PD - 16 Developments on International Accounting Standards From a P

1
PD - 16Developments on International Accounting
Standards From a P C and Life Perspective

• Canadian Institute of Actuaries Annual Meeting
• David Oakden
• June 29, 2007

2
Overview of Risk Margins

• IASB - Preliminary Views on Insurance Contracts
• IAA - Measurement of Liabilities for Insurance
  Contracts Current Estimates and Risk Margins

3
IASB Basic Building Blocks

• Estimate of future cash flows
• Time value of money
• Margin

4
IASB Exit Value

• Amount the insurer would expect to have to pay
  today to another entity if it transferred all its
  remaining contractual rights and obligations
  immediately to that entity
• excluding any payment for other rights and
  obligations

5
IASB Margin

• As required by market participants for
• Bearing risk
• Providing services
• Not a shock absorber
• More guidance is needed on calibration

6
IASB Risk Margin Approaches

• Confidence level
• CTE
• Canadian approach
• Cost of capital
• Based on CAPM
• Adjustments to cash flows
• Risk adjusted discount rate

7
IASB Calibration of Margins

• Observed price to policyholder
• Price to policyholder is a reasonableness check
• Profit or loss at inception is permitted
• Unbiased estimate of third party acquisition
• Business combination or portfolio transfer

8
IAA - Current Estimate

• Expected present value of probability weighted
  cash flows using current assumptions

• Exit Value Current Estimate Margin

9
Current Estimate Considerations

• All relevant expected cash flows are included
• Consistent with financial reporting standards
• Reflects observed market inputs
• Otherwise model-based estimates may be used
• Unit of account is portfolio
• Similar risks
• Managed together
• Current estimates not current conditions

10
Current Estimate Considerations Ctd.

• Consistent assumptions
• Any significant asymmetry in cash flow should be
  reflected
• Approximations can be used if impact is small in
  relation to cost of a more refined approach
• Alternate data sources may be used where the
  actual data is inadequate
• Assumptions should be reviewed systematically and
  revised when appropriate

11
IAA Risk Margin Approaches

• Cost of capital
• Apparent preferred approach
• Statistical Methods
• Quantile
• Conditional tail expectation
• Explicit assumption approaches (Canadian method)
• May produce inconsistency between
• Assets and liabilities
• Insurance and other industries

12
IAA High Risk Margin Situations

• Less information
• Low frequency / high severity
• Longer payment terms
• Wider probability distribution
• To the extent that emerging experience reduces
  risk then risk margins should decrease

13
IAA Reference Entity

• To be consistent with an exit value approach, it
  is reasonable to construct a reference entity to
  which the portfolio would be transferred
• The use of a reference entity would promote
  increased comparability between preparers
  financial statements

14
IAA Reference Entity

• Large
• Process risk is as small as practical
• Multi-line / diversified
• Benefits of risk diversification
• Highly rated
• AA
• Business similar in nature

15
IAA Cost of Capital

• Preferred method
• Cost of capital
• 4 to 6 (above the risk free rate) used to
  illustrate the method
• Seems low by North American standards
• Wide range
• Capital
• IAA Blue Book
• Solvency II SCR
• More guidance needed

16
IAA Sample Risk Margins
Capital Cost of Capital Short Tail Line of Business Long Tail Line of Business
35 10 6.3 17.2
70 10 12.6 34.4
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Questions

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