1. 2008 Annual Meeting ● Assemblée annuelle 2008 Québec 2008 Annual Meeting ● Assemblée annuelle 2008 Québec Canadian Institute of Actuaries IP-25 Canadian Institute of Actuaries IP-25 L’Institut canadien des actuaires PI-25 L’Institut canadien des actuaires PI-25

2. IP-25 Earnings by Source - Group Tom Strickland and Jonathan Ferron October 2007 - committee formed to develop Group-specific earnings by source (EBS) guidance. Committee representation : 9 Group insurance 1 Group reinsurance 1 Group consulting Working on final draft for exposure later this year Today’s session will discuss the concepts developed so far and ask for feedback 2008 Annual Meeting Assemblée annuelle 2008 2008 Annual Meeting Assemblée annuelle 2008

3. Why is Group EBS Different? For individual and annuity lines of business, reserves based on full future cash flows are projected as soon as a premium is received CALM projection of cash flows can be done for Group - then EBS is very similar to individual CALM allows an approximation that does not generate full cash flows if no material interest rate risk, pricing is adequate Most companies apply the approximation for Group business, with the possible exception of Long Term Disability (LTD) 2008 Annual Meeting Assemblée annuelle 2008 2008 Annual Meeting Assemblée annuelle 2008

4. Implications of Group Valuation for EBS CALM valuation - earnings after first premium based on variances from valuation assumptions CALM approximation - most earnings based on variances from pricing assumptions at quote and renewal Draft shows what to do when the approximation is used Draft is fairly detailed – expect some companies will need to simplify External reporting less detailed (need for consistency with other lines) 2008 Annual Meeting Assemblée annuelle 2008 2008 Annual Meeting Assemblée annuelle 2008

5. Characteristics of Group Business Short Term vs Long Term For many companies, most premiums come from high credibility, short term benefits: Health, Dental, Short Term Disability (STD) Life claims are mostly short term, but about 10% lead to long term reserves (waiver of premium on disability, paid up life) Change in PFADs on reserves plays a minor role in earnings, except for LTD – could be ignored for other lines 2008 Annual Meeting Assemblée annuelle 2008 2008 Annual Meeting Assemblée annuelle 2008

6. Characteristics of Group Business Underwriting/Pricing Initial (quote) underwriting and renewal underwriting are separate processes, usually done in separate departments Group underwriters / sales have substantial leeway to give marketing discounts or load rates at quote and renewal Competition and lack of data at quote lead to generally lower earnings in first policy period Renewal underwriting should gradually improve earnings each policy period after the first to achieve overall target profit levels Overall underwriting process as critical as (maybe more critical than) tabular rates in maintaining profitability 2008 Annual Meeting Assemblée annuelle 2008 2008 Annual Meeting Assemblée annuelle 2008

7. Definition of New Business For Group, the impact of the initial pricing really extends to the end of the first policy period, when the pricing can first be revised Renewal profits start at the beginning of the second policy period New business gain is defined as profits during the first policy period (until the first repricing opportunity) – consistent with first term of liability Committee recommends analyzing first period vs renewal period(s) separately Aligns well with the way the business is underwritten and managed (separate initial and renewal underwriting processes) 2008 Annual Meeting Assemblée annuelle 2008 2008 Annual Meeting Assemblée annuelle 2008

8. Definition of New Business The first policy period is typically 15 months, but could be longer (especially for Life and LTD) EBS analysis for a given calendar year would include “new business premium” from cases issued before the start of that calendar year Example: a case issued November 1, 2007 with a 15 month renewal would have new business experience in: – November / December 2007 – All of 2008 – January 2009 2008 Annual Meeting Assemblée annuelle 2008 2008 Annual Meeting Assemblée annuelle 2008

9. Types of Group Business The main portion of the draft deals with fully insured (pooled) and ASO (fee for service) business There are also brief sections covering other types of business: – Refund accounting: Profit margin from retention accounting Limited risk if in surplus or covered by hold harmless agreement - but could still have risk elements: – Pooled elements (e.g. high amount Health) – Policy reserves different from valuation reserves – Expense charges in the refund accounting vs actual – Interest credits on policy reserves/deposits vs actual – Reinsurance ceded - recommend gross EBS with fairly simple reinsurance adjustments – Reinsurance assumed - depends on data available 2008 Annual Meeting Assemblée annuelle 2008 2008 Annual Meeting Assemblée annuelle 2008

10. Preliminary Information Needed Expected pricing margins as % premium - commissions, premium taxes, expenses, standard risk and profit margins Must also understand the pricing and underwriting philosophy (real profit margins by policy period) – Profit margins - both explicit and implicit (claims trend?) – Expected and actual marketing discounts by policy period Likely larger discounts in first period than in later periods Differentiate between risk adjustment and marketing discount – Risk adjustment » Real risk factor - not in base pricing module » Profit neutral (price could go up or down) – Marketing discount – only down – For many companies, expected profits as % premium would not be level by policy period 2008 Annual Meeting Assemblée annuelle 2008 2008 Annual Meeting Assemblée annuelle 2008

11. Treatment of PFADs For most Group lines, PFAD buildup/release has a very small impact on overall earnings The exception is LTD: – Increase in reserves typically 70-100% of first year claims – Total initial PFADs could be 20-25% of reserves – Should model the buildup and runoff of PFADs by policy period as additional expected profit elements 2008 Annual Meeting Assemblée annuelle 2008 2008 Annual Meeting Assemblée annuelle 2008

13. % Premium Earnings by Policy Year 2008 Annual Meeting Assemblée annuelle 2008 12345 1 -22.6%13.5%6.0%4.2%1.7% 2 -22.6%13.5%6.0%4.2% 3 -22.6%13.5%6.0% 4 -22.6%13.5% 5 -22.6% Total -22.6%-9.1%-3.1%1.1%2.8%

14. Typical Group EBS Report + Expected profit on inforce operations (renewal) + Expected profit on new business + Experience gains + Changes in assumptions and other changes = Earnings on operations 2008 Annual Meeting Assemblée annuelle 2008 2008 Annual Meeting Assemblée annuelle 2008

15. Expected Profit on Inforce Operations + Profit margin on renewal business premiums (including expected change in PFAD) + Expected gain on interest + Expected gain on commission, expenses, and premium taxes + Expected gain on fee income 2008 Annual Meeting Assemblée annuelle 2008 2008 Annual Meeting Assemblée annuelle 2008

16. Develop Margin Gains (Beginning of Year) Identify expected % gain for the various sources of earnings: – Potential source for assumptions below: prior pricing, Business Plan, last year’s EBS – Net risk and profit as % premium Explicit margin + implicit margins - marketing discounts + gain/loss from PFADs (LTD) Should be analyzed by policy period (at least period 1 vs renewal) – Expected % gain on interest Expected % return on assets backing liabilities - % required interest on liabilities – Expected % gain on fee income (fee income - expenses allocated to fee income groups) / fee income – Expected % gain on commissions and premium taxes Usually explicitly priced for - most companies would assume zero expected gains – Expected % gain on expenses (expense loads - actual expenses - change in expense reserves) / expense loads Excludes fee income groups 2008 Annual Meeting Assemblée annuelle 2008 2008 Annual Meeting Assemblée annuelle 2008

17. Calculate Expected Profits (Quarterly Reporting) From net risk and profit margin = actual premium received * (net risk and profit as % premium) Split between new business and inforce (renewal) Could split renewal into multiple years From interest = actual mean liabilities * expected % gain on interest From fee income = actual fee income * expected % gain on fee income From expenses = actual premium * expense margin * expected % gain on expense margin From commissions, premium tax – same as expenses (but usually zero) New business expected profits are just net risk and profit margin – remainder are inforce (renewal) items for simplicity 2008 Annual Meeting Assemblée annuelle 2008 2008 Annual Meeting Assemblée annuelle 2008

18. Comparison to Plan EBS expected profits based on actual premiums received If mix of premium is much different from Business Plan (e.g. big new business), this may create a variance from Plan You may wish to do an analysis of expected profits from Plan premiums vs actual premiums to better understand this variance – would be outside the core EBS process 2008 Annual Meeting Assemblée annuelle 2008 2008 Annual Meeting Assemblée annuelle 2008

19. Experience Gains & Losses + Claims experience gain: renewal business + Claims experience gain: new business + Investment income experience gain + Expense experience gain + Commissions experience gain + Premium taxes experience gain + Fee income experience gain 2008 Annual Meeting Assemblée annuelle 2008 2008 Annual Meeting Assemblée annuelle 2008

20. Experience Gains and Losses Claim Experience Gain Usually the biggest source of experience gain Split between new business and renewal business “Actual” claims vs “Expected” claims “Expected” claims = premiums + required investment income – expense loads – commission loads - premium tax loads – net profit loads “Actual” claims = claims paid + actual change in claim reserves 2008 Annual Meeting Assemblée annuelle 2008 2008 Annual Meeting Assemblée annuelle 2008

21. Experience Gains and Losses Claim Experience Gain Refinements for longer term lines of business – Long Term Disability Incidence gain + Termination gain DLR portion + IBNR portion + Paid Claim portion Settlement Gain Offset Gain Actual vs expected incidence & termination rates – Life Mortality Gain + Morbidity Gain Actual vs expected mortality rate 2008 Annual Meeting Assemblée annuelle 2008 2008 Annual Meeting Assemblée annuelle 2008

22. Experience Gains and Losses Investment Income Experience Gain “Actual” vs “Expected” investment income “Actual” = income statement investment income “Expected” = actual required interest + expected profit from interest Impact of fair value accounting – Fair value of assets (CICA 3855) vs – Fair value of liabilities (through CALM)  Net market gain (loss) Mismatch (C3) PFAD 2008 Annual Meeting Assemblée annuelle 2008 2008 Annual Meeting Assemblée annuelle 2008

23. Experience Gains and Losses Expense Experience Gain “Actual” vs “Expected” expenses “Expected” = expense loads (non-fee income) + required investment income on expense reserves - expected expense gain “Actual” = income statement expenses (non-fee income) + change in expense reserves 2008 Annual Meeting Assemblée annuelle 2008 2008 Annual Meeting Assemblée annuelle 2008

24. Experience Gains and Losses Other Expenses Experience Gain Commissions experience gain Premium taxes experience gain Fee income experience gain Calculated using same principles as expense gain Except no reserves 2008 Annual Meeting Assemblée annuelle 2008 2008 Annual Meeting Assemblée annuelle 2008

25. Other items Other EBS items can generally be treated same way as for regular life EBS Of particular interest are: – Changes in assumptions – Other changes and management actions 2008 Annual Meeting Assemblée annuelle 2008 2008 Annual Meeting Assemblée annuelle 2008

26. Feedback Questions or comments? 2008 Annual Meeting Assemblée annuelle 2008 2008 Annual Meeting Assemblée annuelle 2008