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Old 02-15-2019, 02:50 AM
genuinev genuinev is offline
Join Date: Feb 2014
College: Warwick University
Posts: 3
Default Waiver of Premium - US GAAP Reserve for Disabled Life


I have a technical question regarding how WoP should be treated under US GAAP. Hope someone could help me clarify.

Please assume the following:
- 3-year premium paying, 3-year TL policy that has waiver of premium feature.
- The 'expected' cost of waiver of premium is $10 per year, and this expected cost is modelled as reduction of gross premium. The gross premium charged to policyholder is $110, so the Premium Income will be $100.

Below is the 'expected' CF as at inception.
Year 1: Premium Income 100, Death Benefit 20
Year 2: Premium Income 100, Death Benefit 40
Year 3: Premium Income 100, Death Benefit 60

Benefit K, ignoring discount and BOY/EOY, will be (20+40+60)/(300) = 120/300

For this policy, benefit reserve at Y2 will be PV(Ben) - PV(Prem) * Ben K = 100 - 200 * (120/300) = 20 -> This benefit reserve takes into account 'expected' cost of waiver of premium as a deduction of premium (both reflected in Ben K by reducing Premium Income)..

Now, imagine this policy is 'in reality' waived of premium as at Y2.
Then, my benefit reserve at Y2 under US GAAP will still be 20, because it is all locked-in under USGAAP.

My question is, if this policy is waived in reality, should I hold a disabled life reserve for this policy?
It seems like holding benefit reserve of 20 only seem to be too small (because I know that I will not have future premium of 200), but also it could be argued that cost of waiver is already reflected in the premium, so it should be ok not to set up DLR when we look at the benefit reserve at a portfolio level.

Also, I would be grateful if you could share any website that discusses this topic if you know.

Thank you.
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Old 02-21-2019, 02:11 PM
PaulP's Avatar
PaulP PaulP is offline
Join Date: Jul 2013
Studying for ERM, CFE, SDM
Posts: 1,387

Let's ignore the $10 'cost' of waived premiums, and imagine what our reserves would look like if our gross premiums were just $100. We can come back to that later.

From your example, your benefit reserve over time will look like:

Y1: $0
Y2: $20
Y3: $20

What happens if your premiums go to zero, though, in Y2, on a best-estimate basis? That is, what if US GAAP allowed us to unlock our assumptions. Then our benefit reserves will have to be...

Y1: $0
Y2: $100
Y3: $60

That second calculation was nice and easy - it's just the sum of the future benefits. So how does this relate to WOP?

Well, the second method is representing our true, expected net costs from this policy. We should recognize that cost immediately after the policy stops paying premium. And, since WOP is a disabled life reserve, we get a lot more freedom from USGAAP to use best-estimate assumptions.

Then what we'll want to do is set up a reserve that will, when added to our Benefit Reserve, will get us to the second set of numbers. That means our WOP would be:

Y1: $0
Y2: $80
Y3: $40

If you add this to the $0, $20, $20 set, you get the second set of numbers. With that, we have just recognized the true cost of losing that premium!

This shows to important and interesting things about WOP:

1) We should hold a reserve based on the net premium, not the gross premium. You can tell in Y2, we have two net premiums (120/300 * 100 * 2 = $80), and in Y3, we have one net premium. The cost isn't how much premium we've lost, but rather how much of that premium we were going to use to pay claims.

2) We don't consider the premium that we're not getting as a cost that we have to pay. We don't have to set up a reserve to recognize that we aren't getting $200 in the same we we'd have to set up a reserve to recognize that we had to pay $200. Rather, the WOP Reserve just "fills in the gap" to get us from our locked-in GAAP reserves to our best-estimate disabled life reserves. For example, if our expected benefits were $0 in all years, we would NEVER set up a WOP Reserve. Why would we? That would result in us taking a loss and then getting profits over time for no reason.

So then, to your question of recognizing at $10 cost of waiver. I would model this, in your locked-in assumptions, as a reduction to premiums that would increase your benefit reserve, like a lapse without a reduction in death benefit. That way, part of your benefit reserves is building towards this. It would be similar to how Long-term Care and Disability insurance have an active life reserve and a disabled life reserve. As people die, this reserve will get released, which will pay for the WOP Reserve you set up as people become disabled. These two things would ideally roughly offset one another, but you still do need an explicit WOP Reserve once someone stop paying premiums.

Just my thoughts of the top of my head! I'm sure I could dig up some material on this if you'd like.
Paul - CFE/SDM/ERM Online Seminar Instructor
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Old 02-21-2019, 10:38 PM
genuinev genuinev is offline
Join Date: Feb 2014
College: Warwick University
Posts: 3

Thank you so much. This helped me get things straight.
Especially thinking through Lock-in and BE helped a lot.
Could you please kindly share some material if available?
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dlr, us gaap, waiver of premium

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