CIA MfAD

Question 1

Definition of MfAD

Answer 1

Reflect the degree of uncertainty of the best estimate assumption. It is the deviation of actual from expected xp resulting from:
• Error in estimation
• Change of expected xp from non-anticipated influences
• Statistical fluctuations

Question 2

Desirable risk margin characteristics

Answer 2

• Less that is known about the current estimate and its trend, the higher the risk margin should be
• Risk with low freq/high sev should have a higher risk margin than risk with high freq/low sev
• Longer contracts should have longer risk margin
• Risk with wide Pr distribution should have higher risk margin than risks with narrow Pr distribution
• If emerging xp reduce uncertainty, risk margin should decrease

Question 3

Identify three PfADs

Answer 3

• Claims development
• Recovery from Re Ceded
• IRR

Question 4

Provide examples where a large MfAD is appropriate (compared to the best estimate assumption)

Answer 4

• Less confidence in the best estimate assumption
• Approximation with less precision is being used
• Event assumed is farther in the future
• Potential consequence of the event is more severe
• Occurrence of the event is more subject to stat fluctuations

Question 5

Provide examples where it would be appropriate to have a margin of 20% for claim development

Answer 5

• Significant changes due to tort reform
• Introduction of new LOB
• Significant change expected in future claims
• Financial crisis and its effect on longer tailed LOB

Question 6

Calculate investment return MfAD according to the “explicit quantification of 3 margins” approach

Answer 6

Total Margin = Asset/Liab Mismatch Margin + Timing Risk Margin + Credit Risk Margin

Question 7

Calculate asset/liability mismatch risk margin

Answer 7

Coverage Ratio * [(Asset D - Liab D) / Liab D] * (Interest Rate Movement in Runoff Period)

***Coverage ratio = policy liabs / invested assets

Question 8

Calculate timing risk margin

Answer 8

L/(1+d’)^D = L/(1+d)^D’

MfTR = d-d’

d' = Discount rate adj for timing risk
D' = Changed duration of liabs

Question 9

Calculate the credit risk margin

Answer 9

Extra yield on a corporate bond compated to a risk-free bond

Question 10

MfAD disclosure considerations

Answer 10

• Complexity of the concept
• Importance of the concept to users
• Sophistication of users

NOTE: These are same as AA disclosure considerations

Question 11

Types of Quantile approaches

Answer 11

• Multiples of Standard Deviation: Simple and practical
• Percentiles or Confidence Levels: Most common
• Conditional Tail Expectation: Better for more skewed distributions

Question 12

Calculate investment return MfAD according to the “weighted formula” approach

Answer 12

MfAD = iPM – iAM

iAM = interest rate for discounting after MfAD
= min[iPM, iRFM*(1-k)]

iPM = interest rate for discounting, prior to MfAD

iRFM = interest rate of risk-free bonds that matches the payout of liabs

k is the % by which iRFM would need to be adj to reflect a plausible shortening of the uncertain duration of the claim liabs

Question 13

Provide techniques to derive MfADs

Answer 13

• Deterministic techniques

* Stochastic techniques are not expected to be so high that the Pr(unfavorable dev)

Question 14

State one thing PfAD do not cover and one thing it covers when using stochastic models

Answer 14

• Do not cover the stat volatility arising from the model

* Covers the uncertainty in whether the actuary has the right model or the right parameter

Question 15

Provide and briefly describe general considerations for claim dev MfADs

Answer 15

Any situation where there is a significant change in:
• Insurer’s operations (claim management, UW, other operations)
• Data on which the estimate is based (volume of losses, homogeneity)
• LOB (Length of tail, latent claim, liab exposure)

Question 16

Provide considerations for MfADs from Re ceded

Answer 16

• High Ceded LR
• High Ceded commission rates
• Significant Unregistered Re
• Significant Re under liquidation
• Significant Re with weak financial condition
• Significant disputes with Re

Question 17

Provide the several different types of risk addressed for investment return rates

Answer 17

• Mismatch risk between payment of claims and availability of liquid assets
• Error in estimating payment pattern for future claims
• Asset risk including credit/default and liquidity risk

Question 18

Provide considerations for MfADs for investment return rates

Answer 18

• Matching of assets and liabs
• Low asset quality
• High loss of capital
• High asset default risk
• Determination of interest rates
• Concentration by type of investments
• Economic conditions (recession)

Question 19

Which type of product will a stochastic modelling approach be benefiting the most ?

Answer 19

Products with skewed loss distributions with low freq/high sev
• Stop loss Re
• CAT insurance risk
• Credit, warranty, mortgage insurance
• Long tailed LOB

Question 20

Discuss documentation of MfAD deviations

Answer 20

• Actuaries to document the considerations that were critical in their selections of MfADs
• Actuaries conducting stochastic analyses document what components are modeled as random variables as well as primary assumptions
• Documentation for both explicit and stochastic techniques would include support for key decisions

Question 21

Discuss why normal distribution would not be appropriate in PC Insurance

Answer 21

• Rarely enough risk
• Risks are usually correlated
• Risks are rarely symmetric*

*Positive skewness: Distribution with a high Pr of having no claim and decreasing Pr as the claim amount increases

Question 22

List features a risk margin methodology should have

Answer 22

• Consistent methodology for lifetime of the contract
• Assumptions consistent with current estimates
• Consistent with sound pricing practices
• Vary by product based on risk diff by product
• Consistently determined between reporting periods
• Consistently determined between entities
• Consistent with IASB objectives
• Consistent with regulatory solvency and other objectives