1. PD 27 CLIFR Update 2008 General Meeting Assemblée générale 2008 Toronto, Ontario PD 27 CLIFR Update 2008 General Meeting Assemblée générale 2008 Toronto, Ontario Canadian Institute of Actuaries Canadian Institute of Actuaries L’Institut canadien des actuaires L’Institut canadien des actuaires

2. 2008 General Meeting Assemblée générale 2008 2008 General Meeting Assemblée générale 2008 Valuation of Group Life and Health Policy Liabilities

3. 2008 General Meeting Assemblée générale 2008 2008 General Meeting Assemblée générale 2008 Agenda Educational Note Group Experience Rating Refunds

4. 2008 General Meeting Assemblée générale 2008 2008 General Meeting Assemblée générale 2008 Background First Educational Note on Group valuation in Nov 2000 Companion piece to draft Life SOP Reduced to Research Paper Sep 2001 Recently revisited by CLIFR Educational Note to be re-published with modifications

5. 2008 General Meeting Assemblée générale 2008 2008 General Meeting Assemblée générale 2008 Facts Varieties in groups and their risks Employee groups, association, creditor Size of groups Industries and occupations Varieties in benefit provisions Many products, variations within products Varieties in financial arrangements Fully pooled, prospectively rated, refund accounting, hold harmless, ASO, etc.

6. 2008 General Meeting Assemblée générale 2008 2008 General Meeting Assemblée générale 2008 Valuation Challenges Customization Specific client needs  complexity Refund accounting Additional complexity Data issues Policies may be administered by the insurer, or the client, or a third party Some contract information may exist but not available to the valuation actuaries

7. 2008 General Meeting Assemblée générale 2008 2008 General Meeting Assemblée générale 2008 What’s in the Educational Note General descriptions Group business characteristics, benefit descriptions, financial arrangements CALM, term of the liability Cash flows Reported claims, IBNR Future claims (premium rate guarantees) Experience rating refunds (ERR) Other miscellaneous guidance

8. 2008 General Meeting Assemblée générale 2008 2008 General Meeting Assemblée générale 2008 Experience Rating Refund Applicable to refund accounting Policyholder (PH) eligible for refund if experience better than assumed Typically one-way: head you win, tail I lose Refund to PH similar to income to insurer ERR = premium – retention charges – claims + interest credited – increase in PH reserves (Income = premium – expenses – claims + investment income – increase in reserves)

9. 2008 General Meeting Assemblée générale 2008 2008 General Meeting Assemblée générale 2008 Where Come the Profits? Retention charges Interest spread Premiums? Only if already in deficits, additional premiums could generate profits by recovering past deficit losses Pooling charges

10. 2008 General Meeting Assemblée générale 2008 2008 General Meeting Assemblée générale 2008 Managing Refund Risks Financial arrangement CFR, cross-rating, hold harmless provisions alleviate but do not eliminate the risk Risk charges Conservative PH valuation basis Other management Prudent underwriting, effective deficit management practice, pooling charges

11. 2008 General Meeting Assemblée générale 2008 2008 General Meeting Assemblée générale 2008 Liabilities for ERR Margin returnable to PH Policy by policy calculation John’s win does not offset Joe’s loss Complex due to varieties in arrangements Guidance No one-size-fits-all approach, always more peculiarity, exception and variation Focus on key considerations Discuss approximations and limitations

12. 2008 General Meeting Assemblée générale 2008 2008 General Meeting Assemblée générale 2008 Accrued ERR (retrospective) Refund based on past experience Calculation reflects terms in agreement Expenses, risk and profit charges to be deducted from premiums; interest to be credited; policyholder reserves to be held Refundable surplus recorded as liability Paid out as refund, or used to fund CFR Deficit may or may not reduce liability

13. 2008 General Meeting Assemblée générale 2008 2008 General Meeting Assemblée générale 2008 Future ERR (prospective) Margins in existing PH reserves Mort/morb assumptions Valuation expense Valuation interest rate Margins in future premiums Premiums to the end of the guarantee period

14. 2008 General Meeting Assemblée générale 2008 2008 General Meeting Assemblée générale 2008 Projecting Future ERR Not projected on expected basis Projected experience follows CALM, that is, with MfAD  projected ERR less than what is expected PH reserve does not follow GAAP PH cash flow assumptions  expected + MfAD in CALM PH valuation expense  what is charged PH valuation interest rate  credited rate and not based on investment return

15. 2008 General Meeting Assemblée générale 2008 2008 General Meeting Assemblée générale 2008 Benefit Cash Flows (Mort/Morb) PH valuation benefit cash flows – CALM benefit cash flows (expected + MfAD) 0  no contribution to future ERR +ve  may contribute to future ERR -ve  generates future deficits, may reduce future ERR cash flows from other sources Analogy: head you win, but I won’t pay if you still owe me money; tail I lose, but not if I have collateral to draw on.

16. 2008 General Meeting Assemblée générale 2008 2008 General Meeting Assemblée générale 2008 Valuation Expense Expenses charged in calculating ERR based on retention formula in contract PH valuation expense ≠ formula Valuation expense in PH reserve – expense charge 0 / +ve / -ve  same treatment as for ERR due to difference in benefit cash flows Insurer actual expense has no impact on ERR

17. 2008 General Meeting Assemblée générale 2008 2008 General Meeting Assemblée générale 2008 Interest Credit Interest crediting often based on GICs Interest rate used to calculate PH reserve not tied to crediting basis Interest credit – interest assumed in PH reserve 0 / +ve / -ve  same treatment as for ERR due to difference in benefit cash flows Actual investment yield by insurer has no impact on ERR

18. 2008 General Meeting Assemblée générale 2008 2008 General Meeting Assemblée générale 2008 Premium Margins Only to the end of rate guarantee period Premium – retention charges – PH reserves on future claims 0 / +ve / -ve  same treatment as for ERR due to difference in benefit cash flows A -ve amount alone does not imply premium inadequacy due to presence of strains in PH reserves

19. 2008 General Meeting Assemblée générale 2008 2008 General Meeting Assemblée générale 2008 Other Considerations … Project ERR cash flows by duration Consider effect of accumulated deficit or CFR at each duration +ve contributions first reduce deficit before becoming refund cash flow -ve contributions … CFR … hold harmless … increase accumulated deficits If policy terminates, cash flows change Adjust for policy persistency?

20. 2008 General Meeting Assemblée générale 2008 2008 General Meeting Assemblée générale 2008   So Complicated?!  Does it have to be so complicated? YES - do this if you can NO - use of approximation is more common than not, be sure to understand the limitations MAYBE you were using approximation without fully understanding the principles supporting it  Evaluate

21. 2008 General Meeting Assemblée générale 2008 2008 General Meeting Assemblée générale 2008 A Common Approximation Approximate future ERR liability (by policy) ≈ (PH reserve – statutory reserve) – PH deficit, subject to zero floor Understand the limitations, which are deviations from key principles (   ) Apply judgment and materiality principles

22. 2008 General Meeting Assemblée générale 2008 2008 General Meeting Assemblée générale 2008 Questions To all your good questions, here is my answer: “It’s a very good question. I’ll get back to you.” Have a good lunch