P&C Loss Reserve Discounting
Canadian Perspective
Spring Meeting
Quebec City
June 18, 2008
Claudette Cantin
MROC
Munich Re Group
Overview
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
2
Background
MROC
Munich Re Group
 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
3
Background
MROC
Munich Re Group
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.”
4
Background – Time Line
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
5
Background - Arguments
MROC
Munich Re Group
•
Major Arguments Against
Discounting:
Compliance costs vs. benefits
• Distortion to the financial statements
Major Arguments for Discounting:
• Additional requirements minimal as
practice already in place
• Reserves always only estimates
international standard developments • International standards pointing in
• Canada, an anomaly relative to
• Be part of a comprehensive review
of the overall accounting framework
• Piece meal approach to regulatory
that direction
• Conform with accepted actuarial
practice
review process
• No actual relationship between
values of liabilities and investments
and no efforts to match investments
to liabilities
6
Background – Time Line
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
7
Implementation
What Changed?
MROC
Munich Re Group
 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
8
Implementation
What Changed?
MROC
Munich Re Group
 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)”
9
Implementation Issues
MROC
Munich Re Group
 Volatility in results
 Reporting basis different from parent
 Comparability of industry results
 Impact on Capital Requirements
 Ceded liabilities
10
Methodology/Assumptions
MROC
Munich Re Group
 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
11
CIA Standards of Practice
MROC
Munich Re Group
 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
12
Methodology/Assumptions - PfAD
MROC
Munich Re Group
 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.”
13
Implementation Issues
MROC
Munich Re Group
 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
14
Impact of Discounting – Industry in 2003
MROC
Munich Re Group
• Net unpaid claims
• Capital
• MCT – Canadian
• MCT – Foreign
• MCT – All
0.3%
0.4%
(0.1%)
8.0%
1.0%
The expected impact was 1 ½% reduction on net claims liabilities and 8
to 10 points on MCT (based on 2001 data)
15
Impact of Discounting – Industry in 2003
MROC
Munich Re Group
$ Millions
Undiscounted Unpaid Claims
% of
Undiscounted
10,259
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%
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Impact of Discounting
MROC
Munich Re Group
Top 10
Insurers
Primary
(excl.
Lloyds)
Total
Industry
2003
0.34%
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%
17
CICA New Accounting Standards
MROC
Munich Re Group
 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
18
Market Rates Decrease
MROC
Munich Re Group
 Available-for-sale
• Investment carried at fair value
• Change in fair value recorded in Other Comprehensive Income
• Income statement mismatch
Available-for-Sale
Invested assets Values
Assets
Liabilities
Up
Discount Rate for
Actuarial Liabilities
Down
Actuarial Liabilities
Up
Net Income
Total
No effect
Down
Down
Other Comprehensive
Income
Up
No effect
Up
Equity
Up
Down
Depends
19
Market Rates Decrease
MROC
Munich Re Group

Held-for-trading (including Fair Value Option)
• Investment carried at fair value
• Gains and losses through net income
Available-for-Sale
Invested assets Values
Assets
Liabilities
Up
Discount Rate for
Actuarial Liabilities
Down
Actuarial Liabilities
Up
Net Income
Other Comprehensive
Income
Equity
Total
Up
Down
Depends
No effect
No effect
No effect
Up
Down
Depends
20
Actuarial Considerations for Asset Classification
MROC
Munich Re Group
 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
21
New Challenges
MROC
Munich Re Group
 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
22
Impact of IFRS on Canadian Discounted Reporting
MROC
Munich Re Group
 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
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Thank you very much for your attention.
Claudette Cantin
MROC
Munich Re Group