Odo.FinReg

Question 1

SAP vs GAAP - Objective

Answer 1

SAP: measure ability to pay claims

GAAP: measurement of emerging earnings

Question 2

SAP vs GAAP - Intended user

Answer 2

SAP: regulators

GAAP: general audience (policyholders, investors, public)

Question 3

SAP vs GAAP - Asset Recognition

Answer 3

SAP: asset recognized when expense incurred

GAAP: may defer recognition of asset for asset/revenue matching with expenses (ex: DPAE)

Question 4

SAP vs GAAP: treatment of reinsurance in loss reserves

Answer 4

SAP: loss reserves NET of reinsurance

GAAP: loss reserves GROSS of reinsurance

Question 5

SAP vs GAAP - Deferred income taxes

Answer 5

SAP: doesn’t defer

GAAP: does defer

Question 6

Compare and contrast the liquidation and the going-concern accounting concepts

Answer 6

• Liquidation basis is an accounting concept where the elements are valued on a run-off. It is of regulators interest to see if insurer is able to render the obligations to policyholders.
• Going-concern is an accounting concept where elements are valued on a normal and continued basis. It is of investor’s interest

Question 7

Compare and contrast the fair value and the historical cost accounting concepts

Answer 7

• Recording an asset or liability at fair value means recording it at a value that it would be bought or sold for in the open market.
• Recording at historical cost means valuing it at the original purchase price less depriciation

In cases where the value of an asset/liability is uncertain, there is a trade-off between the reliability (since easier to obtain & calculate vs fair value) of the historical cost method and accuracy of the fair value approach

Question 8

Compare and contrast principle-based & rule-based accounting systems

Answer 8

• Principle based is an accounting concept that must be interpreted and applied. It is more adaptable to change, but it may be interpreted.
• Rule based is an accounting concept with strict rules that must be followed. It is easier to understand and to audit.

Question 9

What is Solvency 2

Answer 9

Solvency 2 is a:
- principles-based insurance regulatory system
- for capital levels of insurance companies
- in the European Union

Question 10

What are the 3 pillars of Solvency 2?

Answer 10

1. Quantification: sets SCR & MCR (Solvency & Minimum Capital Requirements)
   - uses a total balance sheet approach
   - SCR is defined as 99.5% VaR meaning that the prob of ruin is less than 0.5%
2. Governance: Supervisory activities (internal control & risk management, supervisory review process)
   - Requires adequate governance for the functions: internal audit, actuarial, risk management, compliance
   - Supervisor identifies high-risk companies and may intervene
   - Note that companies are required to perform ORSA
3. Transparency: supervisory reporting & public disclosure
   - Information from pillars 1&2 is given to the supervisor & financial markets
   - Purpose is to increase market discipline because companies know their decisions are public

Question 11

Governance Pillar - What are the key responsibilities of the 4 functions: Internal Audit

Answer 11

Produce a report at least annually to the BoD on any deficiencies of the internal controls and any shortcomings in compliance with internal policies and procedures

Question 12

Governance Pillar - What are the key responsibilities of the 4 functions: Actuarial

Answer 12

Ensure the reasonability of methods and assumptions used in calculating the technical provisions and providing a look-back analysis of best estimates against experience.

Question 13

Governance Pillar - What are the key responsibilities of the 4 functions: Risk Management

Answer 13

Monitoring the risk management function and maintaining an aggregated view. Ensure the integration of any internal model with the risk management function.

Question 14

Governance Pillar - What are the key responsibilities of the 4 functions: Compliance

Answer 14

Ensure the internal control system is effective to comply with all applicable laws and regulation, promptly reporting any major compliance issues to the BoD.

Question 15

Quantitative Pillar - what happens if total capital falls below SCR; below MCR

Answer 15

• If total capital < SCR, leads to regulatory intervention
• If total capital < MCR, leads to company not permitted to operate

Total capital = IFRS assets available, if SCR assets required ≤ IFRS assets available, then no action

Question 16

Quantitative Pillar - method for calculating SCR (Solvency Capital Requirements)

Answer 16

SCR is set using a total balance sheet approach

Methods:
- Standard/Regulator model
- Approved internal model (more costly than standard model but gives lower capital requirements & more tailored to company risk profile. Company must demonstrate that the model is used in running the business, has been validated by an independent third party and is documented appropriately)
- Could also use mix of both

Question 17

Governance pillar - identify conditions that must be addressed (3)

Answer 17

• Fitness & propriety
• Outsourcing
• Internal control

Question 18

Governance pillar - ORSA should contain at a minimum the following:

Answer 18

• The overall solvency needs, taking into account the specific risk profile, approved risk tolerance limits and the business strategy of the undertaking
• The compliance with the capital requirements and the requirements regarding technical provisions
• The extent to which the risk profile of the undertaking deviates significantly from the assumptions underlying the SCR, calculated with the standard formula or with its partial or full internal model

Question 19

Briefly describe the “Windows & Walls” approach of the US Solvency Modernization Initiative as it applies to Solvency 2

Answer 19

Gives “windows” for state insurance regulators to look into group-wide operations
- Enhanced communications between the state insurance regulators within the group
- Enhanced access to upstream entities within a group structure including regulated and non-regulated entities
- Enforcement measures - tools to protect policyholders if violation occurs

But maintains the walls at the statutory legal entity level
- Capital cannot be “shared” between legal entities

Question 20

According to the NAIC, what are the two primary goals of ORSA?

Answer 20

1. To foster an effective level of ERM at all insurance companies through which each insurance company identifies, assesses, monitors, prioritizes and reports on its material and relevant risks, using techniques that are appropriate to the nature, scale and complexity of the insurer’s risks, in a manner that is adequate to support risk and capital decisions.
2. To provide a group-level perspective on risk and capital, as a supplement to the existing legal entity view

Question 21

What are the 3 key areas the NAIC has established that the ORSA Summary Report should cover:

Answer 21

1. Description of the Insurer’s Risk Management Framework
2. Insurer’s Assessment of Risk Exposure
3. Group Assessment of Risk Capital and Prospective Solvency Assessment

Question 22

Differences between OSFI and NAIC (2)

Answer 22

OSFI covers all FRFIs and not just insurance companies

OSFI has authority over entities it regulates, whereas NAIC is a coordinating body that works with state insurance regulators to provide support and coordination to the regulation of multi-state insurers.

Question 23

The accounting for foreign branches and domestic insurers is substantially the same, and their financial statements are prepared in accordance with IFRS. However, there are two key differences for foreign branches:

Answer 23

1. The assets of foreign branches are required to be under the control of either the Minister of Finance of Canada or the branches’ Chief Agent in Canada
2. There is no share capital account, as the entity is operating as a branch of its parent; therefore, there is a head office account instead

Question 24

Advantage of IFRS 17 vs IFRS 4

Answer 24

IFRS 17 is expected to improve the comparability of financial performance of insurance contracts between different entities.

Question 25

SAP vs IFRS

Answer 25

Many differences between SAP and IFRS, including the valuation of invested assets & the valuation of policy liabilities.

These differences arise because in Canada there is a desire to achieve consistency with published financial statements and in the US there is a focus on insurer solvency

Question 26

What is a “commutation agreement” in the context of reinsurance

Answer 26

A process in which one party is relieved of its obligations in respect of the claim in exchange for a cash payment.

For reinsurance, the contract may contain a commutation clause, which requires the insurer to relieve the reinsurer of its obligations in exchange for a cash payment

Question 27

Reasons for commutation - from reinsurer’s POV

Answer 27

• Give stability in the report for long tailed claims
• Free up capital to lower UW leverage
• Savings in claims adjusting and admin costs
• Wish to exit the market

Question 28

Reasons for commutation - from insurer’s POV

Answer 28

• Suspicious on the creditworthiness of the reinsurer
• Decrease expense cost
• Expect more favorable loss development than planned
• More efficient to handle claims themselves
• Receive a cash flow right away

Question 29

Disadvantages of commutation from primary insurer POV

Answer 29

• Risk of adverse development on claims
• Capital required increases (to support increased liabilities)