2004 Towers Perrin September 22, 2004 Thomas L. Ghezzi, FCAS, MAAA CANE Fall 2004 Meeting Statements of Actuarial Opinion Changes for 2004 and 2005

September 22, 2004

Thomas L. Ghezzi, FCAS, MAAA

© 2004 Towers Perrin

CANE Fall 2004 MeetingStatements of Actuarial Opinion – Changes for 2004 and 2005 Reporting Years

This document was designed for discussion purposes only. It is incomplete, and not intended to be used, without the accompanying oral presentation and discussion.

2© 2004 Towers Perrin

Agenda Changes to statutory Statements of Actuarial Opinion

(SAO) Year-end 2004 Anticipated 2005

Focus on SAO required to be attached to financial statements of US property/casualty insurers

Based on NAIC Annual Statement Instructions –Property/Casualty, for the year 2004

Based on my interpretation Individual opinions must be based on appointed

actuary’s interpretation of the principles applicable to the particular situation


Background The SAO is an important manifestation of

actuarial work Presents actuarial conclusions Important tool for solvency monitoring

SAO needs to Opine on held reserves Disclose relevant issues Flag material issues/risks


Recent Criticism of Actuaries Reserve performance has been generally poor in

recent years Not only due to asbestos and other mass torts Often for companies with “clean” opinions

Credibility of the SAO is brought into question Regulators External users

— Rating Agencies — SEC— Standard & Poors— Public


Intent of the Changes for 2004 and 2005 Bring more order to the Opinion Instructions

Seventeen sections consolidated into nine sections and two exhibits

Provide better disclosures Within the SAO Within the Actuarial Report

Formal acknowledgement of regulatory reliance on the Actuarial Standards of Practice of the Academy and the Statement of Principles of the CAS

Provide additional disclosures in a confidential document – the Actuarial Opinion Summary – for 2005


Major Categories of Change for 2004

SAO• Substantive

Changes• Format

Actuarial Report

Process

SubstantiveRisk of

Material Adverse Deviation

Materiality Standard

Data Reliance Opinion

Section Wording

FormatSCOPE Items

Moved to Exhibits

Miscellaneous Scope of the Auditor’s Examination

Compare Actuary’s Conclusions to Carried Amounts

Extended Comment on Risk of Material Adverse Deviation

Describe Basis of Materiality Standard

Extended Comment on Exceptional IRIS Test Results

Reconciliation to Schedule P


Risk of Material Adverse Deviation (RMAD) The SAO Must state whether or not there are

“Significant risks and uncertainties that could result in material adverse deviation.”

The actuary needs to judge Whether the risk is “significant”

— Based on actuary’s reasonable belief— Not intended to include every conceivable risk

What is material


Materiality Standard Must be disclosed in all opinions (Exhibit B) General approach is to consider how user will be

influenced An item is material if it would change the user’s

interpretation of the situation Depends on the context

Solvency monitoring - might imply a standard based on surplus

Actuarial appraisal – might imply a standard based on net income or net worth

Other standards are possible Involves qualitative and quantitative considerations


RMAD Disclosure Explanatory paragraph must describe

Major risk factors Combination of factors Particular conditions underlying the risks and uncertainties

Include basis of the materiality standard

Should not include broad general statements E.g., Risk of future adverse legislative or judicial

changes is too broad a statement

The list need not be exhaustive

10


NAIC “Bright Line Test” Regulators plan to use a bright line test for 2004 in

evaluating if there is a risk of material adverse deviation

Based on the relationship of 10% of held reserves Difference between surplus and company action

level RBC

Not conclusive, but disclosure and discussion will be looked for in the SAO and Actuarial Report A more restrictive standard is expected to apply in

most cases

11


Data Reliance Identification of data source to include

Name, affiliation, relation to company Previously, referred to:

“Responsible officers and employees…”

Prior reference provided no useful data to regulators

Response to past situations where adverse development attributed to “bad data”

12


Opinion Section Must state category of opinion, based on ASOP #36

definitions Reasonable Deficient or Inadequate Redundant or Excessive Qualified

— Really a “limited scope” opinion No Opinion

13


Items Included in the Opinion Moved from the SCOPE paragraph to Exhibit A

Loss reserve items listed separately from premium reserve items

Claims-made extended reserve not explicitly listed

“Other” categories, e.g., Extended reserve

14


Exhibit A: SCOPELoss Reserves: Amount A. Reserve for Unpaid Losses (Liabilities, Surplus and Other Funds

page, Line 1) $ ________

B. Reserve for Unpaid Loss Adjustment Expenses (Liabilities, Surplus and Other Funds page, Line 3)

$ ________

C. Reserve of Unpaid Losses – Direct and Assumed (Schedule P, Part 1, Totals from Cols. 13 and 15)

$ ________

D. Reserve for Unpaid Loss Adjustment Expenses – Direct and Assumed (Schedule P, Part 1, Totals from Cols. 17, 19 and 21)

$ ________

E. The Page 3 write-in item reserve, “Retroactive Reinsurance Reserve Assumed”

$ ________

F. Other Loss Reserve items on which the Appointed Actuary is expressing an Opinion (list separately)

$ ________

Premium Reserves: Amount G. Reserve for Direct and Assumed Unearned Premiums for Long

Duration Contracts $ ________

H. Reserve for Net Unearned Premiums for Long Duration Contracts

$ ________

I. Other Premium Reserve items on which the Appointed Actuary is expressing an Opinion (list separately)

$ ________

15


Additional Disclosures Moved from the SCOPE paragraph to Exhibit B

Disclosure of materiality standard added Standard used to judge the risk of material adverse

deviation Stated in $US

Includes disclosure of statutory surplus

Includes listing of items covered in RELEVANT COMMENTS

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Exhibit B: DISCLOSURES1. Materiality Standard expressed in $US $ ________ 2. Statutory Surplus $ ________ 3. Anticipated net salvage and subrogation included as a reduction to loss

reserves as reported in Schedule P $ ________

4. Discount included as a reduction to loss reserves and loss expense reserves as reported in Schedule P

4 (a) Nontabular Discount $ ________ 4 (b) Tabular Discount $ ________ 5. The net reserves for losses and expenses for the company’s share of

voluntary and involuntary underwriting pools’ and associations’ unpaid losses and expenses that are included in reserves shown on the Liabilities, Surplus and Other Funds page, Losses and Loss Adjustment Expenses lines.

$ ________

6. The net reserves for losses and loss adjustment expenses that the company carries for the following liabilities included on the Liabilities, Surplus and Other Funds page, Losses and Loss Adjustment Expenses lines. *

6 (a) Asbestos, as disclosed in the Notes to Financial Statements $ ________ 6 (b) Environmental, as disclosed in the Notes to Financial Statements $ ________

7. The total claims made extended loss and expense reserve (Schedule P Interrogatories).

7 (a) amount reported as loss reserves $ ________ 7 (b) amount reported as unearned premium reserves $ ________ 8. Other items on which the Appointed Actuary is providing Relevant

Comment (list separately) $ ________

17



SAO• Substantive

Changes• Format

Actuarial Report

Process

Compare Actuary’s Conclusions to Carried Amounts

Extended Comment on Risk of Material Adverse Deviation

Describe Basis of Materiality Standard

Extended Comment on Exceptional IRIS Test Results

Reconciliation to Schedule P

18


Actuarial Report - General Considerations Regulators want to be able to rely on the Actuarial

Report Timely Consistent with ASOP #9, Other ASOPs, Statement

of Principles

Needs to convey completely the significance of the actuary’s opinion and findings

19


Comparison of Actuary’s Conclusions to the Carried Reserves Must show either

Point estimate Range of reasonable estimates Both

The held amount must tie to the Annual Statement

Although new to the instructions, this has always been considered by many to be a best practice

20


Extended Comments on RMAD Substantive support for the actuary’s conclusions

regarding RMAD

Cite trends that indicate the presence or absence of RMAD

Will likely need to be extensive in many situations

21


Description of the Basis of the Materiality Standard Supportive of disclosures in the SAO

Will likely include Actual data and conclusions underlying any

calculations used in derivation of the standard Bright line test documentation

Will likely include both quantitative and qualitative considerations and discussion

22


Extended Comment on Exceptional IRIS Test Results Substantive comment regarding the failed tests is

required

Mostly a requirement for the Actuarial Report, but best practice for the SAO as well

Key considerations Prior year carried reserves vs current evaluation Implicit assumption is that test result is predictive of

future changes in current reserve If current reserves are reasonable, irrelevance of

failed test must be explained

23


Reconciliation of Analysis Data to Schedule P Historical standard includes

Paid amounts Case reserves Earned premium

May include additional items Salvage/Subrogation Claim counts Other

More of an interpretation change than a change in the instructions

24



SAO• Substantive

Changes• Format

Actuarial Report

Process

Scope of the Auditor’s Examination

25


Process Change – Scope of the Auditors’ Examination Auditor must obtain an understanding of data identified

by the appointed actuary as significant to reserve projections

Separate testing may be required “Unless otherwise agreed” among the appointed

actuary, management and the auditor

This requirement may cause difficulties May shift role of the actuary to include data testing

issues May cause conflict with auditor and management

Early discussions are advisable

26


Role of the Actuary and the Auditor This instruction places responsibility on the auditor and

the company However, it anticipates significant interaction between

the auditor, company and the appointed actuary Actuary must decide what data is significant

Losses LAE Premium Claim counts Data for a particular state Sub-component/line of business Other

27


Anticipated Changes for 2005 – Actuarial Opinion Summary (AOS) Due March 15 following statement year Confidential document To include at least

Actuary’s point estimate, gross and net Actuary’s range, gross and net Company’s recorded reserves, gross and net Discussion of differences between estimated

reserves and recorded reserves, gross and net Discussion of recent adverse development

— Greater than 5% of surplus in three of last five calendar years

— Discussion of major contributors

28


AOS Continued Model law to protect confidentiality of the AOS

Passage to take several years

Voluntary compliance may be requested as early as year-end 2004 Only if confidentiality of AOS can be protected

AOS content requirements may change

29


Other 2005 Change Process of changing appointed actuary

To track process for changing independent auditor

Will require disclosures of disagreements

30


Resources NAIC Annual Statement Instructions

Property and Casualty Practice Note Will contain additional appendices related to

— Changes to the opinion, including NAIC guidance memorandum

— Data audit, including discussion of communication with auditors

NAIC Accounting Practices and Procedures Manual Other

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Discussion

Documents

2004 Towers Perrin September 22, 2004 Thomas L. Ghezzi, FCAS, MAAA CANE Fall 2004 Meeting Statements of Actuarial Opinion Changes for 2004 and 2005