2006 General Meeting

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Canadian Institute of Actuaries
LInstitut canadien des actuaires

• 2006 General Meeting
• Assemblée générale 2006
• Chicago, Illinois

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Improving Actuarial Processes Beyond AuG-43
Compliance

• Jacqueline Friedland, FCAS, FCIA, MAAA KPMG LLP
• Neville Henderson, FSA, FCIA, MAAA PwC LLP

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Presentation Outline

• Introduction
• Current environment
• Implications
• Controls
• Recomputation
• Conclusion

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Introduction New Audit Guideline AuG-43

• Replaces old guideline AuG-15
• New guideline includes insurance enterprises
• Applicable to life insurers, PC insurers,
  reinsurers, and workers compensation boards
• May also be used for enterprises whose products
  have similar characteristics to insurance
  products
• Issued December 2005, effective 2006

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Introduction Why the change?

• Auditor audits the financial statement as a whole
• Audit opinions do not (and cannot) express
  reliance on the AAs opinion
• CIA/CICA Joint Policy Statement provides
  framework
• Greater consistency with US and UK GAAS
• Change in audit standards with respect to
  internal controls

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Introduction Basic Principles

• AA is responsible for valuing policy liabilities
• Requirement for independent check on actuarial
  liabilities
• Requires use of audit support actuary
• Clarifies that AA cannot provide audit support
  role
• Requires corroborative evidence for use of AAs
  work

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Introduction Audit Approach

• Understand and test internal controls over the
  actuarial valuation (new)
• Substantive tests
• Test data used in valuation
• Review of valuation for reasonableness
• Testing of calculations, including consideration
  of complex models (new)
• Extent of testing dependent on
• Complexity and subjectivity of estimation of
  policy liabilities
• Availability and reliability of data
• Nature and extent of assumptions
• Degree of uncertainty of future events

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Current Environment Life Insurers

• Prior to AuG-43 wide variance in practice
• Dependent on circumstances
• Little documentation or testing
• Reliance on post review
• Controls have not kept pace
• Poorly documented processes and controls
• Increasingly complex products
• AuG-43 forces Actuaries to re-examine processes
  controls

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Current Environment Property Casualty Insurers

• Not significant communication between AA and
  audit actuary
• Review of assumptions, methodology, findings
• Varying degree of review of calculations

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Implications Life Insurers

• AuG-43 provides guidance on reviewing policy
  liabilities
• Address the risk of material misstatement
• Identify the risks and how they are mitigated
• Review the effectiveness of the controls
• Independent corroborative evidence
• Recomputation
• Recomputation is complex for insurers
• Improve controls to minimize recomputation

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Implications Property Casualty Insurers

• Requirement for documentation of internal
  controls and data validation procedures
• Requirement for more communication with AA
• Expect closer relationship with AA
• The audit actuary must test (not do over) the
  AAs calculations
• Extent of recalculation depends on
• Nature of policy liabilities
• Internal control processes
• Difference of opinion regarding within a
  reasonable range
• Timing of AA work and audit actuarial specialist

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Controls General

• Traditionally more reliance on back-end
• Increasingly difficult due to tighter timelines
• Simple trending not enough with complex products
• More controls on the front-end
• Quality control rather than correction
• Limited resources can focus more on analysis
• Three critical stages to valuation process
• Collection of data
• Complex valuation models and calculation systems
• Other adjustments

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Controls Data I

• Issues beyond usual IT controls
• Quality of data filters handling of rejected
  data
• Interfaces all data transfer points
• Data from third parties or specialty admin
  systems
• Legacy systems and multiple admin platforms
• Admin may improvise for shortcomings in systems
• Handling of new products
• Critical information in comment sections

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Controls Data II

• Actuaries need to capture all policy attributes
  that materially affect valuation
• Is the right information being extracted for
  valuation?
• Sufficient differentiation for complex products
• UL min vs max funding
• Lapse experience dependent on premium features
• Review use of averages and approximations
• AuG-43 forces actuaries to review these issues
  and document controls

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Controls Valuation Models

• Complex models to value complex products
• Commercial software vs home-grown models
• Similar control issues
• Different approaches to testing
• Set-up of valuation assumptions
• Check consistency between assumptions and studies
• Consider uncertainty in future events
• Reasonableness in the range

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Controls Reasonability

• Complex models combined with complex products
• How do actuaries get comfort with result?
• Critical back-end checks and analysis
• Trending reserve / 1000 face amount
• Reserve roll-forward or reserve continuity
• Variance to plan / budget
• Strain at issue compared to pricing expectations
• Earnings by source
• Techniques for analyzing results have evolved but
  documentation may not have

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Controls Adjustments Outside the Model

• Adjustments occur throughout the process
• Several types of adjustments (post model)
• Handling of financial statement presentation
• Inclusion of liabilities not modeled
• Known model deficiencies
• Significant challenge due to fewer controls
• Late adjustments
• Use of spreadsheets

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Controls Spreadsheets

• Steps to ensure appropriateness of adjustments
• Itemize and track changes in adjustments
• Regular review of need and reasonability
• Limit who has ability to approve
• Many adjustments rely on spreadsheets
• Need same discipline as model
• Limit authority
• Version control
• Establish naming conventions
• Perform independent checks
• Document in addition to comments

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Recomputation

• Significant effort in case of most life insurance
  products
• Commercial software vs home-grown models
• Companies to perform and document self- testing
• Better controls are demonstrated then need for
  recomputation reduced
• Always some requirement for testing

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Conclusion

• Audit is more robust with improved quality of
  financial statements
• Greater consistency with other jurisdictions
• Forcing actuaries to document is not the point
• Reduce need for recomputation
• Hopefully identify control gaps and fix
• Improve processes before a problem occurs

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Presenters Contact Details

• Jacqueline Friedland, FCAS, FCIA, MAAA
• KPMG LLP
• (416) 777- 8320
• jfriedland_at_kpmg.ca
• Neville S. Henderson, FSA, FCIA, MAAA
• PricewaterhouseCoopers LLP
• [phone]
• neville.s.henderson_at_ca.pwc.com