Reserves and Risk Management

A long-duration policy is described and you must compute reserves under one or more reserving frameworks.

Statutory: use prescribed mortality table and discount rate; reserves are conservative. GAAP: use best-estimate assumptions with provisions for adverse deviation (PADs); recognizes profit smoothly via DAC amortization. Principle-based reserves (PBR / VM-20): stochastic projection across many scenarios using prudent estimate assumptions plus margins. Choose the framework matching the question.

Statutory ≥ GAAP ≥ best estimate; PBR introduces stochastic scenarios with margins.

A policy has substantial first-year acquisition costs and you must capitalize and amortize them under GAAP.

Capitalize the deferrable acquisition costs at issue. Amortize over the premium-paying period (FAS 60) or in proportion to estimated gross profits (FAS 97, universal life). The net GAAP reserve = benefit reserve - unamortized DAC. Watch unlocking — assumption changes lead to DAC adjustments that flow through earnings.

DAC = capitalized acquisition expenses amortized over premium or EGP pattern.

A block of variable annuities with guarantees has interest-rate and equity-market exposure, and you must propose a risk management strategy.

Identify the exposures: rho (rate), delta (equity), vega (volatility), basis risk between hedge instrument and liability. Propose a hedging program (delta and rho hedging via swaps/futures, possibly vega via options). Discuss model risk and operational risk. Quantify hedge effectiveness using historical scenarios or stochastic projections.

Hedge greeks: delta, rho, vega; recognize basis and model risk in any hedging program.