Casualty Loss Reserve Seminar
Session 7
Loss Reserve Discounting
Canadian and US Perspectives
Claudette Cantin, FCIA, FCAS, MAAA
Munich Reinsurance Company of Canada
September 14, 2004
Las Vegas
1
Overview
1.
2.
3.
4.
5.
6.
Background
CIA standards
Methodology and Assumptions
What Changed?
Impact of discounting 2003
Going Forward
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Background
 Accepted Actuarial Practice requires that valuation
of policy liabilities reflects the time value of money
 Until 2003, The Office of the Superintendent of
Financial Institutions (OSFI) directed that
valuation not reflect the time value of money for
P&C
 For income tax purposes, reserves have been
discounted for some time
3
Background
 In 1996, OSFI discussion paper - Reporting for
Actuarial Liabilities for P&C
 “OSFI will no longer prohibit discounting of
actuarial liabilities once …”


CIA finalizes CSOP
CIA develops further guidance
4
Background
 April 1999, CIA Educational Note on
Discounting
 December 1, 2002, CIA CSOP General
Standards
 January 1, 2003, CSOP Practice-Specific
Standards for Insurers
 December 31, 2003, financial statements
included discounted policy liabilities
5
CIA Standards
CSOP 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.”
6
CIA Standards
CSOP 2230.01 – “The amount of premium
liabilities (after deducting any deferred policy
acquisition expense asset) should be equal to the
present value, at the balance sheet date, of cash
flow on account of premium development and of
the claims, expenses and taxes to be incurred
after that date on account of the policies in force
at that date or an earlier date.”
7
CIA Standards
CSOP 2240.01 – “The expected investment
return rate for calculation of the present value of
cash flow is that to be earned on the assets which
supports the policy liabilities.”
CSOP 2250 deals with the selection of a margin
for adverse deviation for a valuation of policy
liabilities.
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Methodology and Assumptions
 Undiscounted liabilities are calculated by
line by year – gross, ceded and net
 Then the present value (PV) of these
liabilities is calculated
 And provisions for adverse deviations
(PfAD) are added
9
Methodology and Assumptions
Three major assumptions for discounting

Payment pattern

Discount rate

Margin for adverse deviation
(MfAD) to determine the PfADs
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Payment Patterns
 From company’s historical data – very
long tail may need more judgment
May vary by year i.e. changes in
legislation, reinsurance – not commonly
done
Vary by lines of business, usually using the
same groupings as for the valuation of
undiscounted
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Payment Patterns
Should be consistent with assumptions in
the valuation of undiscounted
Payment patterns are updated as claim
experience matures/changes
Gross, Ceded and Net
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Discount Rate
 CSOP 2240 – “…..on the assets which support the
policy liabilities.”
 CSOP 2240 lists considerations in determining
return rate and includes:





method of valuing assets.
allocation of assets among lines of business.
return on the assets at the balance sheet date and
yield on asset acquire after that date.
capital gains or loss.
investment expenses, loss from default.
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Discount Rate
 Common to use a single rate for all lines, all
years
 Portfolio yield rate used for both premium
and claims liabilities
 Must define which assets support the
liabilities
 Common practice to use the bond portfolio
if sufficient to cover all net policy liabilities
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Discount Rate
 Duration mismatch and use of new
premiums
 Appropriate rate for ceded liabilities



Portfolio yield?
Risk free rate ?
Rate used by assuming company ?
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Provision for Adverse Deviations
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 1740.13 – “If assumptions could be made with
complete confidence, if there were no statistical fluctuations,
and if data had no defect, then there would be no need for a
provision.”
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Margin for Adverse Deviations
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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Margin for Adverse Deviations
Three types



Claims Development
Recovery from reinsurance ceded
Investment rate of returns
Ranges

Claims : 2.5% to 15% of PV of claims liabilities
Reinsurance : 0% to 15% of PV of ceded liabilities

Rate of Returns : 50 to 200 basis points

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Margin for Adverse Deviations
Claims Development
Past or expected instability in the data
Changes in reserving practices, mix of
business, insufficient details or lack of
credibility
Around 5% for short tail, 7.5% to 15% for
auto AB and BI and 10% GL,E&O etc
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Margin for Adverse Deviations
Recovery From Reinsurance
History of claims and coverage dispute
with reinsurers
Quality of reinsurers, affiliated, unregistered
Ratio of ceded reinsurance
Not the same as provision for existing
dispute
Usually around 0% to 5%
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Margin for Adverse Deviations
Return Rate
Reduction of the selected investment rate
of return
Depends on quality of assets, concentration
and types of assets
Economic environment, liquidity of assets
Matching of duration, length and predictability
of claim payment
21
What Changed ?
 Qualification removed from actuarial
opinion
 Discounting assumptions should be
explicitly explained
 Restatement of prior year-end
22
What Changed ?
 Disclosure in the Annual Statement




Discount rate and its selection (as a
minimum)
“Pure” discount amount
PfADs
Measurement uncertainty attached to
PfADs
23
What 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)
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What Changed?
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)”
Not commonly done
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Impact of Discounting on 2003
Total Industry
Net unpaid claims
0.3%
Capital
0.4%
MCT – Canadian
(0.1%)
MCT – Foreign
8.0%
MCT – All
1.0%
Expected results was 1 ½% reduction on net
claims liabilities and 8 to 10 points on MCT (based
on 2001 data)
From OSFI presentation to Canadian Insurance Accountants Association April 2004
26
Impact of Discounting on 2003
Based on 10 of the Largest Companies
$ Millions
Total Undiscounted unpaid claims
Present Value of unpaid claims
Difference
% Change
10,269
9,114
1,155
11.2%
From OSFI presentation to Canadian Insurance Accountants Association April 2004
27
Impact of Discounting on 2003
Based on 10 of the Largest Companies
Change as of % of Undiscounted Claims
Liability
Auto BI
Auto AB
Personal Property
Auto PD
Commercial Property
14.5%
11.4%
10.9%
4.3%
3.8%
3.6%
Total All Lines
11.2%
From OSFI presentation to Canadian Insurance Accountants Association April 2004
28
Impact of Discounting on 2003
The range of changes in PV (before PfADs)
 Low 6.9% largely personal lines
 High 13.4% largely commercial lines
 Overall 11.2%
From OSFI presentation to Canadian Insurance Accountants Association April 2004
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Impact of Discounting on 2003
Based on 10 of the Largest Companies
Undiscounted Unpaid Claims
% of
$ Millions Undscntd
10,269
Present Value
1,155
11.2%
PfAD - Claims
PfAD - Reinsurance
PfAD - Interest Rate
Total PfAD
934
24
172
1,130
9.1%
0.2%
1.7%
10,244
99.8%
Discounted Unpaid Claims
Impact of discounting - 10 companies
Impact of discounting - Industry Total
0.2%
0.3%
From OSFI presentation to Canadian Insurance Accountants Association April 2004
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Going Forward
CIA Survey
Discounting had been done for many years
Look at ranges of practice
Seek input on needs for future guidance
Ceded liabilities ???
Issuing revised Educational Note (previous Note
dealt with net liabilities only)
Narrowing range of practices
Better consensus amongst actuaries
31
Going Forward
Discounting and Canadian GAAP ??
Changes in CICA handbook
Industry practice is NOT GAAP
Present value is an acceptable measurement but
discount rate ? Portfolio or risk free
PfAD’s ?? Real liabilities or contingencies? Why
not in undiscounted?
Integration with IFRS
Update ACG-03 to permit “discounting” using CIA
methods as an acceptable accounting treatment
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Loss Reserve Discounting
Canadian Perspectives
Questions ?
Thank You
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