The Actuarial Role on Risk-Focused Examinations Rebecca Freitag, FCAS, MAAA Merlinos & Associates IASA GEORGIA CHAPTER Fall Education Conference October.

The Actuarial Roleon Risk-Focused Examinations

Rebecca Freitag, FCAS, MAAAMerlinos & Associates

IASA GEORGIA CHAPTER Fall Education ConferenceOctober 2015

Kirk Braunius, ASA, MAAAMerlinos & Associates

WHAT IS A “RISK-FOCUSED” EXAMINATION?

2

“The primary purpose of a risk-focused examination is to review and evaluate an insurer’s business processes and controls . . . to assist in assessing and monitoring its current financial condition and prospective solvency. . . . As part of this process, the examiner identifies and evaluates risks that could cause an insurer’s statements to be misstated both currently and prospectively.”

2015 NAIC Financial Condition Examiners Handbook, Preamble

RISK-FOCUSED METHODOLOGY

3

More clearly directs financial statement verification to only those key accounts and control objectives of those accounts with the greatest risk.

Directs the examination focus to the identification of significant strategic and operating risks, investigation of mitigation strategies for those risks, and recommendations for enhancements where appropriate to reduce residual risks to a more acceptable level.

2015 NAIC Financial Condition Examiners Handbook

TYPES OF INSURANCE EXAMINATIONS

4

Financial Condition Examination Market Conduct Examination

Actuaries are requested to assist on both types

WHAT IS AN ACTUARY?

5

“A person whose job it is to tell insurance companies how much they should charge people for insurance based on risks; a person who calculates insurance and annuity premiums, reserves, and dividends.”

noun ac·tu·ary \ˈak-chə-ˌwer-ē, -shə-, -ˌwe-rē-\

WHAT IS AN ACTUARY?

6

“Part super-hero. Part fortune-teller. Part trusted advisor. We help organizations plan for the future and protect themselves from loss.”

BeAnActuary.org

WHAT ACTUARIES DO…

7

Ratemaking:

TRADITIONAL

insuranceself-insurancecaptivesaudit support

Reserving:

analysiscompliance

WHAT ACTUARIES DO…

8

Due Diligence/Valuations Reinsurance Program Development, Negotiations,

Risk Transfer Enterprise Risk Management/Own Risk Self-

Assessment Liquidations and Rehabilitations Product Management Exposure Monitoring Predictive Analytics Litigation Support Public Policy Analysis Strategic Planning Systems Implementation/Conversion/Statistical

Reporting Business Plans/Feasibility Studies

PHASES OF A RISK-FOCUSED EXAMINATION

9

PHASE 1

Understand the Company and Identify Key Functional Activities to be Reviewed

PHASE 2

Identify and Assess Inherent Risk in Activities

PHASE 3

Identify and Evaluate Risk Mitigation Strategies (Controls)

PHASE 4

Determine Residual Risk

PHASE 5

Establish/Conduct Detail Examination Procedures

PHASE 6

Update Prioritization and Supervisory Plan

PHASE 7

Draft Examination Report and Management Letter

HOW ACTUARIES ASSIST ON RISK-FOCUSED FINANCIAL CONDITION EXAMINATIONS

10

Reserve Adequacy Underwriting and Pricing

Strategy/Quality Reserve Data Appropriateness/Adequacy of

Reinsurance Program Reinsurance Reporting and Collectability

Of 10 “Critical Risk Categories,” P&C/health actuaries are frequently involved in 5:

RESERVE ADEQUACY EXAMPLE

11

Prior to risk-focused exams…

Actuary would perform an independent analysis on the reserves in the Annual Statement, Page 3, Lines 1 and 3, and Schedule P

RESERVE ADEQUACY EXAMPLE

12

In Phase 2 of the risk-focused exam process, an actuary may review… Annual and Quarterly Statements Management Discussion and Analysis Statement of Actuarial Opinion Actuarial Opinion Summary High-level review of report supporting the

Actuarial Opinion Comments by External Auditor on Reasonability

of Reserves Prior Examination Report and/or Letter to

Management, as well as any company responses A.M. Best or other analytical summaries Publicly-available information

PHASE 2:

DETERMINE

INHERENT RISKS

RESERVE ADEQUACY EXAMPLE

13

In addition, the following may influence the actuary’s determination of inherent risk… Conduct/attend interviews with Company

personnel Are reserves primarily for long or short-tailed

lines? Are any particularly risky or volatile lines involved?

Is reserve development historically favorable, adverse, or neutral?

What is the relationship of reserves to surplus? Does the actuarial report appear to be well-

documented? Does the Company book reserves close to the

Appointed Actuary’s central estimate? If not, how material is the deviation?

PHASE 2:

DETERMINE

INHERENT RISKS

RESERVE ADEQUACY EXAMPLE

14

Some controls/processes which Companies may have in place regarding reserves… Is the carried reserve based on an actuarial

analysis? Does the actuary producing this analysis

communicate with other departments to stay informed of any operational or industry changes that may impact the analysis? If so, is there any documentation of these meetings?

Is the analysis technically and/or peer-reviewed? Who makes the decision on what reserve

amount is carried? Exchange of ideas between the outside and/or

auditor actuary and management.

PHASE 3: IDENTIFY

AND EVALUATE

RISK MITIGATION STRATEGIES

RESERVE ADEQUACY EXAMPLE

15

How does management use the actuarial analysis to determine the carried reserve? Are there procedures, committees, controls in place? If management deviates materially from the Appointed Actuary’s central estimate, is there a quantitative analysis supporting this deviation?

How involved/knowledgeable is the Audit Committee and/or the Board?

Some controls/processes which Companies may have in place regarding reserves… (more)

Actuaries may advise Departments of Insurance regarding control recommendations.

PHASE 3: IDENTIFY

AND EVALUATE

RISK MITIGATION STRATEGIES

RESERVE ADEQUACY EXAMPLE

16

Review any Sarbanes-Oxley, Model Audit Review, or other similar documentation provided by the Company processes and controls

Review auditor testing of controls (internal audit or external auditors)

Make direct inquiries of Company personnel

In determining and reviewing the controls in place, actuaries may…

PHASE 3: IDENTIFY

AND EVALUATE

RISK MITIGATION STRATEGIES

RESERVE ADEQUACY EXAMPLE

17

PHASE 3: IDENTIFY

AND EVALUATE

RISK MITIGATION STRATEGIES

Q:

What can a Company do to enable Phase 3 to proceed more smoothly?

A:

Document processes and have documentation and evidence of controls readily available.

RESERVE ADEQUACY EXAMPLE

18

At the end of this process, the actuaries in coordination with the exam team determine the strength of the risk mitigation presented by the controls with two primary questions:

PHASE 3: IDENTIFY

AND EVALUATE

RISK MITIGATION STRATEGIES

Are the controls effectively designed to mitigate the risk?

Actuaries (or other examiners) occasionally issue

recommendations related to the design or operation of controls.

Are the controls operating effectively?

RESERVE ADEQUACY EXAMPLE

19

Residual risk is classified as low, moderate, or high

It is determined somewhat formulaically based on inherent risk and control strength, with some room for judgment

Moderate or high risk results in some substantive (“detail”) procedures

PHASE 4: DETERMINE RESIDUAL

RISK

RESERVE ADEQUACY EXAMPLE

20

As examinations evolved, the focus moved from independent estimate to a review of the Appointed Actuary’s work, when possible

As the risk-focused examination process evolved even further, the focus moved from reviewing the Appointed Actuary’s work to reviewing the Company’s own actuarial support for the carried reserve

PHASE 5: ESTABLISH/

CONDUCT DETAIL EXAMINATION PROCEDURES

RESERVE ADEQUACY EXAMPLE

21

Q:

How can Phase 5 proceed more efficiently for my Company?

A:

The Company actuaries’ work should be organized and well-documented

Management deviations from the Company actuaries’ (or Appointed Actuary) central estimate should be documented and quantitatively supported when possible

PHASE 5: ESTABLISH/

CONDUCT DETAIL EXAMINATION PROCEDURES

RESERVE ADEQUACY EXAMPLE

22

Review the Appointed Actuary’s report Review the external auditor or external

consultant’s actuarial analysis (if performed)

Sensitivity test some inputs and selections in the actuarial or management support

Produce independent analysis on some portions of the reserve

Produce independent analysis on the majority or the entirety of the reserve

PHASE 5: ESTABLISH/

CONDUCT DETAIL EXAMINATION PROCEDURES

If needed, examination actuaries may:

RESERVE ADEQUACY EXAMPLE

23

PHASE 5: ESTABLISH/

CONDUCT DETAIL EXAMINATION PROCEDURES

The examining actuary will inform the regulator of any recommendations or concerns

OTHER RISKS

24

Pricing Reinsurance Death, Disability, and Retirement

Reserve Unearned Premium Reserves on Long-

Duration Contracts

MARKET CONDUCT EXAMINATIONS:ACTUARIAL INVOLVEMENT

25

Review of premium reporting by line Price optimization Industries or lines in which there

appear to be discriminatory or unfair pricing

Confirmation that filed rate are being followed correctly

QUESTIONS?

26

Thank

you!

The Actuarial Roleon Risk-Focused Examinations

IASA GEORGIA CHAPTER Fall Education ConferenceOctober 2015

Rebecca Freitag, FCAS, MAAAMerlinos & AssociatesKirk Braunius, ASA, MAAAMerlinos & Associates