1. © 2004 Towers Perrin September 22, 2004 Thomas L. Ghezzi, FCAS, MAAA CANE Fall 2004 Meeting Statements 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 2 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

3. © 2004 Towers Perrin 3 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

4. © 2004 Towers Perrin 4 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

5. © 2004 Towers Perrin 5 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

6. © 2004 Towers Perrin 6 Major Categories of Change for 2004 SAO Substantive Changes Format Actuarial Report Process Substantive Risk of Material Adverse Deviation Materiality Standard Data Reliance Opinion Section Wording Format SCOPE 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

7. © 2004 Towers Perrin 7 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

8. © 2004 Towers Perrin 8 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

9. © 2004 Towers Perrin 9 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. © 2004 Towers Perrin 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. © 2004 Towers Perrin 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. © 2004 Towers Perrin 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. © 2004 Towers Perrin 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. © 2004 Towers Perrin 14 Exhibit A: SCOPE

15. © 2004 Towers Perrin 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

16. © 2004 Towers Perrin 16 Exhibit B: DISCLOSURES

17. © 2004 Towers Perrin 17 Major Categories of Change for 2004 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. © 2004 Towers Perrin 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. © 2004 Towers Perrin 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. © 2004 Towers Perrin 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. © 2004 Towers Perrin 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. © 2004 Towers Perrin 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. © 2004 Towers Perrin 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. © 2004 Towers Perrin 24 Major Categories of Change for 2004 SAO Substantive Changes Format Actuarial Report Process Scope of the Auditor’s Examination

25. © 2004 Towers Perrin 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. © 2004 Towers Perrin 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. © 2004 Towers Perrin 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. © 2004 Towers Perrin 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. © 2004 Towers Perrin 29 Other 2005 Change Process of changing appointed actuary To track process for changing independent auditor Will require disclosures of disagreements

30. © 2004 Towers Perrin 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

31. © 2004 Towers Perrin 31 Discussion