Ted Strickland, GovernorMary Jo Hudson, Director

NAIC PotpourriMary Miller FCAS, MAAA

Assistant Director, Product Regulation & Actuarial Services

June 24, 2009Kansas City Actuarial Club Seminar

Agenda• NAIC Risk-Focused Examinations• New Health Actuarial Opinion Instructions• Actuarial Opinion Summary and Other

Initiatives

• Financial Analysts/Examiners have used Risk Assessment for many years - SRA’s

• Focus was on the past – Balance Sheet• Used to determine whether prior period

financials were fairly stated

Risk Assessment and the NAIC

• Risk – Focused Surveillance Process• Evolution or Revolution?• CARRMEL Rating Determines Priority• Coordinated Examinations• Emphasis on

– Corporate Governance– Quality of the Board– Risk Management

Change Has Occurred

• Prioritization system• Improves decision-making and

communications• Validated/Revised as part of the

examination effort• Facilitates analysis to identify strengths and

weaknesses• Scores management• As time goes on, it becomes a better tool

CARRMEL rating

• Capital Adequacy• Asset Quality• Reserves• Reinsurance• Management• Earnings• Liquidity

CARRMEL

• Board of Directors• Senior Management• Control Functions

– Audit– Compliance– Risk management

Corporate Governance

1. Assess external and internal audit functions- Maximize use where appropriate

2. Interview senior management- Assessing corporate governance and ERM

3. Focus on high risk areas (examples include):- Reserves- Reinsurance- Inter-company transactions

Top-Down, Risk-Focused Surveillance Process

• Identification of risks• Assessment of governance structure • Allocation of Department resources• Assessment of risk management

framework & practices • Meaningful communication of findings

with Board and/or Senior Management• Update CARRMEL rating

Objectives

• Active Board and Senior Management oversight

• Adequate policies, limits and procedures• Adequate risk management, monitoring

and management information systems• Comprehensive internal controls• Compliance to law, regulations, and

internal policies

Risk Management Principles

• Tone at the top – Audit/compliance relationships

• Adherence to Board policies and procedures

• Internal control environment

Assessment of Risk Management Framework & Practices

• Credit• Market• Pricing/Underwriting• Reserving• Liquidity• Operational• Legal • Strategic• Reputation

Inherent Risks

• Pricing/Underwriting• Reinsurance• Investments• Claims/Reserves• Support

– Accounting– Actuarial– IT– Legal– Human Resources

Application of these Risks to Key Business Activities

Identification of Inherent Risk Plus

Assessment of Risk Management Processes Equates to

Residual Risk Determination

Risk Assessment Steps

Residual Risk GridInherent

RiskStrong Risk

Controls

Acceptable Risk

Controls

Weak Risk Controls

High Moderate to High

Moderate to High

High

Moderate Moderate Moderate to High

Moderate to High

Low Low Low Low to Moderate

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7 Phases

• Phase 1 Understand Company/Key Activities• Phase 2 Inherent Risk• Phase 3 Risk Mitigation Strategies/Controls• Phase 4 Residual Risk• Phase 5 Exam Procedures• Phase 6 Prioritization/Supervisory Plan• Phase 7 Exam Report/Management LetterRisky Business

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Phase 1 – Understand Company/ Key Activities

1. Understanding the Company• Steps to Phase 1, Part 1

1. Gather Necessary Planning Information2. Review the Gathered Information3. Perform Analytical and Operational Reviews4. Consider Information Technology Risk5. Update the Insurer Profile Summary

2. Understanding Corporate Governance Structure3. Assessing Adequacy of Audit Function4. Identifying Key Functional Activities5. Consider Business and Prospective Risks

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Examination Interviews Why

• Gather undocumented information

• Clarify information• Interpret information• Identify key activities• Identify strengths• Identify risks• Identify risk mitigating strategies

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Examination InterviewsWho

• CEO• CFO• COO• CIO• Controller• Chief Actuary• Board’s Audit Committee chairperson

P a tty M e ltP re m iu m s

C a th y Fra n k linP a yab les

T o m T yle rA c cou n tin g M a na g er

F re d S ilv e rIT M an a g er

D a ryl M o n yC F O

S a m S lyV P U n de rw rit ing

B a bs Jon esV P In v es tm e n ts

H o m er S m ithV P C la im s

J . D oeP re s id en t/C E O

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Example:Phase 1, Part 1, Step 3Analytical and Operational Reviews• Management and reserving processes

– Who determines reserves booked– What analyses performed– Unique types of losses– Surplus and/or RBC level– Basis for variable compensation

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Phase 1, Part 2Corporate Governance & Management• Management controls and reserving

– Management influence– Independence of appointed actuary and their

assumptions– Changes to appointed actuary– Risk transfer due to ceded reinsurance– Reserving actuary meets with Board/Audit

Committee

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Phase 1, Part 2Corporate Governance & Management• ITEMS FOR REVIEW

– Actuary participates in pricing meetings– Exposure growth is monitored regularly– Well-diversified book of business-geographical– Remedy bad situations promptly or drag on– ERM implemented– Carried reserves determined by actuary– Segregation of actuarial duties

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Phase 1, Part 3Assess Audit Function

INDEPENDENCE:• “In all matters relating to audit work, the

audit organization and the individual auditor … should be free both in fact and appearance from personal, external and organizational impairments to independence.”

GAO

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Phase 1, Parts 4-5Key Activities/Prospective Risk

• Key Activities will involve those lines of business with the largest reserves or premiums collected.

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Phase 2Inherent Risk

• Inherent Risks:– Incorrect data– Misapplying methodologies– Invalid assumptions– Incorrect calculations– Improper reporting of reserves

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Phase 2Inherent Risk

• Liquidity– Assess catastrophe management process to

identify likelihood of occurrence and magnitude of impact relative to company’s surplus and claims paying ability:

• as a result of an acceleration in claim payout patterns

• in the event of an insolvency of a significant reinsurer

• an increase in the duration of assets

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Phase 2Inherent Risk

• Pricing/Underwriting – P/C– Consider inherent risks related to:

• An insurance product priced with little margin can lead to significant losses.

• Are separate analyses conducted for certain unique types of losses (e.g., construction defects, class actions, catastrophes, environmental)?

©2008 National Association of Insurance Commissioners

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Phase 3Risk Mitigation Strategies/Controls

• Controls related to specific identified risk• Look at controls over:

– Reserving process– Staffing issues

©2008 National Association of Insurance Commissioners

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Phase 3Risk Mitigation Strategies/Controls

Best Practice Controls• Pricing/Underwriting

– Appropriate rate-setting methodologies– Quality assurance of underwriting guidelines– Experience level of underwriting staff (i.e.,

more complex issues handled by senior staff members)

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Phase 3Risk Mitigation Strategies/Controls

• Liquidity comprised of:– Risk management– Investments– Premiums– Claims

• Proper controls in each area ensure liquidity

Best Practice Controls

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Phase 4Residual Risk

• Risk remaining after consideration of controls

Inherent Risk– Internal Controls

Calculated Residual Risk+/- Examiner’s Judgment

Overall Residual Risk Assessment

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Phase 5Exam Procedures

• Procedures based on residual risk assessment– P/C

• Larger, more volatile lines• New lines of business/segments• New geographic areas• Persistent adverse development

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Phase 6Prioritization & Supervisory Plan

Phase 7Exam Report & Management Letter

Health Actuarial Opinion Changes• Define an appointed actuary• Require appointed actuary report findings

to the Board or Audit Committee• Require the reliance statement

Why were changes needed?• Appointment and memorandum

requirements were not specified• Desire for consistency across blanks• Make instructions more relevant to health

blank – not a modified Life opinion• Define process for changing actuaries• Define what Qualified, Adverse and

Inconclusive opinions are

Consistency• Joint CASTF/LHATF subgroup charged with

developing the process for the appointment and change of the actuary

• Definitions• Reliance statements

Appointed Actuary• If you were appointed according to the

new instructions in the past, you don’t need to be re-appointed

• If you were not appointed according to the new instructions, you need to be appointed in order to sign the opinion for 2009

Prescribed Wording• Prescribed wording is preferable if it fits

the situation• Not using prescribed wording does NOT

imply that something is wrong• Makes it easier for non-actuaries to review

the opinions

Table of Key IndicatorsThis Opinion is: Unqualified Qualified Adverse Inconclusive IDENTIFICATION SECTION Prescribed Wording Only Prescribed Wording with Additional Wording Revised Wording SCOPE SECTION Prescribed Wording Only Prescribed Wording with Additional Wording Revised Wording RELIANCE SECTION Prescribed Wording Only Prescribed Wording with Additional Wording Revised Wording OPINION SECTION Prescribed Wording Only Prescribed Wording with Additional Wording Revised Wording RELEVANT COMMENTS Revised Wording The Actuarial Memorandum includes “Deviation from Standard” wording regarding conformity with an

Actuarial Standard of Practice

Other New Stuff• Relevant Comments Section

• Actuarial Memorandum– Narrative and technical components– Tie to financial statements

Definitions – Adverse Opinion• An actuarial opinion in which the

appointed actuary determines that the reserves and liabilities are not good and sufficient.

Definitions – Qualified Opinion• When in the actuary’s opinion the reserves for a certain

item or items are in question because they cannot be reasonably estimated or the actuary is unable to render an opinion on those items, the actuary should issue a qualified opinion.

• A qualified opinion should state whether the reserves would be good and sufficient without the items in question.

• There’s also a provision that the actuary doesn’t have to issue a qualified opinion if the actuary determines the item in question is immaterial.

Definitions – Inconclusive Opinion• If for some reason the actuary can’t reach

a conclusion due to deficiencies or limitations in the data, analysis, assumptions or related information, then the actuary should issue an inconclusive opinion.

• The opinion should then include the reasons why a conclusion could not be reached.

FYI• Ohio in process of changing Life AOMR• Health blank users must use Health

Opinion instructions

• Confidential• Filed only with domiciliary state or as requested• Due March 15• Minimum Requirements:

– Point estimate and/or range of reasonable estimates for loss and loss adjustment expenses, net and gross of reinsurance

– Company’s recorded loss and loss adjustment expense reserves, net and gross of reinsurance

– Difference between carried reserves and point estimate/range of reasonable estimates, net and gross of reinsurance

– Explicit discussion of persistent adverse reserve development (1 year development of 5% of surplus in 3 of the last 5 years)

• Uses:– Tool for deciding when to request Report– Use in conjunction with Opinion and Report when planning exam

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ACTUARIAL OPINION SUMMARY

AOS StatisticsCombined Net

Data from 825 Companies domiciled in seven states

Reflects 2007 AOS data

Includes some companies that carry net zero 18%

30%

52%

PointRangeBoth

AOS Statistics – Carried to Actuary Estimate

• Combined Net data from 732 companies in 7 states

• Excludes companies that carry zero-net reserves 0%

10%

20%

30%

40%

50%

Implications• P&C Companies coming off a hard market

with generally strong reserves• Tracking AOS data going forward will add

an additional tool for monitoring the industry

Other Regulatory Initiatives• Regulator Guidance in COPLFR Practice

Note• Frequent interaction and collaboration

with Accounting Groups at NAIC• RBC trend test• LOB survey• Continued Discussing Premium Deficiency

Reserves at June NAIC Meeting