Practical Ideas for AuG-43 Success: How to Enjoy the Experience

1. Canadian Institute of Actuaries L’Institut canadien des actuaires 2009 Annual Meeting ●Assembléeannuelle 2009 Halifax, Nova Scotia ● Halifax (Nouvelle-Écosse)

2. PD-7 Audit Standard AuG-43 Dean Michael Ron McKellar June 25, 2009 2009 Annual Meeting Assembléeannuelle 2009

3. Practical Ideas for AuG-43 Success … and how to enjoy the experience Dean Michael Manulife Financial 2009 Annual Meeting Assembléeannuelle 2009

4. AuG-43 Overview Who: Several levels of insurance company External Auditor What: Spot-checking of policy reserves When: Annually with tasks throughout year Why: Ensure no material misrepresentation of financial statement policy reserves Actuarial reserves are hardest item to check How: Verify valuation system assumptions against AAR 2009 Annual Meeting Assembléeannuelle 2009

5. Attitudes Towards Audit Audit success mirrors audit attitude Alternate views: “audits are core valuable functions” or “audits keep me from my real work” 2009 Annual Meeting Assembléeannuelle 2009

6. Intent of Valuation Actuary Valuation Actuary’s intent is that: Reserves will be calculated using specific assumptions, methods, and data AuG-43 checks this for a random sample of policies AuG-43 allows for proof of intent of Valuation Actuary Expressed in Appointed Actuary’s Report Reflected in valuation system Assumptions Calculations 2009 Annual Meeting Assembléeannuelle 2009

7. Create Great Relationship with Your Auditor Understand their requirements Find out their resource constraints priorities and preferences staffing levels during year Refrain from blame game Discuss and work around bottlenecks Talk with the external auditor very early on and periodically 2009 Annual Meeting Assembléeannuelle 2009

8. Understand the Auditor’s Perspective Requirements for success all auditor’s material concerns alleviated regarding upcoming year-end policy reserves meet deadline for auditor’s signoff Constraints staffing bottlenecks of auditor staffing levels of expertise will vary Solutions provide full clear documentation be available to provide detailed explanations to junior audit staff 2009 Annual Meeting Assembléeannuelle 2009

9. 2009 Annual Meeting Assemblée annuelle 2009 AuG-43 Annual Timeline

10. 2009 Annual Meeting Assemblée annuelle 2009 AuG-43 Annual Timeline

11. 2009 Annual Meeting Assemblée annuelle 2009 AuG-43 Annual Timeline

12. Policy and Plan Selection Work with auditor negotiate number of policies to spot-check, whether full or limited checks policy selection must be by external auditor Choose among largest product groups then select specific product then give auditor inforce policy list for this product Ensure policy selection is random don’t just choose biggest policy - it won’t be representative (outlier) 2009 Annual Meeting Assembléeannuelle 2009

13. Full versus Limited Spot-checks Limited Spot-checks to prove: assumptions policy data from admin systems and contract First-Principle Spot-checks also prove: reserve calculation is right build spreadsheet calculation independent of valuation system show that both calculate the same policy reserve within tolerance stated as $ and % of reserve threshold send auditor spreadsheet file 2009 Annual Meeting Assembléeannuelle 2009

14. Criteria for Type of Spot-check Limited Spot-checks: if full spot-check was done in recent year if more confident that product is valued correctly First-Principle Spot-checks: if new product or feature if prior year’s testing revealed issues if degree of risk is higher bigger block 2009 Annual Meeting Assembléeannuelle 2009

15. Data Gathering Make list of departmental contacts: policy admin: screenshots as of valuation date, policy contract reinsurance admin: for all applicable treaties distribution: for field force compensation include all compensation costs Inform them that you will send them requests Send requests early as soon as policy sample is chosen follow up in a structured way 2009 Annual Meeting Assembléeannuelle 2009

16. What if You Find a Match? Source Independence You may be checking an item to itself For instance a lapse or mortality table found on LAN matching an AXIS file Must verify that the file is as intended by the valuation actuary “should be the right one since it matches” means “still needs to be proven” 2009 Annual Meeting Assembléeannuelle 2009

17. What if You Find an Error? Congratulations knowing your problem is halfway to solving it Check AAR timing has an assumption change after the AAR affected the valuation system? obtain this year’s assumption change memos wouldn’t be in annual AAR yet Talk with Valuation Actuary Calculate impact of error on aggregate reserves for block affected Document in summary of findings binder for the policy 2009 Annual Meeting Assembléeannuelle 2009

18. Run it Like a Project Allocate enough resources for full year Schedule when each policy will be done (sent to auditor) Communicate timeline with auditor Post-mortem and discuss with auditor 2009 Annual Meeting Assembléeannuelle 2009

19. Run it Like a Project Track progress throughout the year make this detailed: track each policy and its components limited checks should be much faster than first-principle checks Build into an assembly line remove sequential lags manage cues at each station 2009 Annual Meeting Assembléeannuelle 2009

20. Communicate With Many Groups Internal Audit External Audit Valuation Actuary Staff doing work training tracking Other departments and roles 2009 Annual Meeting Assembléeannuelle 2009

21. Contents of AuG-43 Policy Binders For each policy spot-checked: Binder cover: product, policy #, CGAAP or USGAAP, date Signoff page and summary of results product name, results of testing, valuation date if first-principles check numerical result of tolerance check if errors found state nature, direction, size Policy information section screen shots from admin system 2009 Annual Meeting Assembléeannuelle 2009

22. Contents of AuG-43 Policy Binders For each policy spot-checked: Assumptions with one section for each reserve component pertinent AAR page – highlight applicable section for policy valuation system screenshots of assumptions line these up and show they match Policy contract Reinsurance Treaties Send to auditor and keep a copy 2009 Annual Meeting Assembléeannuelle 2009

23. 2009 Annual Meeting Assemblée annuelle 2009 AuG-43 Message Flow

24. Multi-Year Plan Create strategy to cover most of block in X years Show current state based on past years’ work Increase % spot-checked of Total Business Unit portfolio reserve Include policies from new products Give document on products getting valuation systems converted $ amounts of conversion impacts on reserves Test the system that will be used at year-end production run Don’t test stale system for first-principle checks 2009 Annual Meeting Assembléeannuelle 2009

25. Developments in AuG-43 Requirement will not disappear under IFRS policy reserves and exposure are too big not to verify Spot-checking is a basic audit tool 2009 Annual Meeting Assembléeannuelle 2009

26. Reframe AuG-43 Purpose Can use this to improve valuation system and AAR Catch errors before they get too big on growing portfolio Can find errors that look okay in aggregate Build into regular cycle Have it affect (within a regular process): AAR production add enough detail to confirm assumptions spot-checked Requirement isn’t to save paper since could be electronic Instead of stating average rates, state rates for each block Assumption changes Confirm early findings to valuation actuary Allows proactive assumption changes early enough where errors found Can then state in binder’s summary that this has been reflected 2009 Annual Meeting Assembléeannuelle 2009

27. Size of Sample Set and Composition Assess your valuation process How much of current inforce reserve has been positively spot-checked? Choose from areas of maximum exposure and uncertainty Watch for new products especially if they’re growing 2009 Annual Meeting Assembléeannuelle 2009

28. USGAAP Spot-check same policy group for both CGAAP and USGAAP Policy reserve spot-check depends on FAS 2009 Annual Meeting Assembléeannuelle 2009

29. Share the Joy … set up all these items and enjoy your team’s AuG-43 success! 2009 Annual Meeting Assembléeannuelle 2009

30. The Auditor’s perspective on AuG-43 … how to keep your auditor happy Ron McKellar Manulife Financial 2009 Annual Meeting Assembléeannuelle 2009

31. Nature of “normal” financial statement entries: High volume: Each transaction has limited impact Controls around each process: Approvals, exception reporting Based on “facts”: Little judgment required 2009 Annual Meeting Assembléeannuelle 2009

32. Auditing the Actuarial world Low volume: Reserves run monthly/quarterly Assumptions reviewed annually High impact Some controls are more subjective: Movement review Based on both “facts” and assumptions 2009 Annual Meeting Assembléeannuelle 2009

33. What could go wrong? Data: Is it all there? Is it correct? Assumptions: Are you using what you think you’re using? Calculators: Are they working as you expect? 2009 Annual Meeting Assembléeannuelle 2009

34. AuG-43 Pre-AuG-43: Peer Review AuG-43 strengthened standards: Auditor must retain actuarial support to corroborate work of Appointed Actuary Audit test actuarial calculations 2009 Annual Meeting Assembléeannuelle 2009

35. Spot Checking issues Data: Sample selection: Coverage Selection bias Obtain from raw sources (contract) Non-standard options Riders Policy provisions 2009 Annual Meeting Assembléeannuelle 2009

36. Spot Checking issues Calculators: AXIS: Are switches correct? Spot-checking model from first principles Reinsurance 2009 Annual Meeting Assembléeannuelle 2009 Spot Checking issues

37. Spot Checking issues Stochastic reserves Aggregation of policy reserves Aggregate reserves “Manual” reserves Spreadsheet calculators 2009 Annual Meeting Assembléeannuelle 2009 Non-standard situations

38. Spot Checking issues Plan of action for complete coverage Complete documentation As issues arise, communicate Appropriate resources to spot-checking 2009 Annual Meeting Assembléeannuelle 2009 How to make my life easy

39. Spot Checking issues AuG-43 is a fact of life Provides high level assurance of reserve appropriateness Planning and communication is key to using this tool effectively Highly interdependent so enjoy the interactions Remember its value – you’ll improve or vindicate and both feel good Organize it all early and you’ll feel better 2009 Annual Meeting Assembléeannuelle 2009 PD-7 Audit Standard AuG-43 Summary

40. Spot Checking issues Questions? 2009 Annual Meeting Assembléeannuelle 2009