II Report are different. The E factor in AG 43 is an “effectiveness factor” while in C-3 Phase II it is an “error factor”. Conceptually one may be considered the complement of the other. As the sophistication of the Cash Flow Model (incorporating the hedge strategy) increases, the “effectiveness factor”, E, in AG 43 increases while the “error factor”, E, in C-3 Phase II decreases. The value for E reflects the actuary’s view as to the level of sophistication of the stochastic cash flow model and its ability to properly reflect the parameters of the hedging strategy (i.e., the “Greeks” being covered by the strategy) as well as the associated costs, risks, and benefits. Appendix 7 of AG 43 specifies that the value of E will be no greater than 0.70. Some actuaries believe that the derivation of “E” may be based in part on stochastic-on-stochastic analysis and can be performed prior to the valuation date without including a large number of base paths since the calculation is not involving a stochastic-based price nor a CTE. Example Adjustments to the ‘E’ Effectiveness factor: Targeting liability “Greeks” using expected mortality while Prudent Estimate mortality is used elsewhere in the model. This difference in assumptions should be reflected in the “E” factor. A hedging strategy that does not hedge rho can explicitly be reflected by decreasing E. Appendix 7 of AG 43 specifies the following limits on “E”: Model Type
Level of E
Hedge Cash Flows Not Directly or Simplistically Modeled (or for a company that does not have 12 months of experience to date)
Low (less than 0.30)
Hedge Cash Flows, ‘Greeks’ covered effectively
High (up to 0.70)
Hedge Cash Flows, ‘Greeks’ not covered Effectively
(between 0.30 and 0.70)
Q11.8 What is the difference between the TAR(adjusted) and CTE(adjusted) from a hedging point of view? A: In concept, both TAR (adjusted) and CTE (adjusted) are computed to compensate for potential overstatement of the impact of the hedging strategy. In C-3 Phase II, the adjusted TAR reflects impacts of risk not reduced, eliminated, contemplated by the hedging strategy, imperfections and uncertainty of the effectiveness of the program. In AG 43, the adjusted CTE assumes the company has no dynamic hedging strategy. AG 43 further clarifies that this means that it only reflects the hedge positions held by the company at the Valuation Date. Some actuaries may, for practical purposes, model this as if the company has no hedging at all for both TAR (adjusted) and CTE (adjusted) if it can be demonstrated that this does not materially misstate the results. Some actuaries may compute TAR (adjusted) and CTE (adjusted), putting more refined considerations in the computation of the former as compared to the latter, if it can be demonstrated that this does not materially misstate the results. July 2009
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