RMAD _ RISK OF MATERIAL ADVERSE DEVIATION A Regulator’s Viewpoint

1. RMAD _ RISK OF MATERIAL ADVERSE DEVIATIONA Regulator’s Viewpoint CASUALTY LOSS RESERVE SEMINAR September 10-11, 2007 Wendy Germani, FCAS, MAAA (retired) Texas Department of Insurance

2. WHAT IS MATERIALITY? • AAA Task Force on Materiality – developed a generalized description of the concept of Materiality. • ASOP 36 and other Standards of Practice don’t define it per se. • “Materiality & ASOP 36; Considerations for the Practicing Actuary” - CAS • NAIC APPM has a definition. • SEC’s definition is similar to the NAIC’s.

3. According to NAIC Accounting Practices & Procedures Manual • “A omission or misstatement of an item in a statutory financial statement may be material if it is of such a magnitude that it is probable that the judgment of a reasonable person relying upon the statutory financial statement would be changed or influenced by the inclusion or correction of the item.”

4. Know Your User !!! • Principal User • Intended User • Unintended User • Different Users have different expectations regarding materiality.

5. Considerations in Materiality Standard for ReservesFrom Materiality & ASOP 36 • Would the misstatement put the insurer in danger of a breach of covenant or regulatory requirement? • RBC Trigger? • Minimum Capital Requirement • IRIS ratio failure • Turn profit into loss? • Relative size is usually more important than absolute size. • Lines of business written by company

6. Possible Standards of Materiality • % of Surplus • % of Reserves • Reinsurance (Zero Net Reserve Companies) • Minimum of % of Surplus, % of Reserves and/or Amount to trigger an RBC action level. • Other

7. Standards Used in 2006For CT IL NY OH PA TX Domestics

8. Standards Used for Texas Domestics 2004 to 2006

9. Standards Used for Pennsylvania Domestics 2004 to 2006

10. General ObservationsMateriality Standards • Appears to be a general trend to consider multiple measures of materiality: • More “combinations” of materiality bases in Opinions. • Less Opinions with a single basis of materiality.

11. Combination – Example #1 • “In determining the materiality standard, I note the Opinion is a tool of solvency regulation. Thus, the selected standard is oriented towards the potential impact a misstatement of reserves would have on surplus levels…and is a minimum of three values: (1) 20% of surplus, (2) 10% of loss and LAE reserves after pooling and (3) difference between surplus less Company Action Level RBC.”

12. Combination – Example #2 • “Based on my understanding of the use of this (Opinion), I evaluated materiality in the context of 15% of loss and LAE reserves, 25% of surplus, and action/control level from RBC, of which the minimum was selected as a materiality standard.

13. Consideration of RBC Position • “I have considered a MAD to be one in which the actual net outstanding loss and LAE exceed carried reserves by an amount greater than 10% of surplus... I also verified that a 10% deviation in the Company’s net reserves would not reduce the Company’s Total Adjusted Capital to below the Company Action Level Capital.” • May be MORE appropriate to include this for companies with RBC scores at lower end of spectrum vs. healthy RBC scores. • Regulators do not necessarily have to see this in all Opinions.

14. Is there a Risk of Material Adverse Deviation?

15. I do not believe that there are significant risks and uncertainties that could result in material adverse deviation in the loss and loss adjustment expense reserves.

16. Is there a risk of MAD • “The actuary should explicitly state whether or not he or she reasonably believes that there are significant risks and uncertainties that could result in material adverse deviation.” • Exhibit B for 2007 Actuarial Opinions has a box to check Yes or No if there is RMAD.

17. So is there RMAD?Using data from CT, IL, NY, OH, PA, TX

18. Relevant Comments should allow a regulator to answer these questions: • Is there a Risk of Material Adverse Deviation? • What amount of adverse deviation does the actuary consider material? • Why does the actuary consider that amount to be material for this company? • Do I understand why the actuary believes that material adverse deviation is or is not a risk for this company?

19. Is there a risk of MAD for Zero Net Reserve Companies? • The opining actuaries concluded that 95% of the companies in Ohio, Pennsylvania and Texas with zero net reserves do not have a risk of RMAD. • Reinsurance and/or rapid growth are cited as reasons for possibility of RMAD.

20. Companies with zero net Reserves – 2006OH PA TX Domestics

21. CRUSAP Report :Observations on Communication • “..many users of actuarial services don’t adequately understand the inherent variability and uncertainty that attach to actuarial opinions and projections.” • This is “..one of the most significant communication problems the profession currently faces.” • “… placing too much emphasis on the variability of actuarial results could undermine the perceived value of actuarial services in the eyes of the users.”

22. Materiality and Link to Actuarial Opinion Summary • What if actuary said “no” to RMAD, yet company carried reserves in lower end of actuarial range? • Consideration given to surplus and RBC levels. If low, appointed actuaries should expect a call from the domestic regulator. • Why is there no RMAD? • Is the Materiality threshold possibly set too high?

23. Questions ?????