NAIC Potpourri Mary Miller FCAS, MAAA Assistant Director, Product Regulation & Actuarial Services

1. NAIC PotpourriMary Miller FCAS, MAAAAssistant Director, Product Regulation & Actuarial Services June 24, 2009 Kansas City Actuarial Club Seminar

2. Agenda • NAIC Risk-Focused Examinations • New Health Actuarial Opinion Instructions • Actuarial Opinion Summary and Other Initiatives

3. Risk Assessment and the NAIC • Financial Analysts/Examiners have used Risk Assessment for many years - SRA’s • Focus was on the past – Balance Sheet • Used to determine whether prior period financials were fairly stated

4. Change Has Occurred • Risk – Focused Surveillance Process • Evolution or Revolution? • CARRMEL Rating Determines Priority • Coordinated Examinations • Emphasis on • Corporate Governance • Quality of the Board • Risk Management

5. CARRMEL rating • Prioritization system • Improves decision-making and communications • Validated/Revised as part of the examination effort • Facilitates analysis to identify strengths and weaknesses • Scores management • As time goes on, it becomes a better tool

6. CARRMEL • Capital Adequacy • Asset Quality • Reserves • Reinsurance • Management • Earnings • Liquidity

7. Corporate Governance • Board of Directors • Senior Management • Control Functions • Audit • Compliance • Risk management

8. Top-Down, Risk-Focused Surveillance Process 1. Assess external and internal audit functions - Maximize use where appropriate 2. Interview senior management - Assessing corporate governance and ERM 3. Focus on high risk areas (examples include): - Reserves - Reinsurance - Inter-company transactions

9. Objectives • Identification of risks • Assessment of governance structure • Allocation of Department resources • Assessment of risk management framework & practices • Meaningful communication of findings with Board and/or Senior Management • Update CARRMEL rating

10. Risk Management Principles • Active Board and Senior Management oversight • Adequate policies, limits and procedures • Adequate risk management, monitoring and management information systems • Comprehensive internal controls • Compliance to law, regulations, and internal policies

11. Assessment of Risk Management Framework & Practices • Tone at the top • Audit/compliance relationships • Adherence to Board policies and procedures • Internal control environment

12. Inherent Risks • Credit • Market • Pricing/Underwriting • Reserving • Liquidity • Operational • Legal • Strategic • Reputation

13. Application of these Risks to Key Business Activities • Pricing/Underwriting • Reinsurance • Investments • Claims/Reserves • Support • Accounting • Actuarial • IT • Legal • Human Resources

14. Risk Assessment Steps Identification of Inherent Risk Plus Assessment of Risk Management Processes Equates to Residual Risk Determination

15. Residual Risk Grid

16. 7 Phases • Phase 1 Understand Company/Key Activities • Phase 2 Inherent Risk • Phase 3 Risk Mitigation Strategies/Controls • Phase 4 Residual Risk • Phase 5 Exam Procedures • Phase 6 Prioritization/Supervisory Plan • Phase 7 Exam Report/Management Letter Risky Business

17. Phase 1 – Understand Company/ Key Activities • Understanding the Company • Steps to Phase 1, Part 1 • Gather Necessary Planning Information • Review the Gathered Information • Perform Analytical and Operational Reviews • Consider Information Technology Risk • Update the Insurer Profile Summary • Understanding Corporate Governance Structure • Assessing Adequacy of Audit Function • Identifying Key Functional Activities • Consider Business and Prospective Risks

18. Gather undocumented information Clarify information Interpret information Identify key activities Identify strengths Identify risks Identify risk mitigating strategies Examination Interviews Why

19. Examination InterviewsWho • CEO • CFO • COO • CIO • Controller • Chief Actuary • Board’s Audit Committee chairperson

20. Example:Phase 1, Part 1, Step 3Analytical and Operational Reviews • Management and reserving processes • Who determines reserves booked • What analyses performed • Unique types of losses • Surplus and/or RBC level • Basis for variable compensation

21. Phase 1, Part 2Corporate Governance & Management • Management controls and reserving • Management influence • Independence of appointed actuary and their assumptions • Changes to appointed actuary • Risk transfer due to ceded reinsurance • Reserving actuary meets with Board/Audit Committee

22. Phase 1, Part 2Corporate Governance & Management • ITEMS FOR REVIEW • Actuary participates in pricing meetings • Exposure growth is monitored regularly • Well-diversified book of business-geographical • Remedy bad situations promptly or drag on • ERM implemented • Carried reserves determined by actuary • Segregation of actuarial duties

23. Phase 1, Part 3Assess Audit Function INDEPENDENCE: • “In all matters relating to audit work, the audit organization and the individual auditor … should be free both in fact and appearance from personal, external and organizational impairments to independence.” GAO

24. Phase 1, Parts 4-5Key Activities/Prospective Risk • Key Activities will involve those lines of business with the largest reserves or premiums collected.

25. Phase 2Inherent Risk • Inherent Risks: • Incorrect data • Misapplying methodologies • Invalid assumptions • Incorrect calculations • Improper reporting of reserves

26. Phase 2Inherent Risk • Liquidity • Assess catastrophe management process to identify likelihood of occurrence and magnitude of impact relative to company’s surplus and claims paying ability: • as a result of an acceleration in claim payout patterns • in the event of an insolvency of a significant reinsurer • an increase in the duration of assets

27. Phase 2Inherent Risk • Pricing/Underwriting – P/C • Consider inherent risks related to: • An insurance product priced with little margin can lead to significant losses. • Are separate analyses conducted for certain unique types of losses (e.g., construction defects, class actions, catastrophes, environmental)?

28. Phase 3Risk Mitigation Strategies/Controls • Controls related to specific identified risk • Look at controls over: • Reserving process • Staffing issues ©2008 National Association of Insurance Commissioners

29. Phase 3Risk Mitigation Strategies/Controls Best Practice Controls • Pricing/Underwriting • Appropriate rate-setting methodologies • Quality assurance of underwriting guidelines • Experience level of underwriting staff (i.e., more complex issues handled by senior staff members) ©2008 National Association of Insurance Commissioners

30. Phase 3Risk Mitigation Strategies/Controls • Liquidity comprised of: • Risk management • Investments • Premiums • Claims • Proper controls in each area ensure liquidity Best Practice Controls

31. Phase 4Residual Risk • Risk remaining after consideration of controls Inherent Risk –Internal Controls Calculated Residual Risk +/- Examiner’s Judgment Overall Residual Risk Assessment

32. Phase 5Exam Procedures • Procedures based on residual risk assessment • P/C • Larger, more volatile lines • New lines of business/segments • New geographic areas • Persistent adverse development

33. Phase 6Prioritization & Supervisory PlanPhase 7Exam Report & Management Letter

34. Health Actuarial Opinion Changes • Define an appointed actuary • Require appointed actuary report findings to the Board or Audit Committee • Require the reliance statement

35. Why were changes needed? • Appointment and memorandum requirements were not specified • Desire for consistency across blanks • Make instructions more relevant to health blank – not a modified Life opinion • Define process for changing actuaries • Define what Qualified, Adverse and Inconclusive opinions are

36. Consistency • Joint CASTF/LHATF subgroup charged with developing the process for the appointment and change of the actuary • Definitions • Reliance statements

37. Appointed Actuary • If you were appointed according to the new instructions in the past, you don’t need to be re-appointed • If you were not appointed according to the new instructions, you need to be appointed in order to sign the opinion for 2009

38. Prescribed Wording • Prescribed wording is preferable if it fits the situation • Not using prescribed wording does NOT imply that something is wrong • Makes it easier for non-actuaries to review the opinions

39. Table of Key Indicators This Opinion is:  Unqualified  Qualified  Adverse  Inconclusive IDENTIFICATION SECTION  Prescribed Wording Only  Prescribed Wording with Additional Wording  Revised Wording SCOPE SECTION  Prescribed Wording Only  Prescribed Wording with Additional Wording  Revised Wording RELIANCE SECTION  Prescribed Wording Only  Prescribed Wording with Additional Wording  Revised Wording OPINION SECTION  Prescribed Wording Only  Prescribed Wording with Additional Wording  Revised Wording RELEVANT COMMENTS  Revised Wording  The Actuarial Memorandum includes “Deviation from Standard” wording regarding conformity with an Actuarial Standard of Practice

40. Other New Stuff • Relevant Comments Section • Actuarial Memorandum • Narrative and technical components • Tie to financial statements

41. Definitions – Adverse Opinion • An actuarial opinion in which the appointed actuary determines that the reserves and liabilities are not good and sufficient.

42. Definitions – Qualified Opinion • When in the actuary’s opinion the reserves for a certain item or items are in question because they cannot be reasonably estimated or the actuary is unable to render an opinion on those items, the actuary should issue a qualified opinion. • A qualified opinion should state whether the reserves would be good and sufficient without the items in question. • There’s also a provision that the actuary doesn’t have to issue a qualified opinion if the actuary determines the item in question is immaterial.

43. Definitions – Inconclusive Opinion • If for some reason the actuary can’t reach a conclusion due to deficiencies or limitations in the data, analysis, assumptions or related information, then the actuary should issue an inconclusive opinion. • The opinion should then include the reasons why a conclusion could not be reached.

44. FYI • Ohio in process of changing Life AOMR • Health blank users must use Health Opinion instructions

45. ACTUARIAL OPINION SUMMARY • Confidential • Filed only with domiciliary state or as requested • Due March 15 • Minimum Requirements: • Point estimate and/or range of reasonable estimates for loss and loss adjustment expenses, net and gross of reinsurance • Company’s recorded loss and loss adjustment expense reserves, net and gross of reinsurance • Difference between carried reserves and point estimate/range of reasonable estimates, net and gross of reinsurance • Explicit discussion of persistent adverse reserve development (1 year development of 5% of surplus in 3 of the last 5 years) • Uses: • Tool for deciding when to request Report • Use in conjunction with Opinion and Report when planning exam

46. AOS Statistics • Combined Net Data from 825 Companies domiciled in seven states • Reflects 2007 AOS data • Includes some companies that carry net zero

47. AOS Statistics – Carried to Actuary Estimate • Combined Net data from 732 companies in 7states • Excludes companies that carry zero-net reserves

48. Implications • P&C Companies coming off a hard market with generally strong reserves • Tracking AOS data going forward will add an additional tool for monitoring the industry

49. Other Regulatory Initiatives • Regulator Guidance in COPLFR Practice Note • Frequent interaction and collaboration with Accounting Groups at NAIC • RBC trend test • LOB survey • Continued Discussing Premium Deficiency Reserves at June NAIC Meeting