Ted Strickland, Governor Mary Jo Hudson, Director NAIC Potpourri Mary Miller FCAS, MAAA Assistant Director, Product Regulation & Actuarial Services June 24, 2009 Kansas City Actuarial Club Seminar

Agenda NAIC Risk-Focused Examinations New Health Actuarial Opinion Instructions Actuarial Opinion Summary and Other Initiatives

Financial Analysts/Examiners have used Risk Assessment for many years - SRA’s Focus was on the past – Balance Sheet Used to determine whether prior period financials were fairly stated Risk Assessment and the NAIC

Risk – Focused Surveillance Process Evolution or Revolution? CARRMEL Rating Determines Priority Coordinated Examinations Emphasis on – Corporate Governance – Quality of the Board – Risk Management Change Has Occurred

Prioritization system Improves decision-making and communications Validated/Revised as part of the examination effort Facilitates analysis to identify strengths and weaknesses Scores management As time goes on, it becomes a better tool CARRMEL rating

Capital Adequacy Asset Quality Reserves Reinsurance Management Earnings Liquidity CARRMEL

Board of Directors Senior Management Control Functions – Audit – Compliance – Risk management Corporate Governance

1. Assess external and internal audit functions - Maximize use where appropriate 2. Interview senior management - Assessing corporate governance and ERM 3. Focus on high risk areas (examples include): - Reserves - Reinsurance - Inter-company transactions Top-Down, Risk-Focused Surveillance Process

Identification of risks Assessment of governance structure Allocation of Department resources Assessment of risk management framework & practices Meaningful communication of findings with Board and/or Senior Management Update CARRMEL rating Objectives

Active Board and Senior Management oversight Adequate policies, limits and procedures Adequate risk management, monitoring and management information systems Comprehensive internal controls Compliance to law, regulations, and internal policies Risk Management Principles

Tone at the top – Audit/compliance relationships Adherence to Board policies and procedures Internal control environment Assessment of Risk Management Framework & Practices

Credit Market Pricing/Underwriting Reserving Liquidity Operational Legal Strategic Reputation Inherent Risks

Pricing/Underwriting Reinsurance Investments Claims/Reserves Support – Accounting – Actuarial – IT – Legal – Human Resources Application of these Risks to Key Business Activities

Identification of Inherent Risk Plus Assessment of Risk Management Processes Equates to Residual Risk Determination Risk Assessment Steps

Residual Risk Grid Inherent Risk Strong Risk Controls Acceptable Risk Controls Weak Risk Controls HighModerate to High High Moderate Moderate to High Low Low to Moderate

16 7 Phases Phase 1Understand Company/Key Activities Phase 2Inherent Risk Phase 3Risk Mitigation Strategies/Controls Phase 4Residual Risk Phase 5Exam Procedures Phase 6Prioritization/Supervisory Plan Phase 7Exam Report/Management Letter Risky Business

17 Phase 1 – Understand Company/ Key Activities 1.Understanding the Company Steps to Phase 1, Part 1 1.Gather Necessary Planning Information 2.Review the Gathered Information 3.Perform Analytical and Operational Reviews 4.Consider Information Technology Risk 5.Update the Insurer Profile Summary 2.Understanding Corporate Governance Structure 3.Assessing Adequacy of Audit Function 4.Identifying Key Functional Activities 5.Consider Business and Prospective Risks

18 Examination Interviews Why Gather undocumented information Clarify information Interpret information Identify key activities Identify strengths Identify risks Identify risk mitigating strategies

19 Examination Interviews Who CEO CFO COO CIO Controller Chief Actuary Board’s Audit Committee chairperson

20 Example:Phase 1, Part 1, Step 3 Analytical and Operational Reviews Management and reserving processes – Who determines reserves booked – What analyses performed – Unique types of losses – Surplus and/or RBC level – Basis for variable compensation

21 Phase 1, Part 2 Corporate Governance & Management Management controls and reserving – Management influence – Independence of appointed actuary and their assumptions – Changes to appointed actuary – Risk transfer due to ceded reinsurance – Reserving actuary meets with Board/Audit Committee

22 Phase 1, Part 2 Corporate Governance & Management ITEMS FOR REVIEW – Actuary participates in pricing meetings – Exposure growth is monitored regularly – Well-diversified book of business-geographical – Remedy bad situations promptly or drag on – ERM implemented – Carried reserves determined by actuary – Segregation of actuarial duties

23 Phase 1, Part 3 Assess Audit Function INDEPENDENCE: “In all matters relating to audit work, the audit organization and the individual auditor … should be free both in fact and appearance from personal, external and organizational impairments to independence.” GAO

24 Phase 1, Parts 4-5 Key Activities/Prospective Risk Key Activities will involve those lines of business with the largest reserves or premiums collected.

25 Phase 2 Inherent Risk Inherent Risks: – Incorrect data – Misapplying methodologies – Invalid assumptions – Incorrect calculations – Improper reporting of reserves

26 Phase 2 Inherent Risk Liquidity – Assess catastrophe management process to identify likelihood of occurrence and magnitude of impact relative to company’s surplus and claims paying ability: as a result of an acceleration in claim payout patterns in the event of an insolvency of a significant reinsurer an increase in the duration of assets

27 Phase 2 Inherent Risk Pricing/Underwriting – P/C – Consider inherent risks related to: An insurance product priced with little margin can lead to significant losses. Are separate analyses conducted for certain unique types of losses (e.g., construction defects, class actions, catastrophes, environmental)?

©2008 National Association of Insurance Commissioners 28 Phase 3 Risk Mitigation Strategies/Controls Controls related to specific identified risk Look at controls over: – Reserving process – Staffing issues

©2008 National Association of Insurance Commissioners 29 Phase 3 Risk Mitigation Strategies/Controls Best Practice Controls Pricing/Underwriting – Appropriate rate-setting methodologies – Quality assurance of underwriting guidelines – Experience level of underwriting staff (i.e., more complex issues handled by senior staff members)

30 Phase 3 Risk Mitigation Strategies/Controls Liquidity comprised of: – Risk management – Investments – Premiums – Claims Proper controls in each area ensure liquidity Best Practice Controls

31 Phase 4 Residual Risk Risk remaining after consideration of controls Inherent Risk – Internal Controls Calculated Residual Risk +/- Examiner ’ s Judgment Overall Residual Risk Assessment

32 Phase 5 Exam Procedures Procedures based on residual risk assessment – P/C Larger, more volatile lines New lines of business/segments New geographic areas Persistent adverse development

33 Phase 6 Prioritization & Supervisory Plan Phase 7 Exam Report & Management Letter

Health Actuarial Opinion Changes Define an appointed actuary Require appointed actuary report findings to the Board or Audit Committee Require the reliance statement

Why were changes needed? Appointment and memorandum requirements were not specified Desire for consistency across blanks Make instructions more relevant to health blank – not a modified Life opinion Define process for changing actuaries Define what Qualified, Adverse and Inconclusive opinions are

Consistency Joint CASTF/LHATF subgroup charged with developing the process for the appointment and change of the actuary Definitions Reliance statements

Appointed Actuary If you were appointed according to the new instructions in the past, you don’t need to be re-appointed If you were not appointed according to the new instructions, you need to be appointed in order to sign the opinion for 2009

Prescribed Wording Prescribed wording is preferable if it fits the situation Not using prescribed wording does NOT imply that something is wrong Makes it easier for non-actuaries to review the opinions

Table of Key Indicators This Opinion is:  Unqualified  Qualified  Adverse  Inconclusive IDENTIFICATION SECTION  Prescribed Wording Only  Prescribed Wording with Additional Wording  Revised Wording SCOPE SECTION  Prescribed Wording Only  Prescribed Wording with Additional Wording  Revised Wording RELIANCE SECTION  Prescribed Wording Only  Prescribed Wording with Additional Wording  Revised Wording OPINION SECTION  Prescribed Wording Only  Prescribed Wording with Additional Wording  Revised Wording RELEVANT COMMENTS  Revised Wording  The Actuarial Memorandum includes “Deviation from Standard” wording regarding conformity with an Actuarial Standard of Practice

Other New Stuff Relevant Comments Section Actuarial Memorandum – Narrative and technical components – Tie to financial statements

Definitions – Adverse Opinion An actuarial opinion in which the appointed actuary determines that the reserves and liabilities are not good and sufficient.

Definitions – Qualified Opinion When in the actuary’s opinion the reserves for a certain item or items are in question because they cannot be reasonably estimated or the actuary is unable to render an opinion on those items, the actuary should issue a qualified opinion. A qualified opinion should state whether the reserves would be good and sufficient without the items in question. There’s also a provision that the actuary doesn’t have to issue a qualified opinion if the actuary determines the item in question is immaterial.

Definitions – Inconclusive Opinion If for some reason the actuary can’t reach a conclusion due to deficiencies or limitations in the data, analysis, assumptions or related information, then the actuary should issue an inconclusive opinion. The opinion should then include the reasons why a conclusion could not be reached.

FYI Ohio in process of changing Life AOMR Health blank users must use Health Opinion instructions

Confidential Filed only with domiciliary state or as requested Due March 15 Minimum Requirements: – Point estimate and/or range of reasonable estimates for loss and loss adjustment expenses, net and gross of reinsurance – Company’s recorded loss and loss adjustment expense reserves, net and gross of reinsurance – Difference between carried reserves and point estimate/range of reasonable estimates, net and gross of reinsurance – Explicit discussion of persistent adverse reserve development (1 year development of 5% of surplus in 3 of the last 5 years) Uses: – Tool for deciding when to request Report – Use in conjunction with Opinion and Report when planning exam 45 ACTUARIAL OPINION SUMMARY

AOS Statistics  Combined Net Data from 825 Companies domiciled in seven states  Reflects 2007 AOS data  Includes some companies that carry net zero

AOS Statistics – Carried to Actuary Estimate Combined Net data from 732 companies in 7 states Excludes companies that carry zero-net reserves

Implications P&C Companies coming off a hard market with generally strong reserves Tracking AOS data going forward will add an additional tool for monitoring the industry

Other Regulatory Initiatives Regulator Guidance in COPLFR Practice Note Frequent interaction and collaboration with Accounting Groups at NAIC RBC trend test LOB survey Continued Discussing Premium Deficiency Reserves at June NAIC Meeting