6. Stress and scenario testing Flashcards
Define financial condition testing (FCT)
Financial Condition Testing (FCT) is an analysis that must be done at least once a year by the appointed actuary. This analysis usually implies that the AA reviews the financial state of the firm in recent years and develops a few financial scenarios. Within the scenarios, there should be a base scenario and a few adverse scenarios. The FCT is an exercise to identify possible threats to the financial condition of the insurer and the appropriate way to manage such threats.
Name 5 key elements the FCT is composed of
- Development of a base scenario
- Development of adverse scenario
- Identification and analysis of the effectiveness of corrective management actions
- Report on results and recommendation
- Signed opinion of AA
Name 3 documents to look at to possibly assess the financial state of an insurer in previous years
- Financial statements
- Internal income reporting/experience analysis
- Results of regulatory tests of capital adequacy
There are three types of adverse scenarios, name them and describe them
- Solvency scenario: 95th+ percentile scenario where we would assess if assets > liabilities
- Going concern scenario: 90th+ scenario where we would asses if regulatory minimums are respected
- Integrated scenario: adverse scenario arising from combining two or more risks factors
How many solvency scenarios, going concern scenarios and integrated scenarios should at least be considered?
Solvency scenarios : 2
Going concern scenarios: 1
Integrated scenarios: 1
Define ripple effects
A domino effect. Can be automatically modelled by the model, or manually by the actuary by modifying assumptions.
How long is the forecast period in the FCT?
Usually 3 to 5 years, but judgement is key since the important part is that all effects of stress testing are contained within the forecast period.
How would we assess if the financial condition of the insurer was satisfactory throughout the forecast period?
The financial condition of the insurer would be satisfactory if under the solvency scenarios, the assets had a higher value than the liabilities. Under the going concern scenario, the insurer would need to meet minimum regulatory capital and under the base scenario, the insurer would need to meet its internal target capital as determined by the ORSA.
What are 3 reasons to consider certain elements instead of others within the FCT model? (Targets, metrics to measure financial state)
- It’s a key metric used by the board of directors
- Elements that give insights on the insurer’s exposure
- Elements useful in assessing reasonableness of scenarios
The CIA’s educational note on FCT recommends to segment the model into different parts. Why is this relevent and name 3 possible segments.
Management (management structure, decision making)
Investment (investment income based on asset categories)
Product (similar products may be combined)
The objective is to be able to use different types of model to modelize the different segments of the insurer’s financial structure. This offers more flexibility and interpretability.
What is the difference between management’s routine actions and corrective management actions?
Corrective management actions will require approval from senior management or the board. Corrective management actions are not considered as “in the normal course of business”. Implementing a new reinsurance arrangement would be an example of corrective management action.
