CIA Annual Meeting

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

2. CIA Annual MeetingSession: 1401ALM With/Without MFADs • Executing ALM with and without MFADS • Moderator • Ted Steven • Speaker • Don E. C. Fischer LOOKING BACK…focused on the future

3. Why this particular topic? • ALM Working Group • ALM Practitioners Association • March 30, 2005 Special ALM PA Meeting

4. Why this particular topic? ALM Working Group ALM Practitioners Association March 30, 2005 Special ALM PA Meeting What is best practice? Theoretical Considerations Practical Considerations

5. Why this particular topic? • ALM Working Group • ALM Practitioners Association • March 30, 2005 Special ALM PA Meeting • What is best practice? • Theoretical Considerations • Practical Considerations • Who is your teacher today?

6. MFADs in CALM- Liability or Appropriated Surplus • CSOP calls for reserve testing using CALM. • CALM tests the adequacy of the asset cashflows to service the liability. • CALM requires the inclusion of Margins For Adverse Deviations (MFADs) • MFADs increase the required assets • What is an appropriate investment policy ?

7. Alternative Views of the MFADs • Expected cashflows for the LOB/company • Appropriated future surplus Investment Policies: 1)Fixed income assets that cashflow match the expected release of MFADs 2)Invest the MFADs as if they represented surplus

8. Testing: • To examine the financial impact of alternative investment policies for the assets backing MFADs in CALM valuation

9. Testing Approach • Test a simple policyholder liability • A 5 Year Compound GIC • Priced the 5 Year GIC using a spot yield curve • Investments in Zero-coupon bonds • Prepared Financial Statements for 5 Years • Cashflow Statement (Source and Use of Funds) • Income Statement • Balance Sheet

10. Testing Approach (Continued) • Used 3 different scenarios for the actual interest rate movement 1)Initial spot rate curve persists 2)Parallel shift upward annually of 80 basis points (B.P) 3)Parallel shift downwards annually of 40 basis points • Annual CALM testing using 20 different future interest rate scenarios • Tested several investment strategies for MFADs 1)Matching Strategy - Cashflow Matching with fixed income assets 2)Mismatched Long 10 Year Strategy - Investment in 10 Year Zero-coupon bonds

11. Assumptions • Reporting year = Policy year • All (internal or external) asset sales at market value • Shareholder dividends payout a fixed % of company earnings • Liability segment at maturity reports through reserves gain/(loss) on sale of any remaining assets • MFADs = Profit Objective • Higher investment returns expected under a “surplus investment strategy” than a “matching” strategy

12. Pricing Model for 5 Year GIC

13. Liability Summary • 5 Year Compound GIC Single Premium $100,000 Credited Rate 3.00% Maturity Benefit $115,927

14. Expected Liability Cashflows (End of Year)

15. 5 Year GIC • Investment Strategy • Full Match including MFADs • Duration of MFADS = 3.0 years • Match liability and expense • Duration of asset for MFADs = 10 years • Durational mismatch for MFADs = 7.0 years

16. Statement of Cashflow at T = 0 (Matched)

17. Statement of Cashflow at T = 0 (Mismatched)

18. Income Statement at T = 1 (Matched - Increasing Rates)

19. Income Statement at T =1 (Income Comparison - Increasing Rates)

20. Statement of Cashflow at T = 1 (Matched - Increasing Rates)

21. Statement of Cashflow at T = 1 (Matched - Increasing Rates)

22. Statement of Cashflow at T = 1 (Mismatched - Increasing Rates)

23. Statement of Cashflow at T = 1 (Mismatched - Increasing Rates)

24. Required Reserves as determined by CALM

25. Required Reserves as determined by CALM

26. Balance Sheet (Increasing Rates)

27. Balance Sheet (Increasing Rates)

28. Liability Profit Summary (Matched - Increasing Rates)

29. Liability Profit Summary (Mismatched - Increasing Rates)

30. Income Statement at T = 1 (Matched - Stable Rates)

31. Income Statement at T = 1 (Mismatched - Stable Rates)

32. Required Reserves as determined by CALM

33. Required Reserves as determined by CALM

34. Liability Profit Summary (Matched - Stable Rates)

35. Liability Profit Summary (Mismatched - Stable Rates)

36. Balance Sheet (Stable Rates)

37. Balance Sheet (Stable Rates)

38. Reserve Comparison

39. Reserve Comparison

40. Liability Profit Comparison

41. Liability Profit Comparison

42. Company Profit Comparison

43. Company Profit Comparison

44. Liquidation Value Summary

45. Liquidation Value Summary

46. Observations • Asset Activity • Mismatch strategy requires liability segment to sell assets at end of each reporting period • GIC Reserves • Mismatch strategy requires higher reserves for first 2 years in all interest rate scenarios • Mismatch strategy results in lower reserve at year 5 if rates decline or are stable • Mismatch strategy results in higher reserve at year 5 if rates increase

47. Observations • GIC LOB Profit • Profit over the 5 year horizon is increased if interest rates are stable or decline under a mismatched strategy • Profit over the 5 year horizon is reduced if interest rates are increasing under a mismatched strategy

48. Observations • Company Profit under a mismatched strategy • Profit over the term of the liability is increased if interest rates are stable • Profit over the term of the liability is reduced if interest rates are increasing

49. Observations • Shareholder Dividends • Fixed 50% distribution policy results in volatile dividends (likely unacceptable) under mismatch strategy • Liquidation Value • Varies depending on interest rate movements • Varies more using a Mismatched strategy

50. Comments • Impact of Mismatching MFADs • Modestly more income with greater volatility in earnings • Probably less income in first policy year • Dividends or retained surplus (& capital ratio) could be more variable • Results dependent on • Additional yield expected from Surplus Investment Strategy • Experienced change in interest rates • The total company investment policy should be appropriate