C - CIA DCAT Flashcards
CIA DCAT
2 requirements for financial condition to be satisfactory.
1) Under DCAT base scenario and under all adverse scenarios, ASSETS > LIABILITIES throughout the forecast period
2) Under Base scenario, insurer meets Supervisory Target Capital Requirement (150%)
CIA DCAT
5 key elements of DCAT
1) Development of a Base scenario
2) Analysis of impact of plausible adverse scenario
3) Identification/Analysis of corrective management actions to mitigate risks
4) Report and Recommendations to management and board
5) Opinion signed by AA and included in report on financial condition
CIA DCAT
Define RIPPLE EFFECT
6 inclusions in RIPPLE EFFECTS
an event that occurs when an adverse scenario triggers a change in one or more interdependent risk factors
It includes :
1) chg in assumptions of base scenario that are no longer appropriate for adverse scenario being tested
2) Insurer’s expected RESPONSE to adversity
3) policyholder’s RESPONSE
4) rating agency’s RESPONSE
5) change in planned capital injections
6) regulatory RESPONSE
CIA DCAT
2 Principal goals of DCAT
Describe 3 steps of DCAT Process
identify possible threats to financial condition
identify appropriate corrective actions to address those threats
1) review recent and current financial position
2) run base scenario and several adverse scenarios
3) report the results including at least 3 adverse scenarios
CIA DCAT
Discuss typical approach of DCAT
1) Review financial position of 3 most recent years
2) DEVELOP BASE SCENARIO for forecast period (consistent with business plan). Forecast period NPT LESS THAN 3 FISCAL YEARS
3) ASSESS the RISK CATEGORIES. Identify those relevant to circumstances (may use sensitivity testing for identification)
4) SELECT PLAUSIBLE ADVERSE SCENARIOS
(single-risk sc, integrated sc, combination of single-risk scenarios).
Identify interactions and RIPPLE EFFECTS.
Consider reverse stress testing of adverse scenarios (see how far the risk factor has to be changed to drive a negative surplus during forecast period, then evaluate whether that degree of change is plausible)
5) Select at least 3 SCENARIOS WITH GREATEST SURPLUS SENSITIVITY to include in DCAT. Also include any scenario where insurer fall below STCR (150%)
6) IDENTIFY POSSIBLE CORRECTIVE MGMT ACTIONS
7) IDENTIFY POSSIBLE REGULATORY ACTIONS for each scenario causing insurer to fall below STCR
CIA DCAT
Contrast
Materiality Standard of
DCAT vs VALUATION of policy liabilities.
3 considerations of AA when selecting a materiality standard
Materiality for DCAT should be less vigorous than the one used for valuation of policy liabilities
1) SIZE
2) FINANCIAL POSITION (more rigorous if base scenario closer to STCR)
3) NATURE of REGULATORY TEST
CIA DCAT
DEFINE
Base scenario in DCAT
A realistic set of assumptions used to forecast financial POSITION over the forecast period
consistent with business plan
AA must report material inconsistency between base scenario and business plan
CIA DCAT
4 items to recognize in future financial position under BASE SCENARIO when it differs from the projected financial results in the business plan
1) change in distribution assumptions
2) management decisions not discussed in business plan
3) change in capital level not reflected in business plan
4) impact actual recent experience on future experience
CIA DCAT
Define PLAUSIBLE ADVERSE SCENARIOS
Define them within STOCHASTIC MODELS
scenario, being MATERIAL, PLAUSIBLE and ADVERSE, to which the financial condition is sensitive.
Reverse stress testing can help identify material plausible adverse risk over the forecast period
–Under stochastic models–
PLAUSIBLE ADVERSE SCENARIOS must be in the 95-99 percentile range
-95th percentile or greater : ADVERSE
-99th or lower are deemed PLAUSIBLE
CIA DCAT
5 examples of POSSIBLE CORRECTIVE MGMT ACTIONS to reduce likelihood of threat identified by plausible adverse scenarios
1) change pricing
2) suspend payment of dividends
3) raise more capital
4) strengthen of ERM practice
5) increase risk monitoring and reporting
6) mitigate the risk causing the capital shortfall
CIA DCAT
Define
INTEGRATED SCENARIOS
combining 2 or more adverse scenarios
the 2 adverse scenarios may or may not be correlated
Resulting integrated scenario must be REALISTIC ADVERSE and PLAUSIBLE (aka between 95 and 99 percentile range)
use reverse stress test to assess if Integrated scenarios is PLAUSIBLE
CIA DCAT
3 approaches used to determine adverse scenarios
STOCHASTIC risk (such as capital markets, exposure to CATS) are ideally modeled stochastically
DETERMINISTIC
scenarios selected judgmentally by the AA
COMBINATION
risk modeled stochastically and then result used to derive deterministic scenario
CIA DCAT
2 possible approaches to model ripple effects in a DCAT
1) Automatically generated by the model
2) manually created by the AA by modifying appropriate assumptions
CIA DCAT
5 frequency and severity risks that can be included in DCAT
single CAT event (natural, man-made)
single LARGE CLAIM (full PML)
Multiple CAT event
Multiple LARGE CLAIM
Social Inflation (from suits, awards)
CIA DCAT
Examples of RIPPLE EFFECTS arising from
freq and sev risk
insolvency of reinsurer
increase in reinsurance rates or non-availability of coverage for next term
post-event inflation
increased PACICC assessment resulting from failure of other insurers
CIA DCAT
Examples of CORRECTIVE MANAGEMENT ACTIONS to correct for freq and sev risk
1) review reinsurance coverage
2) rate increase
3) change in mix of business
4) restrict writing in hazard-prone zones
CIA DCAT
9 broad risk categories considered in DCAT
1) freq and sev risk
2) policy liabilities risk
3) inflation risk
4) premium risk
5) reinsurance / counterparty risk
6) investment risk
7) governmental / political risk
8) off-balance sheet risk
9) related-company risk
CIA DCAT
5 examples of ADVERSE SCENARIOS from POLICY LIABILITIES risk in DCAT
1) selection of inadequate LDFs
2) class actions and mass torts
3) change in mix of business
4) claims paid faster than assumed
5) actual RoR on investments supporting liabilities lower than assumed
CIA DCAT
4 examples of RIPPLE EFFECTS from POLICY LIABILITIES RISK
1) rating agency downgrade
2) liquidation of assets
3) increase in Ultimate Claims cost and adjustment expenses
4) effect of APV for scenarios affecting undiscounted policy liabilities
CIA DCAT
4 examples of CORRECTIVE MANAGEMENT ACTIONS for POLICY LIABILITIES RISK
1) setting claims faster by minimizing litigation
2) review reserving and claims handling guidelines
3) implement rate increases
4) review mix LoB
CIA DCAT
3 examples of ADVERSE SCENARIOS due to INFLATION RISK
1) significant, rapid and sustained increase in the general rate inflation
2) a significant temporary increase in cost of labour and materials following a CAT
3) a severe recession in the economy
CIA DCAT
3 examples of RIPPLE EFFECTS due to INFLATION RISK
1) rapid and sustained increase in interest rates
2) increase in operating expenses
3) increase in reinsurance rates and swing-rated contracts
CIA DCAT
5 examples of CORRECTIVE MANAGEMENT ACTIONS for INFLATION RISK
1) Review of insurance coverage
2) implement rate increase
3) review mix of business by LoB
4) review type of products offered
5) adjusting insurance to value or cost calculator
CIA DCAT
6 examples of events resulting in a significant reduction of premium volume (compared to base scenario) - (PREMIUM RISK)
1) new competitor in the market
2) more competitiveness in market
3) loss of a distribution channel
4) loss of a key client
5) non-competitive rates
6) inability to implement rate increase
CIA DCAT
6 examples of RIPPLE EFFECTS due to significant decrease in premium volume (compared to base scenario) - (PREMIUM RISK)
1) increase in loss ratio due to inadequate pricing
2) increase in fixed expense ratio
3) increase in certain types of expenses (ads)
4) change in mix of business
5) increase in reinsurance costs as a % of subject premium
6) liquidation of assets
CIA DCAT
5 possible CORRECTIVE MANAGEMENT ACTIONS for a significant decrease in premium volume (PREMIUM RISK)
1) reducing personel
2) increasing rates
3) identifying other key distributors
4) uw actions in market subject to competition
5) changing reinsurance coverage
CIA DCAT
5 examples of events resulting in a significant increase of premium volume (compared to base scenario) - PREMIUM RISK
1) withdrawal of competitor from market
2) appointment of a new distributor
3) unexpected new business from a large client
4) unexpected success in a new product area
5) premium rates too low compared to competition
CIA DCAT
5 examples of RIPPLE EFFECTS due to significant increase in premium volume (compared to base scenario) - PREMIUM RISK
1) higher loss ratio on new business due to inadequate pricing
2) shift in mix of business to new business entry
3) higher expenses
4) increase PACICC and pool assessments
5) increased reinsurance costs
CIA DCAT
5 possible CORRECTIVE MANAGEMENT ACTIONS for a significant increase in premium volume (compared to base scenario) - PREMIUM RISK
1) implementing rate change
2) uw actions (restriction of new business) in unprofitable markets
3) reviewing the distribution channels
4) reducing certain types of expenses (ads)
5) using reinsurance to mitigate capital strains
CIA DCAT
4 possible ADVERSE SCENARIOS arising from REINSURANCE RISK in DCAT
1) reinsurer insolvency
2) an increase in reinsurance rates (or reduction in reinsurance commission)
3) reduction in capacity
4) disputes over policy condition
CIA DCAT
4 AA considerations when developing an adverse scenario for reinsurer insolvency in DCAT
1) whether reinsurer is AFFILIATED or not (easier to assess likelihood of insolvency if affiliated)
2) rating of reinsurer (weaker rating most likely to fail)
3) whether reinsurer is REGISTERED or not (non-registered reinsurer funds are more difficult to secure)
4) concentration of reinsurance
CIA DCAT
2 examples of RIPPLE EFFECTS due to REINSURANCE/COUNTERPARTY RISK
1) increase in reinsurance rates
2) reduced availability of reinsurance
CIA DCAT
5 possible CORRECTIVE MANAGEMENT ACTIONS to REINSURANCE/COUNTERPARTY RISK
1) changing the reinsurance structure
2) diversifying reinsurers
3) retaining bigger proportion of business to decrease reinsurance costs
4) changing reinsurers
5) reducing primary policy limits
CIA DCAT
8 possible ADVERSE SCENARIOS arising from INVESTMENT RISK
1) significant change in yield curve
2) significant change in foreign exchange rates
3) increase in default rate on debt securities
4) decrease in returns and value of equities
5) decrease in returns and value of real estate
6) decrease in returns and value of subsidiary
7) decrease in returns and other major asset categories
8) the AA may consider integrated scenarios (combination of these events)
CIA DCAT
8 possible RIPPLE EFFECTS due to INVESTMENT RISK
1) liquidation of assets / forced sale
2) significant cash flow impacting liquidity position
3) negative change on derivative position
4) default by counterparty on derivatives
5) rating agency downgrades
6) liquidity crisis caused by large default losses
7) increase in freq and sev of claims due to deteriorating economic events
8) change in discount rate used for calculating actuarial value of policy liabilities
CIA DCAT
6 possible CORRECTIVE MANAGEMENT ACTIONS to INVESTMENT RISK
1) selling assets
2) changing the investment strategy
3) repositioning derivative tools-
4) reducing the amount of business underwritted
5) implementing rate increase
6) reducing costs through layoffs or consolidation or branch offices
CIA DCAT
8 possible ADVERSE SCENARIOS arising from GOVERNMENT and POLITICAL RISK
1) rate freeze by regulator
2) change to regulations regarding use of rating variables
3) change in legislation prescribing levels of insurance coverage
4) increase in taxation rates
5) nationalization of a LoB
6) change in legislation restricting distribution channels
7) change in regulatory solvency standards
8) political instability leading to closure for new business.
CIA DCAT
8 possible RIPPLE EFFECTS due to political government risk
1) deterioration of loss ratios
2) increased litigation costs
3) reduced availability of insurance to public
4) increased volume of industry pools
5) increased regulatory monitoring
6) forced sales
7) problem with reinsurance coverages
8) increase reinsurance rates
CIA DCAT
4 CORRECTIVE MANAGEMENT ACTIONS to POLITICAL/GOVERNMENT RISK
1) reducing volume of business written
2) creating/expanding a separate company or distribution channel
3) reviewing target mix by LoB
4) reviewing reinsurance coverage
CIA DCAT
Define
OFF-BALANCE SHEET RISK
Risk arising from new or evolving industry practices not yet recognized in balance sheet, but may be in subsequent years
actuary must be aware of emerging risks
CIA DCAT
6 possible ADVERSE SCENARIOS from OFF-BALANCE SHEET RISK
1) structured settlement (when a pc insurer buys an annuity and is exposed to the credit risk associated with the insolvency of the annuity company)
2) contingent liabilities or losses
3) letter of credit and pledged assets
4) capital maintenance agreements
5) Derivative instruments
6) pension underfunding
CIA DCAT
4 risks associated with DERIVATIVES
1) MARKET RISK
a) liquidity risk
risk of not being able to cancel a contract at a favorable price
b) basis risk
risk that the price of the derivative does not act as expected, undoing the intended hedging benefits
2) DEFAULT RISK
risk that a loss will be incurred due to default in making the full payment
3) MANAGEMENT RISK
potential for unexpected losses on derivatives due to inadequate management supervision
4) LEGAL RISK
risk that the derivative agreement is not binding as intended
CIA DCAT
2 possible effect due to OFF-BALANCE SHEET RISK
forced sales
significant CFs, affecting liquidity position
CIA DCAT
5 possible CORRECTIVE MANAGEMENT ACTIONS to OFF-BALANCE SHEET RISK
changing the pension plan from defined benefit to defined contribution
selling assets
changing the reinsurance strategy
repositioning the derivatives tools
reducing costs through layoffs and consolidation of branch offices
CIA DCAT
4 possible ADVERSE EFFECT due to RELATED-COMPANY RISKS in a DCAT
reduction in reliance on the parent cie for financial support
increase in provision of financial support to the parent
high level of dependency on group operational resources
a rating agency downgrade reflecting difficult financial conditions
CIA DCAT
3 possible RIPPLE EFFECTS due to RELATED-COMPANY RISKS
1) management focus on group rather than company priorities
2) a need to provide for service disruptions
3) regulator action to protect local policyholders
CIA DCAT
6 possible CORRECTIVE MANAGEMENT ACTIONS due to RELATEd-COMPANY RISK
1) finding alternative sources of funds for operations
2) adjusting premium volumes and mix of business
3) reviewing reinsurance coverage
4) reviewing target mix by LoB
5) reviewing types of products offered
6) selling assets
