MROC

Munich Re Group

P&C Loss Reserve DiscountingCanadian Perspective

Spring MeetingQuebec CityJune 18, 2008

Claudette Cantin

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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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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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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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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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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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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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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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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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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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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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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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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

MROC

Munich Re Group

Thank you very much for your attention.

Claudette Cantin