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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