Casualty Loss Reserve Seminar

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

2. Overview • Background • CIA standards • Methodology and Assumptions • What Changed? • Impact of discounting 2003 • 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 judgment • May 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 undiscounted • Payment patterns are updated as claim experience matures/changes • Gross, 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 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.”

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 data • Changes 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, unregistered • Ratio of ceded reinsurance • Not the same as provision for existing dispute • Usually 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 assets • Matching 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 • 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) From OSFI presentation to Canadian Insurance Accountants Association April 2004

27. Impact of Discounting on 2003Based on 10 of the Largest Companies From OSFI presentation to Canadian Insurance Accountants Association April 2004

28. Impact of Discounting on 2003Based on 10 of the Largest Companies From OSFI presentation to Canadian Insurance Accountants Association April 2004

29. Impact of Discounting on 2003 • The range of changes in PV (before PfADs) • Low 6.9% largely personal lines • High 13.4% largely commercial lines • Overall 11.2% From OSFI presentation to Canadian Insurance Accountants Association April 2004

30. Impact of Discounting on 2003Based on 10 of the Largest Companies From OSFI presentation to Canadian Insurance Accountants Association April 2004

31. Going ForwardCIA Survey • Discounting had been done for many years • Look at ranges of practice • Seek input on needs for future guidance • Ceded liabilities ??? • Issuing revised Educational Note (previous Note dealt with net liabilities only) • Narrowing range of practices • Better consensus amongst actuaries

32. Going Forward • Discounting and Canadian GAAP ?? • Changes in CICA handbook • Industry practice is NOT GAAP • Present value is an acceptable measurement but • discount rate ? Portfolio or risk free • PfAD’s ?? Real liabilities or contingencies? Why not in undiscounted? • Integration with IFRS • Update ACG-03 to permit “discounting” using CIA methods as an acceptable accounting treatment

33. Loss Reserve Discounting Canadian Perspectives Questions ? Thank You