CIA Annual Meeting Assemblée annuelle de l’ICA

VAL -6: Update from the CIA Committee on Risk Management and Capital Requirements

CIA Annual Meeting Assemblée annuelle de l’ICA

CIA Annual MeetingAssemblée annuelle de l’ICA

June 29 & 30, 2006 Ÿ Les 29 et 30 juin 2006

Ottawa, Ontario



Today’s Session

1. New Life Actuary MCCSR Opinion (Denis Ricard)

2. Revised DCAT Education Note & SOP (Wally Bridel & Isabelle Perigny)



CIA Risk and Capital Committee

MCCSR / TAAM certification

•by Denis Ricard



Background information

MCCSR/TAAM has evolved => more interpretation or technical calculations

OSFI

– Looking for increased certification

– Has asked the CIA to look at a formal certification

Support by:

– CIA Board

– AA committee

– Committee on Risk Management and Capital

Lead to increase in role of AA



Committee on Risk Management and Capital

• The committee has developed a new MCCSR certification standard and an accompanying educational note

• The new standard and the educational note have been approved by the Committee on Risk Management and Capital

• Exposure draft sent to members in Nov 2005

• Few comments by CIA members

• Revised document approved by PSC May 17th 2006

• Effective for fiscal year 2006



Opinion

Actual opinion:

"I confirm that I have read the relevant guideline and annual return reporting instructions issued by the Office of the

Superintendent of Financial Institutions and that this form is completed in accordance with them"

• Annual opinion: must be signed by the AA and one officer

• Quarterly: requires signature of a company officer



Opinion

New additional annual opinion by the actuary:

2480 Certification of regulatory capital filing

.06 I have reviewed the calculation of the Minimum Continuing Capital and Surplus Requirement ratios of [Company name] as at [Date]. In my opinion, the calculation of the components of the required and available capital has been determined in accordance with the regulatory guidelines, and the components of the calculation requiring discretion were determined using methodologies and judgment appropriate to the circumstances of the company.



Opinion



.06 For Test of Adequacy of Assets in Canada and Margin Requirements form filings “Minimum Continuing Capital and Surplus Requirement ratios”, and “required and available capital” are replaced by “Test of adequacy of margin”, and “required and available margin”.

For filings for provincially regulated companies, the ratio definition and definitions of required and available resources should be amended to reflect the appropriate definitions in the provincial requirements.



OpinionNew additional annual opinion by the actuary:2480 Certification of regulatory capital filing

.01 This subsection applies to the AA of a life insurer when giving an opinion on the appropriateness of capital requirement calculations pursuant to law.

.02 The certification should contain an opinion signed by the actuary.



Opinion



.03 The actuary should prepare a memorandum to support the opinion that outlines the areas where the calculation required discretion or significant technical calculations, and the methodologies and judgments that were applied.



Opinion



.05 the actuary is not opining on whether the underlying factors or specified methods to be followed are appropriate but rather on the appropriateness of any interpretation and discretionary technical calculations and methods with respect to such guidelines.



Educational note

Provide guidance:

• Appropriate practice

• Documentation in memorandum

• How to interpret the guidelines



Educational note - Memorandum

• Support of the Opinion

• Areas where the AA has applied material judgement or performed technical calculations

• Outline specific issues, explain the interpretation and the underlying rationale

• Not intended to be long and detailed (high level)

• Prepared as a note to file from the appointed actuary



Educational note

Examples of areas of interpretation:

• risk pass-through

– participating insurance

– index-linked products

• seg fund guarantees

• new mortality risk formula

• reinsurance



CIA Risk and Capital CommitteeDCAT

• Wally Bridel• Isabelle Périgny



Overview of Session• Background and reasons for updating the

DCAT Ed Note• Changes to Ed Note• Changes to Standards of Practice• P&C Risk Categories• Life Risk Categories• Next steps



Background• Review of DCAT Ed Note initiated by PCFRC in

2003• Life representation from RMCR committee began in

summer 2004• Joint effort between PCFRC and RMCR• Consensus of opinion between CIA, OSFI, AMF,

Assuris (formerly CompCorp)



Reasons for Updating the Ed Note• Update DCAT Ed Note to be consistent with current

SoP• Update for changes in the regulatory capital measures

for P&C companies• Add emphasis on risk management and presentation

to the Board• Incorporate feedback from DCAT survey• Reflect current best practices



DCAT Survey• Objective of DCAT: about 75% mentioned risk

management information to Board or Chief Agent• 50% receive 0-2 comments/questions from Board• More than 80% of actuaries felt DCAT was effective

for analyzing risks to the company, but• About 40% of actuaries believe that management sees

little or no value• Also received views on key elements of a useful

DCAT report/presentation



Outline of Revised Ed Note

Preface

I. Introduction

II. Method

III. Modeling

IV. Reporting

Appendix A - Regulatory capital requirements

Appendix B - Life Risk Categories

Appendix C - P&C Risk Categories



• Review of recent operations

• Develop base scenario

• Examine and identify risk categories

• Develop plausible adverse scenarios

–Key scenarios and ripple effects

–Stress testing

–Integrated scenarios

• Possible management actions

The Heart of the Ed Note

The Method section describes the process that would, generally, be followed in conducting the DCAT analysis



• Validating modeled financial information to actual financial results

• Validating year to year flow under the base scenario• Reasonableness under plausible adverse scenarios

The Heart of the Ed Note

The Modeling section discusses the considerations in building and testing the model to be used in the DCAT analysis



• Developing base scenario• Developing and analyzing the impact of plausible

adverse scenarios• Identifying and analyzing the effectiveness of risk

mitigation• Reporting to the Board

Changes to the Ed Note

Emphasis has been added on the key components of a DCAT analysis



• Actual recent experience– New OSFI requirements in E-15

• Assumptions different from those expected in the plan• Recent management decisions which may not have been

anticipated in plan• Impact on future experience of the above• Differentiate between factual and subjective changes


Base scenario may still be consistent with business plan, while recognizing



• They are anticipated and agreed to by company management

• They are feasible given company circumstances• Clear reporting of assumptions made on capital

injections and capital distributions is essential


Capital injections or changes to capital distributions may be assumed in the base scenario, provided



Changes to the Ed Note • Forecast period extended from 2 to 3 years for P&C

companies• SoP 2530.07 changed accordingly



• More emphasis on 95th to 99th percentile range• Draw on stochastic work where available• For others, variation in experience study results• Stress testing• P&C: less prescriptive than before


Development of plausible adverse scenarios



• Additional capital resources would generally not be considered– However, in limited instances where adverse factors are

more under management’s control (e.g. sales) it may be appropriate to assume capital injections or change in capital distributions

• Management actions should be considered• Clear reporting of assumed management actions or

capital assumptions is essential


In analyzing impact of plausible adverse scenarios:




Ripple effects• Include:

– Changes in base scenario assumptions that may no longer be appropriate

– Insurer’s expected response

– Policyholder actions

– Regulatory actions

– Rating agency actions

– Changes in capital injections or distributions

• Specific ripple effects are outlined in each risk category

• Actuary should report on potential regulatory or rating agency actions but does not need to their model financial impact.

• SoP 2530.18 to .20 changed accordingly




Modeling section

• More detail on level of accounting information the model should produce

• Reasonableness of results under plausible adverse scenarios, including ripple effects

• Use results of stochastic modeling in DCAT analysis (i.e., not stochastic DCAT)

• Modeling of ripple effect automatic or manual

• Draw from economic capital work to build adverse scenarios




Reporting section• Emphasize the primary audience is Board or Chief

Agent• Audience also includes management and regulator• Increased guidance on key elements of a good DCAT

report• Tailor to Board requirements and interests



Changes to the Ed NoteKey elements in the report are:• Executive Summary• DCAT Opinion• Introduction• Capital Adequacy Measure• Background Discussion• Base Scenario• Adverse Scenarios• Conclusions and Recommendations• Appendices



SoP ChangesReporting on Risk Categories2530.21• CURRENT

– The report would contain the key assumptions of the base scenario and the plausible adverse scenarios posing the greatest risk to the satisfactory financial condition of the insurer. The report would also include comments on each of the risk categories identified in this standard. The meaning of satisfactory financial condition under this standard would be disclosed in the report.

• PROPOSED– The report would contain the key assumptions of the base scenario and

the plausible adverse scenarios posing the greatest risk to the satisfactory financial condition of the insurer. The report would disclose each of the risk categories considered in undertaking the DCAT analysis, including those identified in this standard. The meaning of satisfactory financial condition under this standard would be disclosed in the report.



P&C Risk Categories – Grouping ChangesOriginal Risk Category New Risk Category

Frequency and Severity Loss Frequency and Severity Risk

Pricing

Misestimation of Policy Liabilities Policy Liabilities Risk

Inflation Inflation Risk

Interest Rate

Premium Volume Premium Risk

Expense

Reinsurance Risks Reinsurance Risk

Deterioration of Asset Values Investment Risk

Government and Political Action Government and Political Risk

Off-Balance-Sheet Risks Off-Balance Sheet Risk

Related Company Risk NEW

SoP 2530.13 changed accordingly



P&C Risk Categories – General Change

General Structure – Each section lists examples of: possible events or triggers

possible ripple effects

possible management actions

Removing all references to specific percentages

More guidance to determine the 95th to 99th percentile range

more examples added for each



P&C Risk Categories – Loss Frequency & Severity Risk• Added more sample events:

– single major loss– social inflation (moved from old inflation risk

category)• Changed Loss Ratio event to simple Frequency &

Severity – wanted to keep premium effects as a separate risk

category



P&C Risk Categories – Policy Liabilities Risk(Formerly Misestimation of Policy Liabilities)

Adjusted to reflect discounted reserves• Removed set percentages for stress-testing• Added suggestions on how to determine the 95th to

99th percentile range– analyze history of actual to expected loss

development– fitting a model to loss development factors



P&C Risk Categories – Inflation Risk• Clarified that this category is for inflation in costs

extraneous to the insurance business (covered in risk category 1)

• Social inflation moved to risk category 1• Added a suggestion on how to determine the

95th to 99th percentile range – review of variation in 3-year band of CPI over

time (3-year to match forecast period)



P&C Risk Categories – Premium Risk (Formerly Pricing and Premium Volume)

Old Pricing• Rate Freeze – moved to Government Action• Parameter Risk eliminated (since it applies to all risk categories)• Left with events related to competition and underpricing

– similar to premium volume risk category– recommend combining the two risk categories

New Premium Risk• Removed set percentages for stress testing• Two situations may create an adverse scenario:

– Premium volume lower than base scenario– Premium volume higher than base scenario



P&C Risk Categories – Expense Risk• Eliminated• Risk category had limited application• Most events are really ripple effects



P&C Risk Categories – Reinsurance Risk• Added more guidance about items to consider that

may impact company• Removed set percentages for stress-testing



P&C Risk Categories – Investment Risk(Formerly Interest Rate and Deterioration of Asset Values)

• Removed set percentages for adjustments to asset values

• Added guidance on determining probability– analyze CIA Canadian Economic Statistics for

1-year variation equities or 3-year variation in interest rates (3-year to match forecast period)

– use stochastic modeling if available



P&C Risk Categories – Related Company Risk NewA legal entity may run into difficulties due to difficulties encountered by another entity to which it is related. Simply put, the goal of this category is to evaluate the impact on the valued company (insurer) of circumstances happening in the related companies.Why is it important?•more globalization in the insurance industry•more consolidation in the insurance industry•more variety in corporate organizational structures



P&C Risk Categories – Related Company Risk Possible events or triggers for the risk:• The company cannot rely on financial support from its parent

company – when a group’s financial resources are needed to support a financially-impaired parent or affiliate company

• The company must provide financial support to its parent company. This is equivalent to the first situation except that the funds the company expected to have for its own purposes are now needed to support other entities in the group

• Disruptions in services provided by related companies or at a group level may stress the company’s ability to achieve its business plan

• Rating agency downgrade reflecting difficult financial conditions at the group level.



Life Risk Categories – Minor Changes• Mortality

– Add death supported– Separate ripple effects from management action

• Morbidity– Add examples specific to critical illness insurance– Separate ripple effects from management action



Life Risk Categories – Minor Changes• Persistency/lapse

– Cover both persistency and lapse– Added more causes and ripple effects

• C1– Suggestions on integrated scenarios– Add disability as a ripple effect– Add management actions



Life Risk Categories – Minor Changes• Expense

– Minor changes• Reinsurance

– Added dispute over policy/treaty conditions• Government and political

– Add cost shifting– Add distribution channels– Add ripple effects



Life Risk Categories – Minor Changes• Off-Balance-Sheet

– Add employee benefits and liabilities



Life Risk Categories – Bigger Changes• C3

– Relax stress testing – Determining zero point may be impractical– Additional deterministic testing an option– Using higher percentile values from stochastic

models an option



Life Risk Categories – Bigger Changes• New business

– Increased importance of higher than expected new business

– Equal importance to higher than expected and lower than expected



Life Risk Categories – New• Related company

– Financial support from parent– Impairment of parent or affiliate– Group requirements may impact on insurer’s

strategy– Possible downgrade– SoP 2530.12 changed accordingly



Other risks under consideration• Liquidity

– Cashflow positions– Policyholder withdrawals– Asset sales and run-on-the-bank

• Operational risk– Controls and procedures– Business continuity– Risk management– Reputational risks– Marketing and distribution risks



Appendix A – Regulatory Capital Requirements• Overview of minimum regulatory requirements • Actuary must review appropriate guidelines for

company situation• SoP 2530.06 changed to remove reference to specific

requirementPROPOSED– The minimum regulatory capital requirement is that imposed by

the regulator requiring the actuary’s report on the insurer’s financial condition or, in the absence of such a requirement, that selected by the insurer and approved by the regulator(s).



Next Steps• Revised Ed Note approved by RMCR and PCFRC in

May, 2006• P&C Risk Categories are finalized and approved by

PCFRC• Finalize Life Risk Categories as soon as possible• Release complete Ed Note in 2006



In summary

Practice and approach to DCAT will change as a result of:• Modeling of ripple effects and reflection of regulator

and rating agency actions• Risk categories are broader• Reflection of capital enhancements/distributions• Integration of economic capital and other stochastic

work• Reporting is focused on Board and management



Many thanks to• Emile Elefteriadis • Jean-Guy Lapointe • Marie-Hélène Malenfant • Karim Nanji • Kamran Quavi • Linda Goss• Pierre Dionne• Denis Poulin• Xavier Bénarosch• Wally Bridel• Isabelle Périgny



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