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2007 Annual Meeting ● Assemblée annuelle 2007 Vancouver
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2007 Annual Meeting ● Assemblée annuelle 2007 Vancouver

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  1. Canadian Institute of Actuaries L’Institut canadien des actuaires 2007 Annual Meeting ●Assemblée annuelle 2007 Vancouver

  2. Update on various CLIFR topics Group Education Note Segregated Fund Valuation Issues Calibration of Interest Rate Models 2007 Annual Meeting Assemblée annuelle 2007 PD39 – CLIFR II

  3. PD39 - CLIFR II 2007 Annual Meeting Assemblée annuelle 2007 Valuation of Group Life and Health Policy Liabilities

  4. Revising the May 2000 Research paper on Group insurance valuation considerations Plan to release as an Education Note Fall 2007 Working Group has been reviewing over 2006-2007 Similar content to original Research paper Updated to reflect current Standards Updated to reflect current Group practices Some additional sections added, to provide guidance on CALM, impact of 3855 2007 Annual Meeting Assemblée annuelle 2007 Current Status of Group Education Note

  5. Provides guidance to actuaries valuing group life and health policy liabilities Includes supplemental information to the Standards of Practice Application employee, association and creditor groups Benefits typically covered: short & long-term disability, medical & dental, term life (including group conversion benefits), other Various financial arrangements Refund Accounting,Hold Harmless, ASO, Other 2007 Annual Meeting Assemblée annuelle 2007 Scope

  6. Basic Premium plans are typically yearly renewable term with no guarantee of renewability Fully Pooled Prospectively Rated Refund Accounting for larger groups ERR and deficit recovery Claims Fluctuation Reserves to stabilize premiums Policyholder valuation basis vs Insurer’s CGAAP valuation basis Retrospective Premium Arrangements Administrative Services Only Split Funded Arrangements Combinaton of insured plus ASO beyond specified maximum Hold Harmless Agreements 2007 Annual Meeting Assemblée annuelle 2007 Financial Arrangements

  7. Variety of Benefits and Financial Arrangements Customization in contracts TPAs – record keeping and administrative practices vs valuation data requirements Refund Accounting for large groups Difference between statement and policyholder valuation bases Lack of reliable experience data Materiality considerations Per group By line of business By company 2007 Annual Meeting Assemblée annuelle 2007 Challenges under CALM

  8. Degree of mismatch (long term assets supporting short term liabilities) Surplus implications ERR at market (e.g., maintain BV of ERR and adjust for difference of excess of MV over BV) 2007 Annual Meeting Assemblée annuelle 2007 CICA 3855

  9. SOP 2320.03 the term of the liability should take account of any renewal, or adjustment equivalent to renewal after the balance sheet date if the insurers discretion at that renewal is contractually constrained, and if the policy liabilities are larger as a result of taking account of that renewal. Differentiate between term of active lives and term of claim liabilities Active Lives Next “rate adjustment date” or rate guarantee period (e.g., LTD benefits) Actuary would be cautious if extending period reduces policy liabilities and would select longer term if such action increases policy liabilities. Claim Liabilities Extend to end of claim-paying period 2007 Annual Meeting Assemblée annuelle 2007 Term of the Liability

  10. Termination Rates : SOP 2350.14 to 2350.18 1987 Basic GLTD table Muirhead Table 1985 CIDA for individually underwritten business (e.g., association or creditor plans) CDT64 table is outdated and may not be appropriate without significant modification. Benefit Offsets: e.g., CPP, QPP, SSDI and workers’ compensation Appropriate for the projected benefits to reflect offsets. COLA Provisions: e.g., % of CPI the assumptions for future CPI increases would be consistent with the valuation interest rate scenario 2007 Annual Meeting Assemblée annuelle 2007 LTD considerations

  11. Other considerations which complicate valuation: Pending/Resisted/Suspended Claims Recurrence of Disability (may be part of IBNR liability) Claims Terminated But Not Reported Rehabilitation/Partial Disability: Exercise caution in assuming that the most recent net benefit is representative of longer term net benefit payments Unusual Financial Arrangements: e.g., ASO for a period of time (e.g., two years) after disability, and insured thereafter. Given the complexity, the actuary may find it useful to validate overall reasonableness of the resulting liabilities by performing adequacy testing Note provides an example in Appendix 3. 2007 Annual Meeting Assemblée annuelle 2007 LTD considerations

  12. Liability cash flows include projected death benefits on disabled lives, related expenses and conversion costs to individual life insurance policies Modifications needed to 1970 Kreiger table typically involves substantially reducing the mortality rates and increasing the recovery rates (at least for durations 1 to 10 ) Small insurers issues: consider using LTD valuation assumptions Actuary would exercise caution in applying LTD tables since the insurer’s definitions of disability, and therefore termination experience, may potentially be significantly different for waiver and LTD 2007 Annual Meeting Assemblée annuelle 2007 Waiver of Premium considerations

  13. Liability for Claims Due and Unpaid represents an exact recognition for a known amount owing but not paid Coordinate with liability for reported claims Incurred But Not Reported (IBNR) Claim Liabilities Arise from lags in: reporting of claims to the insurer, recording by the insurer of claims which have been reported (e.g., delay recording of disability claims incurred until the end of the elimination period), and claims that will be appealed or litigated in the future. Note describes various factors that can affect claim lags. Eg: level of claim processing backlog, changes in benefits or exposure, etc 2007 Annual Meeting Assemblée annuelle 2007 Liabilities for unreported claims

  14. Factor Method for benefits where there is a short lag or run-off period (e.g., group term life insurance) Factors based on past experience as % premiums, paid claims, liability, other Loss Ratio Method (AVG EP + AVG Reporting Lag) × Loss Ratio × Premiums inforce. If the information is available, valuation could be done on seriatim basis considering for each group its own elimination period, premiums paid or loss ratios. Suitable for cases where the recording of LTD claims is delayed until after the elimination period. Lag or Development method: Development of paid claims by period of incurral and payment, which is used to develop a claim run-off chart. 2007 Annual Meeting Assemblée annuelle 2007 Common IBNR methodologies

  15. Claims that have not been incurred as at the valuation date but will be incurred before the end of the term of the liability. Mostly significant for long premium rate guarantees on LTD business The longer the term of the premium rate guarantee, the more material is the exposure to risk of inadequate pricing and to interest rate risk (e.g., LTD Benefits) Examples Paid-Up Life LTD: Need to consider incidence of disability rates Creditor Insurance Term of the liability is to the end of the insured loan and subject to any renewal guarantees May exhibit individual and group characteristics 2007 Annual Meeting Assemblée annuelle 2007 Liability for Future Claims

  16. In theory, need a group by group projection of future refunds based on projected experience In practice, approximations often used relationship between reported policyholder reserves and the corresponding statutory (GAAP) reserves policyholder reserves > GAAP reserves  excess margin may generally be expected to be refunded to policyholder policyholder reserves < GAAP reserves  future deficits can be expected to arise. May be partially recoverable if group has hold harmless, CFR, or other risk sharing Interest adjustment to the ERR may be required if interest credited on policyholder reserves does not equal the policyholder valuation interest rate. May need additional provision if actuary has concerns about the adequacy of risk charges 2007 Annual Meeting Assemblée annuelle 2007 Liability for Future Experience Rating Refunds

  17. Deficit represents negative policyholder experience balance net of any funds the insurer has a contractual right to offset. Section 2130.29 - the actuary would test the appropriateness and recoverability of the receivable amount Note outlines specific considerations in determining the amount of deficit deemed recoverable In practice, recoverable deficits only reflected to extent of collateral (Hold Harmless, CFR, etc). 2007 Annual Meeting Assemblée annuelle 2007 Treatment of Deficit Recoveries

  18. Consider both invested and non-invested assets (e.g., outstanding premiums or recoverable deficits) The actuary would consider the likely timing and expected payout of recoverable deficits before considering this within the CALM testing. Actuary may need to further allocate the assets by benefit type to understand any ALM issues that may arise. (e.g., LT assets supporting IBNRs may create additional volatility under 3855) 2007 Annual Meeting Assemblée annuelle 2007 Asset Considerations

  19. Provisions for ASO contracts Stop Loss DAC Reinsurance International Issues Tax Issues 2007 Annual Meeting Assemblée annuelle 2007 Other Considerations

  20. PD39 - CLIFR II 2007 Annual Meeting Assemblée annuelle 2007 Considerations in the Valuation of Segregated Fund Products

  21. 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 Expected Completion – Fall 2007 2007 Annual Meeting Assemblée annuelle 2007 Considerations in the Valuation of Segregated Fund Products

  22. 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 2007 Annual Meeting Assemblée annuelle 2007 Considerations in the Valuation of Segregated Fund Products

  23. 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 2007 Annual Meeting Assemblée annuelle 2007 Considerations in the Valuation of Segregated Fund Products

  24. Methodology – Bifurcated vs. Whole Contract Bifurcated Allocation of revenue to the guarantee would generally be related to the additional charge priced into the product for the guarantee 2007 Annual Meeting Assemblée annuelle 2007 Considerations in the Valuation of Segregated Fund Products

  25. 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 2007 Annual Meeting Assemblée annuelle 2007 Considerations in the Valuation of Segregated Fund Products

  26. Methodology – Bifurcated vs. Whole Contract- Whole Contract Approach – DAC Focus DAC is first tested to ensure recoverability using all fee income In order to calculate the liability for the guarantees, the DAC balance is added to the stochastic result Mathematically equivalent to backing out a PV of fee income equal to the DAC balance 2007 Annual Meeting Assemblée annuelle 2007 Considerations in the Valuation of Segregated Fund Products

  27. Methodology – Bifurcated vs. Whole Contract- Under both methods If the DAC becomes unrecoverable it is written down to the extent it is recoverable Future amortization is reduced accordingly and locked in consistent with SOP Section 2320.24 Once the DAC is written down it may not be written back up 2007 Annual Meeting Assemblée annuelle 2007 Considerations in the Valuation of Segregated Fund Products

  28. Methodology – Considerations Total liability under Whole Contract method will be less than or equal to that under the Bifurcated method Whole Contract method will defer possible writing down of the DAC as long as possible as the DAC has first priority on future revenue. Once the liability for the guarantee has become positive the liability may become more volatile under the Whole Contract method as the allocation of revenue can change period to period. 2007 Annual Meeting Assemblée annuelle 2007 Considerations in the Valuation of Segregated Fund Products

  29. 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 Direction of international standards appears to be toward bifurcated approach When the direction of international standards becomes clearer we will move in that direction. 2007 Annual Meeting Assemblée annuelle 2007 Considerations in the Valuation of Segregated Fund Products

  30. 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… 2007 Annual Meeting Assemblée annuelle 2007 Considerations in the Valuation of Segregated Fund Products

  31. 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 2007 Annual Meeting Assemblée annuelle 2007 Considerations in the Valuation of Segregated Fund Products

  32. 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 2007 Annual Meeting Assemblée annuelle 2007 Considerations in the Valuation of Segregated Fund Products

  33. 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 2007 Annual Meeting Assemblée annuelle 2007 Considerations in the Valuation of Segregated Fund Products

  34. 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 the context 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.” 2007 Annual Meeting Assemblée annuelle 2007 Considerations in the Valuation of Segregated Fund Products

  35. 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 2007 Annual Meeting Assemblée annuelle 2007 Considerations in the Valuation of Segregated Fund Products

  36. 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 2007 Annual Meeting Assemblée annuelle 2007 Considerations in the Valuation of Segregated Fund Products

  37. 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 2007 Annual Meeting Assemblée annuelle 2007 Considerations in the Valuation of Segregated Fund Products

  38. Level of Aggregation CLIFR’s view is that term of the liability can be appliedat the segment level Would have to 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 For practical purposes may want to aggregate at a cohort level where cohorts are homogeneous with respect to key risk characteristics Finer splits into cohorts would be expected to increase total liability Extreme case is seriatim level which would be inappropriate More work required on this 2007 Annual Meeting Assemblée annuelle 2007 Considerations in the Valuation of Segregated Fund Products

  39. Discounting and C3 PfAD Using the CALM method for guarantee reserves likely impractical Implies using stochastic or deterministic interest rate scenarios along each stochastic guarantee test path Common approximation method is to use a discounted cash flow method Discount rate should be related to current statement value of supporting assets as reflected in current book yield Under 3855, if assets are designated as Held for Trading (HFT) yield would be reflective of fair value and discount rate should be variable period to period 2007 Annual Meeting Assemblée annuelle 2007 Considerations in the Valuation of Segregated Fund Products

  40. Discounting and C3 PfAD C3 MfAD is usually estimated as an adjustment to the Discount Rate Theoretically should be calculated or justified by CALM testing reflecting reinvestment or disinvestment exposure of liabilities and supporting assets In practice tested after the fact on representative cash flows Often not a material issue because of the size of the liabilities 2007 Annual Meeting Assemblée annuelle 2007 Considerations in the Valuation of Segregated Fund Products

  41. Policyholder Behaviour – Summary• Policyholder behaviour an important assumption for segregated funds: Full and Partial Withdrawal Resets Fund transfers Annuitizations if material Consider interrelationships, particularly reaction to the scenario Must combine experience data with common sense / intuition when modeling dynamic behaviour Consider higher MfADs for these 2007 Annual Meeting Assemblée annuelle 2007 Considerations in the Valuation of Segregated Fund Products

  42. Policyholder Behaviour – Guiding Principles • Option exercise correlated with in- - the – moneyness Anti-selection Consider reasonable expectations PH sophistication & perceived financial interest in policy < 100% efficiency 2007 Annual Meeting Assemblée annuelle 2007 Considerations in the Valuation of Segregated Fund Products

  43. 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 2007 Annual Meeting Assemblée annuelle 2007 Considerations in the Valuation of Segregated Fund Products

  44. 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 2007 Annual Meeting Assemblée annuelle 2007 Considerations in the Valuation of Segregated Fund Products

  45. VAL-2: CLIFR Part II - PD 2007 Annual Meeting Assemblée annuelle 2007 Calibration of Interest Rate Models

  46. Agenda - Update from the Working Group Recap Goals and Principles from Ottawa 2006 Derivation of Draft Initial Calibration Criteria Model Testing Immediate Next Steps - to complete for 2007 guidance Beyond 2007 Questions 2007 Annual Meeting Assemblée annuelle 2007 CLIFR Calibration of Interest Rate Models Working Group

  47. Objective It is desirable to have a set of calibration standards that can be applied consistently to as wide a range of interest-sensitive insurance and investment products as possible, including both long and short term products. Mandate The working group has been formed to investigate and develop methodologies and standards for the calibration of interest rate models for determining policy liabilities to be held by life insurance companies. 2007 Annual Meeting Assemblée annuelle 2007 CLIFR Calibration of Interest Rate Models Working Group

  48. General Principles Be sufficiently robust to narrow the range of practice, but allow the actuary to apply reasonable judgement to specific circumstances; Be applied to the set of scenarios produced, not to the model parameters or inputs; Be applied to not only the near term, but also the steady state portions of the scenarios produced; 2007 Annual Meeting Assemblée annuelle 2007 CLIFR Calibration of Interest Rate Models Working Group

  49. General Principles (continued) Be applied to more than one point on the yield curve including a mix of short, medium, and long-term points; Promote the development of scenario sets that measure exposure to yield curve shocks as well as long-term paths of declining as well as rising interest rates, consistent with history; Look at average rate distributions corresponding to extended periods of time as well as rate distributions at selected points in time. 2007 Annual Meeting Assemblée annuelle 2007 CLIFR Calibration of Interest Rate Models Working Group

  50. Working Group Contacts Wally Bridel, Chair Edward Astrachan Michael Bean David Campbell Christian-Marc Panneton Jason Wiebe 2007 Annual Meeting Assemblée annuelle 2007 CLIFR Calibration of Interest Rate Models Working Group