2007 General Meeting Assemblée générale 2007 Montréal, Québec

Canadian Institute of Actuaries L’Institut canadien des actuaires 2007 General Meeting Assemblée générale 2007 Montréal, Québec

Agenda • Fall Letter • Segregated Fund Guidance • Mortality Improvements • Equity • Calibration of Interest Rate Models • Group Life & Health

CLIFR Update • CLIFR Committee • Chair – Ty Faulds • Vice Chair – Les Rehbeli • Members – Wally Bridel, Nathalie Bouchard, Tim Cavallin, Sylvain Côté, Alexis Gerbeau, Edward Gibson, Dale Mathews, Jean Mongrain, Hélène Pouliot, Sheldon Selby, Mary Stock, Whitman Wu

CLIFR Update • Guidance this Fall • Guidance for the 2007 Valuation of Policy Liabilities of Life Insurers (207088) • Notice of Intent regarding a change to the treatment of foreign exchange rates in the Standards of Practice – Practice-Specific Standards for Insurers Section 2300 Life and Health Insurance (207104) • Considerations in the Valuation of Segregated Fund Products (207109)

CLIFR Update • Upcoming Guidance • Education Note Currency Risks • Use of currency forwards • if not available • use of interest rate differentials • MfAD ranges from 5% to 50% • Considering application to non-fixed assets • Fall Letter Supplement on Finance Proposal (Fair Value Accounting) • Extending current guidance to include changes related to tracking properties • Would exercise caution before reducing liabilities relative to pre 3855

CLIFR Update • Other Recent Guidance • Implications of CICA Handbook Section 3855 – Financial Instruments on Future Income and Alternative Taxes: Update to Fall Letter (207029), April 2007, • Best Estimate Assumption for Expenses (206134), November 2006, • Approximations to Canadian Asset Liability Method (CALM) (206133), November 2006, • Valuation of Universal Life Policy Liabilities (206148), November 2006, • Margins for Adverse Deviations (206132), November 2006, • Use of Actuarial Judgment in Setting Assumptions and Margins for Adverse Deviations (206147), November 2006,

CLIFR Update • Recent Guidance • Standards of Practice – Practice-Specific Standards for Insurers, Subsections 2320 and 2330 (206120) October 2006, • CALM Implications of AcSB 3855 Financial Instruments – Recognition and Measurement (206077), June 2006, • Standards of Practice – Practice-Specific Standards for Insurers, Section 2100 (206075) June 2006, • Technical Amendments – Standards of Practice – Practice-Specific Standards for Insurers, Part 2000 (except section 2100) (206070), May 2006.

CLIFR Update • Guidance Under Development • Mortality Improvement • Calibration of Interest Rate Models • Treatment of Income tax • Group Life and Health • Equity Returns

2007 CLIFR Fall Letter • Insurance and Annuity mortality • Essentially unchanged from last year • Developing guidance on the level of mortality improvement • Life • Any mortality improvement offset in MfAD • Annuity • Continue the recommended alternative to the AA scale • Detailed in Appendix A

2007 CLIFR Fall Letter • Scenario Assumptions – Interest Rates • Slight Modification to last year • Guidance on the interpretation of the new SoP’s 2320 and 2330 • Illustrated in Appendix B, updated to June 2007, slight change to grading • Wide range of practice possible due to lack of calibration criteria on stochastic testing • Additional Guidance when using stochastic testing • parameters appropriate to Canadian life insurance financial reporting • encompass the nine prescribed scenarios • review parameters if tVx lower than CTE 80% • tVx ≥ prescribed scenario #9 • Ed Note targeted for 2008 release

2007 CLIFR Fall Letter • Lapse Study – Universal Life and T100 • Slight Modification to last year • 2003 UL Level COI lapse study • appropriate for the first 5 policy durations • Lapse Experience under Universal Life Level Cost of Insurance Policies (207086) released in October • Appropriate for the first 10 durations • Both lack UL-specific drivers • Similarity with stand-alone T-100 • Lapse Experience under Term-to-100 Insurance Policies (207085) released in October

2007 CLIFR Fall Letter • Long-Term Equity Return • Guidance unchanged from last year • Canadian market • historical period – Begins in 1956 • Other mature markets • historical period – consistent with recommendation for Canadian market • Less stable or emerging markets • limit the risk premiums (net of MAD) to the assumed Canadian equities • Example in Appendix C

2007 CLIFR Fall Letter • Value of Minimum Interest Guarantees and Embedded Options and • Considerations for Amounts on Deposit and Claims Provisions under AcSB Section 3855 Financial Instruments • Guidance unchanged from last year

2007 CLIFR Fall Letter • Implication of AcSB Section 3855 Financial Instruments on Future Income and Alternative Taxes • Slight Modification to last year • Finance proposal not substantively enacted as of this meeting • Department of Finance has introduced draft changes • New development – tracking properties • Guidance on the new tax timing differences from finance proposal included in the Supplement to last years fall letter

Fall Letter and PublishedEducational Notes • Section 1220 of the Standards • .01The actuary should be familiar with relevant educational notes and other designated educational material. • .03 A practice which the notes describe for a situation is not necessarily the only accepted practice for that situation and is not necessarily accepted actuarial practice for a different situation. • Available on CLIFR Website

Considerations in the Valuation of Segregated Fund Products • Sub-Committee of CLIFR formed late in 2005 • Mandate • Review areas where additional guidance could be provided to ensure compliance with standards and to narrow the range of practice • Published November 2007 Background

Considerations in the Valuation of Segregated Fund Products Contents of note • Methodology – Bifurcated versus Whole Contract • Term of the Liability • Hedging • DAC Recoverability Testing • Level of Aggregation • Discounting and C3 PfAD • Policyholder Behaviour • Provision for Adverse Deviation

Considerations in the Valuation of Segregated Fund Products Methodology – Bifurcated vs. Whole Contract • Bifurcated • Revenue is allocated between recoverability testing of the DAC and the liability for the guarantee. • Allocation does not change from period to period. • Policy liability for the guarantee is calculated separately using revenue based on thisallocation.

Considerations in the Valuation of Segregated Fund Products Methodology – Bifurcated vs. Whole Contract - Whole Contract • Total policy liability is determined using all net cash flows available. • Several Variations of method • Some don’t consider DAC separately • Could cause unamortized DAC to increase • Inconsistent with Section 2320.24 of SOP

Considerations in the Valuation of Segregated Fund Products Methodology – Considerations • At this time CLIFR is not recommending one method over the other. • Both methods consistent with standards. • Currently the whole contract method is more commonly used. • When the direction of international standards becomes clearer we will move in that direction.

Considerations in the Valuation of Segregated Fund Products Term of the Liability • Section 2320.27 • “…the term of the liability ends at the balance sheet date for….the general account portion of a deferred annuity with segregated fund liabilities but without guarantees;” • Section 2320.23 • “The actuary would extend such term solely to permit recognition of cash flow to offset acquisition or similar expenses whose recovery from cash flow that would otherwise be beyond such term was contemplated by the insurer in pricing…

Considerations in the Valuation of Segregated Fund Products Term of the Liability • Add Guarantee: • 2320.22 => term ends at the earlier of: • First renewal or adjustment date at or after B/S date at which there is no constraint • Renewal / adjustment date after the B/S date which maximizes policy liabilities

Considerations in the Valuation of Segregated Fund Products Term of the Liability – what to conclude • CLIFR’s view is that term of the liability • ends at the balance sheet date if the liability would otherwise be negative and • the term would be extended beyond the balance sheet date to the date which maximizes the liability • Corollary is that the liability for the guarantee is floored at zero • SOP implies the above interpretation applies only to contracts with no material constraints • Fully guaranteed contracts would have term equal to the life of the contract • CLIFR may recommend changes to the standards for the fully guaranteed contracts

Considerations in the Valuation of Segregated Fund Products Hedging • Application of zero floor can disrupt the parity between the asset and liability sides of the balance sheet • Hedge assets can start with fair value of zero but this value will go up or down with market movement. • Change in fair market value of derivatives flows through investment income and would be expectedto be offset by a change in the liability. • This balance can be disturbed by the zero floor onthe liability side. • Result can be inconsistent with direction of market movement.

Considerations in the Valuation of Segregated Fund Products Hedging • CLIFR believes it would be appropriate to consider both sides of the balance sheet in this situation. • Negative liability could be acceptable subject to constraints on the amount of profit capitalized, consistent with unhedged position. • Situation viewed as an unforeseen situation in thecontext of General Standards Section 1330.01 • “ Deviation from a particular recommendation or other guidance in the standards is accepted actuarial practice for an unusual or unforeseen situation for which the standards are inappropriate.”

Considerations in the Valuation of Segregated Fund Products DAC Recoverability Testing • Should be tested at least annually. • Assumptions should include margins. • CTE level between CTE60 and CTE80 • If full amount is not recoverable, actuary • reduces unamortized DAC to recoverable amount • reduces remaining future write-down amounts proportionately

Considerations in the Valuation of Segregated Fund Products DAC Recoverability Testing • Amortization period for DAC (length of write-down pattern) • Should be consistent with the extended term for DAC recoverability established at inception perSOP Section 2320.24. • Once established it is locked in. • Extended term for DAC recoverability will differ from the amortization period over time. • Extended term adjusts to reflect only enough revenue to recover DAC.

Considerations in the Valuation of Segregated Fund Products Level of Aggregation • SOP Section 2320.09 presents CALM as an aggregate methodology. • “ The actuary would usually apply the Canadian asset liability method to policies in groups which reflect the insurer’s asset liability management practice for allocation of assets toliabilities and investment strategy.” • Section 2320.22 defines term of the liability at thepolicy level. • Some judgment required. • Level of aggregation is an important consideration for term of the liability / application of zero floor.

Considerations in the Valuation of Segregated Fund Products Level of Aggregation • CLIFR’s view is that term of the liability can be appliedat the segment level. • Test on an ongoing basis for term which maximizes the liabilities. • Term could change more frequently if segment contains diverse cohorts, e.g. when a block reaches maturity date. • May want to aggregate at a cohort level where cohorts are homogeneous with respect to key risk characteristics. • Finer splits into cohorts expected to increase total liability. • Extreme case is seriatim level which CLIFR feels to be inappropriate.

Considerations in the Valuation of Segregated Fund Products Discounting and C3 PfAD • Using CALM for guarantee reserves is impractical. • Implies using stochastic or deterministic interest rate scenarios along each stochastic fund return path. • Common approximation is discounted cash flow method. • Discount rate should be related to current statementvalue of supporting assets. • Under 3855, if assets are designated as Held for Trading (HFT), yield would reflect fair value and discount rate should vary from period to period.

Considerations in the Valuation of Segregated Fund Products Discounting and C3 PfAD • C3 PfAD is usually estimated as an adjustment to the Discount Rate. • Theoretically should be calculated or justified byCALM testing. • In practice tested after the fact on representative cash flows. • Often not a material issue because of the size of the liabilities. • Note the situation where no invested assets (e.g. DAC exceeds liability for guarantee). • Use borrowing strategy with appropriate cost assumption

Considerations in the Valuation of Segregated Fund Products Policyholder Behaviour – Summary• Policyholder behaviour an important assumption for segregated funds: • Consider interrelationships, particularly reaction to the scenario

Considerations in the Valuation of Segregated Fund Products Policyholder Behaviour – Guiding Principles • Option exercise correlated with in-the- moneyness • Anti-selection • Assume behaviour against insurer’s interests • Amplified exercise of more valuable options • PH sophistication & perceived financial interest in policy • Need not assume 100% efficiency

Considerations in the Valuation of Segregated Fund Products Provision for Adverse Deviation • The term of the liability for segregated fund products has resulted in different interpretations as to the period over which the calculation extends. • Distortions can result if related to general account liabilities. • SOP Section 1110.39: “Provision for adverse deviations is the difference between the actual result of a calculation and the corresponding result using best estimate assumptions.” • This suggests there can be a PfAD only if there is a difference between the actual reserve and the best estimate reserve.

Considerations in the Valuation of Segregated Fund Products Provision for Adverse Deviation • Examples • Recoverability margin for DAC would not be a PfAD. • If reserve for guarantees is floored at zero, difference between this and calculated negative reserve would not be a PfAD. • These amounts could be disclosed separately as additional segregated fund margins.

CLIFR Topics: Update on Mortality Improvement Sub-committee • Goal: Propose mortality improvement basis for annuity and life insurance valuation • Sub-Committee Members: • Marc-Andre Belzil, Jacques Boudreau, Edward Gibson, Claude Normand, Helene Pouliot, Les Rehbeli, Mario Robitaille

Update Overview • Current draft of proposal: • Establish a “minimum reserve” prescribed basis for valuation of life insurance and for annuity business • Appointed Actuary may establish different basis (i.e. different best estimate and different MfAD levels), as long as subsequent reserves are at least as high as those established under the prescribed basis • For other countries, use experience if available, or Canadian basis if experience isn’t available

Update Overview • Current draft of “minimum reserve” prescribed basis: • Best estimate improvement scales would be the same for life insurance and for annuity business • Mortality Improvement assumption would have its own MfAD (insurance and annuity MfADs would be in opposite directions, special consideration for death supported insurance policies) • Mortality improvement rates based on Hardy’s paper (Data from 1921 to 2002)

Historical Mortality Improvement Rates: Hardy Study (1921-2002) vs. Proposed Best Estimate

Draft ProposalFor Mortality Improvement • Population data over maximum duration better source than insurance or annuity study data (which are less reliable and have more influences, such as underwriting improvements over time) • Rates will be the same for males and females (more on this shortly) • Improvement rates for first 25 years only, then set to 0% • Introduce concept of “hedge” credit for companies with blends of insurance and annuity business

Draft ProposalFor Mortality Improvement • Why unisex rates? • Menard/Wade Report released in May 2007 • Uses population data • Shows mortality improvement rates over various time periods • For longer durations (e.g. 70 years) female rates higher than male rates; for shorter durations (e.g. 10 years) the converse is true

Mortality Improvement, Menard/Wade1931-2001 vs. Proposed Best Estimate

Draft Proposal for Valuation • Life Insurance mortality improvement: • Maximum improvement rates are equal to 50% of best estimate rates (effectively a 50% MfAD on the improvement rate) • Maximum duration of improvements is 25 years • Special consideration for death supported policies • Annuities mortality improvement • Minimum improvement rates are 150% of best estimate rates • Minimum duration is 25 years

Mortality Improvement Rates

Annuity ValuationMortality Improvement Rates

Additional Comments • Proposed change for life insurance business would require a change in the Standards of Practice • currently 100% of mortality improvement must be in MfADs • Proposed change for annuities would be simpler but sub-committee feels it is better to implement both at the same time, as they are inter-related • therefore no proposed changes for 2007 valuations

Additional Comments • Proposed change has had limited review from CLIFR, but has not yet been endorsed and is still in early draft stage • Comments from the industry are very welcome • Limited testing (2 to 3 companies) indicates material increases to annuity reserves (3% to 5%) and material decreases to life insurance reserves (1% to 2%, but highly dependent on business mix) • We invite CIA members to conduct further testing and to send us your results

Concerns Expressed • Reserve basis is too aggressive for annuities (improvement rates are too low) • Basis is more conservative than current approach • Annuity experience sub-committee research indicates very little mortality improvement • Reserve basis is too aggressive for life insurance (improvement rates are too high) • Sub-committee thought about different basis for insurance; but research indicates a more aggressive basis, particularly for males (see graphs)

2007 General Meeting Assemblée générale 2007 Montréal, Québec