Fall 2015 Flashcards
Question 21 - SAO (2 points)
Management of an insurance company has decided to replace its Appointed Actuary because of disagreements over substantive wording in the Statement of Actuarial Opinion (SAO).
The 2014 SAO Instructions require specific steps be taken as a result of this change in Appointed Actuary. Describe four of these steps.
Step 1:
* The company must notify the domiciliary commissioner of the change in appointed actuary and that the newly appointed actuary meets the qualification standards
* The company must notify the DOI within 5 days
Step 2:
* The company must inform the commissioner of any disagreements related to the substantive wording of the SAO and provide a description of the disagreements and how they were resolved within 10 days.
Step 3:
* The company must request that the former actuary provide a letter stating whether he/she agrees with the statements in the Company’s letter
Step 4:
* The company’s Board of Directors must appoint a new Appointed Actuary by the 2014 year end so they can opine on the 2014 SAO
1) Notify , 2) Inform on disagreements, 3) Request comment, 4) Appoint New
Question 22a - SAO (0.75 points)
OPINION
In my opinion, the amounts carried in Exhibit A on account of the items identified:
* A. Meet the requirements of the applicable insurance laws
* B. Are computed in accordance with accepted actuarial standards and principles
* C. Are less than the minimum amount I consider necessary to be within a range of reasonable estimates of the unpaid loss obligations of the Company under the terms of its contracts and agreements
Identify three errors in the wording of the OPINION section of the SAO.
- Needs to specify the insurance laws of (State of Domicile) OR missing the State
- The actuary should disclose the minimum amount that they believe is reasonable OR The amount by which the recorded reserve differs from the minimum amount the actuary believes is reasonable should be disclosed
- Need specify the opinion is on “loss and loss adjustment expense” as opposed to just “loss”
Question 24a - SAO (0.5 points)
Describe the concept of materiality as it relates to an actuarial work product.
One of the following:
* An omission, understatement, or overstatement in a work product is material if it is likely to affect the intended user’s decision making process or reasonable expectation
* An amount is material if including or excluding from disclosure would impact user’s decision
* Material if it would influence the decisions of regulators, investors, or business partners
The candidate was expected to know the meaning of materiality but was not expected to quote a definition verbatim. Common errors included:
* Only providing a description of possible metrics for determining materiality.
* Not mentioning that materiality depends on the user/audience – it was not sufficient to state that it would change/affect the actuarial opinion with no mention of the impact to the user.
* Simply saying it was something that needed to be disclosed.
* Attempting to define material adverse deviation rather than defining the concept of materiality.
Question 24b - SAO (0.5 points)
Briefly describe one reason why it may not be feasible to accurately determine a range of all possible outcomes when establishing a reserve range. Identify an example for the reason.
One of the following:
* Future liability yet to be identified is not reliably estimable, such as courts ordering payments of insurance claims where perils are explicitly excluded (for example, Asbestos/Product liability).
* There could be an unforeseeable event that the insurer did not consider being liable for – or the extent to which it was liable. A good example of this is asbestos reserves which have caused many insurer’s losses to develop more adversely than anticipated.
Extra Examples:
* Historical events are the usual basis for determining possible outcomes, but an event could occur that wasn’t accounted for. For example, very high inflation on medical WC costs.
* Some possibilities are so far remote that quantification and identification is very challenging. i.e.: Proliferation of lawsuits that would affect line of business. There is no way the actuary can foresee this, but it could happen.
Question 24c - SAO (1.5 points)
For each type of insurance below, describe how the two indicated risk factors could interact and influence the Appointed Actuary’s conclusion of whether there are significant risks and uncertainties that could result in material adverse deviation.
Type of Insurance & Risk Factors
(1) Coastal Homeowners
* Growth in a soft market
* Lack of available experience
(2) Mortgage
* Change in sustained unemployment rate
* Change in home prices
(3) Automobile
* Currency exchange rate
* Availability of repair parts
(1) Coastal Homeowners
* The growth may impact/distort some standard actuarial methods, unless they can be accurately accounted for. The lack of experience will also make accurate reserve estimates very difficult, especially given the CAT nature of the coastal area. This will likely increase the possibility that RMAD exists.
(2) Mortgage
* If the unemployment rate increases and home prices decrease, there will be a much higher rate of default and banks will not be able to recover the outstanding balance due to the home price decrease. This would increase the RMAD.
(3) Automobile
* A stronger dollar in US coupled with an increase in availability of repair parts could lead to cheaper rates to fix cars. This could lead to less uncertainty and less chance of RMAD.
* If car parts for foreign made vehicles become scarce at the same time that the dollar weakens, then severities for auto physical damage could significantly increase, leading to a risk of material adverse deviation.
Question 25a - SAO (1 points)
Identify four items that the Appointed Actuary should disclose in the SCOPE paragraph of the Statement of Actuarial Opinion (SAO).
Any four of the following:
- Date of Review
- Source of data (name, affiliation)
- Evaluation date
- Reconciliation to Schedule P
- Are you opining on UEPR or long duration contracts?
- Reviewed methods/assumptions used in determining reserves listed in Exhibit A
- Reviewed data for reasonableness/consistency
- If there are any reserve amounts the actuary is not opining on
- Reflect Disclosure Items Exhibit B
Question 25b - SAO (1 points)
A company discounts its workers’ compensation reserves. Identify four items that an actuary should disclose related to the discounting of reserves in an actuarial communication.
Any four of the following:
- Whether a Risk Margin is used, and basis for risk margin
- Amount of reserve discount
- Amount of tabular discount
- Amount of non-tabular discount
- Discount table used/description of tabular discount/basis & assumptions for tabular discount
- Determination/basis/selection method/methodology of discount rate (also source)
- Description of tabular discount
- Material changes in discounting methods
- Specific risks/uncertainties with regard to timing of future payments
- Accounting date
- Valuation date
- Review date
- If any assumption/method was prescribed by applicable law (permission granted)
- If a range is specified, basis for the range
- Significant limitations that constrained actuaries analysis
- Materially differs from ASOP 20
- Selection of Tabular discount rate
- Selection of Non Tabular discount rate
Question 26b - SAO (0.5 points)
Briefly describe the requirements for a contract to qualify for reinsurance accounting treatment under GAAP.
To qualify for reinsurance accounting under GAAP the following criteria must be met:
- Significant insurance risk; Transfers both underwriting and timing risk (i.e. uncertainty in the timing of and amount of payments.)
- It’s reasonably possible for reinsurer to incur a significant loss (exception in cases where substantially all of the risk is transferred)
Extra:
Requirements for GAAP/SAP:
- if SAP recognizes then GAAP will too.
- No strict rules for GAP but industry standard is ERD>1% or 10-10 Rule, which says risk transfer exists if >10% chance that reinsurer incurs >10% loss.
Common errors included providing an incomplete answer, such as referencing the 10-10 or 1% ERD rule without discussing how it relates to the GAAP requirements. Many candidates confused the idea of underwriting risk with a chance of significant loss.
Question 26c - SAO (0.5 points)
Briefly explain the rationale for whether each of the following should be included in risk transfer analysis:
- Maintenance fee
- Profit commission
Maintenance Fee
- Yes, it’s a cash flow between insurer and reinsurer
- Yes, cedant must pay this to reinsurer to prevent commutation
- Yes should be included because it is a payment between insurer and reinsurer and could eliminate coverage if not paid
- Yes, it would change the reinsurer’s calculated profit or loss
Profit Commission
- No, risk transfer analysis focuses on loss scenario, which will have no profit commission
- No, profit commission impacts cedent’s results which should not be considered in risk transfer analysis
- No, any indirect economic impact is already accounted for in premium
- No, including would have potential for manipulation
This question required a deeper understanding of risk transfer than part b. Common errors included assuming that a maintenance fee is not a cash flow between insurer and reinsurer, and that not including profit commission would lead to manipulation.
Question 1a - Credit Scores (1 points)
According to McCarty, identify the two age groups where insureds are disparately impacted by the use of credit scoring and briefly describe the reasoning.
The elderly and young adults. Young adults typically have not had the time to build a good credit score or credit history. The elderly typically use less credit, which too has an adverse impact on the credit score. If credit scoring is used to determine rates, these groups will be at a disadvantage.
Question 1b - Credit Scores (0.5 points)
Other than age groups, identify one group of insureds that McCarty claims is disparately impacted by the use of credit scoring and briefly describe the reasoning.
Any one of the following:
- People of lower socioeconomic class / low income / poorer people – may have lower score due to lack of available lines of credit b/c of their income, for example. This drives up premiums for something that is beyond their control.
- Certain religious faiths which don’t support the use of credit / usury / interest, so they wouldn’t have fair credit scores – doesn’t tell about driving ability.
- Race / minorities - McCarty claims credit scores are a proxy for race and socioeconomic status. Poorer minorities are more likely to have a low credit score and insurance companies are effectively increasing their rates
Question 1c - Credit Scores (0.75 points)
Empirical studies have shown that those with different credit scores have an observed difference in total insurance losses.
Identify a key metric and describe how the metric could be driving these loss differences.
Frequency of claims / percent of accidents reported / willingness to file a claim / risk absorbing:
* People with high credit scores may pay for smaller claims out of pocket while low credit scores may file a claim with insurance company. Therefore those with high scores will have lower total losses since they are paying for some claims themselves.
Question 2a - Porter Ch.5 - (1 points)
Identify four reasons why a state might disapprove a rate or form filing.
- Contrary to public interest or Rate is unaffordable to insureds
- Illegal or Rate violates law/statue
- Excessive or Rate too high
- Filing did not meet filing deadline
- Insufficient supporting documentation:
Errors in documentation provided in filing or,
Did not comply with all the state’s filing requirements - The following item is not allowed/approved by regulator or specific item is required to be
used:
Rating variable/assumption/methodology/model
Many candidates did well listing reasons for state disapproval of a rate or form filing. Common errors included simply stating discrimination without qualifying their answer by stating ‘unfairly’ discriminatory or discriminate against ‘protected’ classes. Other candidates made the error of repeating similar answers, such as the rate is excessive and the rate is too high.
Question 2b - Porter Ch.5 - (0.5 points)
Describe one argument in favor of having a no-file law in every U.S. state.
- Market competition keeps insurance pricing fair
- Will reduce the costs of filings for insurers (and these costs get passed down to policyholders). Competition will naturally ensure rates are fair.
- It would reduce costs to both insurers and regulators as insurers would not need to spend money on filings and regulators could use time/budget on other matters concerning insurance regulation (e.g. solvency)
This question was open to interpretation and allowed for many different reasonable answers. A common error made by candidates was that they were able to provide an impact of the No-File law system (i.e. cost/labor reduction, time efficiency, etc.) but did not provide a specific reason for favoring the no-file law (e.g., the cost savings would be passed down to insureds or open competition would lead to fair insurance pricing).
Question 2c - Porter Ch.5 - (1 points)
A personal lines insurer files rates with the state department of insurance 45 days after it begins to use them. The insurer is not in compliance with the state’s rate filing requirements.
Identify two types of rate filing laws that could exist in this state, and briefly describe how the insurer’s filing activity would not comply with each.
Any two of the following:
Prior-Approval
* Insurer must file rates and receive approval notice from the state DOI before using rates, can’t use until approval is received. Rates must be approved BEFORE use
File-and-Use
* The insurer must file for rate changes but allowed to use the rates immediately or after a short waiting period. The insurer files rates 45 days after use. Hence it is not in compliance because rates must be filed first with state before use
Extra
Use-and-File
* Insurer may use the rates as they want and file within a specified period after the rates are put in use. The specified period may be shorter than 45 days, say 30 days. Thus the insurer is not in compliance.
Flex Rating
* Did not comply because insurer’s rates are outside of acceptable change and they used them anyway without prior approval.
State-Mandated Rates
* Insurer cannot do business legally in state if the insurer used a rate in their filing that is not the mandated rate.
The question required application of the specific rate filing laws chosen to the situation presented in the question, specifically the violation/lack of compliance of the rate law. Common errors included omitting or incorrectly stating a rate filing law. There were some candidates who made the error of switching a violation of the Use-and-File law with File-and-Use. Others simply stated a definition of the rate law that did not demonstrate how the insurer was not in compliance with the type of rate filing law specified.
Question 3a - NAIC Solvency/Dearie - (1 points)
Briefly describe one distinct rationale for each of the following elements in a state insurance solvency regulatory system:
* Minimum capital requirements
* A state guaranty fund
* Reinsurance transactions require regulatory approval
* Insurers must submit annual financial statements
Any one of the following bullets for each element:
Minimum capital requirements
* Ensure that company has enough surplus to remain solvent
* Ensure that adequate capital is on hand to fulfill policyholder obligations
* Barrier to entry into state for prospective insurance companies, keeps riskier undercapitalized carriers from entering market
* Helps identify troubled insurers by seeing which insurers are below or near their minimum capital levels
* Allows regulators to take regulatory action against troubled insurers
State guaranty fund
* Protect policyholders when an insurer goes insolvent by paying the claims and/or a portion of the unearned premium of the policyholder; may be subject to limitations/caps
Reinsurance transactions require regulatory approval
* To verify there is risk transfer in the reinsurance contract
* Review to ensure insurer is not using reinsurance to artificially inflate surplus / mask financial issues
* Most reinsurers are outside of the U.S and they are not regulated by the U.S. regulatory system
* Reinsurance coverage may be covering or exposed to large losses or catastrophic risks. This requires regulatory attention
Insurers must submit annual financial statements
* These financial statements allow the regulator to continually monitor insurers
* Statements are used by regulators to assess the insurer’s risk and financial condition
* Encourage market discipline / competition since publically available
* Standardized format allows regulators to compare companies
* Reports feed into offsite monitoring analysis / tools such as RBC and IRIS
Candidates were expected to produce one rationale for each element in a state insurance solvency system. Common errors included:
Minimum capital requirements
* Mentioning that it provides protection if premiums charged are not enough to cover losses
* Stating that it provides protection/additional funding in case an insurer becomes insolvent
State guaranty fund
* Mentioning that funds are available in case of insurer insolvency, without including the uses for the funds
* Mentioning that it provides protection against insolvency, without including what/who is protected
* Describing an assigned risk plan rather than a state guaranty fund
* Mentioning that it helps companies remain solvent during adverse scenarios by helping them pay claims
Reinsurance transactions require regulatory approval
* Referring to assessing the reinsurer’s strength without referencing the transaction or the impact on the ceding company
Question 3b - NAIC Solvency/Dearie - (0.5 points)
Briefly describe two reasons for the development of the Reinsurance Regulatory Modernization Framework of 2008.
Any two of the following:
- Needed to reduce penalties associated with unauthorized but strong reinsurers
- Better reflect the globalization of insurance by recognizing foreign reinsurers
- Allow reinsurers to receive collateral reductions when they meet certain standards
- Promote competition in the reinsurance market
- Standardize treatment/streamline regulation for domestic & alien reinsurers
Candidates were asked to demonstrate knowledge of the reinsurance framework, but this proved challenging. Common errors included:
- Confusing the framework with the provisions of other acts such as the Non-Admitted and Reinsurance Reform Act
- Asserting the framework applied to all reinsurer types
- Stating that too many reinsurer insolvencies prompted action for more stringent regulation
- Mentioning that lessons learned from the recent financial crisis prompted action
- Stating that it ensures that reinsurance transactions actually transfer risk
Question 3c - NAIC Solvency/Dearie - (1 points)
Describe two provisions of the Nonadmitted and Reinsurance Reform Act (NRRA)
Any two of the following bullets:
Reinsurance
- If the insurer’s domiciled state is NAIC accredited and the domiciled state recognized the reinsurance credit, NRRA prohibits other states from denying credit
- The reinsurer’s domiciliary state has sole responsibility of the financial solvency of reinsurer
- Allow states to continue reinsurance collateral reform on individual basis if they are accredited by NAIC
Non-admitted
- Premium taxes for non-admitted insurance transactions are only paid in the home state of the insured
- Placement of non-admitted insurance is only to be regulated by the home state of insured
- Non-admitted /Surplus line brokers only need to be licensed in home state of the insured
The question asked for two provisions in the Non-admitted and Reinsurance Reform Act. Since the question asked candidates to ‘Describe’, this means that full credit answers contained the provision as well as some other supporting/additional verbiage. Common errors included:
Omitting key elements of responses
- Example: Only home state can collect tax
No reference to insured’s home state
No reference to non-admitted business
No reference to premium tax - Example: If home state gives credit, then no other state can deny credit
No reference to ceding insurer’s home state
No reference to reinsurance credit
No specification of home state being NAIC accredited or similar standard - Example: Elimination of the due diligence search
No reference to exempt commercial purchaser / sophisticated purchaser
No reference to actions that must be taken prior to being waived - Stating that it allowed an insurer/reinsurer to be licensed in one state and conduct business in all states
- Interchanging the terms licensing & regulating
- Interchanging the terms broker & insurer
- Referring to ‘certified’ reinsurers
Question 5a - Rating Agencies - (0.5 points)
Describe an A.M. Best interactive rating.
Any one of the following:
- This is when an insurer pays for their rating, which allows them to have more control over their rating by having discussions with the rating agency, providing helpful proprietary data, and answering inquiries from the agency.
- Insurer’s senior management has an interactive meeting with rating analysts, so analysts can understand the company’s business strategy, experience with adverse conditions and integrity. Insurer also submits proprietary info to rating analysts. Analysts determine rating based on findings from meeting, background research and proprietary info.
- Rating agency requires insurers to give proprietary information in a high level interactive meeting to give the right rating. Information can include: U/W, pricing, reserving and investment, etc.
Candidates should provide multiple facts in the answer to demonstrate knowledge of what an interactive rating entailed. General statements about BCAR or financial solvency were not sufficient to receive full credit; an interactive rating includes more than just the calculation of capital requirements.
Question 5b - Rating Agencies - (1 points)
Briefly describe two advantages and two disadvantages for a mid-size mutual insurance company to obtain an interactive rating from A.M. Best.
Advantages (any two of the following):
- Insurer has some control over information reviewed
- Easier to obtain credit for the company
- Fewer chances of error
- Third parties often rely on the assessment
- It is less expensive to pay for a rating than to demonstrate financial strength individually to others
- Agents may be wary of insurers without an interactive rating
- Unrated reinsurers may not be considered as viable by primary insurers placing business
- Certain lines of business can’t easily be sold by companies w/o high ratings (for example: reinsurance, surety, structured settlements, homeowners, and specialty lines)
- Individual and corporate policyholders want to be sure the insurer will be able to pay their claims
- Rating process can give management insight into areas that need improvement
- Ability to purchase reinsurance may be easier if they have an interactive rating
Disadvantages (any two of the following):
- It has a cost, the company must pay for interactive rating
- It requires time, effort, and personnel
- It is intrusive
A common mistake for disadvantages was to state that the interactive rating may result in a poor rating; these answers focused on the rating outcome and not on advantages/disadvantages of an interactive rating as requested.
Question 5c - Rating Agencies - (1.5 points)
Fully describe one argument in favor of and one argument against the following statement:
“A.M. Best is, effectively, a regulator of the insurance industry.”
In favor:
- Since ratings play such an important part in the insurance industry (agents may use rating for placement, insurer may require a certain rating of their reinsurers, etc.) AM Best can bring pressure on companies to provide strong incentive for them to take corrective action, much like a regulator.
- It can have huge impact on insurers as consumers, and agents with limited information on the company rely heavily on financial strength ratings.
Against:
- However, AM Best does not have regulatory authority. It can’t reject filings, approve/reject rate changes, respond to consumer complaints, etc. It can’t force the company to act as a regulator could, it can only exert pressure. Nor can AM Best take control of the company in case of financial difficulty as a regulator could.
- Realistically, all AM Best can do is adjust its ratings. It does not have the regulatory power to control or prohibit insurers to take certain actions.
Candidates had some difficulty with this part, with many candidates not fully explaining their answers.
- For instance in the Against section, several candidates just said that AM Best does not have real regulatory or legal power, without describing some of the regulatory powers that regulators do have.
- Others in the For section mentioned that insurance companies needed a good rating to write a particular line of business, without any further information. The question asked to fully describe, which requires more explanation than a question asking for a brief description
Question 6a - Porter Ch. 4 - (0.75 points)
Briefly describe three key goals of insurance regulation.
Any three of the following:
- Promote fair and equitable treatment of insurance
consumers - Ensure financial stability of insurers
- Ensure insurer solvency
- Ensure availability of insurance in the market
- Prevent unfair discrimination towards consumers
- Ensure availability of coverage
- Promote a competitive market
- Ensure that insurance companies have enough surplus
The most common mistake was to repeat the same answer. For example, stating that regulation should ensure fair and equitable treatment of policyholders, as well as stating that regulation should protect consumers.
Question 6b - Porter Ch. 4 - (1 points)
As part of its modernization plan, the NAIC has undertaken (or plans to undertake) several initiatives to improve state-based insurance regulation. Describe two of these initiatives.
Any two of the following:
- ORSA - own risk and solvency assessment. Companies self-assess their own risk and provide valuable qualitative insight to regulators
- Improve RBC calculation – operational risk charge and improve the square root formula
- Review IFRS accounting standards and improve uniformity in global insurance market while improving assessment of short & long term profitability of insurers
- Solvency maintenance – create document laying out US insurance structure, look for ways to use int’l developments in insurance regulation in US and apply lessons from global financial crisis
- IMF FSAP – financial sector assessment programs is an international in-depth look at regulation, especially on group comparisons
This part was more challenging. The most common mistake was to list current functions of the NAIC that are not related to current initiatives in the NAIC modernization process.
Question 6c - Porter Ch. 4 - (1.5 points)
Describe one argument in favor of and two arguments against the following statement:
“The financial crisis of 2007-2008 demonstrated that insurance should be regulated at the federal level.”
“For” federal regulation (any one of the following):
- Need one national voice in dealing with global insurance topics
- Since insurance is a critical element of society, federal regulation would help avoid a massive insurer failure
- A single authority would allow ease of monitoring so that business transactions in all states can be monitored together, as opposed to state by state
“Against” federal regulation (any two of the following):
- Insurance companies were the least hit by the crisis, which showed that current rules and regulations at the state level are effective in keeping insurance companies afloat and ongoing
- Duplication, peer review, and diversity of opinions among state regulators more likely to catch failing companies
- The low amount of problems in state-regulated insurers relative to federally-regulated banks shows that state regulation is an effective process
Common mistakes included stating that the federal government should regulate insurance because insurance needs federal regulation, or stating that the financial crisis proved state regulation is too expensive.
Question 9a - Porter Ch.12 - (0.5 points)
Describe how a guaranty fund provides services to policyholders.
- Handles claims of insolvent insurer OR Pays claims and returns unearned premium of insolvent insurer
- Provides temporary coverage in case of insolvency
The candidate was expected to know that the guaranty fund continues insurance coverage until policyholders find new insurers and that the guaranty fund handles claims and refunds unearned premium for policyholders of an insolvent insurer.
Most candidates were able to state that the guaranty funds pay the claims of insolvent insurers. Fewer candidates also knew that they provided temporary coverage. The most common errors were restating the question as an answer and rewording the same answer in two different ways.
Question 13a - Odomirok18 (1.5 points)
An insurance company writes multiples lines of business, including both commercial automobile and workers’ compensation. Given the following information from the company’s Insurance Expense Exhibits (IEEs) and Annual Statements (all figures are in thousands of dollars):
Calculate the amount of policyholders’ surplus that would be allocated to commercial automobile and to workers’ compensation in the 2014 IEE.
Option 1
Mean Policyholder Surplus = (15,200+18,500)/2 = 16,850
Total Business: (31,200+36,700)/2 + (7,600+9,000)/2 + 20,000 = 62,250
Surplus Ratio = 16,850/62,250 = 27.07%
Commercial Auto Allocation: 27.07% * [(2,000+2,300)/2 + (3,400+3,700)/2 + 6,600] = 3,329.4
Workers Compensation Allocation: 27.07% *(3,000+3,000)/2 + (1,500+1,500)/2 + 5,000 = 2,571.5
Option 2
Mean Policyholder Surplus = (15,200+18,500)/2 = 16,850
Allocation Basis
Total Business: (31,200+36,700)/2 + (7,600+9,000)/2 + 20,000 = 62,250
Commercial Auto: (2,000+2,300)/2 + (3,400+3,700)/2 + 6,600 = 12,300
Workers Compensation: (3,000+3,000)/2 + (1,500+1,500)/2 + 5,000 = 9,500
Allocated Surplus
Commercial Auto: 12,300/62,250 * 16,850 = 3,329.4
Workers Compensation: 9,500/62,250 * 16,850 = 2,571.5
“The candidate was expected to apply the IEE method of surplus allocation to the given data. The candidate had to demonstrate that average loss & LAE reserves, average unearned premium reserves and most recent year earned premium were used as the basis of the allocation. The candidate had to recognize that there were other lines of business besides Commercial Auto and Workers Compensation. The candidate had to allocate mean policyholder surplus.
Common errors included: calculating the allocated surplus to either Commercial Auto or Workers Compensation instead of both; not knowing the IEE surplus allocation method; not recognizing that there were lines of business other than Commercial Auto and Workers Compensation; not allocating mean policyholder surplus, using most recent year instead of two years.”
Question 14a - Odomirok15 (1 points)
Briefly describe the trends in claim frequency and average closed claim severity, and identify one potential driver for each observed trend.
Claim Frequency Trend:
* Generally increasing at common evaluation points
Frequency Trend Driver (any one of the following):
* Speed up of claim setup in the claim system
* Increase in nuisance claims
* Shorten of statute of limitation
* Deteriorating book of business
* Change in type of claims included
* New business strategy e.g. entering new territory
* Change in reinsurance structure e.g. change in QS %
* Change in policy limit written
* Rate deterioration due to lack of on-leveling of premium
* Change in claim count definition
Severity Trend:
* Generally decreasing at common evaluation points
Severity Trend Driver (any one of the following):
* Improved claims process identifies simpler, lower severity claims and closes them first / atearlier maturities
* Increase in S&S recovery
* Increase in reinsurance coverage
* More closed without payment claims
* Claims closed faster, drives down ALAE
* Change in claim count definition”
“Parts a, b, and c required interpretation of data or situations, but many reasonable answers were possible for each part and candidates did not struggle to identify correct responses.
The candidate was expected to identify the trend in both the frequency and severity triangles. The candidate was also expected to explain the possible drivers for the observed trend. Common errors included:
* Commenting on small fluctuations from one number to the next and not describing general trend
* Drivers provided has no clear link with the observation stated
* Responses that would require Part 5 to be issued on a summary basis”
Question 14b - Odomirok15 (2 points)
Construct the claims closure rate triangle, and briefly describe two observations.
Observations:
* Closure increase faster at later maturity
* Largest jump in % closed was in Yr2013 for all AYs
* Increase in closure rates at each evaluation
* Dip in closure rate in AY 2011
* Stability at age 12
“The candidate was expected to know the formula for closure rate and compute the triangle
correctly using the various claim counts triangle given. The candidate was also expected to state
at least one observation based on the constructed closure rate triangle. Common errors included:
* Developing the claim count triangles into ultimate and used the ultimate as denominator
when calculating closure rate
* Using incremental closed claim counts/outstanding claim counts=closure rate
* Calculating Claim closure rate=closed-with-payment/D&A premium”
Question 14c - Odomirok15 (0.5 points)
Briefly describe two pieces of additional information that might be considered in forming a conclusive opinion regarding the effectiveness of the claims procedure changes.
“Additional info:
* Closed without payment claim counts
* Talk to management regarding changes undergone
* Talk to claim management about implementation of the change
* Claim re-opened ratio
* Change in average case reserves
* Changes in reinsurance structure or intercompany pooling arrangement
* Historical rate changes in premium
* Use non-premium exposure base to avoid distortion caused by rate change
* Whether definition of claim count changed
* Review data prior to 2010
* Ultimate loss ratio by year
* Change in claim count definition
* Changes in number of re-opened claims”
“The candidate was expected to come up with at least one additional piece of information that is
relevant to assessing change in claim closure rate. Common errors included:
* Failing to explain how the information is related to the situation described in the question
* Mentioning closed severity (which was already given in the question)
* Providing the same information stated in two different ways”
Question 14d - Odomirok15 (1.5 points)
One purpose of Schedule P is to facilitate the review of trends in claim frequency and severity. Briefly describe three other functions of Schedule P and, for each function, identify which Part(s) would provide the necessary information.
“Functions of Schedule P:
* Evaluate reserve adequacy (part 2 and part 5)
* Supports and provides necessary disclosures for SAO (part 1)
* Reconciliation of data used in SAO (part 1)
* Premium trend (part 1)
* Shows split between known claims & IBNR claims (part 4 and 5)
* Necessary info to compute loss sensitive discount (part 7)
* Discount factor for IRS tax purposes (part 1)
* Payment discount factors (part 3)
* Development of Earned Premium (part 6)
* Calculate RBC R4 and R5 (part 1 and parts 2 & 3)
* Calculate IRIS ratios 11 & 12 (part 2)
* Calculate IRIS ratio 13 (part 2 & 6)
* Get competitor’s paid loss development for entering new line (part 3)
* Overall profitability of line or in summary (part 1)
* Identify received and /or anticipated salvage and subrogation (part 1)
* Check for existence and size of non-tabular discount (part 1)
* Derive and review Case Reserve Triangle (part 2, 3 & 4)”
“The candidate was expected to come up with at least three functions of Schedule P. Common errors included:
* Listing either inaccurate or not specific parts
* Providing statements related to Schedule F”
Question 15a - Odomirok8/9 (2.25 points)
Identify and calculate the two changes in the company’s surplus that do not impact the Net Income calculation in the Statement of Income in the company’s 2014 Annual Statement.
The company’s changes in unrealized capital gains and changes in provision for reinsurance do not flow through to the income statement.
Change in unrealized capital gain = $98 - $100 = -$2.
It was also acceptable to include the deferred tax asset. -$2*(1-.35)=-$1.3
Provision for reinsurance
Month | Days Overdue | Recovered Z | Received within 90 days
Jun 195 yes yes
Jul 165 yes yes
Aug 135 yes yes
Sep 105 not yet
Oct 75 not yet
Nov 45 not yet
Dec 15 not yet
Reinsurance recoverable on paid loss & LAE more than 90 days overdue = $25.
Total reinsurance recoverable on paid loss & LAE + amounts received in the 90 days prior to
December 31, 2014 = $25 * 4 + $25 * 3 = $175.
Test ratio = $25 / $175 = 14.3%
The reinsurer is non-slow paying because 14.3% < 20%.
Provision for reinsurance = (recoverable on paid loss & LAE more than 90 days overdue, excluding
amounts in dispute + recoverable on paid loss & LAE in dispute) * 20% = $25 * 20% = $5.
Change in provision for reinsurance = prior year’s – current year’s = $0 - $5 = -$5.”
- The candidate was expected to be able to identify and calculate the unrealized capital gain. The candidate was also expected to identify the change in the provision for reinsurance and know the required calculations.
- Some candidates included the calculation of the change in the reinsurance provision in part b instead of part a; credit was awarded in either case.
Common errors included:
* determining the provision but not identifying the change in provision which is the adjustment to the surplus
* not including the correct amounts in the numerator and the denominator of the
slow paying ratio”
Question 15b - Odomirok8/9 (2.5 points)
Calculate the company’s 2014 change in policyholders’ surplus.
“Sample Solution 1 (using income):
Gross premiums earned during 2014 = $1,000 * (1/24 + 1/12 * 8) = $708.
Gross losses paid during 2014 = $50 * 7 = $350.
Gross losses unpaid as of December 31, 2014 = $400 + $100 - $350 = $150.
Gross losses incurred during 2014 = gross losses paid during 2014 + change in gross losses unpaid = $350 + ($150 – 0) = $500.
Net premiums earned = $708 * 50% = $354.
Net losses incurred during 2014 = $500 * 50% = $250.
Net commission incurred = direct commissions incurred – ceded commissions incurred = $1,000 * 10% - $500 * 15% = $25.
Other underwriting expenses incurred during 2014 = net commission incurred + general expenses + taxes, licenses and fees = $25 + $40 + $21 = $86
Net investment income earned = total gross investment income – investment expenses = dividend incurred – investment expenses = $10 - $8 = $2.
Change in realized capital gain / (loss) = $95 - $100 = -$5.
Net income = premiums earned – losses incurred – LAE incurred – other underwriting expenses incurred + net investment income earned + net realized capital gains = $354 – $250 – $30 – $86 + $2 + -$5 = -$15.
Change in policyholders’ surplus = net income + change in net unrealized capital gains + change in non-admitted assets + change in provision for reinsurance = -$15 + -$2 + 0 + -$5 = -$22.
Sample Solution 2 (using assets and liabilities):”
”* The candidate was expected to recognize all the relevant components of the income statement and how to calculate them.
* The more challenging aspects were the monthly pro rata earning routine and the determination of the ceding commission.
* Common errors included incorrect calculation of the gross earned premium and incorrect calculation of net commission amount (agent and ceding).”
Question 15c - Odomirok8/9 (1 points)
Discuss two major factors that contributed to the change in the company’s policyholders’ surplus during 2014.
- The provision for Reinsurance decreases the Surplus and Ceding Commission paid by the reinsurer provided Surplus aid to the PHS. Net Income was negative due to high loss ratio (80%) and high Commissions (10%) on the whole amount of premium (no DPAC for SAP)
- U/W Losses are too high. Expenses are incurred immediately and not amortized so EP is not enough to cover losses and expenses. Slow paying reinsurer increases the provision for Reinsurance which adversely changing surplus.
- Insurer entered into reinsurance agreement to provide surplus relief. PHS increased due to the treaty. Investment in common stock – change in value impacts the surplus along with dividends earned.
- The reinsurance paid a fixed commission which immediately increases assets & increases surplus. If the reinsurer is slow paying and results in an increase to the reinsurance provision which is a liability that decreases surplus.
- Reinsurance Company paying after 90 days is contributing significantly to the decrease in the SAP surplus. The ceding Commission from the reinsurance contract is providing significant surplus relief. W/o this the surplus would have decreased even further.”
- The candidate should be able to identify two different factors that contribute to the change in the PHS.
- The most common error was providing answers that were very generic instead of ones”
Question 16a - Odomirok10 (1.25 points)
Identify the names of the five Notes to Financial Statements that would specifically reference the information provided above and appear in the company’s 2014 Notes to Financial Statements.
Any five of the following:
* Changes in Incurred Loss and LAE
* Discounting
* Premium Deficiency Reserve
* High Deductibles
* Subsequent Events
* Reinsurance Assumed/Ceded
* Summary of Significant Accounting Policy”
The candidate was expected to be able to review the information given and identify five notes to the Financial Statement that would specifically reference that information. The candidate did not need to provide exact names of these Notes as long as they addressed the correct concepts.
Common errors included retroactive reinsurance, unearned premium reserves, catastrophes, investments, and notes to other sections in the annual statement (sch. P, sch. F, page 14, etc.).”
Question 16b - Odomirok10 (1.5 points)
For three of the Notes identified in part a. above, provide any numeric values and descriptions that should be included within the Note.
Change in Incurred Loss
* (2,047,000+353,000)-(1,860,000+265,000) = 245,000;What line of business was cause
* Changes in Losses Note would say losses incurred on prior years are 245K = 2687- 287-2155 and what caused this
Discounting
* Include discount of 3% and where it was derived (i.e. US life table)
* Tabular discount of 3%; assumption and basis
* Premium Deficiency Reserve
* 37,000; was investment income considered
* 0; this assumes the figure in the table is gross of investment income
High Deductible
* Company needs to disclose reserve credit of $1.2M and the billed but uncollected amount of $800K
* Amount of recoverables on high deductible policies: 800+1200=$2M
Subsequent Event
* $50 million loss occurred on 1/15/2015. This event is a Type 2 (non-recognized) event, but needs to be reported because it will be material in future reserves
* On Jan 15 a new loss of $50M occurred. This is a type 2 material subsequent event
* Disclose type 2 unrecognized subsequent event occurred that will have a material impact
* Since this is a non-recognized subsequent event that would have a material impact disclose large factory explosion
Reinsurance Assumed/Ceded
* State there is no assumed or ceded reinsurance”
The candidate was expected to choose three notes from part a and provide any values and
descriptions that should be disclosed in that note. This question was straightforward and the
majority of the values required no calculations. Common errors included:
* Miscalculating the change in incurred losses by including the current year
* Providing the premium deficiency reserve without a comment on investment income
* Failing to acknowledge the subsequent event was not included in the annual statement
* Mentioning only one of the two values needed for high deductible
* Providing numerical values without including the description”
Question 16c - Odomirok10 (1.5 points)
For three of the Notes identified in part a. above, explain how each could assist a user of the financial statements in the evaluation of the company’s financial health.
Change in Incurred Loss
* Can help users identify whether there are significant adverse development. If adverse development consistently occurs, may question under-reserving
* What caused this development to assess whether material adverse risk still remains and determine whether reserves are reasonable
* Shows how company’s reserves are developing (if high adverse development,could hurt surplus, must investigate cause further) just reserve strengthening? Or deficient reserves?
Discounting
* Different companies discount differently so this helps make Financial statements more consistently comparable
* Helps user understand stated basis of reserves and assumptions used in calculation of discount. Different companies use different methods to determine reserves
* Know the discounting method and amount of this insurer; user can compare different company’s reserves without misleading
Premium Deficiency Reserve
* If no note, users may not know that deficiency exists as it is grouped with UEPR, May indicate unprofitable business
* Can assist if non-zero by pointing to lines that have rate adequacy issues; PDR of zero does not necessarily mean that rates are adequate
* Premium Deficiency note would enable the user to detect that rates have not been adequate. The PDR could be hidden in the UEPR and the only way a user would know is by looking at the Notes section
* If the premium deficiency is accounted for by modifying the UEPR in the annual statement, this note is the only way user would know if deficiency. Could lead user to believe that rates are inadequate
High Deductibles
* Help users to estimate the credit risks associated with large deductible recoveries. If there’s a major impact on company’s surplus
* Large deductible policies help user assess the credit risk that insurer is exposed to. User can take the fact that these recoverables may not be recovered into account when evaluating the company’s financial health
* If company has significant amount of recoverables under high ded policies would want to assess credit risk that might reduce financial strength
Subsequent Event
* Provide caveat that though Annual Statement is reflective of 2014 results there is an outstanding situation the co is exposed to. Gives regulators sense that financial condition may be weaker than implied by ’14 statement
* User would not know impact if not disclosed; amount 50M is material to the F/S and may cause insolvency
* The subsequent event note informs us of the company’s exposure to events not considered in the annual statement. The 50M loss will likely have a significant impact on surplus leaving the company in financial difficulty
* User can see if subsequent events have caused a material change to the insurer’s health after the evaluation date of the financial statement
* Since the insured loss was $50M this event has a material impact on the financial health of the company, which the user would not be able to ascertain without the note (not included in financials as non-recognized)
Reinsurance Assumed/Ceded
* Since no reinsurance user will be notified that company may be at risk for insolvency with large losses
The note on reinsurance would simply indicate that the company is not reinsured and this might raise concerns to the user because WC insurance is usually written without claim limits and has a rather wide probability distribution and long-tail exposure
Important to know no reinsurance because exposed to upper limit on all losses, particularly important as WC medical could skyrocket
Reinsurance is very critical to protect the policyholder. Reinsurance provides cat protection and stabilizes income. Regulator and policyholders will be very concerned of this as policyholders will not get the full amount of loss in the event of insurer’s insolvency
Significant Accounting Policies – no candidate used this Note for part c”
The candidate was expected to explain how three notes could assist a user in evaluating the
financial health of the company. This part of the question was the most challenging as the
candidate had to go beyond the information given in the question to assess the usefulness of the
information. Many candidates identified the risk that the note would illustrate; however, few
provided the details that explained how this company’s health was impacted by the risk.
Additionally, many candidates listed general risks that weren’t relevant to the particular company,
such as reinsurance collectability risk when the company had no reinsurance, or non-tabular
discounts when the company only disclosed tabular discounts.”
Question 17c - Odomirok19 (0.5 points)
Briefly describe two ways the insurer could reduce the R1 risk charge without reducing the size of the bond portfolio.
Any two of the following:
* Buy bonds from a larger set of issuers.
* Invest in better rated bonds.
* Shift portion of portfolio to US government guaranteed bonds which have an RBC factor of 0.
* Shift from class 02 to class 01 bonds where the charge is lower, 0.3%
* The insurer could place more bonds with issuer 11 and 12 (and less in issuers 1-10) so they
wouldn’t be included in the asset concentration factor.
* If it increased stock holdings with issuers with low bond holdings, then it would incur
lower asset concentration factors within R1 (but higher in R2)”
“The candidate was expected to know how to calculate RBC charges for R1 and R2 as well as how portfolio changes can affect these charges. Many candidates demonstrated knowledge of the general concepts but failed to correctly complete the calculations.
The candidate was expected to know how adjustments to the portfolio could affect the R1 charge.
Candidates needed to have two separate recommendations that would reduce the R1 charge.
Common errors included giving two answers that were not substantially different, suggesting to buy more bonds without suggesting an increase in issuers, reducing the portfolio (since the
question specifically states this is not allowed), and suggesting a method that would only
redistribute bond holdings without reducing the asset concentration factor.”
Question 17a - Odomirok19 (1.5 points)
Calculate the NAIC’s R1 risk charge.
“R1 Fixed Income
Bond Charge: 20,150 x 0.01 = 201.5
Bond Size Factor: 2.5
Bond Size Charge: (2.5-1) x 201.5 = 302.25
Asset Concentration: Total bond top 10 (20,150 - 550 - 600) x 0.01 = 190
R1 Charge = 201.5 + 302.25 +190 = 693.75”
“The candidate was expected to know how to calculate RBC charges for R1 and R2 as well as how portfolio changes can affect these charges. Many candidates demonstrated knowledge of the general concepts but failed to correctly complete the calculations.
Candidates were expected to accurately calculate the total R1 charge as well as each piece: bond
charge, bond size charge, and asset concentration charge. Common errors included applying the
bond size factor to the asset concentration charge, omitting the asset concentration charge,
omitting the bond charge, and calculating the asset concentration charge using the formula for
loss or premium concentration factors.”
Question 17b - Odomirok19 (1 points)
Calculate the NAIC’s R2 risk charge.
“R2 Charge
Stocks: 9,100 x 0.15 = 1,365
Asset Concentration Factor: (9,100 – 200) x 0.15 = 1,335
R2 charge = 1,365 + 1,335 = 2,700”
“The candidate was expected to know how to calculate RBC charges for R1 and R2 as well as how portfolio changes can affect these charges. Many candidates demonstrated knowledge of the general concepts but failed to correctly complete the calculations.
Candidates were expected to know how to calculate an R2 charge including the asset
concentration factor and the stock charge. Common errors included omitting the asset
concentration charge and calculating the asset concentration charge using the formula for loss or
premium concentration factors.”
Question 18a - Klann (0.75 points)
Restate the accident year 2012 ceded paid loss, ceded loss reserve, and ceded ultimate loss after the commutation.
“Ceded Paid Loss= 2,625 + 2,000 = 4,625
Ceded Reserves = 0
Ceded Ultimate Loss = Ceded Paid Loss + Ceded Reserves = 4,625 + 0 = 4,625”
“The candidate was expected to know how to adjust ceded loss amounts and policy holder surplus for a reinsurance commutation, as well as how to calculate and apply IRIS ratios.
The candidate was expected to know that after the commutation:
* the ceded paid loss should be increased by the price paid for the commutation
* the ceded loss reserve is set to zero
* the ceded ultimate loss = ceded paid + ceded reserve
Most candidates understood that the ceded reserves should be set to zero. However, most
candidates did not get the ceded paid loss and ceded ultimate loss calculations correct.”
Question 18b - Klann (3 points)
Calculate IRIS ratios 2, 7, and 11 after the commutation.
“IRIS Ratio 2
IRIS Ratio 2 = NWP/Surplus
Numerator: NWP =12,500
Denominator: Adjust the Policy Holder Surplus (PHS) to account for the commutation
Adjusted PHS = Current Year PHS as given + Commutation Price Paid – Ceded Reserves Commuted: 50,000 + 2,000 - 3,500 = 48,500 or
Adjusted PHS = Current Year PHS as given + Change in Ultimate Ceded Loss: 50,000 + 4,625 – 6,125 = 48,500
Calculate the ratio NWP/ Adjusted PHS = 12,500 / 48,500 = 25.77%
OR
IRIS Ratio 2 = NWP/Surplus
Numerator: NWP =12,500
Denominator: Adjust the Policy Holder Surplus (PHS) to account for the commutation and state tax
rate and reserve discounting assumptions (example 35% rate, and no discounting)
Adjusted PHS = Current Year PHS as given + Commutation Price Paid – Ceded Reserves Commuted:
50,000 + (2,000 - 3,500) * (1 - 35%) = 49,025 or
Calculate the ratio NWP/ Adjusted PHS = 12,500 / 49,025 = 25.5%
IRIS Ratio 7
IRIS Ratio 7 = Change in PHS / Prior PHS
Find the difference between the current adjusted PHS and the prior PHS and place in the numerator
Adjusted PHS calculated above in Ratio 2
Change in PHS = Current Year Adjusted PHS – Prior Year PHS 48,500 - 55,500 = -7,000
Denominator: Prior year’s PHS = 55,500 (given in the problem, does not require adjustment)
Calculate the ratio Change in PHS/ Prior PHS = -7,000 / 55,500 = -12.6%
OR
IRIS Ratio 7 = Change in PHS / Prior PHS
Find the difference between the current adjusted PHS and the prior PHS and place in the numerator
Adjusted PHS calculated above in Ratio 2, tax effected
Change in PHS = Current Year Adjusted PHS – Prior Year PHS 49,025 - 55,500 = -6,475
Denominator: Prior year’s PHS = 55,500 (given in the problem, does not require adjustment)
Calculate the ratio Change in PHS/ Prior PHS = -7,000 / 55,500 = -11.67%
IRIS Ratio 11
IRIS Ratio 11 = 1 yr. Loss Development/ Prior PHS
Calculate the adjusted 1 yr. Loss Development as a result of the commutation
1 yr. Loss Development = 10,750 - 2,000 + 3,500 = 12,250 or
1 yr. Loss Development = 10,750 + 6,125 – 4,625 = 12,250
Denominator: Prior Year PHS = 55,500 (given in the problem, does not require adjustment)
Calculate the ratio 1 yr. Loss Development/ Prior PHS = 12,250 / 55,500 = -22.07%”
“The candidate was expected to know how to adjust ceded loss amounts and policy holder surplus for a reinsurance commutation, as well as how to calculate and apply IRIS ratios.
In order to properly answer part b, candidates were expected to know the following:
* IRIS Ratios, 2, 7, and 11
* How to adjust the current year surplus for the impact of the commutation
* How to adjust the one year loss development for the commutation
Common errors included:
* Adding the price of the commutation to the Net Written Premium in ratio 2
* Not adjusting the current PHS for the impact of the commutation at all or correctly in ratios
2 and 7
* Subtracting the Current PHS from the Prior PHS in ratio 7, thus reversing the sign and
interpretation of the result
* Dividing by the current year PHS instead of prior years PHS in Ratios 7 and 11
* Trying to adjust the Prior Year PHS for the impact of the commutation in ratios 7 and 11
* Not adjusting the 1 yr. Loss Reserve Development for the impact of the commutation in
ratio 11
* Not knowing the formula for IRIS Ratio 7”
Question 18c - Klann (0.5 points)
Based on the results in part b. above, briefly describe how the examination of two of the remaining IRIS ratios may help the regulator better understand the financial health of the insurance company.
“IRIS Ratio 5: Two-Year Overall Operating Ratio
Will help regulators assess the operating profitability of the company, if the combined ratio is below 100% other unusual values are less of a concern
IRIS Ratio 12: Two-Year Reserve Development to PHS
Will help regulators determine if there is a history of adverse development.
IRIS Ratio 13: Estimated Current Reserve Deficiency to PHS
Will help the regulator determine if the reserves are adequate.
IRIS Ratio 1 : Gross Premium Written to PHS
Based on the very low value of Ratio 2, regulator should check the GWP to Surplus, to assess the
company’s reliance on reinsurance and determine if they are too highly leveraged
IRIS Ratio 3 : Change in NWP
Due to the shrinking surplus in Ratio 7, the regulators may want to investigate whether the company is growing or shrinking based on the change in NWP, because they may not have be able to support the growth
IRIS Ratio 4: Surplus Aid to PHS
Given that the Ratio 7 is below the usual range, regulators should calculate the Surplus Aid to PHS to determine if the company is relying too heavily on reinsurance and assess whether they need to remove the aid from the other ratios calculated
IRIS Ratio 6: Investment Yield
Regulators may want to determine if the company is obtaining an investment yield that is able to compensate for the adverse development observed and additional net reserves taken on.
IRIS Ratio 8: Change in Adjusted PHS
Due to the unusual value for Ratio 7, regulator may want to review the change in surplus that can be attributed to operations only
IRIS Ratio 9: Adjusted Liabilities to Liquid Assets
Regulator may want to review if the insurer has enough assets to cover their liabilities given that the reserves have been developing adversely”
“The candidate was expected to know how to adjust ceded loss amounts and policy holder surplus for a reinsurance commutation, as well as how to calculate and apply IRIS ratios.
The most common error was not basing the answer to this part on the results of part b. (i.e., the
candidate just listed and/or described 2 IRIS ratios but did not tie them back to part b).”
Question 19a - Odomirok25 (1.5 points)
Calculate the Authorized Control Level, and describe the resulting actions of both the regulator and the company under the RBC Model Act.
“Total RBC (before operational risk) = R0 + SQRT(SUMSQ( R1 + R2 + R3 + R4 + R5 + RCAT))
Total RBC (before operational risk) = 26 + SQRT(SUMSQ( 782 + 1042 + 782 + 2602 + 1562)) = $365
Total RBC (after operational risk) = Total RBC (before operational risk) * 1.03 = 375.95
Authorized Control Level (ACL) = 0.5 ∗ Total RBC (after operational risk) *1.03 = 0.5 ∗ 365 *1.03 = 187.97
RBC Ratio = Total Adjusted Capital / ACL = 335/187.97 = 178%
Company Action Level is triggered (from 150% to 200%)
The state department of insurance is not required to take action
The company must submit a plan of action to the insurance commissioner of the domiciliary state explaining how the company intends to obtain the needed capital, or to reduce its operations or risks to meet the RBC standards.”
“Parts a and c asked candidates to demonstrate knowledge of RBC and Solvency II. Part b was challenging, as it required execution of a complex Solvency II capital calculation.
Candidates were expected to calculate the authorized control level and RBC ratio, identify the appropriate action level, and describe the required actions for the regulator and the company.
Common errors included not properly identifying the Company Action Level or the company or regulatory actions to take. Some candidates made calculation errors.”
Question 19b - Odomirok25 (2.75 points)
Determine the actions of the regulator based on the calculations underlying Solvency II quantitative capital requirements.
“Assets = Free Surplus + Solvency Capital Requirement (SCR) + Risk Margin + Best Estimate Liabilities
Solvency Capital Requirement = one-year 99.5% Value at Risk (VaR)=350
Risk Margin and Best Estimate Liabilities are calculated based on the fair value of claims liabilities and risk margin with the following adjustments:
* R-i=6%; i=risk free rate +illiquidity margin
* Required Capital = SCR at each point in time
IFRS Assets = 800 which is > 758.06
Therefore, no regulatory intervention required.
“Parts a and c asked candidates to demonstrate knowledge of RBC and Solvency II. Part b was challenging, as it required execution of a complex Solvency II capital calculation.
Candidates were expected to calculate the present value of liabilities, add a risk margin, determine if the company has any free surplus over the technical provisions and SCR and explain whether any regulatory action is necessary. Common errors included:
* Not accounting for risk margin at all
* Incorrectly calculating the discount rate
* Not correctly comparing IFRS assets to required assets (or, equivalently, not correctly comparing required capital to held capital)
* Incorrectly identifying the Solvency Capital requirement (for example, as 99% VaR)
* Failing to identify the required capital as being equal to the SCR
Most candidates failed to identify the required capital. Other measures of required capital were accepted if candidates stated the assumptions they used.”
Question 26a - Freihaut (1.5 points)
Assess whether each contract meets the “reasonably self-evident” criteria for reinsurance risk transfer.
- Contract #1:
o Yes, contract #1 meets the criteria. It’s a QS agreement that transfers a large
portion of insurer’s risk (80%), the provisional commission looks reasonable.
Although there is a loss ratio cap, the cap is very high, so it should be able to
transfer a large amount of insurance risk.
o Contract 1 meets the criteria for reinsurance risk transfer. It is reasonably
possible for the reinsurer to realize a significant loss, when loss ratio exceeds
200%. Quota share treaty ensures that the reinsurer assumes both underwriting
and timing risks.
o #1: reasonably self-evident due to high loss ratio cap, and high amount of %
ceded in quota share
o Contract #1 qualifies because It has no significant limiting features because it is a
quota share contract with a high loss ratio cap
o Meets because reinsurer assumes substantially all of the underlying risk due to
being quota share with high loss ratio cap - Contract #2:
o No, the premium paid is relatively high compared to the loss transferred. Need
further analysis to investigate whether it’s possible to realize a significant loss.
o Exposed to limit of 0.75 x 1 + 0.56 x 5 = 3.55M:
Given the premium of 2.4M (or 2.47 incl. maintenance fee to avoid commutation),
this is high relative to the limit. Moreover, losses in the high excess layers might
be much less likely. It is therefore not reasonably self-evident that the contract
transfers significant insurance loss.
o Not reasonably self-evident because partial participation in high excess layers are
significant limiting features.
Candidates were expected to have a good grasp of the fundamentals of risk transfer and be able to use a basic understanding of the material and apply it to specific examples.
Candidates were expected to be able to evaluate the “reasonably self-evident” criteria for reinsurance contracts. Common errors included: not providing enough information, assuming that any loss ratio cap meant no chance of significant loss even if cap is high, and misunderstanding commutation clauses, reinsurer’s margin and profit commission. Some candidates seem to have been thrown off by the sliding scale commission stated in the question
for Contract #1 as “90% - LR, if 62% < LR < 71%” and misinterpreted that as the commission is
90% when the LR is between 62% and 71%.
Question 22b - SAO - (0.5 points)
Based only on the information above, evaluate whether risk of material adverse deviation (RMAD) exists.
Yes, the carried reserves with the materiality standard are within the range of estimates.
$600<($590+$100)=$690< $700
OR
Yes, because the difference between the high estimate and the recorded reserve ($110M) is greater than the materiality standard ($100M)
The question expected candidates to be aware of necessary language that is contained within a statement of actuarial opinion and to calculate standard IRIS ratios of One-Year Reserve Development to Surplus.
Candidates were expected to know how to determine whether RMAD exists. The most common error was failing to identify that potential reasonable development on carried reserves (110M) exceeded the materiality threshold (100M). Other errors included using IRIS ratios as justification for RMAD or using historical development relative to the materiality threshold.
Question 22c - SAO - (1 points)
Calculate the one-year reserve development results for each year and propose language for the one-year reserve development disclosure in the Actuarial Opinion Summary.
Since the calculation results in values above 5% in at least three years, the actuary needs to discuss what caused the adverse development.
For proposed language, anything that tied the adverse development back to a cause received credit, such as:
* Due to WC Tail
* Asbestos/Environmental changes
* Unanticipated loss trends
* Company knowingly booking below the range of reasonableness
* Change in statutes
* CAT losses developing adversely
Candidates were expected to be able to calculate the Actuarial Opinion Summary test values and
provide sample language to be included in the disclosure related to these values. Common errors
included: Calculating 1 yr. reserve development with current surplus, stating that 4 years were in
excess of the 5% threshold, forgetting to include explanation for exceptional values, and stating
that adverse development is caused by adverse development or reserve development (rather than
a specific reason).
