1 Casualty Loss Reserve Seminar Claudette Cantin, FCIA, FCAS, MAAA Munich Reinsurance Company of Canada September 14, 2004 Las Vegas Session 7 Loss Reserve.

1

Casualty Loss Reserve Seminar

Claudette Cantin, FCIA, FCAS, MAAAMunich Reinsurance Company of Canada

September 14, 2004Las Vegas

Session 7 Loss Reserve Discounting

Canadian and US Perspectives

2

Overview

1. Background2. CIA standards3. Methodology and Assumptions 4. What Changed?5. Impact of discounting 2003 6. Going Forward

3

Background

Accepted Actuarial Practice requires that valuation of policy liabilities reflects the time value of

money Until 2003, The Office of the Superintendent of Financial Institutions (OSFI) directed that valuation not reflect the time value of money for P&C For income tax purposes, reserves have been discounted for some time

4

Background

In 1996, OSFI discussion paper - Reporting for Actuarial Liabilities for P&C “OSFI will no longer prohibit discounting of actuarial liabilities once …”

CIA finalizes CSOP CIA develops further guidance

5

Background

April 1999, CIA Educational Note on Discounting December 1, 2002, CIA CSOP General Standards January 1, 2003, CSOP Practice-Specific Standards for Insurers December 31, 2003, financial statements included discounted policy liabilities

6

CIA Standards

CSOP 2220.01 – “The amount of claims liabilities should be equal to the present value , at the balance sheet date , of cash flow on account of claims (and related expenses and taxes) incurred before that date.”

7

CIA Standards

CSOP 2230.01 – “The amount of premium liabilities (after deducting any deferred policy acquisition expense asset) should be equal to the present value, at the balance sheet date, of cash flow on account of premium development and of the claims, expenses and taxes to be incurred after that date on account of the policies in force at that date or an earlier date.”

8

CIA Standards

CSOP 2240.01 – “The expected investment return rate for calculation of the present value of cash flow is that to be earned on the assets which supports the policy liabilities.”

CSOP 2250 deals with the selection of a margin for adverse deviation for a valuation of policy liabilities.

9

Methodology and Assumptions

Undiscounted liabilities are calculated by line by year – gross, ceded and net Then the present value (PV) of these liabilities is calculated And provisions for adverse deviations (PfAD) are added

10

Methodology and Assumptions

Three major assumptions for discounting Payment pattern Discount rate Margin for adverse deviation

(MfAD) to determine the PfADs

11

Payment Patterns

From company’s historical data – very long tail may need more judgmentMay vary by year i.e. changes in legislation, reinsurance – not commonly done Vary by lines of business, usually using the same groupings as for the valuation of undiscounted

12

Payment Patterns

Should be consistent with assumptions in the valuation of undiscountedPayment patterns are updated as claim

experience matures/changesGross, Ceded and Net

13

Discount Rate

CSOP 2240 – “…..on the assets which support the policy liabilities.”

CSOP 2240 lists considerations in determining return rate and includes:

method of valuing assets. allocation of assets among lines of business. return on the assets at the balance sheet date and

yield on asset acquire after that date. capital gains or loss. investment expenses, loss from default.

14

Discount Rate

Common to use a single rate for all lines, all years

Portfolio yield rate used for both premium and claims liabilities

Must define which assets support the liabilities Common practice to use the bond portfolio

if sufficient to cover all net policy liabilities

15

Discount Rate

Duration mismatch and use of new premiums Appropriate rate for ceded liabilities

Portfolio yield? Risk free rate ? Rate used by assuming company ?

16

Provision for Adverse Deviations

CSOP 1740.07 “The purpose of a provision is to promote financial security.CSOP 1740.04 – “The amount of the provision should …. in the case of a provision in respect with uncertainty in assumptions, result from selection of assumptions which are more conservative than best estimate assumptions.”CSOP 1740.13 – “If assumptions could be made with complete confidence, if there were no statistical fluctuations, and if data had no defect, then there would be no need for a provision.”

17

Margin for Adverse Deviations

CSOP 2250.04 “The selected margin should varybetween premium liabilities and claim

liabilities,among lines of business, andamong accident years, policy years or

underwriting years, as the case may be, according to how those considerations so

vary.”

18

Margin for Adverse Deviations

Three types Claims Development Recovery from reinsurance ceded Investment rate of returns

Ranges Claims : 2.5% to 15% of PV of claims liabilities Reinsurance : 0% to 15% of PV of ceded liabilities Rate of Returns : 50 to 200 basis points

19

Margin for Adverse DeviationsClaims Development

Past or expected instability in the dataChanges in reserving practices, mix of

business, insufficient details or lack of credibility

Around 5% for short tail, 7.5% to 15% for auto AB and BI and 10% GL,E&O etc

20

Margin for Adverse DeviationsRecovery From Reinsurance

History of claims and coverage dispute with reinsurers

Quality of reinsurers, affiliated, unregisteredRatio of ceded reinsuranceNot the same as provision for existing

disputeUsually around 0% to 5%

21

Margin for Adverse DeviationsReturn Rate

Reduction of the selected investment rate of return

Depends on quality of assets, concentration and types of assets

Economic environment, liquidity of assetsMatching of duration, length and predictability of claim payment

22

What Changed ?

Qualification removed from actuarial opinion

Discounting assumptions should be explicitly explained Restatement of prior year-end

23

What Changed ?

Disclosure in the Annual Statement Discount rate and its selection (as a

minimum) “Pure” discount amount PfADs Measurement uncertainty attached to

PfADs

24

What Changed ?

Additional exhibits to show more information on discounted basis

Unpaid Claims & Loss Ratio Analysis Exhibit Runoff Exhibit has to show investment

income (p. 60.41) earned on unpaid claims during the year (unwinding)

25

What Changed?

CIA Ed Note on Runoff - “For the purposes of the appointed actuary’s report, it would be useful to identify the components of the runoff (i.e. the contribution of the undiscounted claims liabilities,changes in the discount rate, payout patterns and changes in the provision for adverse deviations)”Not commonly done

26

Impact of Discounting on 2003Total Industry

From OSFI presentation to Canadian Insurance Accountants Association April 2004

Net unpaid claims 0.3%Capital 0.4%MCT – Canadian (0.1%)MCT – Foreign 8.0%MCT – All 1.0%Expected results was 1 ½% reduction on net claims liabilities and 8 to 10 points on MCT (based on 2001 data)

27

Impact of Discounting on 2003Based on 10 of the Largest Companies

From OSFI presentation to Canadian Insurance Accountants Association April 2004

$ Millions

Total Undiscounted unpaid claims 10,269 Present Value of unpaid claims 9,114 Difference 1,155 % Change 11.2%

28

Impact of Discounting on 2003Based on 10 of the Largest Companies

From OSFI presentation to Canadian Insurance Accountants Association April 2004

Change as of % of Undiscounted Claims

Liability 14.5%Auto BI 11.4%Auto AB 10.9%Personal Property 4.3%Auto PD 3.8%Commercial Property 3.6%

Total All Lines 11.2%

29

Impact of Discounting on 2003

From OSFI presentation to Canadian Insurance Accountants Association April 2004

The range of changes in PV (before PfADs) Low 6.9% largely personal lines High 13.4% largely commercial lines Overall 11.2%

30

Impact of Discounting on 2003Based on 10 of the Largest Companies

From OSFI presentation to Canadian Insurance Accountants Association April 2004

% of$ Millions Undscntd

Undiscounted Unpaid Claims 10,269

Present Value 1,155 11.2%

PfAD - Claims 934 9.1%PfAD - Reinsurance 24 0.2%PfAD - Interest Rate 172 1.7%Total PfAD 1,130 Discounted Unpaid Claims 10,244 99.8%

Impact of discounting - 10 companies 0.2%Impact of discounting - Industry Total 0.3%

31

Going ForwardCIA Survey

Discounting had been done for many yearsLook at ranges of practiceSeek input on needs for future guidanceCeded liabilities ???Issuing revised Educational Note (previous Note dealt with net liabilities only) Narrowing range of practicesBetter consensus amongst actuaries

32

Going Forward

Discounting and Canadian GAAP ??Changes in CICA handbookIndustry practice is NOT GAAPPresent value is an acceptable measurement but

discount rate ? Portfolio or risk freePfAD’s ?? Real liabilities or contingencies? Why not in undiscounted?

Integration with IFRSUpdate ACG-03 to permit “discounting” using CIA methods as an acceptable accounting treatment

33

Questions ?

Thank You

Loss Reserve Discounting Canadian Perspectives