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MROC
Munich Re Group
P&C Loss Reserve DiscountingCanadian Perspective
Spring MeetingQuebec CityJune 18, 2008
Claudette Cantin
2
MROC
Munich Re Group
1. Background
2. Implementation
3. Methodology/Assumptions
4. CICA New Accounting Standards (01/01/2007)
5. Challenges
6. Impact of IFRS on Canadian Discounted Reporting
Overview
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MROC
Munich Re Group
Background
Statutory reporting follows Canadian GAAP
Accepted Actuarial Practice requires policy liabilities to be calculated on a present value basis
Until 2003, the Office of the Superintendent of Financial Institutions (OSFI) directed that valuation not reflect the time value of money for P&C
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MROC
Munich Re Group
Background
Recommendations for Property – Casualty Insurance Company Financial Reporting effective January 1990 (Section 5.04)
“it is generally accepted actuarial practice to value liabilities as the present value of the payments….. but some jurisdictions require liabilities to be undiscounted”
“Where there is such a requirement, the recommendation …… to establish a present value provision does not apply to the valuation of liabilities in government financial statements and because it is desirable that liabilities be reported the same way in both government and published financial statements, it likewise does not apply to the valuation of liabilities in published financial statements.”
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MROC
Munich Re Group
Throughout the 1990’s
• development of guidance notes and actuarial standards of practice
• consultation between regulators, industry, CIA
In 1996, the OSFI’s discussion paper - Reporting for Actuarial Liabilities for P&C states
• “OSFI will no longer prohibit discounting of actuarial liabilities once…”
– CIA finalizes its Consolidated Standards of Practice (CSOP)– CIA develops further guidance on discounting liabilities
April 1999, CIA Educational Note on Discounting
2001, OSFI announced implementation of discounted reporting
Background – Time Line
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MROC
Munich Re Group
Background - Arguments
Major Arguments Against Discounting:
• Compliance costs vs. benefits
• Distortion to the financial statements
• Canada, an anomaly relative to international standard developments
• Be part of a comprehensive review of the overall accounting framework
• Piece meal approach to regulatory review process
• No actual relationship between values of liabilities and investments and no efforts to match investments to liabilities
Major Arguments for Discounting:
• Additional requirements minimal as practice already in place
• Reserves always only estimates
• International standards pointing in that direction
• Conform with accepted actuarial practice
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MROC
Munich Re Group
December 1, 2002, CIA CSOP General Standards
January 1, 2003, CSOP Practice-Specific Standards for Insurers
January 1, 2003, financial statements included discounted policy liabilities
Year-end 2003 new Minimum Capital Test (MCT) is implemented
January 1, 2007, CICA 3855 – Financial Instruments – Recognition and measurement
Background – Time Line
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MROC
Munich Re Group
ImplementationWhat Changed?
Restatement of prior year-end
Qualification removed from actuarial opinion
Disclosure in the Annual Statement
Discounting assumptions should be explicitly explained in the AA report
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MROC
Munich Re Group
ImplementationWhat Changed?
Additional exhibits to show more information on discounted basis
• Unpaid Claims & Loss Ratio Analysis Exhibit
• Runoff Exhibit has to show investment income (p. 60.41) earned on unpaid claims during the year (unwinding)
CIA Ed Note on Runoff - “For the purposes of the appointed actuary’s report, it would be useful to identify the components of the runoff (i.e. the contribution of the undiscounted claims liabilities, changes in the discount rate, payout patterns and changes in the provision for adverse deviations)”
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MROC
Munich Re Group
Implementation Issues
Volatility in results
Reporting basis different from parent
Comparability of industry results
Impact on Capital Requirements
Ceded liabilities
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MROC
Munich Re Group
Methodology/Assumptions
SOP 2220.01 - “The amount of claims liabilities should be equal to the present value, at the balance sheet date, of cash flow on account of claims (and related expenses and taxes) incurred before that date.”
Three major assumptions for discounting
• Payment pattern
• Discount rate
• Margin for adverse deviation (MfAD) to determine the PfADs
By line of business by year – gross, ceded and net
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MROC
Munich Re Group
CIA Standards of Practice
SOP paragraph 2240.01 - “The expected investment return rate is that to be earned on the assets which support the policy liabilities. It depends on
• the method of valuing assets and reporting investment income,
• the allocation of those assets and that income among lines of business,……”
Common practice – use same portfolio yield rate for all lines
Bond portfolio usually sufficient to support net liabilities
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MROC
Munich Re Group
Methodology/Assumptions - PfAD
CSOP 1740.07 - “The purpose of a provision is to promote financial security.
CSOP 1740.04 - “The amount of the provision should…. in the case of a provision in respect with uncertainty in assumptions, result from selection of assumptions which are more conservative than best estimate assumptions.”
CSOP 2250.04 - “The selected margin should vary between premium liabilities and claim liabilities, among lines of business, and among accident years, policy years or underwriting years, as the case may be, according to how those considerations so vary.”
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MROC
Munich Re Group
Implementation Issues
Discounting and Canadian GAAP?
Present value is an acceptable measurement but
• Discount rate ? Portfolio or risk free?
• Pfad’s ?? Real liabilities or contingencies? Why not in undiscounted?
• ACG-03 to permit “discounting” using CIA methods as an acceptable accounting treatment
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MROC
Munich Re Group
Impact of Discounting – Industry in 2003
• Net unpaid claims 0.3%
• Capital 0.4%
• MCT – Canadian (0.1%)
• MCT – Foreign 8.0%
• MCT – All 1.0%
The expected impact was 1 ½% reduction on net claims liabilities and 8 to 10 points on MCT (based on 2001 data)
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MROC
Munich Re Group
Impact of Discounting – Industry in 2003
$ Millions% of
Undiscounted
Undiscounted Unpaid Claims 10,259
Present Value 1,155 11.2%
PfAD – ClaimsPfAD – ReinsurancePfAD – Interest RateTotal PfAD
93424
1721,130
9.1%0.2%1.7%
Discounted Unpaid Claims 10,244 99.8%
Impact of discounting – 10 companiesImpact of discounting – Industry Total
0.2%0.3%
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MROC
Munich Re Group
Impact of Discounting
Top 10 Insurers
Primary(excl.
Lloyds)
Total Industry
20030.34%
3.42% 0.83%
2004 -0.84%
-0.10% -0.16%
2005 -1.29%
-0.79% 6.05%
2006 -1.14%
-0.40% 4.38%
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MROC
Munich Re Group
CICA New Accounting Standards
CICA 3855, Financial Instruments: Recognition and Measurement
CICA 1530, Comprehensive Income
Classification of Assets Considerations
• Held-to-maturity
> Measurement is on an amortized cost basis
> No effect on discount rate and actuarial liabilities
> No effect on financial statements, all things being equal
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MROC
Munich Re Group
Market Rates Decrease
Available-for-Sale Assets Liabilities Total
Invested assets Values Up
Discount Rate for Actuarial Liabilities
Down
Actuarial Liabilities Up
Net Income No effect Down Down
Other Comprehensive Income
Up No effect Up
Equity Up Down Depends
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MROC
Munich Re Group
Market Rates Decrease
Available-for-Sale Assets Liabilities Total
Invested assets Values Up
Discount Rate for Actuarial Liabilities
Down
Actuarial Liabilities Up
Net Income Up Down Depends
Other Comprehensive Income
No effect No effect No effect
Equity Up Down Depends
Held-for-trading (including Fair Value Option)
• Investment carried at fair value
• Gains and losses through net income
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MROC
Munich Re Group
Actuarial Considerations for Asset Classification
Impact on determination of discount rate: amortized value vs. market-to-market
Timeliness of information
Potential for greater swings in rates
Implications on margins for adverse deviation
Volatility in results
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MROC
Munich Re Group
New Challenges
Increased volatility in financial markets and increased volatility in performance measures such as claims ratios
OSFI request for supplemental filing i.e. non-discounted incurred loss data “to provide greater clarity into underwriting performance”
Disclosure of sources of earnings
Investment policy
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MROC
Munich Re Group
Impact of IFRS on Canadian Discounted Reporting
Canadian P&C insurers to move to IFRS in 2011
Current IFRS (IFRS4) – allows for discounted liabilities
Current IFRS (IFRS4) – allows for portfolio related discount rate
But proposed global standards being developed is expected to result in major changes:
• Expected future cash flows
• Discounting at market interest rates
• Margin for risk and future service