CIA Annual Meeting

1. CIA Annual Meeting LOOKING BACK…focused on the future

2. Speaker: Trevor Howes GGY LOOKING BACK…focused on the future

3. Sources of Earnings • My perspective… • A software vendor with many Canadian clients • System used for Individual life, disability, critical illness, LTC and annuity products, Group life and disability claim reserves • Commenced development of “Earnings by Source” features over 7 years ago

4. Sources of Earnings • What was SOE experience in 2004? • Top-down vs. bottom-up approach • Challenges and questions in implementing a bottom-up approach to SOE

5. Sources of Earnings • What was the experience with required SOE disclosures for 2004 … • Quality of result? • Approach to development? • Cost of delivery? • Anticipated benefits realized?

6. Sources of Earnings • High level issues: • Aggregation and coordination • Approach to analysis for “non-traditional” lines • Top-down vs. bottom-up approach for “traditional” PPM reserve lines

7. Sources of Earnings • Top-down approach • Establish general formula for analysis of aggregate earnings by distributing the change in PPM reserve • Calculate or estimate each component at line of business or block level • Allocate residual balancing amounts

8. Sources of Earnings • Bottom up approach • Each seriatim policy in force in year theoretically contributes to total actual reserve movement and to actual profit components • Software builds total change in PPM reserve and resulting earnings for modeled business with no residual unexplained value

9. Sources of Earnings • Characteristics of a “good” Sources of Earnings analysis process: • Easy for users to understand • Can be produced in timely manner • Well documented and validated • Consistently applied from period to period ….

10. Sources of Earnings • Characteristics of a “good” Sources of Earnings analysis process: • Technically robust; consistent explanations of earnings from period to period • Include all material components of earnings • Identifies the fundamental drivers of earnings

11. Sources of Earnings Management use of a good SOE: • High level reports of overall trends by line of business and major assumption. • Drill down to major blocks for contributions to each gain or loss • Experience analysis studies to support revised reserve assumptions

12. Sources of Earnings CIA recommended SOE report: Expected Profit on Inforce XXX Impact of New Business XXX Experience Gains and Losses XXX Changes in Assumptions XXX Other Changes XXX Pre-tax Operating Earnings XXX Earnings on Surplus XXX Net Income before Tax XXX Taxes XXX Operating Earnings XXX

13. Sources of Earnings • Advantages of bottom up approach: • Technically robust • Components add up with no approximations • Consistency from period to period • Enables timely production • Assures validity vs. reported reserves (provided process uses same software or consistency is regularly verified)

14. Sources of Earnings • Advantages of bottom up approach • Contributions to earnings available at any level below reported lines of business • Meaningful experience gains available by assumption • Seriatim expected and actual movements available for experience studies

15. Sources of Earnings • Software issues of bottom-up approach • Applying the traditional source of earnings formula to real business • Handle all business lines and all assumptions • Reconcile actual movements of business • Include new business • Cope with reporting delays

16. Sources of Earnings • Other challenges of bottom-up approach • Acquiring timely, valid and useable transaction data consistent with ledger data to feed movement analysis • Maintaining cost benefit balance in modelling actual business movements • Applying bottom up approach consistently across business units

17. Sources of Earnings • Reconciling actual business movements • Actual vs. actuarial movements (e.g. reinstatements, NTU, RPU &ETI,policy changes) • Processing delays within period or over reporting dates • Fund transactions for fund-based products

18. Sources of Earnings • Handling new business • Including early terminations in model • Time zero reserve impact (with/without PFADs element) vs. experience gains • Reflecting processing delays • Actual issue costs vs. expected • Adjusting investment income

19. Sources of Earnings • SOE analysis based on traditional reserve accumulation formula: V[0] + VP + II – E – q*DB = V[0]+1*(1–q)

20. Sources of Earnings • After rearrangement, each profit component in traditional approach is: Gain = expected benefit cost less actual benefit cost plus actual release of PFAD where, cost = benefit cashflow less reserve released from decrements

21. Sources of Earnings • For traditional (guaranteed cost) products, profit is mainly experience vs. reserve assumptions • The primary benefits of SOE analysis are • validating reserve methodology and assumptions, • identifying assumptions needing review

22. Sources of Earnings • SOE for fund-based products • reserves are more complex • movements are less predictable • profit is driven by spreads achieved • more sensitive to management action • reserve is largely driven by the size of the policyholder fund • inconsistent with traditional products and requires a different approach to SOE

23. Sources of Earnings • For Universal Life • PPM reserve can be restated as: Reserve = Fund less PV of future spreads • Changes in Fund portion may or may not impact profit

24. Sources of Earnings • SOE for Universal Life Gain = actual spread gain less expected spread gain plus actual release of PFADs where, spread gain = charges deducted less cost of related benefits (i.e. benefits paid net of fund released less PV of future spreads released)

25. Sources of Earnings Challenges of SOE for UL • Reconciliation of actual fund and reserve movement • “Revaluation” at period end • Compromise vs. exact replication of fund movement in model • PV of spreads with level COI

26. Sources of Earnings • SOE for Disability Income is like traditional life, except for morbidity • Separate incidence from termination gains • Actual incidence cost based on PV of claim on DLR basis at date of claim • Termination experience on opening and new claims reflected in claim payment gain • Recovery to active status with new ALR

27. Sources of Earnings • Disability income requires special movement transactions: • incidence by 2 causes • claim terminations by death, recovery, or settlement • claim adjustments, suspensions, re-opens?

28. Sources of Earnings • A bottom-up approach to SOE • enables the full benefit of the analysis • is complex and costly to implement • may pose questions of consistency across lines of business, or between companies • involves both theoretical and practical issues not answered in existing guidance • SOE will evolve over next few years

29. CIA Annual Meeting LOOKING BACK…focused on the future