Life insurance policy reserves are the money an insurance company must set aside today to pay expected future life insurance claims. This (statutory) reserve is not a separate fund that must be set up but rather a mere “recognition” in the books of the company.
Section 216 of the Amended Insurance Code provides that “every life insurance company, doing business in the Philippines, shall annually make a valuation of all policies, additions thereto, unpaid dividends and all other obligations outstanding on the thirty-first day of December of the preceding year. All such valuations shall be made according to the standard adopted by the company, as prescribed by the Commissioner in accordance with internationally accepted actuarial standards.”
Reserves “provide for the minimum amount of obligation that should be recognized by an insurance company for insurance-benefit claims that are expected to be settled in the future to its policyholders.” It “represents the measure of the company’s main liability on in-force policies as at the valuation date.” Indeed, reserving has “provided security and stability for the insurance industry.”
Prior to the amendment of the Insurance Code, Section 210 of Presidential Decree 612 (1974) expressly provided for the Net Premium Valuation of reserves. It is an actuarial calculation, used to place a value on the liabilities of a life insurer. No Circular Letter (CL) was issued in implementation of the Net Premium Valuation. This actuarial valuation was prevalent across jurisdictions until the Gross Premium Valuation (GPV) became the internationally accepted norm. Prior to the adoption of the Net Premium Valuation (NPV), however, life insurance companies had to submit a “valuation exhibit,” which simply shows the total number of policies and the total amount for each of the different kinds of insurance, classified according to plan, year of issue and age at issue” (Circular 15, dated August 20, 1924).
With the amendment of the Insurance Code in 2012, CL 2014-42-A was issued, which shifted the valuation method of reserves from NPV to GPV. Today the prevailing framework is provided by CL 2016-66, dated December 28, 2016, and which became effective on January 1, 2017. The GPV has been lauded for “applying market-based assumptions.” It has been heralded as “an improvement in determining policyholder liabilities for traditional policies.” Where under the NPV method the only inputs to be considered were the discount rates and mortality rates, under the GPV method, other inputs are considered such as morbidity, lapse and/or persistency, expenses, nonguaranteed benefits and Margin for Adverse Deviation (MfAD). Certainly, the process has become more complex and sophisticated.
According to PwC, “the shift to GPV supports a market-based approach and reflects the best estimate of reserve for insurance-policy obligation. The new reserving framework further provides for the use of the current market rate in discounting to present value the future cash flows in the settlement of insurance-benefit obligation, which was capped at the rate of 6 percent under the old framework. Also, the new reserving framework requires consideration of additional assumptions, such as lapse and/or persistency, morbidity and MfAD of 10 percent, in determining the reserve requirement.”
Let us take a look at the application of discount rates. Under the NPV method, discount rates were capped at 6 percent. Under the GPV method, current market rates are used to discount future cash flows. Thus, where the interest rates are volatile, determining liability will be unpredictable. The MfAD is also a new feature that certainly increases the computed reserves.
Net premium value is “the expected present value of a policy’s benefits less the expected present value of future premiums. The net premium calculation does not take into account future expenses associated with maintaining the policy.”
Gross premium value takes into account future expenses. Thus, gross premium valuation is defined as “the sum of the present value of future benefits and expenses, less the present value of future gross premiums arising from the policy discounted at the appropriate risk-free discount rate.”
Dennis B. Funa is the current insurance commissioner. Funa was appointed by President Duterte as the new insurance commissioner in December 2016. E-mail: [email protected]