CIA MfAD Flashcards
What is the purpose of MfAD (Margin for Adverse Deviation)?
To reflect a degree of uncertainty inherent in an actuarial best estimate.
What are some broad methods for calculating MfADs? (2)
Deterministic: Select percentiles based on knowledge of the situation.
Stochastic: Use quantile methods based on a statistical analysis.
What is the technical definition of MfAD?
Fundamentally, it is the difference between 2 ASSUMPTIONS.
It is the difference between the assumption for the ACTUAL calculation and the assumption for the BEST ESTIMATE calculation.
What is the technical definition of PfAD?
Fundamentally, it is the difference between 2 RESULTS.
It is the difference between the result of the ACTUAL calculation and the result of the BEST ESTIMATE calculation.
Note: - the best estimate calculation might be the median of your loss distribution;
- the actual calculation would be more conservative, maybe the 90th percentile, the difference being the PfAD amounts.
Categories of MfADs (3)
- investment return rates
- development on claims
- recovery on losses ceded to reinsurer
According to IAIS, when should a risk margin generally be HIGHER? (4)
- when less is known about the estimate
- for low frequency/high severity LOBs
- for longer contract terms
- when there is a wide probability distribution for the losses
According to IAIS, when should a risk margin be LOWER?
- with emerging experience
What are the deterministic lower and upper percentage limits on MfADs? (3)
- Investment Return Rates: [25 bps, 200 bps]
- Claims Development [2.5%, 20%]
- Reinsurance Recovery [0%, 15%]
Identified CATEGORIES of considerations for selecting CLAIMS MfAD? (3)
- Operations (U/W, Claims Management, other)
- Data (on which estimate is based)
- LOB
Identify OPERATIONAL considerations in selecting CLAIMS MfAD. (2)
- pick HIGH when there are operational changes, employee turnover, lack of guidelines, inadequate staffing. (i.e.: More uncertainty)
- pick LOW when operations are stable, strong, consistent (i.e.: Less uncertainty)
Identify DATA considerations in selecting CLAIMS MfAD.
- pick LOW when data is stable, credible, homogeneous
Identify LOB considerations in selecting CLAIMS MfAD.
- pick LOW when LOBs are ‘stable’
Reasons to select highest CLAIMS MfAD margin of 20%. (3)
- for significant changes (tort reform, legal challenges)
- for a new LOB in a new province with limited data
- for an increase in retentions with limited data for assessing effect
Reasons to select CLAIMS MfAD margin higher than 20%. (3)
- if there is unusually high uncertainty
- if PfAD is already very low because best estimate of claims liability is very low
- if stochastic analysis indicates variability not identified using a deterministic analysis
Reasons to select lowest CLAIMS MfAD margin of 2.5%. (3)
- LOB commuted to reinsurer and is in runoff
- LOB has pre-set payments (Eg: structured settlement)
- Insurer has stop-loss coverage reserved at stop loss limit
Identify considerations in selecting REINSURANCE MfAD. (3)
- consider ceded Loss Ratio (if high: pick MfAD high)
- consider proportion of unregistered reinsurance (if high: pick MfAD high)
- consider financial condition of the reinsurer (if poor: pick MfAD high)
Comment on the selection of REINSURANCE MfAD of 1%.
Near low-end range: indicates that the reinsurer is likely registered and has a highly-rated financial condition.
Identify considerations in selecting INVESTMENT MfAD. (3)
- MATCHING of cash flows from assets and liabilities (if unmatched: pick MfAD high)
- ERROR in estimating payment patterns (if uncertain: pick MfAD high)
- ASSET risk credit/default and liquidity (if high risk: pick MfAD high)
When may the INVESTMENT MfAD be less than 25 bps (<25 bps)?
When the best estimate of the discount rate (based on the insurer’s assets) is already below 25 bps.
Comment on a selection of 25 bps.
Bottom of the range: indicates that invested assets are likely LOW RISK.
Formula-based deterministic approaches for the INVESTMENT MfAD. (2)
- weighted formula
- explicit quantification
Identify the quantile methods for calculating MfADs. (3)
- Multiples of SD (standard deviation)
- VaR (Variance at Risk), also called percentile or confidence interval method
TVaR (Tail Value at Risk) or CTE (Conditional Tail Expectation)
Advantages of multiples of SD method for MfADs. (2)
- simple
- practical
Define the ‘margin’ associated with VaR.
Set margin so that the probability (actual < mean + margin) = p
Define TVaR or CTE(Q%).
TVaR: weighted average of HIGHEST (100-Q%) results of stochastic simulation.
2 aspects of insurance liabilities to consider when setting risk margin or MfADs.
TIME: length of settlement pattern
SHAPE: distribution about mean AT reporting date OVER specified time horizon
Characterization of quantile methods.
Quantile method depend only on the SHAPE of an insurance liability distribution (not the time aspect).
Disadvantage of quantile methods.
Results do NOT vary by length of settlement pattern (risk margin will be the same regardless of tail length).
Enhancement to quantile methods to address disadvantage.
Introduce parameter uncertainty to reflect time consideration AND use higher parameter for longer-tailed LOBs.
Extreme events - describe the problem in selecting MfADs for extreme events.
There is low credibility of data when fitting a distribution to actual data.
Extreme events - what is a specific approach for selecting MfADs for extreme events. (2)
- use a weighted average of a broad range of scenarios
- apply stress-testing techniques
What should be enclosed in the MfAD docs? (2)
- for explicit assumptions: how margins were selected
- for stochastic analysis: describe components modeled as random variables, with their distributions and parameters
Rule of thumb for level of detail to include on MfAD docs. (2)
- strike balance between (too little, too much)
- considering what info (qualitative vs quantitative) best serves the reader’s use-case (understanding, decision-making)
Rule of thumb for level of detail to include in MfAD docs. (3)
- sophistication of user
- importance of concept to user
- complexity of concept
NOTE: cross-reference with materiality paper
What is the difference between PV and APV?
PV: accounts for the time value of money
APV: accounts for the time value of money AND includes a risk margin for INVESTMENT RETURN, CLAIMS DEVELOPMENT and REINSURANCE RECOVERY)
Is APV liabilities always smaller than undiscounted liabilities?
NO, it depends on the balance between discount factors (which decreases APV) and the MfADs (which increase APV).
