PD - 16Developments on International
Accounting Standards From a P & C and Life Perspective
Canadian Institute of Actuaries Annual Meeting
David Oakden
June 29, 2007
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Overview of Risk Margins
• IASB - Preliminary Views on Insurance Contracts
• IAA - Measurement of Liabilities for Insurance Contracts: Current Estimates and Risk Margins
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IASB Basic Building Blocks
• Estimate of future cash flows
• Time value of money
• Margin
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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
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IASB Margin
• As required by market participants for– Bearing risk– Providing services
• Not a shock absorber• More guidance is needed on calibration
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IASB Risk Margin Approaches
• Confidence level• CTE• Canadian approach• Cost of capital• Based on CAPM• Adjustments to cash flows• Risk adjusted discount rate
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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
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IAA - Current Estimate
Exit Value = Current Estimate + Margin
Expected present value of probability weighted cash flows using current assumptions
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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
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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
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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
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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
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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
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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
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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
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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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