stochastic Reserve

Stochastic modelling is a methodology used for reserving where estimates are calculated by varying a set of random values of the variables like mortality rate, morbidity rate, etc., and outcome is noted. This methodology will be repeated for more than thousand times and helps in measuring the tail risk exposure, which is the risk of rare events. For PBR, stochastic reserve is calculated by taking average of the largest 30% of the estimates. Life insurer can exempt a group of policies from the stochastic reserve estimates using a stochastic exclusion test. There are different exclusion tests and this will help the insurer in identifying policies that will not get affected due to interest rate risk or asset return volatility

Deterministic Reserve

The deterministic reserve methodology valuates the gross premium using a single forecast with best estimate assumptions of income and expenses by a margin. The margins considered are with adverse deviation, which is based on the credibili­ty of experience and level of risk and the method considers only one economic scenario - Exemption test for deterministic reserve is comparatively simple where groups of policies are considered and are exempted if the sum of valuation net premiums is less than the sum of anticipated gross premiums in a year. All term policies, few ULSG and few group policies cannot be exempted from deterministic reserve.

Minimum Reserve Calculation:

Minimum reserve is calculated for a group of policies based on the following guidance / considerations:

Stochastic exclusion test Deterministic exclusion test Minimum Reserve calculation
Pass Pass Net premium reserve
Pass Fail Max ({Deterministic reserve + Deferred premium asset}, Net premium reserve)
Fail Pass Max ({Stochastic reserve + Deferred premium asset}, {Deterministic reserve + Deferred premium asset}, Net premium reserve)
Fail Fail Max ({Stochastic reserve + Deferred premium asset}, {Deterministic reserve + Deferred premium asset}, Net premium reserve)

Let us now look at the implications through three different windows – reserve creation, product profitability and regulatory reporting:

Reserve Creation

In comparison with existing reserve levels, reserves may be higher or lower for different products post PBR, as it reflects the risk more accurately. This statement is supported by the study done by NAIC which projected / measured the reserves after five years of PBR implementation. Term insurance products saw a decrease in the projection and at the same time, ULSG products saw a huge variation in the projection (both reduction and increase in reserve). This expected variation is due to the variation in insurer’s interpretation of the reserve requirements for ULSG. Projection for all other products remained almost the same

Product Profitability

The current methodology imposes the same formula for every insurer’s reserve computation, irrespective of their size, type of business or geographical presence. These calculations are static and do not take into account the future economic factors and interest rate fluctuations. The new method allows insurers to determine their reserves based on their individual risk experience. With the advent of technology, new ways of analyzing and measuring insurance risks have emerged.

PBR utilizes simulation models to evaluate future economic scenarios and arrive at the claim reserves. The model regularly consumes company information and economic conditions to recalculate the reserve data. The product-specific reserving would make some products more affordable while rightly pricing the riskier ones. Hence, product profitability of life insurance products is expected to increase marginally with the application of the new model. However, competition might push insurers to reduce the prices based on understanding of the PBR’s impact on the business. Product pricing depends on profit forecasts and tax calculations; hence, it is important for insurers to consider PBR in their product design process to identify product profitability and, price and design the product accordingly.

Regulatory Requirements

The flexibility and complexity that the new VM brings along opens the gate for expanded regulatory requirements. Since the model is now specific to insurance company’s experience and is dynamic in nature, there is a need for companies to disclose the modeling assumptions and other factors considered in the PBR model. The reporting requirements include the PBR actuarial report, which is an annual requirement, experience report and other reports related to corporate governance and supplements. The report data constitutes details on actuaries, valuation assumptions, margins, modeling system, life insurance policies, policy holder behavior, mortality, expenses, assets, and so on. Data collection may also expand to include annuity and health as well in the future. Insurers have to look into the system changes and automation functionalities required to accommodate the new reporting framework and to keep up with the pace. Another expected implication would be in the calculation of tax reserves. Insurers have the need to adopt to the VM early, for understanding the tax obligations related to PBR and for taking necessary steps. In addition, insurers in the scope of Federal Reserve jurisdiction should approach implementing PBR, keeping in mind the regulatory capital requirements in link with the reserves.

PBR is thus an approach that is friendly and adaptable to new products. It also captures risks involved in today’s complex products designed by life insurers. Since it evaluates company experience and dynamically adjusts based on economic scenarios, reserve allocation adapts with the changing environment and potentially, Principle-Based Reserving helps to improve the precision in estimation of reserves based on the risk they possess.


  1. Life Principle-Based Reserves Under VM-20 , American Academy of Actuaries
  2. PBR valuation, American Academy of Actuaries
  3. PBR educational brief, NAIC
  4. Technical Line - How principle-based reserving will affect life insurers, NAIC
  5. Insurance Principle based reserving, KPMG
  6. Impact of VM-20 on Life Insurance Product Development, Society of Actuaries
  7. PBR: What will Regulators be Looking for?, SOA - Society of Actuaries
  8. PBR Reporting and Disclosures – Thinking About the End at the Beginning, SOA - Society of Actuaries
  9. Principle-Based Reserving: A New Way to Insure for Life, American Academy of Actuaries
  10. Principle-Based Reserving (PBR) Implementation Plan, NAIC

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About the Author

Shanmuga Prabhakar
Associate consultant, Mindtree

Shanmuga Prabhakar is a business consultant with 6 years of experience in Insurance domain. He has working experience with US, South Africa and APAC insurance providers across New Business, Underwriting, Policy Servicing and Claims. Interested in new technologies such as NLP, chatbot and voicebot. Loves to drive and travel.

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About the Author

Prathyusha V
Associate consultant, Mindtree

Prathyusha is an Associate Consultant with Mindtree. She has around five years of experience in Business Analysis and Quality Assurance in the domain of Insurance. She holds a PGDM in Marketing and HR

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