Odo.FinReg

Question 1

Contrast (SAP v GAAP) - objective

SAP :statutory Acounting principles / GAAP: Generally Accepted Accounting principales

Answer 1

SAP: measure ability to pay claims
GAAP: measurement of earnings

Question 2

Contrast (SAP v GAAP) - intended user

SAP :statutory Acounting principles / GAAP: Generally Accepted Accounting principales

Answer 2

SAP: regulators
GAAP: general audience (policyholders, investors, public)

Question 3

Contrast (SAP v GAAP) - asset recognition

SAP :statutory Acounting principles / GAAP: Generally Accepted Accounting principales

Answer 3

SAP: asset recognized when expense incurred
GAAP: may defer recognition of asset for asset/revenue matching with expenses (Ex: DPAE)

Question 4

Contrast (SAP v GAAP) - treatment of reinsurance in loss reserves

SAP :statutory Acounting principles / GAAP: Generally Accepted Accounting principales

Answer 4

SAP: loss reserves NET of reinsurance
GAAP: loss reserves GROSS of reinsurance

Question 5

Contrast (SAP v GAAP) - treatment of reinsurance in loss reserves in terms of DEFERRED INCOME TAXES.

SAP :statutory Acounting principles / GAAP: Generally Accepted Accounting principales

Answer 5

SAP: Not permitted
GAAP: Permitted

Question 6

Compare and contrast the liquidation basis and going-concern basis in accounting concepts.

Answer 6

liquidiation:
- an accounting concept where the elements are valued on a <run-off>
- regulators interest to see if insurer is able to render the obligations to policyholders.</run-off>

Going-concern:
- accounting concepts where elements are valued on a normal and continued basis
- of interest to INVESTORS

Question 7

Compare and contrast principle-based accounting and rule-based accounting.

Answer 7

Principles-based:
- require interpretation to apply
- more flexible

Rules-based:
- specific guidance
- easier to apply

Question 8

Compare and contrast fair value and historical cost in terms of accounting.

Answer 8

fair value:
- value in open market
- more accurate
historical cost:
- original cost MINUS depreciation
- easier to calculate

Question 9

Briefly explain 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. QUANTITATIVE: sets SCR & MCR (Solvency CapReq & Minimum CapReq)
   - uses a total balance sheet approach
   - SCR is defined as 99.5% VaR (Value at Risk) meaning that the probability of ruin is < 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

Based on the quantitative pillar of Solvency 2 - what happens if total capital falls
a) below SCR
b) below MCR

Answer 11

• if total capital < SCR –> regulatory intervention
• if total capital < MCR –> company not permitted to operate

Question 12

Based on the governance pillar of Solvency 2 - identify 3 CONDITIONS that must be addressed.

Answer 12

1. fitness & propriety
2. outsourcing
3. internal control

Question 13

Based on the governance pillar of Solvency 2 - describe 4 FUNCTIONS that must be addressed.

Answer 13

• internal audit (annual report to Board of Directors on deficiencies)
• actuarial (reasonability of methods & assumptions)
• risk management (monitor)
• compliance (with law)

Question 14

Identify 1 similarity and 2 differences between MCT and Solvency 2.

Answer 14

Similarity: both are implementations of a capital adequacy framework.
Differences:
1. MCT is for Canada, Solvency 2 is for the European Union
2. MCT applied static risk factors, Solvency 2 is principles-based (more adaptable to circumstances, but harder to apply).

Question 15

Calculate the value of commuted claims.

Answer 15

1. Calculate PV(w/o margin)
   Sum over all years of Paid Liabilities * (1+i)^-t where t = 0.5, 1.5, …
2. Calculate margin
   Sum over all years of Remaining Liabilities * TMF * (1+i)^-t where t = 1, 2,…
   TMF = Total Margin Factor = Required Margin * TargCap to Required Ratio *
   Risk Cost of Capital
3. PV = PV(w/o margin) + margin