Reserving

Question 1

Additional considerations in establishing claim reserves

Answer 1

1. Incurral dating method
2. Reserve basis - statutory, GAAP, and tax bases differ in their use of margin, interest rates, etc.
3. Interest - reserves for claims with long payout may be discounted to reflect inerest
4. Controls and reconciliation - the data used should be tested for accuracy
5. Insurance characteristics - reserves vary depending on the type of risk covered
6. Reserve cells - set up separate cells for each homogenous category of business
7. Managed care features - such as discounts and provider risk sharing arrangements
8. Trends
9. Claim administrative expenses - set up a reserve equal to a percentage of the claim reserve
10. Morbidity assumptions - for long-term claims, morbidity is reflected in continuance tables
11. Use of the case reserves method - very labor intensive, so only recommended for small blocks

Question 2

Advantages and disadvantages of stochastic approaches for reserving

Answer 2

Advantages
1. Provides explicit guidance for establishing provision for adverse deviation in the reserves
2. Provides guidance on potential variability in items such as seasonality and claim trend
4. Allows for improved evaluation of reserve estimates (by knowing the variability of the estimate)
Disadvantages
1. Some audiences that are unfamiliar with this approach may have a false sense of confidence in the approach because of its sophistication
2. May be too complex to be used by all individuals who must perform related functions (such as forecasting and pricing)
3. Not every process can be modeled rigorously

Question 3

Stochastic modeling techniques for reseving

Answer 3

1. Fitting a parametric distribution to the data - this technique works best when the process being modeled is stationary over time.
2. Ordinary least squares regression - this allows for investigation of the effects of specific explanatory variables, such as trend or seasonality
3. Generalized linear models - these models improve upon ordinary regression models because they allow for cases where the dependent variable being modeled is either bounded (e.g., must be greater than zero) or not normally distributed
4. Stochastic time series models - these are useful for handling situations where values are correlated across time (e.g., seasonal or cyclical patterns)
5. Monte Carlo simulation - this approach is of significant practical value when combining results from any of the other techniques

Question 4

Considerations when developing a stochastic approach to reserve estimation

Answer 4

1. Availability of data - historical data is needed to validate the model and assumptions
2. Appropriateness of data - consider whether the processes reflected in the historical data are representative of the process being modeled going forward
3. Access to statistical software - lack of access to or understanding of modeling software will limit the available choices for modeling techniques
4. Appropriateness of the model - this can be validated through goodness-of-fit testing, residual analysis, and hold-out sample evaluation
5. Covariances of modeled estimates - when reserve estimates are calculated through component estimates, the covariance between these components must be estimated

Question 5

Features (or aspects) of LTD and LTC contracts to consider when setting reserves

Answer 5

1. Periodic benefits - benefits typically equal some specified monthly or daily amount
2. Long-term benefit periods - these plans have maximum benefit periods that are much longer than benefit periods for other health benefits
3. Elimination periods - LTD and LTC plans have a variety of elimination periods (often 90 days or more)
4. Optional benefits - these may affect the timing or amount of monthly payments (e.g., partial disability benefits and cost of living adjustments)
5. Integration of benefits - these plans often coordinate benefits with Social Security and Medicare
6. Limitations and exclusions - some claims are excluded (such as intentionally self-inflicted injuries) or subject to limited periods (such as mental and nervous claims)

Question 6

Types of long-term claims and reserve methods

Answer 6

1. Open claims - claims currently being paid (uses tabular reserves)
   a) Reserve = Vn = sum from time n to BP( Benefit at time t * Continuance * Interest Discount)
   i) Benefit = monthly benefit (may vary over time due to product provisions)
   ii) Continuance = probability of a claim continuing to receive payments in the future
   iii) Interest discount = factor to reflect time value of money
   iv) Summation runs from current time period (n) to end of benefit period (BP)
2. Pending claims - claims that have been reported but payments have not yet begun
   a) Reserve for claims that are still in the elimination period = pending factor * tabular reserve
   b) Reserve for claims that have completed the elimination period = pending factor * (tabular reserve + accumulated value of past payments not yet made)
3. IBNR claims - claims that have been incurred but have not been reported to the company. See separate list for reserve methods.

Question 7

Methods for calculating IBNR reserves for long-term claims

Answer 7

1. Percentage of premium method (a special case of the factor method)
   a) For a historical year in which all claims have been reported, list all claims incurred prior to yearend that were reported after yearend. These are the IBNR claims.
   b) Calculate a tabular reserve for each of these claims as of yearend of the historical year
   c) Sum these tabular reserves to get the IBNR reserve for the historical year
   d) Divide this reserve by earned premium for the historical year to get an IBNR reserve factor
2. Lag method - this is a simple case of the development method from GHFV-103-16
3. Loss ratio method - described in list from GHFV-103-16
4. Combination methods - for example, use the lag method for earlier incurral months and the loss ratio method for recent incurral months where the completion factors are low

Question 8

Common data integrity errors related to claim reserving

Answer 8

1. Missing data
2. Misstated age or gender
3. Inaccurate elimination periods or benefit periods
4. Incomplete or inaccurate information on benefit integration
5. Inaccurate or inconsistent determination of the incurral date
6. Inaccurate information on cause of disability
7. Incorrect coding of claim status (open, closed, or pending)

Question 9

Methods for evaluating claim reserve adequacy

Answer 9

1. Runoff studies (commonly done by incurral year) - previous reserve balances are compared to subsequent claim payments and reserve balances, with adjustments for interest
2. Actual to expected claim termination rate studies (commonly done by claim duration) - compares the actual claim termination to the expected claim termination based on the table used for reserving. See separate list for considerations when preparing this study.
3. Experience studies - typically involves a gross premium valuation. The reserve is adequate if PV of future gross premiums + reserves > PV of future claim costs and expenses.
   The third point above came from study notes GHFV-103-16. Note that the second point is a specific type of the experience studies mentioned in the third point.

Question 10

Considerations when preparing a claim termination rate study

Answer 10

1. Credibility - sufficient data is needed before conclusions can be drawn from the study
2. Types of terminations included - only terminations due to recovery and death should be included (terminations due to benefit limitations should not be counted)
3. Exposure characteristics - if there is a disproportionate amount of one type of claim, adjustments may be needed
4. Voluntary claim settlements - claims that are voluntarily settled are commonly excluded when performing this study

Question 11

Types of reserves and liabilities

Answer 11

1. Premium reserves (see separate list for types of premium reserves)
2. Policy reserves (a type of premium reserve)
3. Claim reserves (see separate list in GHFV-103-16 for types of claim reserves)
4. Premium deficiency reserves (discuss in Premium Deficiency Reserves Discussion Paper)
5. Expense reserves - to cover administrative expenses
6. Reserves related to government plans. For example, refund reserves for Medicare Supplement, risk-sharing reserves for Medicare Part D, and special reserves needed for state Medicaid programs.
7. Reserves related to ACA-compliant plans, for risk adjustment, reinsurance, risk corridors, MLR rebates, and reconciliations of various government subsidies
8. Reserves for contracts with providers, such as for withholds, bonuses, or other risk-sharing mechanisms
9. Reserves for experience rating refunds (discussed in Skwire chapter 27)

Question 12

Definitions of reserves and liabilities

Answer 12

1. Liabilities are obligations that are already incurred and accrued (such as the ongoing monthly payments on a known disability income claim)
2. Reserves are for obligations which have not yet been incurred or are not yet accrued
3. In practice (and in the study notes on the syllabus), reserves and liabilities are both referred to as “reserves.” Most reserve calculations focus almost entirely on calculating the combined value of the two.

Question 13

Reserve standards for the different types of financial statements

Answer 13

1. Statutory statement - the focus is on ensuring solvency, so reserves tend to be conservative
2. GAAP statement - the focus is on matching profit streams with revenue streams, with a lesser degree of conservatism (through provisions for adverse deviation)
3. Tax statement - IRS standards make sure profits beyond a set level are recognized, and therefor taxed, immediately
4. Embedded value based statement - may be needed for international companies. Standards are set by the International Accounting Standards Board.

Question 14

Types of premium reserves

Answer 14

1. Types of active life reserves:
   a) Unearned premium reserve (UPR) - reserve for the premium that has been booked to cover the portion of the coverage period which hasn’t yet occurred
   i) Is usually a pro-rata portion of the last gross premium received (gross UPR)
   ii) But when a company holds policy reserves, the gross UPR is replaced by a net UPR that is based on the net premium used in calculating policy reserves
   b) Policy reserves (contract reserves) - this is the portion of premium collected in early durations that is intentionally designed to help pay for anticipated higher claims in later durations. Is needed for products where the claim costs increase with age while the premium is level.
2. Premium paid in advance - reserve for premiums paid in advance for future coverage periods
3. Premium due and unpaid - an asset is created on the statement for the amount of premium that is expected to be received.
   This list includes information from study note GHFV-103-16

Question 15

Formulas for policy reserves

Answer 15

1. The notation:
   ipx = probability of survival to duration i for a policy issued at age x
   v^t = (1 + annual interest rate)^-t = present value factor
   ziCx = claim cost at age x, duration i, and issue year z
   ziPx = net premium at age x, duration i, and issue year z
2. Prospective formula on a per original policy basis:
   ztVx = PV{future claims} - PV{future net premiums} = sum from t+1 to w (ipx * v^(i-t) *ziCx) - sum from t to w (ipx * v^(i-t) *ziPx)
3. Prospective formula on a per original policy basis:
   ztVx = sum from t+1 to w {i-tpx+t * v^(1-t) * ziCx} - sum from t to w{i-tpx+t * v^(i-t) * ziPx}
4. Retrospective formula on a per original policy basis:
   ztVx = sum from 0 to t-1{ipx * v^(i-t) * ziPx} - sum from 1 to t {ipx * v^(i-t) * ziCx}
5. Retrospecitve formula on a per surviving policy basis:
   ztVxs = sum from o t= (t-1) {[1/t-ipx] * v^(i-t) * ziPx} - sum from 1 t= t {[1/t-ipx] * v^(i-t) * ziCx}
6. Two-year full preliminary term method - for the first 2 years, ztVx2PT = 0. Thereafter, the reserve is calculated using the regular policy reserve formulas, but calcualted as if the policy begins at time 2.
7. A modified method to reflect annual inflation (j) on both the claims and premiums - use the formulas above and multiply both the claims and net premiums terms by (1+j)^i

Question 16

Formula for deferred acquisition cost (DAC) reserves

Answer 16

1. DAC = AV{deferrable expense} - AV{net expense premiums}
2. The notation:
   ziEx = deferrable expenses at age x, duration i, and issue year z
   ziPxE = net expense premium at age x, duration i, and issue year Z
3. The formula on a per surviving policy basis:
   ztDACxs = sum from 0 to t-1 {[1/t-ipx+i] * v^(i-t) * [ziEx - ziPxe]}

Question 17

Types of policies for which policy reserves are required

Answer 17

1. Contracts that use level premiums

2. Contracts where the value of the future benefits at any time exceeds the value of future net premiums

Question 18

Reasons why past claim patterns may not be representative of future patterns

Answer 18

These would affect the validity of using the development method for calculating reserves

1. The company starts using electronic submission of claims
2. A change in work flow due to a change in claim administrative systems
3. Slow-downs or speed-ups in the claim administration department
4. Changes in benefits
5. Changes in the level of claim backlog

Question 19

Reasons why a deficiency reserve may be needed

Answer 19

1. A policy is noncancelable, so premium rates cannot be raised
2. Regulators are unlikely to allow the premium rates to rise to self-sufficient levels
3. The size of increases needed might trigger an antiselection spiral that makes it impossible to ever break even

Question 20

. Governing documents for the setting of reserves

Answer 20

Referred to as “guidelines and standards of practice for calculating long-term claim reserves” in Skwire chapter 38. Lists from the two sources are combined here since many items were listed in both sources.

1. US Statutory governing documents
   a) NAIC Accounting Practices and Procedures Manual
   b) NAIC model laws: Standard Valuation Law, Actuarial Opinion and Memorandum Regulation, and Health Insurnace Reserves Model Regulation
   c) NAIC Health Reserves Guidance Manual
2. Canadian governing documents
   a) International Financial Reporting Standards for annual statements
   b) Publications and papers from the Canadian Office of the Superintendent of Financial Insurance and the Canadian Institute of Actuaries
3. US GAAP governing documents
   a) Financial Accounting Standards Board: Statements and Interpretations, and Technical Bulletins
   b) Accounting Principles Board opinions, statements, and interpretations
   c) American Institute of Certified Public Accountants: Statements of Opinion, and Industry Audit and Accounting Guides
4. Tax governing documents
   a) In the US: the IRS code
   b) In Canada: the Canadian Income Tax Act, which requires some adjustemtns to be made to statutory numbers
5. Actuarial governing documents
   a) Various ASOPs, including numbers 5, 7, 10, 11, 12, 18, 21, 22, 23, 28, 41, and 42
   b) The American Academy of Actuaries’ series of Practice Notes
   c) The Guides to Professional Conduct of the American Academy of Actuaries
   d) Literature published in textbooks and by the actuarial profession

Question 21

Duties of the actuary regarding the quality of data

Answer 21

These are from ASOP #23

1. Seek out and use appropriate data and communicate any imperfections
2. Review data for reasonableness and consistency (not necessarily an audit)
3. Disclose reliance upon others for a review, reconciliation, or audit of the data
4. Disclose situations where it is impossible or impractical to perform a sufficient review of the data
5. Consider whether the use of inappropriate data might create a material bias in the work product
6. Maintain adequate documentaiton to support the use of specific data
7. Address reconciliation of paid claims to check registers or general ledgers

Question 22

Types of reserve reporting

Answer 22

1. Regulatory reporting - concerned with solvency and policyholder protection, so conservative
2. GAAP reporting - emphasis on realistic earnings. Assumptions include provision for adverse deviation.
3. Experience reporting for employers and providers - typically less sophisticated except for financial settlement and pricing reviews. For settlements, allow a 3 month run-out period to minimize the size of the estimated reserve.
4. Valuations for acquisitions - reserves are material to profitability, so they are often a focal point of negotiations. There is often a final settlement after several months to revisit the purchase price and assess the impact of claims reserves.

Question 23

Types of claims liabilities and reserves

Answer 23

1. Due and unpaid liabilities - liabilities that have been reported, adjudicated, and processed, but not paid. Is usually small. Itemize or base on historical averages.
2. In course of settlement - liabilities for claims reported and received but not yet adjudicated and paid. System may record receipt and run report. Otherwise, use simple method such as average claim times number of claims.
3. IBNR - liabilities for claims that are anticipated but have not been reported. Project by using existing payment data to develop average expected claims or claim payment patterns.
4. Loss adjustment expenses - liabilities for the administrative costs of adjudicating unpaid claims. Usually a percentage of unpaid claims liability.
5. Present value of amounts not yet due (referred to as “unaccrued” in Skwire chapter 37) - an estiamte of future amounts due on known open claims (commonly for disability or LTC claims). Usually reserved on a seriatim basis using a tabular approach.
6. Resisted claims - includes claims for which a known litigation situation exists. Usually reserved seriatim assuming full benefits and possibly amounts for damages.
7. Outstanding accounting feed (may overlap with due and unpaid liability) - amounts which have been acknowledged as payments, but for which no check has been cut. Reserves are often based on accounts payable and billing notices.
8. Deferred maternity or other extended benefits - the loss is triggered before the valuation date, but beneftis are deferred by contractual provisions
9. Other special reserves - such as for waiver of premium due to disability
   Points #8 and #9 came from Skwire chapter 37

Question 24

Methods of estimation for claim reserves

Answer 24

Some methods have different names in other sources, so this list includes multiple names for those methods.

1. Case reserves - direct enumeration on a claim-by-claim basis. Typically used only when there are very few claims. Can’t use for IBNR.
   a) Examiner’s method - estimate ultimate payment and deduct what’s already been paid
   b) Average size claim method - the number of reported claims times an average claim amount minus the amount already paid
2. Projection method - develop a historical incurred claim rate as a function of some measure of exposure. Then apply this rate to projected exposure to get current incurred claims, and subtract claims already paid. The most common approach is: projected PMPM claim costs * member months - claims already paid.
3. Loss ratio method (aka claim cost method) - loss ratio * earned premium - claims already paid. This method and the projected method can be used when the volume of data is small or to validate other methods.
4. Tabular method - apply a factor to open claims to calculate reserve. Typically used for LTC or disability. Can’t use for IBNR.
5. Development method (aka lag, completion, or triangulation method) - projects historical claim lag pattern into the future to estimate the reserve based on experience data.
6. Factor method (aka formula method) - historical studies are done of reserves paid after the valuation date for claims incurred before that date. These past reserves are stated as a percentage of some unit of exposure int he past time period (such as annual premium in force) to develop a factor. Current reserves equal this factor multiplied by the current amount of exposure.
7. Stochastic approaches - methods where a probabilistic statement can be made about the level and adequacy of the reserve amount. Any of the methods discussed previously can be given a stochastic treatment.
   Points 6-7 are from Skwire chapter 37.

Question 25

Types of coverages for which the development method works well

Answer 25

1. Ability to record incurral and payment dates for each claim
2. Fairly consistent lag patterns
3. Short incurral periods relative to the ultimate run out (monthly is preferred for medical)
4. A sufficient volume of business in each cell, in order to obtain reasonably stable results
5. Availability of either earned premium or exposure data (for volume adjustments and smoothing)

Question 26

Steps of the development method

Answer 26

1. Summarize the data by incurral month vs. paid month to get a claims triangle
2. Sum the cells of the first claims triangle to get cumulative paid claims by incurral month
3. Calculate age-to-age development factors as the ratios of month to month cumulative claims
4. Smooth the month-to-month variations in age-to-age development factors. Various methods are used to do this (see separate list).
5. Calculate age-to-ultimate development factors (called completion factors_ from the smoothed age-to-age factors
6. Divide each incurral month’s cumulative paid claims by its completion factor to get fully incurred claims
7. Subtract cumulative paid claims from the fully incurred claims to get the unpaid claims liability

Question 27

Smoothing methods to apply to development factors

Answer 27

1. Simple averaging - average development factors for each lag month (3 month average is more current; 12 month average is smoother but may bury trends in payment patterns)
2. Removing bumps - throw out the high and low factors and average the rest. May also remove large “shock” claims from the claim triangle and analyze them separately.
3. Weighted averaging - give more credibility to most recent results. Approaches include sum of digits, squared sum of digits, and constant declining percentage.
4. Other types of means - harmonic (use the reciprocal of the “mean of reciprocals”) or geometric (the nth root of the “product of n observations”)
5. Dollar-weighted methods (prior methods have been ratio weighted) - average cumulative payments for consecutive lag months and then compute age-to-age factors as the ratio of those averages
6. Per member age-to-age ratios - divide payments per lay by exposure to create PMPM payments and then apply the dollar-weighted approach as before

Question 28

Methods for adjusting development method reserve estimates for recent incurral months

Answer 28

Completion factors for the most recent months are typically too small to be credible and should be replaced using one of the following methods:

1. Loss ratio method
2. Projection method
3. Credibility-weighted average of completion estimates with estimates based on the projection or loss ratio method. Weights are usually assigned based on how close the completion factors is to 1.000, with the most recent months often receiving zero completion credibility.

Question 29

Process for building in conservatism in claim reserves

Answer 29

1. Development method - can incorporate conservatism in the completion and projection factors. But usually use most likely factors and add an explicit margin to the reserve.
2. Tabular reserves - margins are typically included in the assumptions made to calculate the tabular factors
3. Projection method - add margins to the trend assumptions that are used to project costs per unit
4. Loss ratio method - margins can be explicit or implicit, depending on the choice of loss ratio

Question 30

Assumptions needed to estimate premium deficiency reserves

Answer 30

PDR = PV of future claim costs and expenses less PV of future premiums and current reserves (all types of reserves: contract, claim, and premium)

(Use assumptions that are realistic, rather than conservative)

1. Rate increases - must be reasonable and likely to be implemented and approved
2. Enrollment - cannot project that new entrants will improve morbidity unless there is historical experience to justify this assumption
3. Lapses - should reflect any potential antiselection, particularly if induced by rating actions
4. Expenses - operating costs must be reflected. If other policies can be expected to cover overhead, then zero overhead costs may be assumed
5. Claims trend - reflect reasonable increases in claim costs
6. Interest rates - reasonable interest rate assumptions should be used to discount deficiencies
7. Taxes - reserves should be calculated on an after-tax basis
8. Provider arrangements
   a) Provider settlements under risk sharing arrangements should not be used to offset claims unless they have been specifically determined and billed to the providers
   b) Include capitations as claim costs at the level currently negotiated. Recognize that if the provider goes insolvent, the discounts are lost and costs will rise.
9. Reinsurance - the calculation of the reserve is usually net of reinsurance

The last point comes from the Premium Deficiency Reserves Discussion Paper

Question 31

Types of outcome-based contractual reserves

Answer 31

1. Employer-based contractual liabilities - need to recognize liabilities for contracts where the employer shares the risk of emerging claim experience. The most common is the contractual claims stabilization reserve (CSR) = Prior period CSR + premiums earned + interest credits - claims incurred - risk and retention charge.
2. Accruals for refunds needed to achieve minimum loss rations, such as the ACA medical loss ratio requirements.
3. Provider liabilities - for example, capitation payments owed, withholds, bundled payments, bonuses and incentives, stop loss settlements, and anticipated insolvency of capitated providers

Question 32

Steps for using the authorization method to project claims

Answer 32

1. Gather data on the number of authorized services as of the valuation date
2. Adjust authorized services - adjust for differences between initial authorizations and actual services rendered. Differences arise due to appeals, poor data, and issues with coordination of benefits and enforceability of rules
3. Calculate an average cost per service rendered - this average cost is frequently a blend of provider contractual amounts and actual payments made
4. Estimate incurred claims - multiply the number of services by the cost per service
5. Calculate the estimated IBNR - equals the estimated incurred claims minus the amount of paid claims to date.

Question 33

Methods for calculating provider liabilities

Answer 33

1. Risk-based payments - liabilities are based on projected contractual pay out, which is commonly based on the difference between experienced and targeted costs. Settlements are often done several months after the period ends, so reserves play a minimal role. Reserves should consider any applicable stop-loss or carve-out provisions.
2. Bonus or incentive contracts - estimates are normally based on utilization studies

Question 34

Alternative approaches for estimating liabilities with the development method

Answer 34

1. Multiple triangles - this technique looks at claim triangles in both the traditional way (claims paid by service date) and in a new way (claims reported by service date)
2. Other kinds of lag triangles - some actuaries bucket payments into weekly cells and then apply the traditional development method
3. Time series and other statistical projections (referred to as “regression methods” in Leida chapter 6) - these techniques use advanced statistical and computer tools to help in projecting claims. Uses include:
   a) Project payment patterns for partially complete incurral months (using statistical or time series techniques - instead of development factors - to complete the claims)
   b) Project PMPM costs that can be applied in projection method techniques

Question 35

Challenges in valuations for group life and health business

Answer 35

1. Group insurance encompasses different lines of business with different features
2. There is a wide variety of benefits and financial arrangements
3. For groups beyond a certain size, contracts are usually customized and contain side agreements
4. Record keeping and administration practices for third party administrators do not always meet the actuary’s needs
5. Statutory experience refund reserves may not equal the group’s surplus due to a difference in valuation bases
6. There is a wide variety of benefit types, contract provisions, and rating practices
7. Group contracts are traditionally short term, but some liabilities may be long term
8. There are often data issues

Question 36

Considerations in assessing trends in disability termination rates

Answer 36

1. Change in the mix of disabilities by cause, by severity, or by geographical region
2. Changes int he level of benefits provided
3. Changes in claim administration practices
4. Economic cycles
5. Material change in inflation or benefit indexation
6. Changes in government plan definition of disability (this will impact benefit offsets)

Question 37

Common types of reinsurance for group life and health business

Answer 37

1. Coinsurance - the insurer cedes a portion of the business to one or more reinsurers. Each reinsurer holds the policy liabilities on its portion of the business.
2. Modified coinsurance - the insurer cedes a portion of the liabilities to other insurers, but retains the assets backing the policy liabilities (as an amount owing to reinsurers)
3. Excess of risk reinsurance - the coverage of amounts above the insurer’s retention limit is ceded to a reinsurer who holds the policy liabilities related to the coverage

Question 38

Principles for determining premium deficiency reserves

Answer 38

According to the American Academy of Actuaries PDR work group

1. Situations that result in a PDR being established include:
   a) A block of business expected to have near-term losses
   b) A block of business expected to be profitable in the near term, but long-term guarantees will cause it to be unprofitable over the projection period
2. Should minimize false positives - no PDR should be required unless there is a meaningful potential for loss
3. Should minimize false negatives - a PDR should be required whenever there is an expectation for loss

Question 39

Contract groupings for PDR calculations

Answer 39

1. The process of grouping contracts consists of two levels:
   a) The testing level is the minimum level at which financial projections are performed. The focus is on how to group contracts so that projections will provide meaningful and credible results.
   b) The reporting level is based on how management combines the testing level results for external reporting purposes. Contracts should be grouped in a manner consistent with how policies are marketed, serviced, and measured.
2. Deficiencies on a product can be offset by profits on other products within its group, but not by profits in other contract groupings.
3. The recommended groupings from the Health Reserves Guidance Manual are:
   a) Comprehensive major medical
   b) LTC
   c) Income protection (disability income)
   d) Limited benefit plans

Question 40

Factors that affect how contracts are grouped at the testing level for determining a PDR

Answer 40

1. Materiality of a group relative to size of the whole reporting entity
2. Similarity of product types
3. Differences in marketing methods
4. Potential rate restrictions
5. Geographical rating areas
6. Length of rate guarantee periods
7. Regulatory requirements
8. Line of business (individual vs. group)
9. Case size within group business
10. Expected future growth or decline of a possible grouping

Question 41

Statements the actuary must make in the Statement of Actuarial Opinion for the health annual statement

Answer 41

1. The liabilities are in accordance with accepted actuarial standards
2. The liabilities are based on appropriate actuarial assumptions
3. The liabilities meet the requirements of the laws of the state of domicile
4. The liabilities make good and sufficient provision for all unpaid claims and other actuarial liabilities
5. Liabilities are computed based on assumptions that are consistent with the prior year’s assumptions
6. Liabilities include appropriate provision for all actuarial items that ought to be established

Question 42

Approaches for signing the Statement of Actuarial Opinion when reserves are too high or too low

Answer 42

1. Issue a qualified opinion - be straightforward in laying out the concerns, and then state the actuarial opinion with those exceptions noted
2. Convince management to change the reserves to an appropriate level
3. If other options fail, notify management that you must sign an opinion stating that reserves are inadequate - this decision cannot be taken lightly, since you will probably lose your job as a result

Question 43

Uses of health insurance financial models

Answer 43

1. Pricing - financial and sales models are used to determine premiums
2. Reserve calculations and reserve basis evaluation - some reserves (such as gross premium reserves) are calculated by forecasting models
3. Monitoring of results - to validate assumptions, to warn of deviations from expected values, and for resource planning
4. Solvency testing - may indicate a need for gross premium reserves
5. Financial forecasting - corporations forecast results for various reasons
6. Actuarial appraisals - these are studies of the value of a block of business, typically used when transferring ownership

Question 44

Essential characteristics of a good model

Answer 44

1. Reliable accuracy - a model must be good at predicting the future. It must also be robust.
2. Suitability for use - the model should produce the results it is designed for, without adding unnecessary complications
3. Appropriate precision - this related to how many decimal places should be kept in the values
4. Sensibility - the model should reflect a logical construction of what is being modeled. It should also be theoretically sound.
5. Effectively communicated - this includes communicating everything necessary to understand and use the model’s results

Question 45

Steps in building a forecast model

Answer 45

1. Choosing the basic structure of the model
   a) Tools used include spreadsheets, database models, and sequential programs
   b) Model types include asset share models, reserve development models, and agent-based models
2. Choosing the information to be carried - the information needed will depend on the purpose of the model
3. Choosing assumptions and building a prototype projection
   a) Starting values and assumptions must be built into the model
   b) A prototype cell is defined, and then projected to the end of the forecast period
4. Extending the prototype - after the prototype cell is built, the model must be extended to other cells which represent the different subsets of the business being modeled
5. Validating the model (see separate list of validation methods)
6. Documenting the model - this allows the model to be evaluated by other professionals, and makes it easier to make modifications
7. Designing output and communicating results - the model output can be useless unless it is put into the context of the question being asked

Question 46

Methods for validating forecast models

Answer 46

1. Starting values are compared directly to the actual values for that year
2. Year to year changes in the model are compared to actual past historical results
3. Model results are checked for reasonableness by people familiar with the business
4. Stress testing - analyze how the modeled results behave when some of the underlying assumptions are changed (includes sensitivity testing)

Question 47

Assumptions needed for forecasting

Answer 47

1. Lapse assumptions - lapse rates vary widely by product, duration, company, and member or policy characteristics. They are generally highest in the first year, and then decrease thereafter.
2. Mortality - some models treat mortality as a separate decrement, but most models combine mortality and lapses (because mortality is a minor assumption for health insurance)
3. Claim costs - it is best to use actual experience when possible. Trend assumptions are needed for determining future claim costs.
4. Expense assumptions - expenses are usually expressed on a per unit bases (such as per policy or a percentage of premium or claims)
5. Profit assumptions - profits can be measured as an ROI, an ROE, or a percentage of premium
6. Model office assumptions - these assumptions define the proportion of the block of business that is represented by each model cell

Question 48

ASOP considerations for estimating incurred claims

Answer 48

1. Health benefit plan provisions and business practices - reflect provisions and practices that materially affect the cost, frequency, or severity of claims
2. Economic and other external influences - such as unemployment levels, cost shifting, and catastrophic events
3. Behavior of claimants - consider pent-up demand for new benefits
4. Organizational claims administration - considerations include staffing levels, computer system changes, or seasonal backlogs
5. Claim seasonality - adjustments should be made for the impact of seasonality on claims
6. Credibility - consider how the credibility of the data affects the incurred claim estimates
7. Risk characteristics and organizational practices by block of business - consider the effects of marketing and underwriting on the types of risks accepted
8. Legislative requirements - consider how regulations can affect incurred claims, such as by mandating benefits or influencing rating, reserving, and underwriting practices
9. Carve outs - consider the effect of carved-out benefits on incurred claim levels
10. Special considerations for long-term products - such as cost of living adjustments, inflation protection, and integration with social insurance

Question 49

ASOP procedures for analyzing incurred claims

Answer 49

1. Unpaid claims liability - use incurral and processing dates to estimate the liability for claims incurred as of the valuation date. In doing this, consider:
   a) The intended purpose or use of the estimate
   b) Plan provisions
   c) The claim dating methods used
   d) Provision for adverse deviation
   e) Time value of money
   f) The assumptions and methodology used - these should typically be consistent with those used for estimating related liabilities
2. Categories of incurred claims - consider separate estimation of claims for each category exhibiting different lag patterns, costs, or trends
3. Reinsurance arrangements - consider their effect on estimated claims
4. Large claims - consider the effect or large claims, which includes distortions in payment patterns
5. Coordination of benefits, subrogation, and government programs - understand these items and how they are reflected in the data
6. Provider contractual arrangements - consider how these affect trends, claim costs levels, and claims processing, and consider any changes in the se arrangements

Question 50

Items to include in an actuarial communication subject to ASOP #5

Answer 50

1. Important dates used in the analysis, such as the incurral, processing, and valuation dates
2. Significant limitations that constrained the actuary’s analysis
3. Specific significant risks and uncertainties that could cause actual results to vary from the incurred claim estimate
4. Any explicit provision for adverse deviation
5. The risk that provider insolvency may have a material effect on the liability
6. Any follow-up studies the actuary may have utilized in developing the incurred claim estimate
7. When updating a previous estimate, changes in assumptions, procedures, methods, or models that the actuary believes to have a material impact on the incurred claim estimate, as well as the reasons for such changes

Question 51

Purposes of cash flow analysis

Answer 51

1. Determination of reserve adequacy
2. Determination of capital adequacy
3. Product development or ratemaking studies
4. Evaluations of investment strategy
5. Financial projections or forecasts
6. Actuarial appraisals
7. Testing of future benefits that may vary at the discretion of the insurer (such as dividend scales)

Question 52

When to do cash flow testing

Answer 52

1. Situations where cash flow testing is needed:
   a) Where there are material asset risks
   b) Where there are liabilities that have cash flows far out into the future
   c) Where a company has a new or rapidly growing line of business
   d) Where policyholder options are likely to result in antiselection
2. Situations where cash flow testing is not needed:
   a) Products with short-term liabilities supported by short-term assets
   b) Business that is not sensitive to changes in economic conditions or interest rates
   c) If the risk being evaluated is unanticipated sources of significant claims (past examples include AIDS and asbestos)

Question 53

Cash flow analysis documentation required by actuarial standards

Answer 53

1. Whether any prior analyses were relied on
2. The purpose of the analysis and the risks analyzed
3. The type of analysis performed (such as cash flow testing)
4. The results of the analysis
5. The actuary’s conclusions or recommendations
6. Any conclusions or recommendations related to sensitivity testing
7. The data, assumptions, and methods used

Question 54

Methods used for asset adequacy analysis

Answer 54

1. Cash flow testing - is appropriate where cash flows of existing assets and liabilities may vary under different economic or interest-rate scenarios
2. Gross premium reserve test - may be appropriate where the policy and other liability cash flows are sensitive to moderately adverse deviations int he actuarial assumptions
3. Demonstration or extreme conservatism - when the degree of conservatism in the liabilities is so great that moderately adverse deviations are covered, then a demonstration of this conservatism is sufficient
4. Demonstration that risks are not subject to material variation - for products that have risks that are not subject to material variation, it is sufficient to demonstrate this fact and show that moderately adverse deviations are covered
5. Risk theory techniques - for products with short-term liabilities supported by short-term assets, it may be more appropriate to measure moderately adverse deviations using risk theory techniques
6. Loss ratio methods - these may be appropriate when the cash flows are of short duration

Question 55

Considerations when forming an opinion with respect to asset adequacy

Answer 55

1. Reasonableness of results
2. Adequacy of reserves and other liabilities under moderately adverse conditions. Reserves do not need to be so great as to withstand any conceivable adverse circumstance.
3. Analysis of scenario results - inadequacy in only a small percentage of scenarios does not indicate the need for additional reserves.
4. Aggregation during testing - separate blocks of business should not be combined for reserve testing if their assets cannot be shared for satisfying the liabilities
5. Aggregation of results - results from separate blocks can generally be combined so that deficiencies in one business segment can be offset by sufficiencies in another segment
6. Trends - the actuary should reconcile results from prior years
7. Management action - consider anticipated actions by management to address adequacy concerns
8. Subsequent events - consider all material subsequent events that are likely to affect the analysis

Question 56

Actuarial standards for the use of data

Answer 56

1. Data that is completely accurate, appropriate, and comprehensive is frequently not available, so the actuary should use available data that allows the actuary to perform the analysis
2. Considerations in selecting data (see separate list)
3. Review of data - the actuary should review the data for reasonableness, unless such a review is not necessary or practical
4. The actuary should use appropriate data (see separate list)
5. Reliance on data and other information supplied by others - the accuracy of this information is the responsibility of those who supply it. The actuary may rely on this information, but should disclose this reliance.
6. Confidentiality - the actuary should handle data containing confidential information consistent with Precept 9 of the Code of Professional Conduct
7. Limitation of the actuary’s responsibility - the actuary is not required to audit the data or determine whether data supplied by others is intentionally misleading

Question 57

Considerations in selecting data to use in an actuarial analysis

Answer 57

1. The scope of the assignment and the intended use of the analysis
2. The desired data elements and possible alternative data elements
3. Whether the data is appropriate and sufficiently current
4. Whether the data is internally consistent
5. Whether the data is reasonable given relevant external information that is readily available
6. The degree to which the data is sufficient for the analysis
7. Any known significant limitations of the data
8. The availability of alternative data, and the benefit and practicality of obtaining this data
9. Sampling methods that were used to collect the data

Question 58

Categories of appropriateness of data used in an actuarial analysis

Answer 58

1. The data is of acceptable quality to perform the analysis
2. The data requires enhancement before the analysis can be performed, and it is practical to obtain additional or corrected data
3. Judgmental adjustments or assumptions can be applied to the data, or the analysis results, to allow the actuary to perform the analysis
4. The data is likely to have significant defects
5. The data is so inadequate that it cannot be used to satisfy the purpose of the assignment

Question 59

Required documentation related to data quality

Answer 59

1. The source of the data
2. Any limitations on the use of the actuarial work product due to uncertainty about the data quality
3. Whether the actuary reviewed the data, and any limitations due to data that was not reviewed
4. A summary of unresolved concerns the actuary may have about questionable data values
5. A summary of any significant steps the actuary has taken to improve the data
6. A summary of significant judgmental adjustments or assumptions the actuary applied to the data or to the results
7. The existence of results that are highly uncertain or potentially biased due to the quality of the data
8. The extent of the actuary’s reliance on data and other information supplied by others
9. Disclosures in accordance with ASOP #41 if:
   a) Any material assumption or method was prescribed by law
   b) The actuary relies on other sources and thereby disclaims responsibility for any material assumption or method
   c) The actuary has otherwise deviated materially from the guidance of this ASOP

Question 60

Disclosures required in an actuarial report

Answer 60

This report states the actuarial findings and identifies the methods, procedures, assumptions, and data used

1. The intended users of the report
2. The scope and intended purpose of the assignment
3. The acknowledgement of qualifications as specified in the Qualification Standards
4. Any cautions about risk and uncertainty
5. Any limitations or constraints on the use or applicability of the findings
6. Any conflict of interest
7. Any information on which the actuary relied that has a material impact on the findings and for which the actuary does not assume responsibility
8. The information date (date through which data and other information has been considered)
9. Subsequent events (may have a material effect on the actuarial findings)
10. I appropriate, the documents comprising the actuarial report

Question 61

Disclosure requirements for assumptions and methods used in an actuarial report

Answer 61

1. The communication should identify the party responsible for each material assumption and method
2. If the assumption or method is prescribed by law, disclose the applicable law, the assumptions or methods affected, and that the report was prepared in accordance with the law
3. If a material assumption or method is selected by another party, the actuary has three choices:
   a) If it does not conflict with the actuary’s professional judgment, no disclosure is needed
   b) If it significantly conflicts with the actuary’s professional judgment, then disclose this fact
   c) If the actuary is unable or not qualified to judge its reasonableness, then disclose this fact
   In the case of either b or c, also disclose the affected assumption or method, the party who set it, and the reason it was set by this party, rather than by the actuary

Question 62

Considerations for determining contract reserves

Answer 62

1. Interest rates - rates should be reasonable and consistent with the purpose of the reserve
2. Morbidity - this assumption should reflect the underlying risk, including factors such as age, gender, durational effects, and adverse selection
3. Persistency - this assumption should include both involuntary and voluntary terminations
4. Expenses - consider whether maintenance, acquisition, or claim expenses should be included
5. Trend - inflation, utilization, morbidity, and expense rates should reflect the appropriate trend
6. Premium rate changes - assumptions for future rate changes should reflect market conditions, regulatory restrictions, and rate guarantees
7. Valuation method - when the valuation method is not prescribed, the actuary should choose an appropriate method

Question 63

Considerations for determining provider-related liabilities

Answer 63

1. Risk-sharing and capitation arrangements - the nature of the arrangement should be considered when determining whether to establish a liability
2. Provider financial condition - consider whether the provider will be able to meet its obligations
3. Provider incentive payments - if an agreement with a provider calls for incentive payments, consider whether a liability should be held for those payments