C - CIA MfAD

Question 1

CIA MfAD

Purpose of MfAD

Define MfAD.

Define PfAD.

Answer 1

–Purpose of MfAD–
to reflect the degree of uncertainty of the best estimate assumption

—MfAD—
Aka : Risk Margin
Difference between the assumption of a calculation and the best estimate assumption

factor applied to PV of best estimate to reflect its uncertainty

It is the deviation of actual from expected experience resulting from

• error in estimation
• non-anticipated influences
• statistical fluctuations

—PfAD—
difference between actual result of a calculation and result using best estimate assumption

Question 2

CIA MfAD

2 techniques to derive MfADs.

Answer 2

1) deterministic techniques
2) stochastic techniques

MfADs are not expected to be so high that the probability of an unfavorable development is less than 1% or 5%.

Question 3

CIA MfAD

one thing PfAD do not cover and one thing it covers when using stochastic models.

Answer 3

• PfAD do not cover the statistical volatility arising from the model
• PfAD covers the uncertainty in whether the actuary has the right model or the right parameter

Question 4

CIA MfAD

a 3rd technique (other than deterministic or stochastic), not discussed in the educational note, but seen as an area of development for PC actuaries, to derive MfADs.

Why is this method still an issue?

Answer 4

Cost of Capital Method.
Not clear which basis to use for the determination of capital (economic capital, regulatory capital, rating agency capital, capital used for pricing)

Question 5

CIA MfAD

5 (including c1, c2) desirable characteristics of a risk margin (MfAD).

Answer 5

A) the less knowledge about current estimate and its trend, the higher the MfAD.

B) low freq/high sev risks should have higher MfAD high freq/low sev risks

C) longer contracts should have higher MfAD
C1) due to higher exposure to risk
C2) due to longer settlement period

D) the wider the probability distribution around the risk, the higher the MfAD

E) if emerging experience reduce uncertainty, MfAD should decrease

the more skewed the distribution is, the higher the MfAD

Question 6

CIA MfAD

examples where a large MfAD is appropriate (compared to the best estimate assumption)

Answer 6

• if the actuary has low confidence in the best estimate assumption
• an approx with low precision is being used
• the event assumed is farther in the future
• the potential consequence of the event is more severe
• occurrence of the event is more subject to statistical fluctuations

–when stochastic model indicates variability not identified in deterministic approach

Question 7

CIA MfAD

3 categories of MfAD.
Provide the low and high margins for each category.

Answer 7

CLAIMS DEVELOPMENT
% of claim liabilities (excluding PfADs)
2.5% to 20%

REINSURANCE RECOVERY
% of amount deducted of reinsurance ceded
0% to 15%

INVESTMENT RETURN RATES
deduction from expected investment return rate per year
0.25% to 2%

Question 8

CIA MfAD

features a risk margin (PfAD) methodology should have.

Answer 8

• easy to calculate
• facilitate disclosure of information useful to stakeholders
• provide information useful to users of financial statement
• be consistent :
• -for methodology, across lifetime of contract
• -in assumptions
• -between entities
• -between reporting periods

-vary by product

Question 9

CIA MfAD

3 general considerations for claim development MfADs (in terms of low and high margin)

Answer 9

significant change in:

INSURER’S OPERATION
(claim management, UW)

DATA ON WHICH THE ESTIMATE IS BASED
(volume of losses, homogeneity)

LOBs
(length of tail, latent claim, liability exposure)

Question 10

CIA MfAD

examples where it would be appropriate to have a margin of 20% for claim development.

Answer 10

• significant changes due to TORT REFORM
• introduction of new LoB
• significant change expected in future claims
• financial crisis and its effect on longer tailed LoBs

Question 11

CIA MfAD

7 considerations for MfADs from reinsurance ceded (in terms of low and high margin situation)

Answer 11

• ceded loss ratio
• ceded commission rates
• unregistered reinsurance
• reinsurer under liquidation
• reinsurer with weak financial condition
• claim coverage disputes with reinsurers
• proportion of related party reinsurance

Question 12

CIA MfAD

3 of the several different types of risk addressed in the MfAD for investment return rates

Answer 12

A/L Mismatch risk

Error in estimating payment pattern for future claims

Asset risk (incl. credit/default and liquidity risk)

Question 13

CIA MfAD

considerations for MfADs for investment return rates (in terms of low and high margin situations)

Answer 13

• A/L matching
• quality of assets
• loss of capital
• claim payment patterns
• determination of interest rates
• concentration by type of investments
• investment expenses

Question 14

CIA MfAD

Which type of product will a stochastic modelling approach be benefiting the most?

Provide example of such products?

Answer 14

Products with skewed loss distributions with low frequency and high severity

• stop-loss reinsurance
• CAT insurance risk
• Credit, warranty, mortgage insurance
• Long-tailed LoB

Question 15

CIA MfAD

3 quantile approaches to determine MfADs.

Answer 15

MULTIPLES OF STANDARD DEVIATION
A : simple, practical
A : MfAD increase with increasing skewness
PERCENTILE (VaR)
-Most common approach applied
-in Australia, margin that would give 75% level of sufficiency to meet insurance liabilities
D : MfAD does not increase with increasing skewness

CTE (TVaR)
-average expected value above a percentile
-used by life insurers with CTE(60%) and CTE(80%)
-would be too high for PC insurance.
A : MfAD increase with increasing skewness
A : provide better insight into the tail amounts

Question 16

CIA MfAD

Discuss documentation of MfADs

Answer 16

• Actuaries to document critical considerations in their selections of MfADs
• Actuaries conducting stochastic analyses document what components are modeled as random variables as well as primary assumptions
• documentation for both explicit and stochastic techniques would include support for key decisions

Question 17

CIA MfAD

Discuss reporting of MfADs

Answer 17

• in the USER’s best interest to be aware of the MfADs selected by the actuary.
• Disclosure in a report should balance between too little and too much
• should ask the question: what qualitative and quantitative information best serves the user’s understanding and decision making?

Question 18

CIA MfAD

2 circumstances where it would be appropriate to have a MfAD above the High Margin

Answer 18

for unusually high uncertainty

when resulting PfAD is unusually low because the MfaD is a % of the best estimate and the best estimate is unusually low

Question 19

CIA MFAD

Two alternative formula-based approaches for deriving the margin for investment return.

Answer 19

• Weighted Formula

- Explicit Quantification

Question 20

CIA MFAD

Give the 3 margins and their formulas to derive the margin for investment return based on the explicit quantification

Answer 20

1- Asset Liability Mismatch risk margin

• Risk Margin = Coverage Ratio x ((Asset Duration - Liability Duration)/(Liability Duration)) x Interest rate movement in runoff period
• Coverage Ratio = (Premium Liabilities + Claims Liabilities)/(Investments + Installment Premiums)

2- Timing risk margin

• Risk Margin = Shortening x Normal Discounted Rate x 10,000

3- Credit risk margin

• Could be estimated by comparing the yield curves of high quality bonds (government, municipalities, big 5 Canadian banks) and other corporate organizations. Then the extra yield is considered as the credit risk spread