CLRSNew Orleans, LA

September 10-11, 2001

Actuarial Standard of Practice No. 36 and

Codification of Statutory Accounting

Discussion of Implementation Considerations

Today’s discussion facilitated by:

Mary D. Miller, Moderator, Ohio Department of Insurance

Pat Teufel, KPMG LLP

Charles Yesker, Interstate Insurance Group

Today’s Discussion Will Focus on:

– Risk of Material Adverse Deviation

– Codification

– Materiality

Overview: ASOP 36

Effective: For All Statements of Actuarial Opinion provided for reserves with a valuation date on or after October 15, 2000

Defines 5 Types of Opinions Determination of Reasonable Provision Determination of Deficient or Inadequate Provision Determination of Redundant or Excessive Provision Qualified Opinion No Opinion

Introduces Disclosure Requirements

Disclosure Requirements

Deficient or Excessive ReservesAmount by which the stated reserve would need to increase/decrease to equal the minimum/maximum reasonable amount

Qualified Opinion• Description of the qualification and reasons• Amounts for such items included in the stated reserves, if

disclosed by the entity• If amounts not disclosed by the entity, a statement that the

stated reserves include unknown amounts for such items

• Risk of Material Adverse Deviation

Risk of Material Adverse Deviation

– Where the actuary believes that there are significant risks and uncertainties that could result in material adverse deviation, an explanatory paragraph is required

– The explanatory paragraph should contain: The amount of adverse deviation that the actuary judges to

be material A description of the major factors or particular conditions

underlying risks and uncertainties

Practical Considerations

– For NAIC Opinions, Direct and Assumed vs. Net

Possibility for different conclusions

Implicit requirement for different disclosures

Overview: Codification

Effective January 1, 2001 Recognized as OCBOA by accounting

profession Considerations for opining actuary

• Management’s Best Estimate• Major Risk Factors vs. Material Adv. Deviation• Premium Deficiency Reserves• Pools and Associations• Assessments, e.g. Guaranty Fund

Management’s Best Estimate

By “line of business” and in aggregate Required for loss reserves and recordable loss contingencies But “best estimate” and “line of business” are undefined

– Reasonably certain that “best estimate” is not mean, median, or mode

– “Line of business” is not necessarily annual statement LOB, and may relate more to marketing considerations

BI vs. PD vs. PhysDam vs. Personal Auto vs. Homeowners vs. Personal Lines

Management’s Best Estimate

Management’s best estimate may differ from actuary’s point estimate

– Management should be prepared to document reason for differences

– Actuary can work with management to construct a letter that documents the reasons for differences

– It will be the auditors (not the actuaries) who will be concerned about how management’s best estimate is determined

– Actuary may wish to obtain a letter of representation stating that reserves reflect management's best estimate by LOB and in aggregate

What does this mean?

Management currently should be booking its best estimate

Required documentation could be more stringent

It is uncertain how the auditors will interpret this requirement

Seems to place the spotlight on management’s decision

Materiality (Section 3.4)

– “Material” or “materiality” mentioned at least thirteen (13) times in the ASOP

The actuary is directed to:– Consider the purposes and intended uses for which the

actuary prepared the statement of actuarial opinion– Use professional judgment as well as materiality guidelines or

standards applicable to the Standard of Actuarial Opinion and the actuary’s intended purpose for the opinion.

– Principal use of materiality in the ASOP is to determine if an explanatory paragraph is needed

Where Can We Look for Guidance?

Property and Casualty Practice Note for Statements of Actuarial Opinion: Appendix 7

• Summarizes materiality references in ASOP 36• Reviews materiality as referenced in

• SEC Staff Accounting Bulletin No. 99• NAIC Accounting Practices and Procedures Manual

• Highlights relevant numerical considerations

Materiality Considerations

– Single vs. Multiple Line Company– Net Retention– Single Company vs. Member of a Group– Access to Capital– Management– Prior loss reserve runoff– Financial Strength

What financial values are important to the intended user?

Regulator

Statutory Surplus Risk Based Capital Total Reserves IRIS Tests

Investor

Net Worth Net Income Earnings per Share

Case Studies

Mutual Auto Insurance Company Multi-Line Casualty Company Small Nonstandard Auto Insurance Company New Workers Compensation Insurance Company Lawyers Professional Liability Mutual Insurance

Company Physicians’ Medical Malpractice Insurance Company Reinsurance Company

Mutual Auto Insurance Company

1996 1997 1998 1999 2000

Surplus 25,120 30,054 37,608 41,766 45,792

NWP 24,283 25,060 25,223 24,733 23,994

NWP to Surplus 0.97 0.83 0.67 0.59 0.52

Reserves 14,525 14,555

Reserves to Surplus 0.35 0.32

Loss Reserve Development

-12.6% -9.5% -5.2% -3.9%

Net Income 972 2,343 2,450 1,013 842

Best’s Rating A++ A++ A++ A++ A++

RBC Ratio 7.0 7.1 6.5 7.9 9.8

Mutual Auto Insurance Company

Actuarial Point Estimate = 14,300

Range of Reasonable Reserves 13,825 to 14,972

High End of Range - Carried = 417 2.9% of Reserves .9% of Surplus 49.5% of Net Income

Multi-line Casualty Insurance Company

1996 1997 1998 1999 2000

Surplus 121,337 115,728 128,811 123,289 84,851

NWP 122,945 158,182 93,341 99,390 75,892

NWP to Surplus 1.01 1.37 0.72 0.81 0.89

Reserves 113,867 111,829

Reserves to Surplus 0.92 1.32

Net Income <6,401> <2,893> 10,733 <5,231> <3,857>

Loss Reserve Development

+22.0% +21.9% +20.2% +17.0%

Best’s Rating A- A- A- A- B++

RBC Ratio 3.8 4.5 6.0 5.9 4.1

Multi-line Casualty Insurance Company

Actuarial Point Estimate = 114,500

Range of Reasonable Reserves 109,687 to 119,458

High End of Range - Carried = 7,629 6.8% of Reserves 9.0% of Surplus -197.8% of Net Income

Small Nonstandard Auto Insurance Company

1996 1997 1998 1999 2000

Surplus 5,818 5,751 5,748 5,098 5,953

NWP 465 6,379 11,266 11,793 20,412

NWP to Surplus 0.08 1.11 1.96 2.31 3.43

Reserves 9,369 13,624

Reserves to Surplus 1.84 2.29

Net Income <179> <451> 60 1,185 34

Loss Reserve Development -33.3% -0.9% -9.0% +0.8%

Best’s Rating NR-1 NR-2 NR-2 NR-2

RBC Ratio 11.5 6.2 4.7 3.3 2.1

Small Nonstandard Auto Insurance Company

Actuarial Point Estimate = 13,250

Range of Reasonable Reserves 12,867 to 14,458

High End of Range - Carried = 834 6.1% of Reserves 14.0% of Surplus 2452.9% of Net Income

New Workers Compensation Insurance Company

1996 1997 1998 1999 2000

Surplus 5,016 5,377 6,210 6,361

NWP 1,553 3,390 6,009 7,863

NWP to Surplus 0.31 .63 0.97 1.24

Reserves 220 1,856 4,263 4,832

Reserves to Surplus 0.04 0.35 0.69 0.76

Net Income <46> 261 831 1,019

Loss Reserve Development

+13.6% -24.1% -10.1%

Best’s Rating NR-2 NR-2 B+

RBC Ratio 15.3 11.2 9.8 7.6

New Workers Compensation Insurance Company

Actuarial Point Estimate = 4,800

Range of Reasonable Reserves 4,287 to 6,058

Maximum Adverse Deviation = 1,226 25.4% of Reserves 19.3% of Surplus 120.3% of Net Income

Lawyers Professional Liability Mutual Insurance Company

1996 1997 1998 1999 2000

Surplus 6,305 7,329 7,334 8,154 9,641

NWP 3,347 4,593 4,864 5,678 5,979

NWP to Surplus 0.53 0.63 0.66 0.70 0.62

Reserves 6,401 8,178 8,536 10,141 11,291

Reserves to Surplus 1.02 1.12 1.16 1.24 1.17

Net Income 742 703 278 721 1,079

Loss Reserve Development

+ 4.2% - 0.5% -18.4% -13.4%

Best’s Rating B++ B++ B++ B++ B++

RBC Ratio 4.7 4.8 4.5 4.6 4.4

Lawyers Professional Liability Mutual Insurance Company

Actuarial Point Estimate = 10,900

Range of Reasonable Reserves 9,647 to 12,798

High End of Range - Carried = 1,507 13.3% of Reserves 15.6% of Surplus 139.7% of Net Income

Physicians’ Medical Malpractice Insurance Company

1996 1997 1998 1999 2000

Surplus 134,431 158,621 172,712 187,224 211,140

NWP 96,809 85,532 104,953 134,215 141,016

NWP to Surplus 0.72 0.54 0.61 0.72 0.67

Reserves 636,966 563,768 593,282 654,132 654,865

Reserves to Surplus

4.74 3.55 3.44 3.49 3.10

Net Income <3,157> 22,960 11,335 11,968 21,250

Loss Reserve Development

- 2.1% - 4.0% - 4.7% - 3.4%

Best’s Rating B B B+ B++ B++

RBC Ratio 3.9 4.5 5.6 6.0 5.7

Physicians’ Medical Malpractice Insurance Company

Actuarial Point Estimate = 630,175

Range of Reasonable Reserves 579,647 to 692,789

High End of Range- Carried = 37,924 5.8% of Reserves 18.0% of Surplus 178.5% of Net Income

Reinsurance Company

1996 1997 1998 1999 2000

Surplus 272,374 396,677 423,616 402,652 401,392

NWP 205,065 429,870 645,832 698,440 653,984

NWP to Surplus 0.75 1.08 1.52 1.73 1.63

Reserves 1,038,460 1,179,181

Reserves to Surplus 2.58 2.94

Net Income 22,980 <17,164> 35,794 1,264 8,375

Loss Reserve Development

+ 1.8% + 7.9% + 7.5% + 6.7%

Best’s Rating A A A+ A+ A+

RBC Ratio 25.2 18.9 15.7 12.4 9.8

Reinsurance Company

Actuarial Point Estimate = 1,225,850

Range of Reasonable Reserves 1,079,647 to 1.292,481

High End of Range - Carried = 113,300 9.6% of Reserves 28.2% of Surplus 1352.8% of Net Income