CIA MfAD

Question 1

What is the purpose of MfAD (Margin for Adverse Deviation)?

Answer 1

To reflect a degree of uncertainty inherent in an actuarial best estimate.

Question 2

What are some broad methods for calculating MfADs? (2)

Answer 2

Deterministic: Select percentiles based on knowledge of the situation.
Stochastic: Use quantile methods based on a statistical analysis.

Question 3

What is the technical definition of MfAD?

Answer 3

Fundamentally, it is the difference between 2 ASSUMPTIONS.
It is the difference between the assumption for the ACTUAL calculation and the assumption for the BEST ESTIMATE calculation.

Question 4

What is the technical definition of PfAD?

Answer 4

Fundamentally, it is the difference between 2 RESULTS.
It is the difference between the result of the ACTUAL calculation and the result of the BEST ESTIMATE calculation.
Note: - the best estimate calculation might be the median of your loss distribution;
- the actual calculation would be more conservative, maybe the 90th percentile, the difference being the PfAD amounts.

Question 5

Categories of MfADs (3)

Answer 5

• investment return rates
• development on claims
• recovery on losses ceded to reinsurer

Question 6

According to IAIS, when should a risk margin generally be HIGHER? (4)

Answer 6

• when less is known about the estimate
• for low frequency/high severity LOBs
• for longer contract terms
• when there is a wide probability distribution for the losses

Question 7

According to IAIS, when should a risk margin be LOWER?

Answer 7

• with emerging experience

Question 8

What are the deterministic lower and upper percentage limits on MfADs? (3)

Answer 8

• Investment Return Rates: [25 bps, 200 bps]
• Claims Development [2.5%, 20%]
• Reinsurance Recovery [0%, 15%]

Question 9

Identified CATEGORIES of considerations for selecting CLAIMS MfAD? (3)

Answer 9

• Operations (U/W, Claims Management, other)
• Data (on which estimate is based)
• LOB

Question 10

Identify OPERATIONAL considerations in selecting CLAIMS MfAD. (2)

Answer 10

• pick HIGH when there are operational changes, employee turnover, lack of guidelines, inadequate staffing. (i.e.: More uncertainty)
• pick LOW when operations are stable, strong, consistent (i.e.: Less uncertainty)

Question 11

Identify DATA considerations in selecting CLAIMS MfAD.

Answer 11

• pick LOW when data is stable, credible, homogeneous

Question 12

Identify LOB considerations in selecting CLAIMS MfAD.

Answer 12

• pick LOW when LOBs are ‘stable’

Question 13

Reasons to select highest CLAIMS MfAD margin of 20%. (3)

Answer 13

• for significant changes (tort reform, legal challenges)
• for a new LOB in a new province with limited data
• for an increase in retentions with limited data for assessing effect

Question 14

Reasons to select CLAIMS MfAD margin higher than 20%. (3)

Answer 14

• if there is unusually high uncertainty
• if PfAD is already very low because best estimate of claims liability is very low
• if stochastic analysis indicates variability not identified using a deterministic analysis

Question 15

Reasons to select lowest CLAIMS MfAD margin of 2.5%. (3)

Answer 15

• LOB commuted to reinsurer and is in runoff
• LOB has pre-set payments (Eg: structured settlement)
• Insurer has stop-loss coverage reserved at stop loss limit

Question 16

Identify considerations in selecting REINSURANCE MfAD. (3)

Answer 16

• consider ceded Loss Ratio (if high: pick MfAD high)
• consider proportion of unregistered reinsurance (if high: pick MfAD high)
• consider financial condition of the reinsurer (if poor: pick MfAD high)

Question 17

Comment on the selection of REINSURANCE MfAD of 1%.

Answer 17

Near low-end range: indicates that the reinsurer is likely registered and has a highly-rated financial condition.

Question 18

Identify considerations in selecting INVESTMENT MfAD. (3)

Answer 18

• MATCHING of cash flows from assets and liabilities (if unmatched: pick MfAD high)
• ERROR in estimating payment patterns (if uncertain: pick MfAD high)
• ASSET risk credit/default and liquidity (if high risk: pick MfAD high)

Question 19

When may the INVESTMENT MfAD be less than 25 bps (<25 bps)?

Answer 19

When the best estimate of the discount rate (based on the insurer’s assets) is already below 25 bps.

Question 20

Comment on a selection of 25 bps.

Answer 20

Bottom of the range: indicates that invested assets are likely LOW RISK.

Question 21

Formula-based deterministic approaches for the INVESTMENT MfAD. (2)

Answer 21

• weighted formula

- explicit quantification

Question 22

Identify the quantile methods for calculating MfADs. (3)

Answer 22

• Multiples of SD (standard deviation)
• VaR (Variance at Risk), also called percentile or confidence interval method
  TVaR (Tail Value at Risk) or CTE (Conditional Tail Expectation)

Question 23

Advantages of multiples of SD method for MfADs. (2)

Answer 23

• simple

- practical

Question 24

Define the ‘margin’ associated with VaR.

Answer 24

Set margin so that the probability (actual < mean + margin) = p

Question 25

Define TVaR or CTE(Q%).

Answer 25

TVaR: weighted average of HIGHEST (100-Q%) results of stochastic simulation.

Question 26

2 aspects of insurance liabilities to consider when setting risk margin or MfADs.

Answer 26

TIME: length of settlement pattern SHAPE: distribution about mean AT reporting date OVER specified time horizon

Question 27

Characterization of quantile methods.

Answer 27

Quantile method depend only on the SHAPE of an insurance liability distribution (not the time aspect).

Question 28

Disadvantage of quantile methods.

Answer 28

Results do NOT vary by length of settlement pattern (risk margin will be the same regardless of tail length).

Question 29

Enhancement to quantile methods to address disadvantage.

Answer 29

Introduce parameter uncertainty to reflect time consideration AND use higher parameter for longer-tailed LOBs.

Question 30

Extreme events - describe the problem in selecting MfADs for extreme events.

Answer 30

There is low credibility of data when fitting a distribution to actual data.

Question 31

Extreme events - what is a specific approach for selecting MfADs for extreme events. (2)

Answer 31

- use a weighted average of a broad range of scenarios | - apply stress-testing techniques

Question 32

What should be enclosed in the MfAD docs? (2)

Answer 32

- for explicit assumptions: how margins were selected | - for stochastic analysis: describe components modeled as random variables, with their distributions and parameters

Question 33

Rule of thumb for level of detail to include on MfAD docs. (2)

Answer 33

- strike balance between (too little, too much) | - considering what info (qualitative vs quantitative) best serves the reader's use-case (understanding, decision-making)

Question 34

Rule of thumb for level of detail to include in MfAD docs. (3)

Answer 34

- sophistication of user - importance of concept to user - complexity of concept NOTE: cross-reference with materiality paper

Question 35

What is the difference between PV and APV?

Answer 35

PV: accounts for the time value of money APV: accounts for the time value of money AND includes a risk margin for INVESTMENT RETURN, CLAIMS DEVELOPMENT and REINSURANCE RECOVERY)

Question 36

Is APV liabilities always smaller than undiscounted liabilities?

Answer 36

NO, it depends on the balance between discount factors (which decreases APV) and the MfADs (which increase APV).