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Exam 6C (Fall 2018) > C - CIA DCAT > Flashcards

Flashcards in C - CIA DCAT Deck (47):
1

CIA DCAT

2 requirements for financial condition to be satisfactory.

1) Under DCAT base scenario and under all adverse scenarios, ASSETS > LIABILITIES throughout the forecast period

2) Under Base scenario, insurer meets Supervisory Target Capital Requirement (150%)

2

CIA DCAT

5 key elements of DCAT

1) Development of a Base scenario

2) Analysis of impact of plausible adverse scenario

3) Identification/Analysis of corrective management actions to mitigate risks

4) Report and Recommendations to management and board

5) Opinion signed by AA and included in report on financial condition

3

CIA DCAT

Define RIPPLE EFFECT

6 inclusions in RIPPLE EFFECTS

an event that occurs when an adverse scenario triggers a change in one or more interdependent risk factors

It includes :
1) chg in assumptions of base scenario that are no longer appropriate for adverse scenario being tested
2) Insurer's expected RESPONSE to adversity
3) policyholder's RESPONSE
4) rating agency's RESPONSE
5) change in planned capital injections
6) regulatory RESPONSE

4

CIA DCAT

2 Principal goals of DCAT

Describe 3 steps of DCAT Process

identify possible threats to financial condition

identify appropriate corrective actions to address those threats

1) review recent and current financial position
2) run base scenario and several adverse scenarios
3) report the results including at least 3 adverse scenarios

5

CIA DCAT

Discuss typical approach of DCAT

1) Review financial position of 3 most recent years

2) DEVELOP BASE SCENARIO for forecast period (consistent with business plan). Forecast period NPT LESS THAN 3 FISCAL YEARS

3) ASSESS the RISK CATEGORIES. Identify those relevant to circumstances (may use sensitivity testing for identification)

4) SELECT PLAUSIBLE ADVERSE SCENARIOS
(single-risk sc, integrated sc, combination of single-risk scenarios).
Identify interactions and RIPPLE EFFECTS.
Consider reverse stress testing of adverse scenarios (see how far the risk factor has to be changed to drive a negative surplus during forecast period, then evaluate whether that degree of change is plausible)

5) Select at least 3 SCENARIOS WITH GREATEST SURPLUS SENSITIVITY to include in DCAT. Also include any scenario where insurer fall below STCR (150%)

6) IDENTIFY POSSIBLE CORRECTIVE MGMT ACTIONS

7) IDENTIFY POSSIBLE REGULATORY ACTIONS for each scenario causing insurer to fall below STCR

6

CIA DCAT

Contrast
Materiality Standard of
DCAT vs VALUATION of policy liabilities.

3 considerations of AA when selecting a materiality standard

Materiality for DCAT should be less vigorous than the one used for valuation of policy liabilities

1) SIZE
2) FINANCIAL POSITION (more rigorous if base scenario closer to STCR)
3) NATURE of REGULATORY TEST

7

CIA DCAT

DEFINE
Base scenario in DCAT

A realistic set of assumptions used to forecast financial POSITION over the forecast period

consistent with business plan

AA must report material inconsistency between base scenario and business plan

8

CIA DCAT

4 items to recognize in future financial position under BASE SCENARIO when it differs from the projected financial results in the business plan

1) change in distribution assumptions

2) management decisions not discussed in business plan

3) change in capital level not reflected in business plan

4) impact actual recent experience on future experience

9

CIA DCAT

Define PLAUSIBLE ADVERSE SCENARIOS

Define them within STOCHASTIC MODELS

scenario, being MATERIAL, PLAUSIBLE and ADVERSE, to which the financial condition is sensitive.

Reverse stress testing can help identify material plausible adverse risk over the forecast period

--Under stochastic models--
PLAUSIBLE ADVERSE SCENARIOS must be in the 95-99 percentile range
-95th percentile or greater : ADVERSE
-99th or lower are deemed PLAUSIBLE

10

CIA DCAT

5 examples of POSSIBLE CORRECTIVE MGMT ACTIONS to reduce likelihood of threat identified by plausible adverse scenarios

1) change pricing
2) suspend payment of dividends
3) raise more capital
4) strengthen of ERM practice
5) increase risk monitoring and reporting
6) mitigate the risk causing the capital shortfall

11

CIA DCAT

Define
INTEGRATED SCENARIOS

combining 2 or more adverse scenarios

the 2 adverse scenarios may or may not be correlated

Resulting integrated scenario must be REALISTIC ADVERSE and PLAUSIBLE (aka between 95 and 99 percentile range)

use reverse stress test to assess if Integrated scenarios is PLAUSIBLE

12

CIA DCAT

3 approaches used to determine adverse scenarios

STOCHASTIC
risk (such as capital markets, exposure to CATS) are ideally modeled stochastically

DETERMINISTIC
scenarios selected judgmentally by the AA

COMBINATION
risk modeled stochastically and then result used to derive deterministic scenario

13

CIA DCAT

2 possible approaches to model ripple effects in a DCAT

1) Automatically generated by the model

2) manually created by the AA by modifying appropriate assumptions

14

CIA DCAT

5 frequency and severity risks that can be included in DCAT

single CAT event (natural, man-made)

single LARGE CLAIM (full PML)

Multiple CAT event

Multiple LARGE CLAIM

Social Inflation (from suits, awards)

15

CIA DCAT

Examples of RIPPLE EFFECTS arising from
freq and sev risk

insolvency of reinsurer

increase in reinsurance rates or non-availability of coverage for next term

post-event inflation

increased PACICC assessment resulting from failure of other insurers

16

CIA DCAT

Examples of CORRECTIVE MANAGEMENT ACTIONS to correct for freq and sev risk

1) review reinsurance coverage
2) rate increase
3) change in mix of business
4) restrict writing in hazard-prone zones

17

CIA DCAT

9 broad risk categories considered in DCAT

1) freq and sev risk
2) policy liabilities risk
3) inflation risk
4) premium risk
5) reinsurance / counterparty risk
6) investment risk
7) governmental / political risk
8) off-balance sheet risk
9) related-company risk

18

CIA DCAT

5 examples of ADVERSE SCENARIOS from POLICY LIABILITIES risk in DCAT

1) selection of inadequate LDFs
2) class actions and mass torts
3) change in mix of business
4) claims paid faster than assumed
5) actual RoR on investments supporting liabilities lower than assumed

19

CIA DCAT

4 examples of RIPPLE EFFECTS from POLICY LIABILITIES RISK

1) rating agency downgrade
2) liquidation of assets
3) increase in Ultimate Claims cost and adjustment expenses
4) effect of APV for scenarios affecting undiscounted policy liabilities

20

CIA DCAT

4 examples of CORRECTIVE MANAGEMENT ACTIONS for POLICY LIABILITIES RISK

1) setting claims faster by minimizing litigation
2) review reserving and claims handling guidelines
3) implement rate increases
4) review mix LoB

21

CIA DCAT

3 examples of ADVERSE SCENARIOS due to INFLATION RISK

1) significant, rapid and sustained increase in the general rate inflation
2) a significant temporary increase in cost of labour and materials following a CAT
3) a severe recession in the economy

22

CIA DCAT

3 examples of RIPPLE EFFECTS due to INFLATION RISK

1) rapid and sustained increase in interest rates
2) increase in operating expenses
3) increase in reinsurance rates and swing-rated contracts

23

CIA DCAT

5 examples of CORRECTIVE MANAGEMENT ACTIONS for INFLATION RISK

1) Review of insurance coverage
2) implement rate increase
3) review mix of business by LoB
4) review type of products offered
5) adjusting insurance to value or cost calculator

24

CIA DCAT

6 examples of events resulting in a significant reduction of premium volume (compared to base scenario) - (PREMIUM RISK)

1) new competitor in the market
2) more competitiveness in market
3) loss of a distribution channel
4) loss of a key client
5) non-competitive rates
6) inability to implement rate increase

25

CIA DCAT

6 examples of RIPPLE EFFECTS due to significant decrease in premium volume (compared to base scenario) - (PREMIUM RISK)

1) increase in loss ratio due to inadequate pricing
2) increase in fixed expense scenario
3) increase in certain types of expenses (ads)
4) change in mix of business
5) increase in reinsurance costs as a % of subject premium
6) liquidation of assets

26

CIA DCAT

5 possible CORRECTIVE MANAGEMENT ACTIONS for a significant decrease in premium volume (PREMIUM RISK)

1) reducing personel
2) increasing rates
3) identifying other key distributors
4) uw actions in market subject to competition
5) changing reinsurance coverage

27

CIA DCAT

5 examples of events resulting in a significant increase of premium volume (compared to base scenario) - PREMIUM RISK

1) withdrawal of competitor from market
2) appointment of a new distributor
3) unexpected new business from a large client
4) unexpected success in a new product area
5) premium rates too low compared to competition

28

CIA DCAT

5 examples of RIPPLE EFFECTS due to significant increase in premium volume (compared to base scenario) - PREMIUM RISK

1) higher loss ratio on new business due to inadequate pricing
2) shift in mix of business to new business entry
3) higher expenses
4) increase PACICC and pool assessments
5) increased reinsurance costs

29

CIA DCAT

5 possible CORRECTIVE MANAGEMENT ACTIONS for a significant increase in premium volume (compared to base scenario) - PREMIUM RISK

1) implementing rate change
2) uw actions (restriction of new business) in unprofitable markets
3) reviewing the distribution channels
4) reducing certain types of expenses (ads)
5) using reinsurance to mitigate capital strains

30

CIA DCAT

4 possible ADVERSE SCENARIOS arising from REINSURANCE RISK in DCAT

1) reinsurer insolvency
2) an increase in reinsurance rates (or reduction in reinsurance commission)
3) reduction in capacity
4) disputes over policy condition

31

CIA DCAT

4 AA considerations when developing an adverse scenario for reinsurer insolvency in DCAT

1) whether reinsurer is AFFILIATED or not (easier to assess likelihood of insolvency if affiliated)
2) rating of reinsurer (weaker rating most likely to fail)
3) whether reinsurer is REGISTERED or not (non-registered reinsurer funds are more difficult to secure)
4) concentration of reinsurance

32

CIA DCAT

2 examples of RIPPLE EFFECTS due to REINSURANCE/COUNTERPARTY RISK

1) increase in reinsurance rates
2) reduced availability of reinsurance

33

CIA DCAT

5 possible CORRECTIVE MANAGEMENT ACTIONS to REINSURANCE/COUNTERPARTY RISK

1) changing the reinsurance structure
2) diversifying reinsurers
3) retaining bigger proportion of business to decrease reinsurance costs
4) changing reinsurers
5) reducing primary policy limits

34

CIA DCAT

8 possible ADVERSE SCENARIOS arising from INVESTMENT RISK

1) significant change in yield curve
2) significant change in foreign exchange rates
3) increase in default rate on debt securities
4) decrease in returns and value of equities
5) decrease in returns and value of real estate
6) decrease in returns and value of subsidiary
7) decrease in returns and other major asset categories
8) the AA may consider integrated scenarios (combination of these events)

35

CIA DCAT

8 possible RIPPLE EFFECTS due to INVESTMENT RISK

1) liquidation of assets / forced sale
2) significant cash flow impacting liquidity position
3) negative change on derivative position
4) default by counterparty on derivatives
5) rating agency downgrades
6) liquidity crisis caused by large default losses
7) increase in freq and sev of claims due to deteriorating economic events
8) change in discount rate used for calculating actuarial value of policy liabilities

36

CIA DCAT

6 possible CORRECTIVE MANAGEMENT ACTIONS to INVESTMENT RISK

1) selling assets
2) changing the investment strategy
3) repositioning derivative tools-
4) reducing the amount of business underwritted
5) implementing rate increase
6) reducing costs through layoffs or consolidation or branch offices

37

CIA DCAT

8 possible ADVERSE SCENARIOS arising from GOVERNMENT and POLITICAL RISK

1) rate freeze by regulator
2) change to regulations regarding use of rating variables
3) change in legislation prescribing levels of insurance coverage
4) increase in taxation rates
5) nationalization of a LoB
6) change in legislation restricting distribution channels
7) change in regulatory solvency standards
8) political instability leading to closure for new business.

38

CIA DCAT

8 possible RIPPLE EFFECTS due to political government risk

1) deterioration of loss ratios
2) increased litigation costs
3) reduced availability of insurance to public
4) increased volume of industry pools
5) increased regulatory monitoring
6) forced sales
7) problem with reinsurance coverages
8) increase reinsurance rates

39

CIA DCAT

4 CORRECTIVE MANAGEMENT ACTIONS to POLITICAL/GOVERNMENT RISK

1) reducing volume of business written
2) creating/expanding a separate company or distribution channel
3) reviewing target mix by LoB
4) reviewing reinsurance coverage

40

CIA DCAT

Define
OFF-BALANCE SHEET RISK

Risk arising from new or evolving industry practices not yet recognized in balance sheet, but may be in subsequent years

actuary must be aware of emerging risks

41

CIA DCAT

6 possible ADVERSE SCENARIOS from OFF-BALANCE SHEET RISK

1) structured settlement (when a pc insurer buys an annuity and is exposed to the credit risk associated with the insolvency of the annuity company)
2) contingent liabilities or losses
3) letter of credit and pledged assets
4) capital maintenance agreements
5) Derivative instruments
6) pension underfunding

42

CIA DCAT

4 risks associated with DERIVATIVES

1) MARKET RISK
a) liquidity risk
risk of not being able to cancel a contract at a favorable price

b) basis risk
risk that the price of the derivative does not act as expected, undoing the intended hedging benefits

2) DEFAULT RISK
risk that a loss will be incurred due to default in making the full payment

3) MANAGEMENT RISK
potential for unexpected losses on derivatives due to inadequate management supervision

4) LEGAL RISK
risk that the derivative agreement is not binding as intended

43

CIA DCAT

2 possible effect due to OFF-BALANCE SHEET RISK

forced sales

significant CFs, affecting liquidity position

44

CIA DCAT

5 possible CORRECTIVE MANAGEMENT ACTIONS to OFF-BALANCE SHEET RISK

changing the pension plan from defined benefit to defined contribution

selling assets

changing the reinsurance strategy

repositioning the derivatives tools

reducing costs through layoffs and consolidation of branch offices

45

CIA DCAT

4 possible ADVERSE EFFECT due to RELATED-COMPANY RISKS in a DCAT

reduction in reliance on the parent cie for financial support

increase in provision of financial support to the parent

high level of dependency on group operational resources

a rating agency downgrade reflecting difficult financial conditions

46

CIA DCAT

3 possible RIPPLE EFFECTS due to RELATED-COMPANY RISKS

1) management focus on group rather than company priorities
2) a need to provide for service disruptions
3) regulator action to protect local policyholders

47

CIA DCAT

6 possible CORRECTIVE MANAGEMENT ACTIONS due to RELATEd-COMPANY RISK

1) finding alternative sources of funds for operations
2) adjusting premium volumes and mix of business
3) reviewing reinsurance coverage
4) reviewing target mix by LoB
5) reviewing types of products offered
6) selling assets