Presented by James Marta CPA, ARPM

1. James Marta & Company Certified Public Accountants Accounting, Auditing, Consulting, and Tax Funding Your Pool During Difficult Times: How Payout Patterns and Investment Earnings are Affecting Your Bottom Line Presented by James Marta CPA, ARPM

2. Our current environment • Economy • Interest rates • Benefit costs James Marta & Company, CPAs

3. How is your JPA facing tough times? • Is your pool cutting its funding margin? • Is your discount rate your using much larger than what you will be earning in the next few years? • Are you returning net assets? • Are your members cutting back on risk management? James Marta & Company, CPAs

4. Funding Your Claims In risk financing your learn you can fund claims at different points • Before the loss • During the loss • After the loss James Marta & Company, CPAs

5. Risk financing and sharing allows pools to smooth losses • Among members • Through fiscal years • This smoothes costs over time James Marta & Company, CPAs

6. Facing declining rates • CalPERS discounts at 7.75% • Cuts its rate to 7.50% through vote of the board. • It earned 1.1% in 2011 and 1% in 2012 James Marta & Company, CPAs

7. Discounting • Recognizes that you could pay $1 of claims with 80 cents. • Contemplates payout patterns • Should contemplate default risk • Should only discount the claim liabilities, not assume future earnings on the entire portfolio. James Marta & Company, CPAs

8. History of Discounting • Casualty loss and loss adjustment reserves were not discounted except in narrowly defined circumstances. • 1986, with tax reform act, IRS prescribed discounting claim liabilities for tax purposes • The National Association of Insurance Commissioners (NAIC) has been opposed to discounting except in specific circumstances James Marta & Company, CPAs

9. How sensitive is your equity to your discount assumption? Exhibit 1 James Marta & Company, CPAs

10. Effect of lower current earning rates Exhibit 2 Periods 9-36; rate you must earn over the remaining 27 years to fund claims James Marta & Company, CPAs

11. Will you ever be able to catch up? James Marta & Company, CPAs

12. Remaining investment balances James Marta & Company, CPAs

13. Payments and Liabilities James Marta & Company, CPAs

14. Investment earnings Contributed by Martin Castle, Chandler Asset Management James Marta & Company, CPAs

15. Yields over time 5 year government and corporate note yields Contributed by Martin Castle, Chandler Asset Management James Marta & Company, CPAs

16. What have been your recent rates? James Marta & Company, CPAs

17. What assumptions should you use? • A. You could average the past 10 years • B. Assume yields will improve • C. Assume yields will continue to erode • D. Assume yields will stay the same. • E. Don’t discount your claim liabilities James Marta & Company, CPAs

18. Financial Statement Affect • Earnings GAAP: if you assume you will earn 5% and you only earn 2% then that difference will hit the financial statements as follows. • you will have less earnings • your claim liabilities for the older years will increase. This is known as “Unwinding of the discount” and gets buried in the claims development. • Everything else being normal, you would have a reduction of net assets James Marta & Company, CPAs

19. Why discount? • Rewards: • Contemplates the time value of money • Allows the pool to efficiently price claims and coverage • Improves stated financial position • Future earnings contribute to the expected cash flows and claim funding • Competitive rates • Attract and maintain members James Marta & Company, CPAs

20. Why you shouldn’t discount? • Risks: • Ruin • You are fired • Assessment • Increase in rates • Decrease in ability to compete • Variability • Members leave • Adverse risk pool • Give back money when you shouldn’t • Set rates too low • Based on assumptions you maintain too little capital • Failure in ability to match rates with costs on an incurred or accrued basis James Marta & Company, CPAs

21. Actuary Role James Marta & Company, CPAs

22. Client picks a rate assumption, the actuary disclaims any opinion on it • Really? How can the actuary disclaim on such an important component of the estimate factors? • Actuary: Well, because we have limited background in finance and investments. And, the same reason that accountants and risk managers do not opine on IBNR reserves. James Marta & Company, CPAs

23. Actuary provides a range of claim valuations at various discount rates • Starts the discussion • Gives you information to value using different assumptions. • You could use this information along with other advisor’s information. James Marta & Company, CPAs

24. Actuary recommends a particular discount rate • Industry experience and an understanding of the long-term cash flows. • However, you don’t always have sufficient information on the actual investment portfolio and how the planned investments will affect earnings. • Actuary: we have told clients that their discounts are too high.  But no, we cannot pick it for them.  James Marta & Company, CPAs

25. Actuary recommends or uses a risk free rate • Roger G. Ibbotson and Rex. A . Sinqefiled analyzed treasury bills, long-term bonds and corporate notes and found that the inflation adjusted returns: • Treasury near zero • Long-term government bonds near zero • Long-tem corporate notes .5% James Marta & Company, CPAs

26. Actuary recommends not to discount • Most conservative • May be preferred if there are more volatile factors. James Marta & Company, CPAs

27. Example disclosure • The board has elected to discount claims liabilities at the 3.0% rate. The discounting assumption contemplates that if the value of discounted claim liabilities are invested at the assumed rate, earnings will be sufficient to provide for funding the claims at full value. The current portfolio has been yielding between 1% and 2% and near 1% for new investments. The actual earnings rate may vary from the assumed rate. The chart below shows the claim valuation at different assumptions and the resulting affect on net assets. James Marta & Company, CPAs

28. Should we discount? • Variables: • Claim experience • Claim cost drivers • Legislation • Timing of payments • Are your claims and payments predicable enough to throw in another significant variable? James Marta & Company, CPAs

29. What your auditor might say • We are concerned about the achievability of the discount rate assumptions included in the actuary report. • We will consider the factors and your supporting data when evaluating the interest rate assumptions implicit in the discount rates applied to your claim liabilities. • Changes in these assumptions could be material to your financial statements. • Are your financial statements fairly stated? James Marta & Company, CPAs

30. Are you putting your pool at risk? • Low rates • Dividends • Lower confidence levels • Is your discount rate achievable? James Marta & Company, CPAs

31. Conclusions • Remember: • be conservative • think long-term stability • don’t fall behind by ratcheting down rates overtime • don’t get caught off guard James Marta & Company, CPAs

32. Questions? • What will you do now? James Marta CPA, ARPM Principal James Marta & Company Certified Public Accountants 916-993-9494 jmarta@jpmcpa.com www.jpmcpa.com James Marta & Company, CPAs