1
Q
AA’s duty to report to
- Board of Directors
- CEO
A
Directors:
Report on financial condition and expected future financial position
CEO:
Report on Material Adverse Events that required rectification
2
Q
Responsability when resignation of AA
- Resigning AA
- Newly AA
A
Resigning AA:
Write statement to board of directors and OSFI with reasons and circumstances of resignation
Newly AA:
Request written statement before accepting appointment
3
Q
How can CFO become AA ?
A
Audit committee provides written statement to OSFI stating that the requirements of both CFO and AA can be adequatly and independently performed.
4
Q
Requirements for foreign insurance companies to hold asset in Canada under Insurance Companies Act (2)
A
- Assets vested in Canada and controlled by Chief Agent or Minister of Finance (at least 5M$)
- Sufficient asset to cover liabilities both in Canada + margin determined by BAAT
5
Q
Duties of audit committee (3)
A
- Review annual report before directors
- Meet with auditor to discuss fairness of report
- Meet with actuary to discuss portion of annual report that relates to valuing policy liabilities
6
Q
Key features of Risk Appetite Statement (4)
A
- Short-long term strategies
- Qualitative / Quantitative measures
- Forward-looking
- Consider normal and stressed scenarios
7
Q
Elements of Risk Appetite Framework (3) + Description
A
- Statement : Reflects level of risk and type of risk FRFI is willing to accept to meet business objectives
- Risk Limits: Allocation to risk categories, business unit and lines of business
- Roles and Responsabilities for implementation
8
Q
Duty of Chief Risk Officer in Senior Management (2)
A
- Implementating risk management policy
- Providing regular reports to Directors, Senior Management and Risk Committee
9
Q
Definition Corporate Governance
A
Set of relationships between:
- Directors
- Management
- Shareholders
- Other Stakeholders
10
Q
Actions for non-compliance to OSFI guidelines on risk management limit (3)
A
- Supervisory activity
- Discretionary authority to adjust capital requirement
- Other corrective measures on case-by-case basis
11
Q
What percentage limits apply to investment concentration ?
A
5% asset in Canada
12
Q
What are eligible counterparty risk mitigation techniques to measure ceded unregistered reinsurance exposures ? (3)
A
- Excess Collateral
- Letters of credit
- Other techniques accepted by OSFI
13
Q
Capital requirement for large insurer exposure in GUWP
- Formula
- Limits (3)
A
Net Retention (including reinst prem) + Largest Net Counterparty Unregistered Reinsurance Exposure <= Limit
Limit =
- If widely held or regulated: 100% total capital available
- Otherwise: 25% total capital available
- Foreign: 100% net asset available
14
Q
Definition and key requirements for Gross Underwriting Limit Policy (3)
A
A Gross Underwriting Limit Policy (GUWP) is a formal document for insurers that defines their risk appetite by setting limits on the total gross insurance risk they are willing to accept for a “single insurance exposure”.
Should:
- Define single insurance exposure by class
- Establish limits by class for max gross insurance risk
- Reviewed by Senior Management at least annually
15
Q
How is a single insurance exposure defined for each class ?
- Property
- Credit
- Surety
- Title
A
- Property : Total exposure at one location
- Credit : Exposure related to one or group of connected buyers
- Surety : Exposure related to one of connected group of contractors
- Title : Exposure related to title in one location
16
Q
Describe approaches used by rating agencies to determine economic capital (3)
- Name of approach
- Rating agency using it
- Description
A
Expected policyholder deficit:
- EPD for each risk depends on volatility and size of the risk.
- EPD = Average loss for worst 1% of outcomes
- Used by AM Best
Stochastic cash flow capital models:
- Models based on distribution of each risk and simulate repeatedly from them.
- Cash Flows are projected until all current liabilities are settled
- Used by Moody’s
Principles-based systems:
- Evaluate insurer ERM system and internal capital models
- Capital requirements on a weighted average of its own formula and the client’s economic capital model
- Used by Std and Poors
17
Q
Measures taken by rating agencies to ensure consistent rating across companies (3)
A
- Information gathering and assessment guidelines
- Ratings should be related to economic capital
- Analysis and final ratings should be issued by separate bodies
18
Q
Shortcomings of Rating Agencies (2)
A
- Conflict of interest since agencies are paid by companies they rate
- There is history of unreliability. Agencies haver given high ratings to companies that then went bankrupt.
19
Q
Interactive Rating
- Definition
- Advantage (2)
- Disadvantage (2)
A
Independant assessment of an insurer’s ability to pay claims based on a comprehensive qualitative and quantitative analysis.
Advantages:
- Widely reviewed so reliable
- Insurer may remain unrated without interactive rating
Disadvantages:
- Time-consuming (meeting)
- Expensive
20
Q
Definition Rating Agencies
A
Financial strength ratings help buyers assess an insurer’s ability to pay claims. Some buyers must place business with highly rated reinsurers.
21
Q
Purpose of Rating Agencies by insurers (3)
A
- Agents are wary of unrated insurers
- Regulators may rely on Rating Agency’s Assessment
- Regulator don’t have the expertise to evaluate financial strength
22
Q
Lines of business where high financial ratings are important (3) and why ?
A
- Reinsurance : If downgraded to below investment grade, a reinsurer may not be able to renew
- Homeowners : Banks may require mortgage insurance from a highly rated insurer
- Low Freq/High Sev lines : Harder to assess risk and a high rating is a way of proving that insurer can pay claims
23
Q
ORSA vs FCT
- Forecast period
- Capital requirement operational risk
- Similarities (3)
- Differences (3)
A
ORSA :
- Forecast period : 3 to 5 years
- Capital requirement operational risk : Explicitely modeled with other risks faced by company
MCT :
- Forecast period : >= 3 years
- Capital requirement operational risk : Based on premium volume and other risks
Similarities:
- Involve scenario stress testing
- Assess the capital required related to risk
- Involve identification of material risk
Differences:
- Guidelines (CIA SOPs vs OSFI for ORSA)
- Methods (Quantitative vs Both for ORSA)
- Reporting (AA vs Management for ORSA)
24
Q
Explain usage stress testing to calculate internal capital target for ORSA
A
Use stress testing to identify material risks to company operations and measure impact on future financial condition based on set of risk factors, adverse but plausible event. Relate risks to capital needs to determine the internal capital target.
25
Why ORSA is better than FCT ? (4)
- Include all material risks
- Include assessment of internal control for better management
- Qualitative assess as well as quantitative
- Use stress-testing to set internal capital target to reflect risk appetite
26
Key elements of ORSA (5)
- O : Oversight by senior management
- R : Risk identification and assessment of materiality
- S : Sought good reporting and Monitoring
- A : (Audit) Objective Review and Internal Controls
- R : Relate risk to capital with internal capital target
27
Goal of ORSA
Enhance an insurer's understanding of the relationship between risk profile and capital needs.
28
Solvency 2
- What is it ?
- Pillars (3)
Insurance regulator system to determine required capital levels in European Union.
Pillars:
- Quantitative (Requirement)
- Governance (Supervisory activities)
- Transparency (Supervisory reporting and disclosure)
29
Advantages for insurer to identify ENID (3)
- Increase awareness of potential risks by senior management
- Assist in calculation of leading using freq-sev methods
- Increase regulator confidence in company's risk management
30
Elements to consider for ENID loading
- Catastrophes
- Court awards
- Legislative changes
31
Definition of ENID and ENID loading
ENID is event for which the insurer does not have historical data.
Loading: Balancing amount to bring reserves up to amount allowing for all possible future outcomes
- Journalist info +
- Pending court awarding -
32
Sound Practice for earthquake model component
- Version (3)
- Validation (3)
Version :
- Use more than 1 model
- Regular update (1 year)
- If In-house PML, compare to alternate model
Validation:
- Modeled losses vs actual
- Tailed losses vs market price for reinsurance
- Use global data to supplement limited Canadian earthquake data
33
Financial Resources to support earthquake exposure (4) + Restrictions
(USE IN CALCULATION OF EARTHQUAKE RESERVE FOR INSURANCE RISK)
- Use Capital and Surplus -> Prior approval from OSFI is required under MCT guidelines
- Reinsurance Coverage -> In case of whole account, use full stochastic model
- Earthquake Premium Reserve
- Capital market financing
34
Multi-region exposure for earthquake PML
- Disadvantage (2)
- Reporting of PML for foreign insurer
- Reporting of PML for canadian insurer
Disadvantage :
- Understates PML for insurers with significant exposure in both zones
- Ignore exposure elsewhere
Reporting of PML for foreign insurer :
- Report PML based on Canada exposure
Reporting of PML for canadian insurer :
- Report PML based on worldwide exposure
35
Methods to test completeness, accuracy and consistency of exposure data of earthquake data (2)
- Summarize data and review key statistics
- Look at year-to-year change in exposure and compare with historical data
36
Considerations when evaluating PML estimates (4)
- Data Quality (impact on limitations and adjustments)
- Non-modeled exposure
- Model uncertainty (Safety margin)
- Multi-region exposure
37
Name 4 non-modeled exposures of an earthquake model
- Guaranteed Replacement Cost
- Adequacy of ITV
- Loss Adjustment Expenses
- Claim Handling Expenses
38
Key principles / Qualitative / Sound
practices for managing earthquake (5)
- Risk Management : Oversight of risk management by senior management
- Data Management : Improve quality of data and get audited
- Models : Parameters selection in model
- PML : Compare PML with previous estimate
- Financial Resources & Contingency Plan : Ensure financial flexibility
39
Practices to improve risk management and process (4)
- Improve in technology to improve data quality
- Use multiple models
- Management should set guidelines
- Update models regularly
40
Best Practices for earthquake modeling (4)
- Document use of model with risk management program (Model Assumptions, methods, limitation, data management)
- Knowledge of assumptions, methods, limitations
- Explain why particular model is used vs alternatives
- Qualified staff needed to run in-house models regularly
41
GHG emissions scopes requirement
- Scope 1 and 2 (4)
- Scope 3 (3)
Scope 1 and 2 (2024):
- Separate disclosure
- Absolute gross emissions
- Measurement approach
- GHG protocol
Scope 3 (2028):
- Category 15 mandatory including
- Financed emission (Loans / Investment)
- AUM emission (Asset Management)
- Ins-associated emissions (UW portfolios)
42
Challenges with Climate-Related Scenarios (2)
- Public scenarios (IPCC) not specific enough to model
- Time horizon for development is very long so impact of transition, legal and reputational risk is uncertain
43
1st Principle for Climate Risk
- Name
- What should it look ? (4)
1st : Governance Structure
Should look over:
- Board oversight
- Senior management accountability
- Compensation linkages
- Clear role and responsabilities
44
2nd and 3rd Principle for Climate Risk
- Name of each
- How to integrate in model ? (4)
- How to consider in management ? (4)
- Key process in risk management (4)
2nd : Business Model Integration
How to integrate in model ?
- Identify climate impacts on strategy
- Develop Climate Transition Plan
- Assess plan achievability scenarios
- Set internal metrics/target
3rd : Risk Management Framework
How to consider in management ?
- Risk Appetite Framework
- ERM Framework
- Internal Control Framework
- Clear roles
Key process in risk management :
- Data collection
- Tools and models implementation
- Monitoring and reporting system
- Risk concentration tracking
45
4st Principle for Climate Risk
- Name
- Uses ? (4)
- Requirements (4)
- Essential because ? (5)
4st : Scenario Analysis
Uses ?
- Assess strategy resilience
- Identify risk factors
- Estimate exposures and losses
- Test risk management adequacy
Requirements :
- Multiple plausible scenarios
- Various time horizon
- Both physical and transition risks
- Understand methodologies and limitations
Essential because ?
- Historical data is not predictive
- Manifest over long time horizons
- Relationship are non-linear with potential tipping point
- Multiple plausible futures exist that cannot be extrapolated from past
- Required forward looking analysis
46
Principles of disclosure for climate risk (6)
- Relevant
- Specific and comprehensive
- Clear and balanced
- Reliable and verifiable
- Appropriate size (proportional FRFI complexity)
- Consistent
47
Governance Principles for climate risk (5)
- Governance Structure
- Business Model Integration
- Risk Management Framework
- Scenario Analysis
- Capital and Liquidity (ORSA, stress-testing)
48
*** IMPORTANT ***
What are the 3 expected outcomes OSFI wants FRFIs (Federally Regulated Financial Institutions) to achieve for climate risk?
Considerations for climate risk management
- Business model and strategy (Understand impact, mitigation, opportunities for climate-related risk)
- Governance and risk management (Appropriate to manage risk)
- Financial and operational resilience (resilient through severe climate risk scenario)
49
How climate risk transmit to traditional financial risk ?
- Credit
- Market
- Insurance
- Liquidity
- Operational
* Transmission channel
- Credit : Physical to collateral for banks loan
- Market : Perception of heightened risk that affect investment
- Insurance : Increased weather-related claims
- Liquidity : GHG intensive portfolio
- Operational : Physical damage to premises and potential reputational damages
50
Why climate risk is important ? (4)
- Manifest over varying time horizons
- Can intensify over time
- Drive traditional financial risks
- Can threaten business model vialibility
51
*** IMPORTANT ***
Climate Risk Framework
- Type of risk (3)
- Definition for each
- Examples for each
Physical Risk :
Risk on asset, businesses and operations arising from more frequent climate related phenomenon induced by climate change and impacts on firm's ability to generate profit.
Ex: Increased claims, Investment values, Assessment of credit risk, Increased work corp claims
Transition Risk:
Risk to a firm's business due to shift towards more sustainable and environmentally friendly operations.
Ex: New techs impacts, Market shift, Policy Changes
Liability Risk:
Failure to address financial and strategy risks arising from climate change through mitigation, adaptation or disclosures
Ex: Board sued due to cliamte related losses
52
Types of physical risk for climate risk framework (3)
- Acute : Extreme weather events
- Chronic : Long-term shift (sea level, temperature)
- Indirect : Public health impact
53
Considerations when using IPCC report for scenario analysis of climate risk (5)
- Implicit assumptions that market, system and chain will function at required level
- Inherent assumptions in modelling approach
- Correlation, sequencing, cascading effect importance
- Critical infrastructure risk impact
- Actions to address climate risk may create risk for another
54
Types of scenarios for climate risk (2)
- Exploratory : Explore range of alternative plausible scenarios (Stress testing)
- Normative : Future outcomes are set from plotted pathways (Reverse stress testing)
55
Systems Thinking
- Definition
- Benefits
Tool used to consider social, economic, political and technological environment in which firm operates when considering how it will be affected by climate risk.
Benefit:
Assist firm with thinking of interconnectedness of modern economy
56
Considerations when modelling catastrophes for climate risk (7)
- C : Capturing climate related risks in assumptions
- A : Allowing for factors other than damage
- U : Updating exposure in model
- D : Develop scenarios and metrics to estimate transition and liability risk
- A : Analyzing different time horizons (Short : Valuation - Medium : Steering - Long : Rebalancing business)
- C : Consider non-linearity or step changes that impact climate risks
- S : Segregating the effect of climate change by geography
57
Definition social inflation
Increase in costs because of change in the likelihood of claimants bringing suit, change in awards and change in attitude toward settlement.
Only for line subject to go to court.
58
Requirements of FCT Base Scenario (3)
- Consistent with business plan only if realistic
- In forecast period, base scenario is required to gave MCT > 150% (internal target)
- In forecast period, Asset > Liability
59
Ripple effect
- Definition
- Examples (6)
Event that occurs when an adverse scenario triggers a chain in 1 or more inter-dependant assumptions.
Examples:
- Loss of reinsurance
- Forced sale or liquidation
- Post-Event inflation
- Operating expense (higher loss ratio)
- Shift in portfolio mix
- Regulatory action
60
Corrective management action after FCT (6)
- Rate increase
- Review mix of business
- Sell and reinvest asset
- Review investment strategy
- Review reinsurance
- Tighten UW guidelines
61
Types of stress-testing scenarios (5)
- Base : Assumptions consistent with business plan
- Adverse : Developped by stress testing assumptions that threaten financial condition
- Solvency : Plausible adverse scenario (above 95th percentile)
- Going-concern : Adverse scenario more likely and less severe then solvency (Above 90th percentile)
- Integrated : Combine risk factors to produce new plausible adverse scenario (low-prob + high-prob)
62
Assess financial condition with stress-testing (3)
1. Base Scenario: MCT > Internal Target
2. Going-concern Scenario: MCT > Regulatory Min (100%)
3. Solvency Scenario: Asset > Liability
4. Final Decision
*Only check conditions for years in the forecast period
63
Definition reverse stress-testing and usefulness
Determine how far risk factors need to be changed to drive surplus negative and then determine if it is plausible.
Useful to find adverse scenario.
64
Scenario testing vs Sensitivity Testing (3)
Scenario testing vs Sensitivity Testing
- Risk Factor : Significant changes vs Incremental changes
- Time Horizon : Observe future state (ripple effect, actions) vs Shorter time horizon, shock immediate
- Complexity : Complex vs Simpler
65
Focus area for stress-testing program (5) + Examples
- Risk mitigation (Ex: Reinsurance program for flood)
- Securitization and warehousing
- Reputation (Ex: Flood coverage is optional)
- Credit risk and Counter-party Risk (Ex: Credit risk for reinsurer)
- Concentration risk (Ex: High-risk flood zones)
66
Definition stress testing
Risk management technique to evaluate effects on financial condition of specified changes corresponding to exceptional but plausible events.
67
Consideration when selecting a scenario in stress-testing (3)
- Scenario should cover all important business and product lines
- Create non-historical scenarios (external data)
- Cover severe and sustained downturn (Large losses, loss of reputation, operational risk)
68
Purpose of stress testing (4)
- Identify and control risk to adjust strategy
- Complement to other risk management tool
- Support capital management identifying severe events
- Improve liquidity management
69
Role in stress-testing program for
- Analyst
- Management
- Directors
- Analyst : Build and maintain spreadsheets to do actual calculation
- Management : Less technical work and more planning (implementation, management and oversight)
- Directors : Integrity of program (overseeing, meet with senior management)
70
How a company's stress testing program can be improved ? (5)
*Rudimentary considerations for stress testing
- Documentation available
- Robust flexible infrastructure
- Controls and reviews
- Includes view across organisation and include different risk perspective
- Update more frequently
71
What is required management action if capital available below internal capital target ?
If it happens or expected to happens within 2 year, notify OSFI and submit plans to restore capital to internal target level quickly
72
Internal Target Capital
- Definition
- Considerations (5)
*Will give a big scenario and ask ways in which AA likely did not follow appropriate regulatory guidance and describe appropriate action
- Reasons (2)
Determined by ORSA. Includes risks specified in capital guidelines and all insurer-specific risks
Considerations:
- Stress Testing
- Capital level don't fall under supervisory cap
- Cannot consider future capital injections
- Cannot consider head-office guarantee action
- Analysis forward-looking (do not consider past variability of MCT)
Reasons:
- Gives management time to adress issue
- Captures risks not addressed by industry-wide capital guidelines
73
Unwindind of discount
- Definition
- Calculation methods (3)
- Steps to calculate
Difference between discounting the cash flows to the beginning of the period and discounting to the end of the period.
Methods:
- Constant yield curve (same beginning and end)
- Unwinding using spot rates (End curve = Beginning curve shift by one period)
- Expectation hypothesis : Market expectations of future change
Steps :
1. Calculate CF and PV CF
2. For Constant yield method,
Unwinding = End of year CF - PV CF
3. For spot rates,
Unwinding = PV CF - CF
74
Combined approach steps to calculate liquidity premium
1. Create reference portfolio and calculate rate of return
2. Substract risk-free rate to get indicated liquidity premium
3. Liquidity Premium = r x Indicated Liquidity Premium + Constant
75
Contract features affecting the liquidity premium (3)
- High exit cost -> Decrease liquidity and increase liquidity premium
- Low Inherent Value -> Increase liquidity and decrease liquidity premium
- Exit Value (inherent value being paid) -> Increase liquidity and decrease liquidity premium
76
Steps of calculation of Fulfillment Cash Flows (8)
1. Decide whether to group your data together into net liabilities or gross and ceded based on availability, volatility and reinsurance
2. Select payment patterns (segmenting data) based on business segments, payout period.
3. Calculate liquidity premium using a combined approach
4. Calculate discount rate using one of the two approached to have a yield curve
5. Calculate the discount factors for each payment period
6. Calculate projected cash flows using the given projected cash flow percentages (TRIANGLE)
7. Allocate projected cash flows to issue year and calculate discounted cash flows (TRIANGLE)
8. Calculate the final FCF
FCF = Discounted Cash Flows + Risk Adjustment
Risk Adjustment = Factor given x Issue Year Discounted Cash Flows
77
Characteristics a discount rate should possess in IFRS 17 (4)
- Should reflect Time value of money
- Should reflect characteristics of Cash Flow
- Should reflect timing of cash flows
- Should reflect Liquidity Characteristics of insurance contracts
78
Do actuaries always have to do the duration calculation for assets themselves ?
No, they can rely on investment specialists. Actuary would be the enquiring professional, and investment specialist would be the responding professional.
79
Duration definition
Measures
- the average maturity of fixed future cash flows and
- the sensitivity of previous value cash flows to interest rate changes.
80
Considerations calculation duration liabilities
- Assumption
- Duration by lines
- Duration combined
- GMA : Which components are rate sensitive ?
- PAA : Which components are rate sensitive ?
- Situation where duration = 0
- Assumption : Consistent with discounting calculation from valuation
- Duration by lines : Some patterns as for discounting then total is weighted average
- Duration combined : Effective duration
- GMA : FCF are interest rate sensitive, CSM is not
- PAA : LC is interest rate sensitive, LRC excl LC is not
- Situation where duration = 0 :
When claims are expected to be paid out within a year and LIC and AIC is not discounted
81
Types of Duration (3)
- Formulas
- Difference between 2 ans 3
- Macaulay : Weighted average of time where weights are cash flows
- Modified : Macaulay Duration / (1 + yield rate)
- Effective : Should be used when cash flow are dependant on changes in discount rates
Duration = (Fair value if yields decline - Fair value if yields rise) / (2 x Initial Price x Change in yield)
82
Credit Risk
- Definition
- Components (3)
Risk of loss from counterparty's potential inability or unwillingness to fully meet contractual obligations due to insurer.
Components:
- Balance Sheet Asset
- Off-Balance Sheet Exposure (Risk not listed)
- Collateral and Guarantees
83
What are the components of off-balance sheet exposure in credit risk ? (4)
- Structured Settlements
- Letter of credit
- Non-owned deposit
- Derivatives
84
Operational Risk
- Definition
- Components (3)
Risk of loss from inadequate or failed internal processes people, systems or from external events (Include Legal Risk + Exclude strategic and reputational risk)
Components:
- Sum of insurance, market and credit risk
- Premium volume and growth
- Intra-group pooling
85
Diversification Credit
- Definition
Reduction to capital required recognizing that not all risk categories are likely to suffer their maximum loss simultaneously
86
Market Risk
- Definition
- Components (6)
Risk of loss from changes in prices in various market
Components:
- Interest Rate
- Foreign Exchange
- Equity
- Real Estate
- Right-of-use asset
- Other Market
87
Market Risk : Real Estate risk
- Definition
Risk of economic loss due to changes in value of a property or in the amount and timing of cash flows from a property
88
Market Risk : Right-of-use asset
- Definition
Fluctuating market lease rates
89
Market Risk : Other market
- Definition
Other markets are sold for less than the balance sheet value
90
Market Risk : Equity Risk
- Definition
Risk of economic loss due to fluctuation in the value of common shares and other equity securities
91
Market Risk : Interest Rate Risk
- Definition
Changes in interest rates will impact assets that change liabilities.
92
Insurance Risk
- Definition
- Components (4)
Arising from potential for claims or payouts to be made to policyholder or beneficiaries
Components:
- LIC (reserve)
- Unexpired coverage (incl catastrophe)
- Unregistered Reinsurance
- Earthquake and Nuclear catastrophes
93
Insurance Risk : LIC
- Formula
- Components (3)
Margin = 1,1 x Risk Factor x (Net LIC issued excl RANF) - AIC reheld excl RANF)
Components:
- Percentage that varies by coverage
- LIC net of salvage / subrogation excl risk adjustment
- AIC for reinsurance excl risk adjustment
94
Insurance Risk : Unregistered Reinsurance
- Margin required
- Deduction goal
- Deduction formula
Margin = 20% x (A* + AIC + Cash Outflows fund withheld - Receivables)
Reduction:
Lots of unregistered reinsurance trigger a reduction to capital required (only apply if > 0).
Deduction = (A* + AIC + Cash Outflows withheld)
- (Receivables
+ Non-owned deposits RSA
+ Premiums payable non-owned deposit
+ Reinsurance Collateral Funds held
+ Letters of credit (LIMITS = 30% of ARC + AIC)
)
where A* = PAA LRC + GMM LRC - GMM ARC
95
Definition of self-insured retention
Portion of a loss that is payable by policyholder. Insurer pays and seek reimbursement through Letter of Credit.
96
Regulatory adjustments to MCT capital available
+ CSM associated with title insurance contract
+- Adjustments to owner-occupied property valuation
All other adjustments are deduction
97
Qualitative Considerations MCT capital available (4)
- Availability : Is capital elements fully paid & available to absorb losses ?
- Permanence : Until when is the capital element available ?
- Absence : Does capital element have an absence of encumbrances & mandatory servicing costs ?
- Subordination : Is capital element subordinated to the rights of policyholders in an insolvency ?
98
Allocation Principles for capital requirements (5)
Methods should be:
- Free from bias
- Accurate when allocating revenue and cost
- Consistent with allocation methods used for other business
- Consistent over time
- Systematic and Reasonable
99
*** IMPORTANT ***
MCT Ratio
- Definition
- Formula
- Requirement (2)
Standardized measure of capital adequacy
MCT Ratio = (Capital Available / Capital Required) x 1,5
Requirements :
- 100% by federal
- 150% by OSFI (named supervisory cap)
100
Assess whether a group is onerous (Decision Tree)
1. Qualitative Assessment : Facts and Circumstances
- Specific group of contract
- Past Losses
- Aggressive UW and pricing
- Unfavourable Trends
2. IF YES -> Quantitative Assessment : Calculate difference between FCF and LRC excl LC
3. IF YES -> Group is onerous
LC is released into insured service expense and amortized from the LRC over duration of contracts.
101
Amortization of CSM
- Why ?
- Formula
Determines how the CSM is released into profit or loss with effect of new contracts and interest on CSM.
Formula:
- Proportion of CSM released quarter = Cov Units provided / (Cov units provided + Cov units end of period)
- Amortization of CSM = Proportion x Reporting opening CSM
102
Definition of coverage units
Quantity of insurance contract services provided by the contracts in group.
Determined by quantity of benefits provided.
103
Evolution of LRC through life of policy
Inception : No incurred claim, FCF + CSM
During : FCF decrease, LIC increase, Paid claims increase
End : LRC = 0
104
Aggregation of policies
AND
Allocation of components
- Expenses
- LRC and CSM
- FCF
Aggregation: Portfolios into groups
FCF are calculated at portfolio level and then separate into group.
All others components are calculated at groups level.
105
Definition of
- Asset position
- Liability position
Asset position : Expected cash inflows > Expected cash outflows
Liability position : Expected cash outflows > Expected cash inflows
106
Definition of LRC (2)
Entity obligation to:
- Investigate and pay valid claims for insured event that have not yet occured
- Pay amounts that relate to:
- Insurance contract services not yet provided
- Any investments components not transferred to liability for incurred claims
107
Calculation : LRC (GMA approach)
- Formula
- Components of FCF
LRC = Fulfillment Cash Flows + Contractual Service Margin (0 if onerous)
Fulfillment Cash Flows :
- Future Cash Flows (premiums and claims)
- Adjustment time value
- Financial risk
- Risk adjustment for non-financial risk
108
Calculation : LRC (PAA approach)
- Formula LRC
- Formula LRC excl LC initial and subsequent
LRC = LRC excl LC + LC
Initial :
LRC excl LC = Premiums - Acquisition Cash Flows +/- Amounts arising from decorognition of assets and liabilities
Subsequent :
LRC excl LC = Premiums - Acquisition Cash Flows
+ Amortization
- Insurance revenue
- Investments components for LIC
+ Adjustment Financing Component
+ Carrying Amount at start
* CAN ASK TO CALCULATE THAT VALUE*
109
*** IMPORTANT ***
Calculation : Loss Component for LRC (5)
* REVOIR NUMÉRO POUR CALCULER
1. Calculate Fullfilment Cash Flows = Losses
- Premium Receivable
+ Risk Adjustment
+ Other Attributable Costs
+ (Deferred Acq Cost (net cancel) - Deferred Acq Cost (Gross Cancel)
+ Future Acquisition Cost (net cancel)
* Losses : Must be Discounted
* Premium Receivable : Remove unearned premium that are cancelled and discount
* Other Attributable Cost : Apply % on unearned premium net of cancellation and discount
* Risk Adjustment : Apply % on discounted losses
* Deferred Acq Cost (net cancel) : Cancellation % is only apply to variable part of cost
* Future Acquisition Cost (net cancel) : Cancellation % is only apply to variable part of cost
2. Calculate PAA LRC (excl LC) = Premium Received
- Insurance Revenue
- Deferred Acquisition Costs (Gross cancel)
3. Calculate LC = FCF - LRC (excl LC)
110
Recognition of onerous/non-onerous contracts in financial statement
- Onerous
- Non-onerous
- Reinsurance
Onerous :
It must be recognized even before coverage begins.
Not Onerous :
Only recognized when in force.
Same logic if reinsurance is entered into.
111
Determining PAA eligibility (4)
1. Coverage period <= 1 year
2. IF NO: Group revenue <= 1% total company
3. IF NO: PAA materially not different than GMA
PAA - GMA | < (Aggregate Treshold x (Group Revenue x Group LR)) / Total
4. IF NO : Is there any significant variability in cash flow ?
5. IF NO : Eligible
112
Considerations to use MCT to calculate Risk Adjustment confidence interval (3)
- Insurer's mix and volume of business when aggregating multiple lines and potentially LRC and LIC
- Adjustment for size relative to average insurer in the MCT (Smaller insurer are more volatile, larger spread in distribution)
- Remove additional 10% loading on LIC factors for transition to IFRS 17
113
Risk Adjustment reinsurance held : Proportional scaling method
- Definition
- Consideration to have for percentages (3)
Use the same percentage of FCFs for the ceded Risk Adjustment as for the direct one
Percentage can be modified for considerations such as :
- Commissions
- Expense allowance
- Reinstatement premium
114
Risk Adjustment reinsurance held : Catastrophe models method
Use output from a catastrophe model tailored to an entity's book of business.
Select a percentile directly from the given distribution
115
Risk Adjustment : Margin method
Select margin that reflects the compensation the entity requires for uncertainty related to non-financial risk
116
Risk Adjustment : Cost-of-capital method
- Definition
- Components (3)
- Advantage
- Disadvantage
Based on compensation an entity requires to meet a target return on capital
Components:
- Projected capital amounts
- Cost of capital rates
- Discount rates
Advantage : Close to the definition of the RA
Disadvantage : More complex because projection of capital requirements is an input to liability calculation
117
Risk Adjustment : Quantile method
- Definition
- Advantage
- Disadvantage
Assess probability of the adequacy of FCF. These probs are used to quantify Risk Adjustment using VAR or CTE.
Advantage : Satisfies disclosure requirements regarding confidence level
Disadvantage : If misrepresented, it may introduce spurious accuracy
118
Methods to calculate risk adjustment under IFRS 17 for non-financial risk (4)
- Quantile
- Cost of capital
- Margin
- Combination of methods
119
Methods to calculate risk adjustment under IFRS 17 for reinsurance held (4)
- Quantile
- Cost of capital
- Catastrophe models
- Proportional scaling
120
Method to calculate risk adjustment under IFRS 17 for catastrophe reinsurance
- Why different analysis ? (2)
Cost of capital method with an assumption for required capital set a higher percentile.
Why different analysis ?
- Catastrophe reinsurance covers low-fre, high-sev events
- Standard quantile method produce an Risk Adjustment that is too small or even 0
121
Risk Transfer : Commutation Clause Considerations
- Financial (3)
- Non-Financial (3)
**Financial :**
- Amount and timing of cash flows
- Discount rate applied to cash flows
- Payment pattern of cash flows
**Non-Financial :**
- Court Decision
- Life expentancy of claimant
- Quality of reinsurer
122
Risk Transfer : Parameters selection Interest Rate
- Why choose above risk-free rates ?
- Why not ?
Why choose above ?
Reinsurer's average rate of return is above risk free rate
Why not ?
Result should not depend on quality of reinsurer's investment strategy
123
Conditions that limit risk transfer in reinsurance contract (3)
- Commutation clause
- Reinstatement clause
- Forced Renewals
124
Risk Transfer : Advantage / Disadvantage of pricing assumptions
Advantage : More in line with reinsurer's view on the risk transfer and incorporate market view of the risk
Disadvantage : Assumptions are market driven (may not reflect true expected loss)
125
Risk Transfer : Accounting of parameter risk
- Explicitly
- Implicitly
Explicitly : Giving parameters a probability distribution and incorporate this into simulation
Implicitly : Higher expected loss selection and volatility
126
Risk Transfer : Incorporation of reinsurer expenses
Not included. Only cash flows between cedent / reinsurer should be considered in ERD calculation.
127
Risk Transfer : Incorporation of profit commission
Not included. Result of cedant should not be included in risk transfer analysis.
128
Risk Transfer : Methods to evaluate (4)
1. QUALITATIVE : Is transfer of risk self-evident ?
-> Intuitively obvious that contracts protects cedant from future events that would adversely impact financial condition
2. QUALITATIVE : If significant loss not reasonably possible but reinsurer assumes substantially all risk (Quota share)
3. QUANTITATIVE : Calculate Expected Reinsurer Deficit = Freq x Sev as a % of premium (IF > 1%, risk)
4. QUANTITATIVE : If reinsurer has 10% chance of suffering a 10% loss, then contract is deemed to have risk transfer
129
Requirements common to GAAP and SAP for determining existence of risk transfer in reinsurance (2)
*Conditions for a contract to receive reinsurance accounting treatment
- Significant insurance risk is assumed by reinsurer
- Significant loss to reinsurer is reasonably possible
130
Reasonably self-evident risk transfer
- Definition
- Requirements (2)
Intuitively obvious that contract protects cedant from future events that would adversely impact the financial condition of ceding company.
Requirements :
- Done at arms length
- There are risk limiting clauses
131
Key Principles in assessment of risk transfer (4)
- Use quantitative and/or qualitative approaches
- Use professional judgment
- Consider overall agreement (Contract, amendments, verbal, written)
- Re-check risk transfer when certain conditions occurs (change in terms affect expected future cash flow)
132
Risk-limiting features vs Non-Limiting Features in reinsurance
- Examples of features (4)
Risk-limiting features: Terms set in advance. Force renewal term that profit reinsurer.
Ex :
- Retention level high (10%)
- Limit on excess of loss
- Swing loss ratio
- Automatically commuted unless maintenance fee
- Pre-set limit
Non-limiting features examples:`
- Loss paid when occur
- Premium payable in quarterly installment
- Reinsurer expense
- Taxes
133
Reinsurance : FRI informations to OSFI (4)
1. Reinsurance risk management policy
2. Ongoing due diligence performed on counterparties
3. Complete description of all reinsurance arrangement
4. Stress testing performed on reinsurance program
134
Reinsurance : Key principles of reinsurance (4)
1. Reinsurance risk management policy
2. Due diligence performed on counterparties
3. Clear contract terms and conditions
4. Terms should not adversely affect ceding FRI
135
1st Principle : Elements of Reinsurance Risk Management Policy (4)
- Purpose and objectives for seeking reinsurance
- Ceding limits
A FRI should not cede 100%, or substantially all of its risk (like 95%).
- Counterparty risk management
- Concentration limits
136
2nd Principle : Due diligence
- Definition
- Factors (6)
- Why might OSFI require higher due diligence for unregistered reinsurers? (3)
Research done by company in preparation for a business transaction.
- Claim payment record
- Balance sheet strength
- Funding sources
- Management quality and governance
- Expected future claims obligation
- Retrocession arrangements
Unregistered reinsurers present higher counterparty risk because they:
- are not subject to Canadian regulatory oversight
- Operate different legal/regulatory frameworks
- Have greater uncertainty regarding financial strength
137
4th Principle : Insolvency clause requirements for third-party reinsurers or affiliated reinsurer in a reinsurance contracts (3)
THIRD-PARTY REINSURERS:
- Must provide full payment to insolvent cedant
- No reduction due to insolvency
- Receivables paid directly to cedant in Canada
AFFILIATED REINSURER:
- Receivables paid directly to cedant in Canada
138
When will OSFI not recognize capital credit for reinsurance ?
When a foreign insurer ceded Canadian risks back to foreign insurers home office through affiliated reinsurers.
139
Reinsurance : Risks created (4)
- Operational risk
- Legal risk
- Counterparty risk
- Liquidity risk
140
Reinsurance : Benefits (6)
- W : Withstand catastrophic events
- R : Reduce insurance risks and volatility
- A : Access reinsurer's expertise
- I : Increase UW capacity
- S : Stabilize solvency
- E : Efficient capital use
141
Approaches which account for time value of money when evaluating runoff of claim liabilities (2)
- Discounting : Discount paid and unpaid amounts back to original period
- Substraction : Substract investment income earned during CY on supporting assets and liabilities
142
Objectives sought by OSFI for peer review (3)
- Assist OSFI in assessing insurer safety and soundness
- Assist AA and provide education
- Raise confidence in AA with management, public and regulators
143
Roles and duties of AA (4)
- Produce AA report
- Valuation of reserve using AAP
- Produce financial position report for Directors
- Produce material adverse event report to CEO/CFO
144
AA : Qualifications (5)
- FCIA
- 3 years experience in past 6 years with 1 year in valuation
- Continuous professional development
- No adverse findings with CIA disciplinary tribunal
- Comply with CIA SOP
145
Peer reviewer qualifications (6)
- Fellow
- Cannot have direct financial interest in company (can be indirect)
- Cannot have worked for insurer in past 3 years
- Must have experience with at least 2 other related companies
- Can be from same consulting firm as auditor or colleague doing financial statement
- Can't be from the same firm as AA
146
Peer Reviewer vs Auditor diff (3)
Peer Reviewer vs Auditor :
- Standard of Practice : CIA vs CICA
- Recalculation : No vs Yes
- Verification of data : No vs Yes
147
OSFI : Conditions peer reviewer cycle (5)
- Peer review of assumptions and methods every 3 year
- Peer reviewer must be change after 2 cycles
- Actuary of same firm of previous can perform peer review
- A previous peer reviewer can rebecome peer reviewer after one cycle
- If no material change, only review reasonableness annually
148
OSFI : External peer reviewing expectations (4)
- Did AA use Accepted Actuarial Practice ?
- Appropriateness of assumptions and methods
- Consider material internal and external changes
- Feedback on AA's work and document process
149
*** IMPORTANT ***
AA : Report to take responsability of work of others (2)
- Why choose the first report ? (4)
- Report with reservations : Used but not take responsability
- Change in assumption or methodology affecting disclosure items
- Liabilities different from those calculated by actuary
- New appointment (predecessor AA's work)
- Takeover of insurer with insufficient records
- Report without reservations : Used and take responsability
150
AA : Items that can be set by others (4)
- Discount Rate
- Level of aggregation
- Contract boundary
- Risk adjustment for non-financial risk
151
Differences in wording of AA's opinion IFRS 17 vs Old (3)
- IFRS Compliance :
Liabilities valuation complies with relevant IFRS standards
- Appropriate for Financial Statement :
AA no longer opines that liabilities make appropriate provision for all obligations. Liabilities provision is appropriate for inclusion in financial statement.
- Broader Scope :
Scope of fairly present is broader. More extensive presentation and disclosure requirements
152
IFRS 17 vs Current SOP : Valuation of liabilities (4)
- Level of aggregation : Separate profitable vs non-profitable contract
- Measurement approach : Determine onerous vs non-onerous contract
- Discounting : Yield curve LIC
1. Do not have to discount LRC if coverage period < 1 year or if discounting not significant
2. Discount Rate is to reflect characteristics of the liability
- Risk Adjustment : Risk adjustment based on appetite and tolerance
* ALL INFO ARE FOR IFRS 17
153
Enquiring Professional
- Definition
- Communication actions (3)
Professional who will consider the work of other professional.
Actions:
- Notify responder that work is being used
- Ask if responder is a professional
- Ask if professional was appointed to do the job intented to be considered
154
Responding Professional
- Definition
- Communication actions (3)
Professional of whom the work is being used by enquiring professional.
Actions:
- Discusss any problem with work including materiality
- Confirm to enquiring professional that he is a pro
- Confirm he was appointed to do the work intended
155
Definition of model
A practical representation of relationships among entities using Financial, Economic, Mathematical and Statistical concepts.
156
Definition of model risk
Risk of drawing incorrect conclusion due to limitations or flaws of underlying model.
157
Evaluating risk exposure of model : Considerations
- Severity of failure (3)
- Likelihood of failure (4)
Severity of failure :
- Financial Significance
- Importance of model
- Frequency of use
Likelihood of failure :
- Complexity
- Expertise of user
- Documents
- Testing
158
Key elements of a model (5)
- Specification : Description parts and interactions
- Implementation : Systems
- Limitation
- Run : Input/output
- Documentation
159
Purposes sensitivity testing for a model (4)
- Validate a model
- Understand relationship between input/output
- Develop sense of confort with model
- Test assumptions outside expected range, singly and then in combination or with non-linear relationship
160
Quality Assurance Considerations (6)
- Significance
- Purpose
- Vulnerability to error
- Complexity
- Expectations of user
- Legislative requirements
161
Items considered before using another's person work (3)
- Qualification
- Communication
- Awareness
162
Types of actuarial reports (4)
- External : Formal and Detailed (Narrow)
- Internal : Depending on use (Wide)
- Oral
- Summary
163
Subsequent Event Decision Tree
1. Aware before calculation date -> Reflect event in work
2. Aware between calculation and report date ->
- Error ? If yes, reflect in work
- When ? On or before, reflect in work
- Make entity different ? On or before, reflect in work
- Purpose of work ? Report as it will be as a result of event, reflect in work
- If nothing respected, report event but do not reflect in work
3. Aware after report date ->
- Would event have been reflected in work ? If yes, no action needed
- Does event invalidate report ? If yes, Amend report and disclose it
- If nothing respected, report event but do not reflect in work
164
Definition Subsequent Event
An event of which the actuary becomes aware after the calculation date but before the corresponding report data.
165
Definition of Materiality
An omission/over-statement or understatement will materially affect user's decision making or expectations.
166
Characteristics of company that affect materiality standards (5)
* Which company between the 2 in the given scenario would have the greater materiality standards ? (More rigorous = More regulatory)
- Size (Smaller companies should have smaller standard since less capital)
- Type of business (Long tail and short tail are different)
- Access to capital
- Net Retention
- Stage of organization's life cycle (newer should have smaller standard)
167
Considerations disclosure of materiality level (3)
- Sophistication of user
- Importance of concept of user
- Complexity of concept
168
Materiality Level FCT vs Valuation Work
FCT : Less rigourous. Used in scenario testing
Valuation : More rigourous. Used in Financial Statement
169
Financial metrics for materiality level for :
- Regulation
- Appraisal
- Financial Statements
- Regulation : MCT Ratio, Regulatory Capital
- Appraisal : Net income, Net worth
- Financial Statements : Net income, Net Capital
170
Calculation : Net Income in Financial Statements
Net Investment Income = Insurance service result
+ Net Investment Result
+ Other Income and Expenses
- Taxes
+ Discontinued Operations
171
Calculation : Investment Yield in Financial Statements
Numerator = 2 x (Investment Return + Share of Net Income Equity account invest)
Denominator = Total Asset(x) + Total Asset(x-1) - Investment Return - Share of Net Income Equity account invest
Yield = (Numerator / Denominator) x 100
172
Accounting Principles : SAP vs GAAP
- Objective
- Intended User
- Asset recognition
- Deferred income taxes
- Treatment reinsurance
SAP (Statutory Accounting Principles) :
- Objective : Measure ability to pay claims
- Intended User : Regulators
- Asset recognition : When expense incurred
- Deferred income taxes : Net
- Treatment reinsurance : No
CGAAP (Canadian Generally Accepted Accounting Principles) :
- Objective : Measure earnings
- Intended User : General Audience
- Asset recognition : Defer matching with expense
- Deferred income taxes : Gross
- Treatment reinsurance : Yes
173
Accounting Concepts : Fair value vs Historical Cost to value an asset
Fair Value : Record asset at a value that would be bought or sold for in open market
Historical Cost : Record asset at the original purchase price less depreciation
174
Accounting Concepts : Principle-based vs Rule-based system
Principle-based : Accounting concept that must be interpreted and applied. More flexible.
Rule-based system : Accounting concept with strict rules that have to be followed. Easier to understand and audit.
175
Accounting Concepts : Liquidation vs Going-concern basis
Liquidation : Accounting concept where elements are valued on a runoff
(REGULATORS) to see if insurer is able to render obligation)
Going concern : Accounting concept where elements are valued on a normal and continued basis
(INVESTORS)
176
Definition of Commutation and Reason
An agreement between ceding insurer and reinsurer that provides valuation, payment and complete discharge of all obligations. Close with one payment. Reinsurer gives ceded claims back to original insurer.
Reason : Reinsurer insolvency, desire to finally
177
Commutations :
- Advantages Insurer / reinsurer (4)
- Disadvantage Insurer (2)
Insurer adv :
- Remove reinsurance credit risk
- More efficient claim handling
- Immediate cash flows
- Decrease expense cost
Insurer disadv :
- Adverse development on claims
- Capital requirements go up to support increased liability
Reinsurer adv :
- Stability for long-tailed line
- Decrease claims expense
- Decrease UW leverage
- Exit market quickly
178
Definition of Contract Boundary
The contract boundary defines the cash flows that should be included when measuring the insurance liability arising from a contract.
179
Risk Adjustment : Principles
- Higher (4)
- Lower (3)
*Gives lines of business or stakeholders and ask which one would result in higher risk adjustment ?
Should be higher for :
- Risks with less info
- Low freq / High sev risk
- Longer duration contracts (> 1 year)
- Wide loss distribution risk
Should be lower for :
- Emerging experience
- Pooling similar risk
- Negatively correlated risk (will offset each other)
180
Examples of material changes that peer reviewer must consider (3)
- System change
- Valuation assumption change
- Valuation method change
181
Describe Windows & Walls approach for Solvency II
Gives windows for state insurance regulators to look into group-wide operations but maintains the walls at the statutory legal entity level (capital cannot be shared)
182
CALCULATION : Regulatory Action under Solvency II
- Solvency 2 Capital Requirement
- Regulator Action
SCR = VAR at percentile 99,5%
Boundaries for regulator action:
Capital Available - Liabilities - Risk margin >
- Solvency capital requirement -> IF BELOW, INTERVENTION
- Minimum capital requirement -> IF NOT, CANNOT OPERATE
183
Key elements that should be included in Climate Transition Plan (3)
- Metrics and targets for measuring progress
- Alignment with business strategy
- Assessment of achievability under different scenarios
184
Things AA should comment on climate risk based on IAA (2)
- Regulatory and legal changes that can emerge rapidly over short time frames
- New products and designs as well as industry developments
185
What document are needed if a comprehensive reinsurance contract isn't signed by the effective date?
Contractually binding summary documents that include:
- Premium paid by cedant
- % of risk assumed by reinsurer
- Risk reinsured
- Duration of coverage
- Etc
186
Could the given scenario lead to the AA reporting with reservation in the financial statements.
ALWAYS FIRST TWO QUESTIONS:
- Consistent with IFRS 17 ?
- Consistent with AAP ?
- Similar to what AA would have chosen ?
187
*** IMPORTANT ***
LIC calculation (4)
1. LIC cash flows for each payment year (undiscounted cash flows)
2. PV of LIC cash flows using discount curve (discounted cash flows)
3. Risk Adjustment for non financial risk
- Capital held x Cost of capital rate
- Discount the results and sum
4. LIC = PV(Cash Flows) + Risk Adjustment
188
The company has chosen to use the top-down method to determine a discount curve for the liability for incurred claims (LIC) of its personal auto insurance portfolio. Fully explain whether the company can use its own assets to derive this discount curve ?
and for LRC of ins contract issued ?
and for LRC of reinsurance contract held ?
The company cannot use its own assets in this scenario because under the top-down method the reference portfolio must match the characteristics of the liabilities, including liquidity.
The LIC for typical P&C products such as personal auto is illiquid, because the policyholder is unable to obtain the exit value in advance of normal payment dates.
LRC is liquid since it is the basis for varying liquidity. Ability of policyholder to cancel policy before expiry date and to receive value without cost
LRC is liquid since it is the basis for varying liquidity. Ability of purchaser of reinsurance to cancel policy before expiry date and to receive value without cost
189
Risk-attaching vs loss-occurring quota share treaty
- Measurement method (PAA or GMA)
Entities can opt to use the PAA for loss-occurring reinsurance contracts where the coverage period can be easily defined as one year or less based on the contract’s effective date and expiry date.
For 12-month risk-attaching reinsurance treaties covering underlying insurance contracts with terms of 12 months, the reinsurance coverage would usually span two loss occurrence years, assuming that underlying contracts are underwritten throughout the year.
190
Appropriateness of using bootstrapping to determine RA ?
Support since this is a specialty company, this method will produce results that more closely resemble what historical data of this company has shown can happen - not the same as all other generalist companies
191
States four factors that may differ between reference portfolio vs insurance contracts and describe
- **Liquidity :**
Fixed percentage of asset reference portfolio spread over risk-free rates and an additional constant adjustment to reflect the difference between the liquidity characteristics of the insurance contract and the asset reference portfolio.
- **Investment Risk**
- **Timing**
Assess the consistency of the timing of payments between the assets in the reference portfolio and the insurance contract liabilities
- **Currency Risk**
Select a reference portfolio made up of investments denominated in the same currency as the insurance contracts
192
State 1 advantage and 1 disadvantage of top-down method for determining discount curves.
**Advantage:**
Does not require the explicit derivation of a liquidity premium
**Disadvantage:**
Complexity of the derivation of a reference portfolio rate and applicable adjustments.
193
*** IMPORTANT ***
Methods for selecting a discount rate (3)
- Definition
- Formula (practice excel)
Bottom-up approach :
A liquid risk-free yield curve is adjusted to reflect the differences between the liquidity characteristics of market financial instruments and the liquidity characteristics of the insurance contracts.
Discount Rate for each year = Risk-free rate + Liquidity Premium
Top-down approach :
The yield to maturity of a reference portfolio of assets is adjusted to eliminate any factors that are not relevant to insurance contracts.
Discount Rate for each year = Reference portfolio - Credit Risk - Market Risk
Adjustment not required when the reference portfolio is comprised solely of bonds
Hybrid approach :
The hybrid approach estimates the liquidity premium using a top-down approach. You then use this liquidity premium in the bottom-up approach to get the final selected discount rate.
194
Describe the apriori assumption about future discount rates used to unwind discount under
- Constant yield curve method
- Spot rates method
**Constant yield curve method :**
Using the same discount curve at the beginning and end of the period. It corresponds to the a priori assumption that the discount curve will remain the same at the end of the period.
**Spot rates method :**
Using an end of period discount curve that is equal to the beginning discount curve shifted by one period.
195
Can a company use its own asset to derived the discount curve under top-down approach?
The company cannot use its own assets (0.25) in this scenario because under the top-down method the reference portfolio must match the characteristics of the liabilities, including liquidity (0.25).
The LIC for typical P&C products such as personal auto is illiquid (0.25), because the policyholder is unable to obtain the exit value (or "liquidate" the claims payment) in advance of normal payment dates (0.25).
196
***IMPORTANT***
What is a locked-in yield curve?
When it is used ? (2)
Locked-in yield curves refer to yield curves determined at the initial recognition of the group of contracts.
Locked-in yield curves would be used when:
- the entity uses the GMA to determine the LRC for some contracts
- the entity elects the OCI option for some contracts
197
***IMPORTANT***
Steps to calculate insurance revenue
1. Calculate Revenue PAA Contract
2. Calculate Revenue GMA Contract
3. Calculate Revenue VFA Contract
4. Sum all revenue
Equivalent of earned premium for each group
198
***IMPORTANT***
Steps to calculate insurance service expense
Equivalent of incurred claims for each group
199
***IMPORTANT***
Components of net expenses from reinsurance contract held
- Reinsurance Premium
- Recoverables for reinsurance
- Non performance risk of reinsurer
Equivalent of earned premium for reinsurance
200
***IMPORTANT***
Steps to calculate insurance service result + Signification
1. Calculate Insurance Revenue
2. Calculate Net expenses from reinsurance
3. Calculate Insurance Service Expenses
Insurance service result = Total insurance revenue (Revenue PAA Cont, GMA cont, VFA cont)
+ Net expenses from reinsurance contract held
- Insurance service expenses
+ Loss Component (if initial recognition)
+ Amortization of loss component (if initial recognition)
The insurance service result, under IFRS 17, represents the net profit or loss from an insurer's underwriting activities.
201
***IMPORTANT***
Steps to calculate net insurance service result
Remove expense from reinsurance from insurrance service result
202
*** IMPORTANT ***
Calculate the insurance revenue and Liability for Remaining Coverage (LRC) balance for the policy at initial recognition
LRC at initial recognition = Premium received - Acquisition Cost
203
*** IMPORTANT ***
Calculate the insurance revenue and Liability for Remaining Coverage (LRC) balance for the policy at end of year 1, 2, 3
LRC balance = LRC balance at start
+ Premium received in period
+ Financing Component (LRC balance start * Discount Rate)
- Acquisition CF amortized in period
- Insurance Revenue
- Investment Component for LIC
* Faire un tableau 8 colonnes (une ligne par année)
* Faire des numéros de pratiques
204
*** IMPORTANT ***
Identify considerations when estimating the risk of non-performance of a reinsurer. (4)
- Financial strength of the reinsurers
- History of claims and coverage disputes with reinsurers
- Delays in payments and concentration risk
- Length of time over which liabilities are expected to be settled
205
*** IMPORTANT ***
Describe Risk Adjustment for non financial risk
Describe Risk Adjustment for reinsurance held
Risk Adjustment for non financial risk :
RA adjusts PV to reflect the compensation the entity requires for bearing uncertainty about the amount and timing of cash flows that arise from non-financial risks.
Risk Adjustment for reinsurance held :
Amount of risk that an entity transfers to a reinsurer.
206
*** IMPORTANT ***
Compare 2 quota share treaties
- Quota share with fixed ceded %
- Quota share with variable ceded %
based on
- Accounting
- Presence in income financial statement
- Potential risk
Fixed :
- Accounting :
Simple, single ceded prem and loss for entire portfolio
- Financial Statement :
Shrinks entire portfolio by a fixed scale so all ratios are staying the same
- Risk :
Protected proportionally, if a specific class of business sucks, u are tied at a constant rate
Variable :
- Accounting :
Complex. Require policy by policy accounting. Increase the risk of error and audit burden.
- Financial Statement :
Net result can be pretty different from gross since % change. Safer net income but higher ceded commission
- Risk :
Keep the best and ceded the rest. If anti selection, reinsurer will raise prices or cancel treaty
207
*** IMPORTANT ***
Capital Available
- Formula (including limits)
- Common Equity components (8)
- Regulatory Adjustment components (13)
* Just able to recognize them
Capital Available = Common Equity + B + C
+ Non Controlling Interest
+/- Regulatory Adjustment
Apply Limits :
- B + C < 40% * (Total - AOCI)
- C < 7% * (Total - AOCI)
Common Equity Component :
- Common Share
- Accumulated Other Comprehensive Income
- Nuclear And Other Reserve
- Retained Earnings
- Other Capital
- Contributed Surplus
- Share Premium
- Residual Interest (Non-Stock)
Regulatory Adjustment Components :
- Interests / loans to subsidiaries
- Unsecured unregistered reinsurance exposures
- Earthquake premium reserve not used as financial resources
- Insurance acquisition cash flows
- Accumulated other comprehensive income on cash flow hedges
- Goodwill and other assets
- Deferred tax assets
- Cumulative gains and losses due to change in credit risk
- Defined benefit pension fund
- Investments in own instruments (treasury)
- Reciprocal cross holdings in common share
+ CSM
-/+ Adjustment to owner-occupied property valuations
208
*** IMPORTANT ***
Capital Required
- Formula
Capital Required = Insurance Risk
+ Credit Risk
+ Market Risk
+ Operational Risk
- Diversification Credit
*Be able to calculate each risk margin to get capital required
209
*** IMPORTANT ***
Capital Required
- Insurance Risk margin
- Each component margin formulas (4)
Insurance Risk = LIC margin
+ Unexpired coverage including catastrophes
+ Unregistered reinsurance
+ Earthquake and Nuclear Catastrophes
LIC MARGIN :
Margin = 1,1 * Risk Factor * (Net LIC issued excl RA - AIC held excl RA)
* If no reinsurance involved, AIC held = 0
UNEXPIRE COV MARGIN :
Margin = Risk Factor * max (Net Unexpired Coverage, 30% * Net Premium received in past 12 months)
UNREGISTERED REINSURANCE :
Margin = 20% * (A* + AIC + Cash Outflows fund withheld - Receivables)
where A* = ARC for reinsurance + PAA LRC + GMM LRC - GMM ARC
*ALWAYS CHECK FOR LETTERS OF CREDIT LIMIT BEFORE CALCULATING DEDUCTION
EARTHQUAKE COMPONENT :
Margin = 1,25 * (Premium Reserve + Risk Exposure - Financial Resource)
where Risk Exposure = (EAST PML500^1,5 + WEST PML500^1,5)^(1/1,5)
Financial Resource = Capital/Surplus + Reinsurance Coverage + Premium Reserve + Capital Market Financing
NUCLEAR COMPONENT :
Margin = 1,25* (Premium Received - Premium Paid - Commission)
210
*** IMPORTANT ***
Deduction for unregistered reinsurance from capital available or required (depending on +/-)
Deduction for unregistered reinsurance = (A* + AIC + Cash Outflows fund withheld)
- (Receivables
+ Non-owned Deposits RSA
+ Premiums payable non-owned deposit
+ Reinsurance Collateral Funds held
+ Letters of Credit (LIMITS = 30% * ARC + AIC))
where A* = ARC for reinsurance + PAA LRC + GMM LRC - GMM ARC
211
What is the meaning of a factor of change for risk adjustment ?
Means the regulator wants your RA to be X% higher than what you reported in your IFRS 17 Risk Adjustment.
212
*** IMPORTANT ***
Capital Required
- Credit Risk margin
- Each component margin formulas
Credit Risk = Balance Sheet Assets + Off-Balance Sheet Assets + Collaterals and Guarantees
For each component, the margin =
SUM (Risk Factor * Credit Conversion Factor * (Credit Equivalent Amount - Eligible Collateral)) for each asset.
213
*** IMPORTANT ***
Capital Required
- Market Risk margin
- Each component margin formulas
Market Risk = Interest Rate Risk
+ Equity Risk
+ Right-of-use assets Risk (GIVEN)
+ Real Estate Risk
+ Foreign Exchange Risk
+ Other Market Risk (GIVEN)
INTEREST RATE :
Interest Rate Margin = | (Asset Duration x Rate Shock x Asset Value - Liability Duration x Rate Shock x Liability Value) |
*For each asset that are interest rate sensitive, multiply shock, duration and value and sum them. Same thing for liability
*Rate Shock = 1,25%
EQUITY :
Margin = 30% * (Common Shares + Joint Ventures + Futures + Forwards + Swaps)
REAL ESTATE :
Margin = Sum (Value of Property x Risk Factor) for each property
* Risk Factor Owner-Occupied Property = 10%
* Risk Factor Investment Property = 20%
FOREIGN :
Margin = 10% x max (Long Position; Short Position)
* Long Position = Foreign Assets - Foreign Liabilities
214
*** IMPORTANT ***
Capital Required
- Operational Risk margin
- A and B formulas
Operation Risk = min (30% * (Insurance Risk + Market Risk + Credit Risk); A + B)
A = Risk Factor * (Insurance Risk + Market Risk + Credit Risk)
+ Risk Factor * Direct Written Premium
+ Risk Factor * Premium Ceded
+ Risk Factor * Premium Assumed
+ Risk Factor * Growth above 20% * (Direct Premium + Assumed Premium) / (1 + Growth)
B = Risk Factor * Assumed Written Premium intra-group pooling
+ Risk Factor * Ceded Written Premium intra-group pooling
215
*** IMPORTANT ***
Capital Required
- Diversification Credit formula
Diversification Credit = Insurance Risk + Market Risk + Credit Risk - SQT ( Insurance Risk ^2 + (Market Risk + Credit Risk)^2 + 2 * Conversion Factor * Insurance Risk * Market Risk * Credit Risk)
216
Complete the blanks :
Scope
I have examined the policy liabilities of [Company Name] for its consolidated balance sheet as at December 31, 202X, and their changes in the consolidated statement of income for the year then ended.
My examination included the insurance contract liabilities and reinsurance contract assets, including the Liability for Incurred Claims (LIC) and the Liability for Remaining Coverage (LRC). I have also examined the related disclosures in the notes to the financial statements.
Data and Methodology
I have relied upon data provided by the Company and have performed such tests as I considered necessary to satisfy myself as to the ____________________ of the data used in the valuation.
The valuation conforms to ____________________ in Canada, which includes the selection of appropriate assumptions and methods and the consideration of materiality.
Opinion
In my opinion:
The data are ___________________ for the purpose of the valuation;
The methods and assumptions used are appropriate to ________________ of the Company and the insurance and reinsurance contracts; and
The amount of policy liabilities, as determined in accordance with International Financial Reporting Standard 17 (IFRS 17), makes appropriate provision for all _________________ and is appropriate for inclusion in the __________________.
[Signature]
[Actuary's Name], FCIA
Appointed Actuary
[Date of Report]
Scope
I have examined the policy liabilities of [Company Name] for its consolidated balance sheet as at December 31, 202X, and their changes in the consolidated statement of income for the year then ended.
My examination included the insurance contract liabilities and reinsurance contract assets, including the Liability for Incurred Claims (LIC) and the Liability for Remaining Coverage (LRC). I have also examined the related disclosures in the notes to the financial statements.
Data and Methodology
I have relied upon data provided by the Company and have performed such tests as I considered necessary to satisfy myself as to the accuracy and completeness of the data used in the valuation.
The valuation conforms to accepted actuarial practice in Canada, which includes the selection of appropriate assumptions and methods and the consideration of materiality.
Opinion
In my opinion:
The data are sufficient and reliable for the purpose of the valuation;
The methods and assumptions used are appropriate to the circumstances of the Company and the insurance and reinsurance contracts; and
The amount of policy liabilities, as determined in accordance with International Financial Reporting Standard 17 (IFRS 17), makes appropriate provision for all policy obligations and is appropriate for inclusion in the financial statements.
[Signature]
[Actuary's Name], FCIA
Appointed Actuary
[Date of Report]
Exam 6C
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