P&C Loss Reserve Discounting Canadian Perspective

1. P&C Loss Reserve DiscountingCanadian Perspective Spring Meeting Quebec City June 18, 2008 Claudette Cantin

2. Overview • Background • Implementation • Methodology/Assumptions • CICA New Accounting Standards (01/01/2007) • Challenges • Impact of IFRS on Canadian Discounted Reporting

3. Background • Statutory reporting follows Canadian GAAP • Accepted Actuarial Practice requires policy liabilities to be calculated on a present value basis • Until 2003, the Office of the Superintendent of Financial Institutions (OSFI) directed that valuation not reflect the time value of money for P&C

4. Background • Recommendations for Property – Casualty Insurance Company Financial Reporting effective January 1990 (Section 5.04) • “it is generally accepted actuarial practice to value liabilities as the present value of the payments….. but some jurisdictions require liabilities to be undiscounted” • “Where there is such a requirement, the recommendation …… to establish a present value provision does not apply to the valuation of liabilities in government financial statements and because it is desirable that liabilities be reported the same way in both government and published financial statements, it likewise does not apply to the valuation of liabilities in published financial statements.”

5. Background – Time Line • Throughout the 1990’s • development of guidance notes and actuarial standards of practice • consultation between regulators, industry, CIA • In 1996, the OSFI’s discussion paper - Reporting for Actuarial Liabilities for P&C states • “OSFI will no longer prohibit discounting of actuarial liabilities once…” • CIA finalizes its Consolidated Standards of Practice (CSOP) • CIA develops further guidance on discounting liabilities • April 1999, CIA Educational Note on Discounting • 2001, OSFI announced implementation of discounted reporting

6. Background - Arguments Major Arguments Against Discounting: Major Arguments for Discounting: Additional requirements minimal as practice already in place Reserves always only estimates International standards pointing in that direction Conform with accepted actuarial practice • Compliance costs vs. benefits • Distortion to the financial statements • Canada, an anomaly relative to international standard developments • Be part of a comprehensive review of the overall accounting framework • Piece meal approach to regulatory review process • No actual relationship between values of liabilities and investments and no efforts to match investments to liabilities

7. Background – Time Line • December 1, 2002, CIA CSOP General Standards • January 1, 2003, CSOP Practice-Specific Standards for Insurers • January 1, 2003, financial statements included discounted policy liabilities • Year-end 2003 new Minimum Capital Test (MCT) is implemented • January 1, 2007, CICA 3855 – Financial Instruments – Recognition and measurement

8. ImplementationWhat Changed? • Restatement of prior year-end • Qualification removed from actuarial opinion • Disclosure in the Annual Statement • Discounting assumptions should be explicitly explained in the AA report

9. ImplementationWhat 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) • 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)”

10. Implementation Issues • Volatility in results • Reporting basis different from parent • Comparability of industry results • Impact on Capital Requirements • Ceded liabilities

11. Methodology/Assumptions • SOP 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.” • Three major assumptions for discounting • Payment pattern • Discount rate • Margin for adverse deviation (MfAD) to determine the PfADs • By line of business by year – gross, ceded and net

12. CIA Standards of Practice • SOP paragraph 2240.01 - “The expected investment return rate is that to be earned on the assets which support the policy liabilities. It depends on • the method of valuing assets and reporting investment income, • the allocation of those assets and that income among lines of business,……” • Common practice – use same portfolio yield rate for all lines • Bond portfolio usually sufficient to support net liabilities

13. Methodology/Assumptions - PfAD • 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 2250.04 - “The selected margin should vary between premium liabilities and claim liabilities, among lines of business, and among accident years, policy years or underwriting years, as the case may be, according to how those considerations so vary.”

14. Implementation Issues • Discounting and Canadian GAAP? • Present value is an acceptable measurement but • Discount rate ? Portfolio or risk free? • Pfad’s ?? Real liabilities or contingencies? Why not in undiscounted? • ACG-03 to permit “discounting” using CIA methods as an acceptable accounting treatment

15. Impact of Discounting – Industry in 2003 • Net unpaid claims 0.3% • Capital 0.4% • MCT – Canadian (0.1%) • MCT – Foreign 8.0% • MCT – All 1.0% • The expected impact was 1 ½% reduction on net claims liabilities and 8 to 10 points on MCT (based on 2001 data)

16. Impact of Discounting – Industry in 2003

17. Impact of Discounting

18. CICA New Accounting Standards • CICA 3855, Financial Instruments: Recognition and Measurement • CICA 1530, Comprehensive Income • Classification of Assets Considerations • Held-to-maturity • Measurement is on an amortized cost basis • No effect on discount rate and actuarial liabilities • No effect on financial statements, all things being equal

19. Market Rates Decrease • Available-for-sale • Investment carried at fair value • Change in fair value recorded in Other Comprehensive Income • Income statement mismatch

20. Market Rates Decrease • Held-for-trading (including Fair Value Option) • Investment carried at fair value • Gains and losses through net income

21. Actuarial Considerations for Asset Classification • Impact on determination of discount rate: amortized value vs. market-to-market • Timeliness of information • Potential for greater swings in rates • Implications on margins for adverse deviation • Volatility in results

22. New Challenges • Increased volatility in financial markets and increased volatility in performance measures such as claims ratios • OSFI request for supplemental filing i.e. non-discounted incurred loss data “to provide greater clarity into underwriting performance” • Disclosure of sources of earnings • Investment policy

23. Impact of IFRS on Canadian Discounted Reporting • Canadian P&C insurers to move to IFRS in 2011 • Current IFRS (IFRS4) – allows for discounted liabilities • Current IFRS (IFRS4) – allows for portfolio related discount rate • But proposed global standards being developed is expected to result in major changes: • Expected future cash flows • Discounting at market interest rates • Margin for risk and future service

24. Thank you very much for your attention. Claudette Cantin