Appendix A

EXAMPLE OF VIABILITY ANALYSIS CURRENTLY BEING PERFORMED

BY A MUTUAL LIFE INSURANCE COMPANY

The following description of a planning and projection process constitutes an example of

viability analysis currently being carried out by a large mutual life and health insurance
company. The numbers in the illustrative reports have been scaled to conceal the identity of the
company, but are representative of typical results.

At the current time this company does not prepare a formal Viability Report. The process is
ongoing and communication between the product actuaries and managers that participate in this
activity and the company’s top management is continual throughout the year. New scenarios are
run on a frequent basis to test the current and future effect of feasible risks and opportunities that
have been identified.

The main focus of this effort is not to demonstrate solvency. This company is very well
capitalized and projects some level of positive earnings under all feasible scenarios. The focus is
on finding the growth patterns and productivity improvements required to achieve competitive
levels of the company’s financial performance measures. The primary measures are GAAP
earnings and GAAP ROE. However, the process does produce STAT and GAAP income
statements, balance sheets and Risk Based Capital amounts for each quarter of the projection
period.

After many trial runs, a financial plan is adopted for a new five-year period. The actual results
for each quarter are compared to the plan for each product group. The differences and the
corresponding reasons are identified and communicated to the product managers and top
management on a quarterly basis. As a result of this analysis the plan may be “returned” and
appropriate management action taken. On a somewhat higher level, the results compared to plan
and the proposed management actions are reported to the Board of Directors.

1
 LARGE MUTUAL LIFE INSURANCE COMPANY
CORPORATE PROJECTION PROCESS

I. OVERVIEW

Large Mutual provides a wide range of insurance products, which are sold through varied
distribution systems. Individual health insurance products sold directly by the parent company
include major medical, Medicare supplement, Long Term Care, critical illness, disability, as well
as supplemental health coverage. Through its life insurance subsidiary, the company sells
Individual Term, Universal Life, Variable Universal Life, Flexible Premium annuities, Single
Premium annuities, and variable annuities. Individual products are sold through captive agents,
brokers and direct response marketing. The companies also serve the group insurance market
with medical, life, LTD, pension and other insurance products.

The Corporate Planning process at Large Mutual currently supports modeling for these varied
lines of business as well as incorporating a “Corporate” line. Full SAP and GAAP income
statements, as well as certain balance sheet entries, are projected over a 7 year period. Scenarios
are run to examine results under various production and expense levels. Additionally, results are
stress tested to examine the effects of experience changes or interest rate changes.

The results of these scenarios are then used to:

a. Set Corporate and product line profitability goals,

b. Examine expected cash flow for investment purposes,
c. Set strategic goals for the future growth and viability of the business. E.g. expense/
production levels needed to grow to a 12.5% R.O.E.,
d. Examine expected tax status of the companies(life versus P&C insurer) based on reserve test

II. PRODUCT PROFITABILITY MODELS

Product profit models are built in various areas throughout the companies, using various systems.
These may include packages such as PTS or TAS for life and annuity products or Excel for
group and individual major medical. All of the base models share certain characteristics.

First, a common set of interest rate assumptions is used. Second, initial runs are performed using
current best estimate assumptions. These may vary from original pricing. Third, all models
produce the usual income statement and balance sheet entries along with key statistics used for
expense projection purposes These include in-force counts, premium, sales levels, claim counts
etc. Expense units are determined for each line based on the current level of expenses or
expected budgeted expenses.

In-force models are built separately from new business models for each product line. New
Business models are built assuming 1 million dollars of annualized new business premium
(ANBP). After the models are built and validated, cash flow as well as income statement and
balance sheet entries for the in-force and new business models are passed separately to the
Corporate planning area for development of the first pass corporate projection.

2
III. DEVELOPING THE FIRST PASS CORPORATE PROJECTION

Given an in force model and a million dollar ANBP new business model, it is a simple task to
generate a projection based on a given ANBP target for the next 7 years. For example suppose
the premium entries are as follows for a given line:

Year 1 Year 2 Year 3 Year 4

In force 190M 185M 177M 165M
NB (1M ANBP) 0.65M 0.9M 0.8M 0.7M

If production is assumed to be 10M, 12M, 15M and 20M in years 1 through 4 respectively, then
the total premium expected in year 4 is given as 165M + (.7M * 10) + (.8M * 12) + (.9M * 15)
+ (.65M * 20).

This process is a simple programming task and is only restricted by the number of years of data
provided by the respective models. Additionally, the process can be performed for each entry to
provide income statement, balance sheet entries, as well as expense drivers for a given set of
production scenarios across all of the various lines of business in a timely manner. As an
example, projecting 65 distinct lines of business full SAP and GAAP entries takes under 5
minutes, using a visual basic program which is not focused on efficiency.

Expense units can be added to the process to also allow for changes in expense level
assumptions. Included in this variation are assumptions used to take into account step-variable
nature of certain expenses using a linear approximation , as well as reflecting the impact of
changes in deferred expenses on resulting GAAP amortization for a given issue year.

Changes in amortization can be modeled by introducing a variable which records the base level
of deferred expenses assumed in the 1 million dollar ANBP model. Should the deferred expenses
increase due to ANBP growth alone, then the resulting issue year’s amortization of DAC is
simply the base model’s amortization ratio by ANBP as described above for premium. If there is
also a change in the assumed level of expenses, then amortization needs to be additionally
changed to reflect the increase in deferrals over and above volume changes. If, for example, the
base deferred expense level doubles, prior to volume increases then the base model needs to
amortize at twice the rate. These calculations are all performed at the individual product level.

When complete, a process is in place, which allows for a quick turnaround of various ANBP and
expense unit level scenarios for the entire Company, under assumed interest rate, mortality,
morbidity assumptions.

If, for example, interest rate scenarios are desired, additional runs of the base models are needed.
These can be defined up front, and the resulting data flows can be saved as alternate scenarios to
be calculated through the same process described above.

Mortality and morbidity scenarios are typically treated as sensitivity runs to determine some
what-ifs. An example is the case of what if mortality increases x%? These runs are typically
3
treated as another scenario to be run through the base models and entered as another scenario in
the corporate planning process described above.

IV. TYPICAL SCENARIOS

Typically scenarios which are run focus on variants of the following:

1. Production growth/ distribution and expenses based on historical trend.

2. More growth in Products of type X versus type Y, with expenses at current levels.
3. Grading expenses to “allowable” or pricing levels over 5 years.
4. Production growth needed to obtain critical mass.
5. Increase in morbidity, mortality or lapse rates.
6. Changes in interest rate levels.

Following are example reports from two scenarios varying ANBP and expenses.

Baseline: ANBP distribution based on prior year results. Growth determined by Sales and
Marketing. Expense levels are at current Budgeted levels by product.

Scenario 2: ANBP distribution assumes flat medical product sales and increases in individual life
/ annuity.

Expense assumptions assumes individual products reach allowable expenses over 7 years.

4
5
Run STATUTORY FINANCIAL REPORTING Scenario 2 ANBP SHIFT to Life/Annuity Appendix A 2
999 0 Indiv. Product Expenses to allowable
0.0005
PROJ98 PROJ99 PROJ00 PROJ01 PROJ02 PROJ03 PROJ04 PROJ05 TERM LIFE AGENCY
ANBP 774 895 1,133 1,364 1,492 1,632 1,787 1,956 TRAD LIFE AGENCY
INTEREST-SENS LIFE AGENCY
Premium 1,881 1,960 2,353 2,610 2,831 3,079 3,351 3,651 VUL AGENCY
Inv. Income 311 316 327 345 368 396 428 462 TERM LIFE DRM
Other Income 35 44 55 68 72 76 82 87 TRAD LIFE DRM
Total 2,227 2,320 2,735 3,023 3,271 3,551 3,860 4,200 TERM LIFE BROKER
INTEREST-SENS LIFE BROKER
VUL BROKER
Benefits/Claims 1,549 1,531 1,840 1,966 2,110 2,292 2,478 2,695 DEFER FIXED ANN-AGENCY
Resv Increase 101 87 114 171 210 247 295 333 DEFER FIXED ANN-COPELAND
Commission(w/out Agent Fin) 99 112 131 156 171 186 202 221 DEFER FIXED ANN-BANK
Agent Fin 4 4 5 5 5 6 6 7 IMMEDIATE FIXED ANNUITY-AGCY
Expense s 341 353 374 401 428 450 470 494 IMMEDIATE FIXED ANNUITY-BROKER
Other Expenses/Ptaxes 20 20 21 23 25 27 30 32 STRUCTURED SETTLEMENTS
Incr in Loading 2 2 2 2 2 4 5 5 VARIABLE ANNUITY - AGENCY
Transfer to sept. Acct 59 131 158 195 202 198 203 214 VARIABLE ANNUITY - BROKER
Total 2,173 2,240 2,644 2,918 3,154 3,410 3,690 4,000 PPO-INDEMNITY-AGENCY
MED SUPP - AGENCY
HOSPITAL MEDICAL - AGENCY
Pre-Tax Operating Gain 54 81 91 105 117 141 170 200 DISABILITY INCOME - AGENCY
ACCIDENT ONLY-AGENCY
Before Expenses/Taxes/Ag Fin 418 458 491 534 575 625 677 733 LONG TERM CARE - AGENCY
SUPPLEMENTAL HLTH-AGENCY
Before Expenses/Taxes 414 453 486 529 570 619 670 726 PPO-INDEMNITY-DRM
MED SUPP - DRM
DISABILITY INC - DRM
Expense / Premium 18.10% 17.99% 15.89% 15.37% 15.11% 14.62% 14.04% 13.53% ACCIDENT ONLY - DRM
Commiss/ Premium 5.48% 5.92% 5.78% 6.17% 6.24% 6.24% 6.23% 6.23% LONG TERM CARE - DRM
SUPPLEMENTAL HEALTH - DRM
Loss Ratio (w/ Chng in resv) 87.68% 82.56% 83.02% 81.85% 81.95% 82.47% 82.77% 82.94% PPO-INDEMNITY-ACQUIS
MED SUPP - ACQUIS
Stat Resv+Sep Accts 5,199 5,418 5,668 5,996 6,519 6,982 7,570 8,223 HOSPITAL MED - ACQUIS
Stat Target Surplus 383 394 414 442 473 508 548 594 DISABILITY INCOME - ACQUIS
ACCIDENT ONLY - ACQUIS
Stat TS/RBC Factor LONG TERM CARE - ACQUIS
Projected RBC 232 239 251 268 287 308 332 360 SUPPLEMENTAL HEALTH - ACQUIS
PPO-INDEMNITY-BROKER
ACCIDENT ONLY-BROKER
MED SUPP - BROKERS
MED SUPP - MANUFACT
SPECIAL RISK
4/24/00 3:24 PM X:\CMODEL\Lance\[Scenario_reporterO.xls]reports DISABILITY INCOME - BROKER
ED ANNUITY-AGCY
ED ANNUITY-BROKER

L HLTH-AGENCY

L HEALTH - DRM

L HEALTH - ACQUIS
 Appendix B

POSSIBLE APPROACH TO VIABILITY STUDY

THE ATTACHED NUMBERS HAVE BEEN CAMOUFLAGED SOMEWHAT, BUT

STILL REPRESENT ONE SMALL COMPANY’S APPROACH.

EACH YEAR, GAAP AND STATUTORY EARNINGS ARE PROJECTED FOR THE
NEXT TWO YEARS. THE PRESIDENT, EXECUTIVE VICE PRESIDENT AND
CHIEF ACTUARY, AND SENIOR VICE PRESIDENT AND CONTROLLER MEET
TO DISCUSS THESE PROJECTIONS. THESE ARE THE THREE TOP COMPANY
OFFICERS AND MEMBERS OF THE BOARD OF DIRECTORS. THEIR MEETING
AGENDA INVOLVES ASKING QUESTIONS OF EACH OTHER OF A DEVIL’S
ADVOCATE SORT, TO MAKE SURE THE PROJECTIONS STAND UP.

OUTSIDE DIRECTORS MAY ASK QUESTIONS ABOUT THE PROJECTIONS, BUT

RELY HEAVILY ON OUR MANAGEMENT.

QUESTIONS INCLUDE:

1. CAN THE INDIVIDUAL MARKETING DEPARTMENT ACHIEVE NEW

PREMIUM GOALS? THESE INCLUDE GROWTH IN LONG-TERM CARE,
WORKSITE UNIVERSAL LIFE, AND TERM LIFE WITH MULTIPLE
UNDERWRITING CLASSES.

2. CAN PRODUCTION INCREASES COME FROM NEW GENERAL AGENCY

DISTRIBUTION OUTLETS IN HAWAII, ARIZONA, NEVADA, TEXAS,
AND GEORGIA?

3. CAN OUR BRANCH OFFICE AGENTS SELL THE COMPETITIVE TERM

WE HAVE DESIGNED?

4. IS OUR LONG-TERM CARE REINSURANCE FOR LONG NURSING HOME

STAYS IN PLACE? IS OUR REINSURER SATISFIED?

5. WILL THIS NEW PRODUCTION LEAVE OUR RISK BASED CAPITAL

RATIOS STILL VERY HIGH?

6. CAN OUR TWO INVESTMENT ADVISERS MEET THEIR INTEREST

GOALS AND KEEP OUR ASSETS EVEN BETTER MATCHED WITH
LIABILITIES THAN CURRENTLY?

7. CAN WE CONTINUE TO AVOID PAYING SHAREHOLDER DIVIDENDS?

IF WE PAY, HOW MUCH INVESTMENT INCOME WILL BE LOST?
8. CAN SIGNIFICANT NEW LIFE PRODUCTION COME FROM EMPLOYER-
SPONSORED SOLICITATIONS OF EMPLOYEES AT LOCAL TEXTILE
FIRMS?

9. CAN GROUP LIFE AND SHORT-TERM DISABILITY PREMIUMS

CONTINUE TO GROW DESPITE COMPETITIVE PRESSURES?

10. CAN ASO FEES CONTINUE TO GROW WITH OUR NEW SYSTEM? ARE
WE STILL PROVIDING UNIQUE CASE MANAGEMENT SERVICES?

11. CAN OUR INDIVIDUAL CONVERSION TO A REAL TIME

ADMINISTRATIVE SYSTEM PRODUCE THE EXPENSE SAVINGS
PROJECTED? WILL THIS ALLOW OTHER EXPENSES TO CONTINUE TO
REDUCE?

12. WILL OUR RATE INCREASES ON ASSUMED BLOCKS OF HEALTH

INSURANCE PROVIDE THE DESIRED REDUCTIONS IN LOSS RATIOS?

13. ARE SALARY LEVELS STILL COMPETITIVE WITH THE ATLANTA-

CHARLOTTE CORRIDOR?
 SMALL COMPANY PROJECTED STATUTORY NET INCOME 2000 (000's) Appendix B 2

Health Health Total Life Life Total Health Life Credit Group/
<=99 2000 Health <=99 2000 Life Assumed Assumed OB ASO ANN Corporate Expense Total
------------------ ------------------ ------------------ ------------------ ------------------ ------------------ ------------------ ------------------ ------------------ ------------------ ------------------ ------------------ ------------------ ------------------
Premiums 12,697 3,412 16,109 30,193 15,362 45,555 8,966 5,886 600 10,988 88,104
Fees 0 0 700 14,334 384 15,418
Inv Income 2,081 (14) 2,067 7,894 242 8,136 2,001 7,215 1,389 5,587 26,395
------------------ ------------------ ------------------ ------------------ ------------------ ------------------ ------------------ ------------------ ------------------ ------------------ ------------------ ------------------ ------------------ ------------------
Subtotal 14,778 3,398 18,176 38,087 15,604 53,691 11,667 13,101 600 25,322 1,389 5,971 0 129,917

Benefits 5,574 505 6,079 16,239 6,717 22,956 7,020 7,575 700 9,756 90 54,176
Surrenders 0 3,536 9 3,545 1,289 4,834
Oth Benefits 0 1,480 3 1,483 1,483
Oth Acquisition 1,451 1,451 1,666 1,666 3,117
Oth Maintenance 1,412 1,412 4,300 4,300 5,712
Commissions 1,065 1,996 3,061 3,740 6,906 10,646 8 6,336 (2,353) 17,698
Exp Taxes 1,977 1,205 3,182 2,041 1,611 3,652 1,011 515 100 16,919 520 25,899
Res Increase 1,530 299 1,829 3,611 1,100 4,711 (3,608) (4,342) (1,410)
Net Amort 0 0 0
Reduced Exps 0 0 (2,000) (2,000)
------------------ ------------------ ------------------ ------------------ ------------------ ------------------ ------------------ ------------------ ------------------ ------------------ ------------------ ------------------ ------------------ ------------------
Subtotal 11,558 5,456 17,014 34,947 18,012 52,959 4,431 10,084 800 24,322 1,289 610 (2,000) 109,509

Net Income 3,220 (2,058) 1,162 3,140 (2,408) 732 7,236 3,017 (200) 1,000 100 5,361 2,000 20,408

Note: Total Exps 32,728

PAGE 1
 SMALL COMPANY PROJECTED STATUTORY NET INCOME 2001 (000's)

Health Health Total Life Life Total Health Life Credit Group/
<=99 2000 Health <=99 2000 Life Assumed Assumed OB ASO ANN Corporate Expense Total
------------------ ------------------ ------------------ ------------------ ------------------ ------------------ ------------------ ------------------ ------------------ ------------------ ------------------ ------------------ ------------------ ------------------
Premiums 11,239 6,333 17,572 26,549 29,290 55,839 7,621 5,395 11,988 98,415
Fees 0 0 400 15,334 384 16,118
Inv Income 2,017 8 2,025 8,057 720 8,777 1,728 6,905 1,489 6,629 27,553
------------------ ------------------ ------------------ ------------------ ------------------ ------------------ ------------------ ------------------ ------------------ ------------------ ------------------ ------------------ ------------------ ------------------
Subtotal 13,256 6,341 19,597 34,606 30,010 64,616 9,749 12,300 0 27,322 1,489 7,013 0 142,086

Benefits 5,716 1,017 6,733 15,024 13,174 28,198 6,925 7,263 10,256 90 59,465
Surrenders 0 3,557 57 3,614 1,289 4,903
Oth Benefits 0 1,536 12 1,548 1,548
Oth Acquisition 1,089 1,089 1,249 1,249 2,338
Oth Maintenance 1,059 1,059 3,225 3,225 4,284
Commissions 872 3,044 3,916 3,068 11,102 14,170 4 6,057 (1,853) 22,294
Exp Taxes 1,805 1,904 3,709 1,785 2,796 4,581 907 469 16,919 520 27,105
Res Increase 582 913 1,495 2,726 3,686 6,412 (1,869) (3,785) 2,253
Net Amort 0 0 0
Reduced Exps 0 0 (3,500) (3,500)
------------------ ------------------ ------------------ ------------------ ------------------ ------------------ ------------------ ------------------ ------------------ ------------------ ------------------ ------------------ ------------------ ------------------
Subtotal 10,034 7,967 18,001 30,921 32,076 62,997 5,967 10,004 0 25,322 1,289 610 (3,500) 120,690

Net Income 3,222 (1,626) 1,596 3,685 (2,066) 1,619 3,782 2,296 0 2,000 200 6,403 3,500 21,396

Note: Total Exps 30,227

PAGE 2
 SMALL COMPANY PROJECTED GAAP NET INCOME 2000 (000's)

Health Health Total Life Life Total Health Life Credit Group/
<=99 2000 Health <=99 2000 Life Assumed Assumed OB ASO ANN Corporate Expense Total
------------------ ------------------ ------------------ ------------------ ------------------ ------------------ ------------------ ------------------ ------------------ ------------------ ------------------ ------------------ ------------------ ------------------
Premiums 12,697 3,412 16,109 30,193 15,362 45,555 8,966 5,886 600 10,988 88,104
Fees 0 0 700 14,334 384 15,418
Inv Income 1,342 (73) 1,269 6,229 129 6,358 2,001 7,215 1,389 8,163 26,395
------------------ ------------------ ------------------ ------------------ ------------------ ------------------ ------------------ ------------------ ------------------ ------------------ ------------------ ------------------ ------------------ ------------------
Subtotal 14,039 3,339 17,378 36,422 15,491 51,913 11,667 13,101 600 25,322 1,389 8,547 0 129,917

Benefits 5,574 505 6,079 16,239 6,717 22,956 7,020 7,575 700 9,756 90 54,176
Surrenders 0 3,536 9 3,545 1,289 4,834
Oth Benefits 0 1,480 3 1,483 1,483
Oth Acquisition 1,451 1,451 1,666 1,666 3,117
Oth Maintenance 1,412 1,412 4,300 4,300 5,712
Commissions 1,065 1,996 3,061 3,740 6,906 10,646 8 6,336 (2,353) 17,698
Exp Taxes 1,977 1,205 3,182 2,041 1,611 3,652 1,011 515 100 16,919 520 25,899
Res Increase 876 1,157 2,033 2,063 3,732 5,795 (3,608) (4,342) (122)
Net Amort 1,400 (3,250) (1,850) 2,460 (5,968) (3,508) 1,472 1,693 (2,193)
Reduced Exps 0 0 (2,000) (2,000)
------------------ ------------------ ------------------ ------------------ ------------------ ------------------ ------------------ ------------------ ------------------ ------------------ ------------------ ------------------ ------------------ ------------------
Subtotal 12,304 3,064 15,368 35,859 14,676 50,535 5,903 11,777 800 24,322 1,289 610 (2,000) 108,604

Net Income 1,735 275 2,010 563 815 1,378 5,764 1,324 (200) 1,000 100 7,937 2,000 21,313

Note: Total Exps 32,728

PAGE 3
 SMALL COMPANY PROJECTED GAAP NET INCOME 2001 (000's)

Health Health Total Life Life Total Health Life Credit Group/
<=99 2000 Health <=99 2000 Life Assumed Assumed OB ASO ANN Corporate Expense Total
------------------ ------------------ ------------------ ------------------ ------------------ ------------------ ------------------ ------------------ ------------------ ------------------ ------------------ ------------------ ------------------ ------------------
Premiums 11,239 6,333 17,572 26,549 29,290 55,839 7,621 5,395 11,988 98,415
Fees 0 0 400 15,334 384 16,118
Inv Income 1,364 (145) 1,219 6,504 426 6,930 1,728 6,905 1,489 9,282 27,553
------------------ ------------------ ------------------ ------------------ ------------------ ------------------ ------------------ ------------------ ------------------ ------------------ ------------------ ------------------ ------------------ ------------------
Subtotal 12,603 6,188 18,791 33,053 29,716 62,769 9,749 12,300 0 27,322 1,489 9,666 0 142,086

Benefits 5,716 1,017 6,733 15,024 13,174 28,198 6,925 7,263 10,256 90 59,465
Surrenders 0 3,557 57 3,614 1,289 4,903
Oth Benefits 0 1,536 12 1,548 1,548
Oth Acquisition 1,089 1,089 1,249 1,249 2,338
Oth Maintenance 1,059 1,059 3,225 3,225 4,284
Commissions 872 3,044 3,916 3,068 11,102 14,170 4 6,057 (1,853) 22,294
Exp Taxes 1,805 1,904 3,709 1,785 2,796 4,581 907 469 16,919 520 27,105
Res Increase 7 2,088 2,095 1,385 6,947 8,332 (1,869) (3,785) 4,773
Net Amort 1,258 (3,512) (2,254) 2,344 (7,256) (4,912) 1,212 1,454 (4,500)
Reduced Exps 0 0 (3,500) (3,500)
------------------ ------------------ ------------------ ------------------ ------------------ ------------------ ------------------ ------------------ ------------------ ------------------ ------------------ ------------------ ------------------ ------------------
Subtotal 10,717 5,630 16,347 31,924 28,081 60,005 7,179 11,458 0 25,322 1,289 610 (3,500) 118,710

Net Income 1,886 558 2,444 1,129 1,635 2,764 2,570 842 0 2,000 200 9,056 3,500 23,376

Note: Total Exps 30,227

PAGE 4
 Appendix C

VIABILITY ANALYSIS
Fraternal Organization

OVERVIEW

Objective
To assure that the company will have sufficient surplus, now and into the future,
to deliver on contractual obligations, to provide reasonable protection from risk,
and to provide working capital to enable continued growth of the organization.

Scope
Viability analysis will cover the entire enterprise, including the fraternal benefit
society and all of its subsidiaries and affiliates. The organization’s approach to
financial management is to view the organization as a single business enterprise
comprised of many legal entities. We comply with legal and business
requirements entity by entity, but we focus on performance of the enterprise as a
whole. We view capital as being fully mobile across the enterprise, except as
may be limited by legal requirements applicable to specific entities.

Responsibility
The Appointed Actuary will have primary responsibility and accountability for
viability analysis. Significant support and assistance will be required from others,
including product actuaries, investment personnel, and financial managers of
subsidiaries.

Uses
1. Understand the association’s risk profile and risk appetite. Results should
demonstrate the ability and resiliency to withstand a broad range of potential
variances, through sufficiency of available surplus, ability to alter strategy,
and/or adoption of hedging strategies. Accomplished through a
comprehensive annual viability study and report which includes stress tests of
all assumptions significant to success of the business plan.
2. Support decision-making and development of the association’s business plan.
Accomplished by incorporating proposed plans, initiatives, and decisions into
a selected subset of scenarios from the annual study.

3. Understanding the financial impact of disruption of basic components of the

business plan.

5/2/00
Viability Analysis, page 2

4. OUTLINE OF VIABILITY ANALYSIS REPORT

Executive Summary
A brief summary of key findings and conclusions, plus recommendations as may
be appropriate.

Business Plan
A summary of key elements of the association’s business plan, focussing on
business decisions that directly affect viability results.
• Development or expansion of a marketing channel
• Marketing initiatives
• Start-up of a new subsidiary
• Introduction of new benefits
• Withdrawal from existing products
• New initiatives

Business Assumptions
Identification of assumptions that are controlled by management and are
embedded in the projections supporting the viability analysis. Some of these
may be singular assumptions; others may be a range of assumptions to be
tested via multiple scenarios.
• Productivity of distribution channels
• Hiring & retention of career agents
• Product pricing profitability targets (or margins, spreads, etc.)
• Commissions and compensation
• Expense assumptions

Environmental/Economic Assumptions
Identification of assumptions that cannot be controlled by management. These
are generally incorporated into the analysis via stochastic simulation; sensitivity
testing via multiple scenarios may also be used.
• Interest rates
• Equity market changes
• Mortality and morbidity rates
Viability Analysis, page 3

Business Continuity Assumptions

Identification of basic components of business operations implicit in the going

business assumption of the business plan. These are incorporated into the
analysis on a momentum basis; with accompanying analyses of impact of
disruption from the momentum assumption.

• Tax status of benefit structures

• Lutheran structure
• Failure of organization brand value
• Longevity of life span

Results
A summarized display of numerical and graphical results from the projections
comprising the analysis. This section will include results for several key financial
measures, such as the following:
1. Surplus (GAAP, Statutory Accounting) and economic value added. This is
the most important indicator, as it relates to financial strength and to capacity
for future growth. Total surplus to be identified as:

• Surplus committed to existing business

• Surplus committed to business plan initiatives
• Uncommitted available surplus
2. Annual income (GAAP and Statutory Accounting). This is important as it
relates to continuity of operations and to external perceptions.
3. Margins available for indirect and overhead expenses. Important as it relates
to management of the company infrastructure.
4. Total annual revenue by source. An indicator of growth.
5. Total assets under management. An indicator of growth.

“S-curve” displays will be used to display variations due to stochastic variables.

Individual scenarios with extreme or adverse results will be reviewed to identify
causes of such results. Line or bar graphs will be used to illustrate dispersion of
results caused by variations of other variables.

A compilation of low frequency exposures and the impact of adverse experience,

especially high risk exposures.
Viability Analysis, page 4

Conclusions

This section will contain conclusions from the analysis, together with rationale for
arriving at the conclusions. Conclusions will address:

1. With respect to the business plan assumptions:

• Overall assessment of viability of the business plan

• Identification of threats to viability, including assessment of likelihood and
recommendations, if appropriate
• Assessment of business plan alternatives (if any)

2. With respect to business plan components and the long-term going business
assumption:

• Analysis of effect of disruptions in plan components

• Impact of low frequency environmental exposures
 Appendix D

Top Ten Risk Management Areas of Concern

For Financial Services

1. Capital Management
Definition of and Corporate Constraints on Capital
- Internal
- Rating Agencies
- Allocation of Capital by Line of Business
Relationship of Capital to Risk
Measurement of Capital
Measurement of Risk
- Experience Studies – decrements, expense
- DFA
- Growth Expectations
- Definition of Risk
Value – of business/corporation

2. Credit Risk Management

Credit Quality of Portfolio(s)

- Current
- Prospective
- Spread Management for Spread-Gain Products
Development of a Company/Portfolio Investment Policy
Internal Controls on - who is investing, how they are investing, investment activity
Default Experience
Forecasting

3. Foreign Exchange Risk Management

Comparison of Assets and Liabilities by Currency – Absolute Amounts

Incidence of Anticipated Cash Flows
Hedging
Regulations on Capital Flows in Foreign Countries
Repatriation of Foreign Investments

4. Securities Portfolio Management

Monitoring and financial review of all counterparties

Variation of strategies by type of portfolio – separate vs general accounts
Review of market strategies in light of current conditions
Comparison of portfolio performance against relevant benchmarks
Comparison of portfolio management against investment policy guidelines
Accounting controls

5. Real Estate Appraisal

Maintenance of an up-to-date assessment of real estate values of holdings

Review of administrative and accounting procedures in light of financial performance
Liquidity risk assessment

6. Product Design and Pricing Management

Monitor product competitiveness

- features compared to those of selected relevant competitors
- prices/rates/guarantees compared to those of relevant competitors
Documentation of actual pricing and re-pricing testing and procedures
- Does pricing/re-pricing meet corporate RoE/NOI goals
- Use of DFA techniques
Prepare a business plan based on pricing to be the expected basis against which to compare experience items
 Risks to products posed by regulatory or market action
Examine effect of extremes on results

7. Underwriting and Liability Management

Training in new compliance/underwriting/claims regulations and procedures

Related items such as complaints, fraud, agent negligence
Audit and review of retention levels
Audit results by claim examiner and underwriter
Review any special underwriting
Review claims for trends and pricing implications
Reinsurance policy
- implications on pricing
- implications on capital requirements
- implications on risk exposure

8. Interest Rate Risk Management

Review of target durations/key rate durations/convexity for underlying liability elements and capital
Similar review re assets by portfolio
Hedging strategies – residual risk after hedging, relative to corporate capital and surplus levels
Use of derivatives to offset product risks

9. Liquidity Management

Projection of future benefit flows for current book – DFA approaches

Cash flow testing – DFA approaches
Project policyholder obligations, expenses, and capital requirements over several selected future periods
Prepare a 1-3 year projection of expected asset and liability flows by month, and compare
Prepare a Strategic Plan over a longer horizon
Assessment of run-on-the-bank scenarios
- How much of the portfolio is considered liquid – potential losses if liquidation of assets required quickly
- For investment products, any surrender an important deterrent to early surrender, but not in extreme
cases under extreme run-on-the-bank scenarios

10. Internal Control

Personnel, hiring/termination
Compensation/benefits
Auditing policies and procedures
Organization – responsibilities, authorities
Licensing and appointment – operations, field, security dealing
Market conduct
Due Diligence – merger, acquisition, JV

11. Uncontrolled

Politics – state/national/international
Public concerns – trends in issues in which public is interested
Regulation/legislation - in effect and proposed
 Three T’s of Risk Management
For Financial Institutions

A. TERMS

• Risk – definition, measurement, corporate/business tolerance, correlations, volatility and ruin, EPD/VaR/CER
• Capital – definition, relationship to risk, profitability measurement, relationship to ratings, allocation by business,
optimization, operational/credit/market(/insurance)
• Value – definition, corporate/business, relationship to capital, purpose

B. TOOLS

• ALM – cash flow, duration, key rate duration, convexity

• DFA – cash flow testing, projection, UVS, risk
• Audit – regular, pricing/procedures analysis
• Experience Analysis – decrements, default, expense, investment benchmarks
• Analysis of selected scenarios – run-on-the-bank, extreme loss, stress testing
• Optimization techniques – risks/capital
• Volatility analysis – by business, ruin
• Identification and analysis of correlations – may have to be estimated ie incomplete data
• Risk adjusted return on capital techniques – primarily in banking
• Distribution and parameter estimation - may have to be estimated ie incomplete data

C. TACTICS

• Matching – cash flow, duration/key rate durations, convexity

• Volatility goals – corporate/business, ruin probilities
• Hedging – derivatives, caps/floors, currency, etc
• Investment policy by portfolio purpose – credit quality, liquidity, composition, turnover
• Claim/underwriting review – distributions, A/E experience
• Monitoring of competition – pricing, product, performance
• On-going review of new legislation/regulation – investment, product, market conduct, employment, tax
• Corporate goals – risk tolerance, RoE, NOI, sales, etc
• Product design/pricing review
• Planning – long and short term
• Procedures and controls – all areas
• Reinsurance – reinsurance, coinsurance, mod-co, co-mod-co, etc; effect on risk/profitability
• Sales strategy/markets – changes to meet goals, sources of profitability
• Ratings – comparison with market to derive capital requirement
Credit Risk

A. What is the credit risk?

1. probability of default of the assets;

2. probability of downgrades by rating agencies

3. probability of widening spreads

B. How to measure the credit risk?

1. RBC factors (C1) and RBC ratios

2. historical default rates: industry studies and company’s own experience

3. how is your company’s asset portfolio classified : (a) hold to maturity; (b) available for sale; (c) trading
account;

C. How to manage the credit risk?

1. define asset allocation by quality and maturity;

2. monitor the relative performance of each asset class - poor performance of high yield bonds could imply
economic slow down or recession;

3. establish a stochastic model to calculate the VAR with respect to credit risk only

D. Example of Executive Life (1990):

1. about 50% of their asset portfolio was in high yield bonds, and the market collapsed at the beginning of the
recession;

2. the company surplus fell below the statutory minimum and the State of California took over

3. the company assets were liquidated at depressed prices to pay for all the claims and policies, although the
junk bond market rebounded sharply in 1991 and 1992.
Interest rate risk

A. What is the interest rate risk?

1. mismatch of asset/liability cash flows, market values and duration/convexity

2. the prepayment of interest rate sensitive assets (CMOs and mortgages)

3. the capital losses/gains from the unexpected liquidation of assets

B. How to measure the interest rate risk?

1. RBC factors (C3) and RBC ratios

2. for cash flow testing, use dynamic models for the interest rate sensitive parameters, such as lapse rates for
annuities and UL

3. in addition to the NY7 scenarios, generate multiple stochastic economic scenarios to stress test the
outcomes

C. How to manage the interest rate risk?

1. define the investment strategies when designing new products (life, LTC, annuities)

2. for the interest rate sensitive products, such as GICs and fixed annuities, calculate the key rate durations for
both assets and liabilities, and define the risk tolerance for the differences between the key rate duration.

3. use interest rate derivatives (such as caps) to hedge some of the interest rate risk.

D. Examples:

1. in Japan during 1990’s, the guaranteed minimal interest rates on policies are often higher than the interest
rates on the domestic corporate bonds

2. in U.S. before 1970’s, the interest rates for policy loans were often fixed around 5%, and the policy loans
skyrocketed around 1980 when the prime rate reached 20%.