Roles and Responsibilities of External Auditors and Actuaries Insurance Industry Workshop 1 2 Novemb

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Roles and Responsibilities of External Auditors
andActuaries Insurance Industry Workshop 1
2 November 2005 Bangkok, Thailand
Kim Norris Managing Director International
Advisory Group www.osfi-bsif.gc.ca
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Discussion Points

• External Auditors
• Roles and responsibilities of the Actuary
• Roles and responsibilities of an actuary
• Reporting
• Dynamic Capital Adequacy Testing (DCAT)
• Professional Standards and OSFIs role

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External Auditors

• An independent audit opinion (required by
  legislation) provides credibility to financial
  statements
• External auditors are subject to standards with
  respect to qualifications, work and behaviour
• Professional standards
• Peer review
• Statutory requirements
• Public Oversight Board

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External Auditors

• Auditors opinion unqualified or reserved
• reservation or qualification may be important
  from a supervisory perspective
• need to understand the reasons for the
  qualification
• does not necessarily provide assurance on the
  future viability of the institution or the
  effectiveness of management

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External Auditors

• OSFI reviews External Auditors work to
• Help assess the institution
• enhance supervisors knowledge of the institution
• identify any prudential concerns raised and hence
  target areas for in-depth reviews

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Appointed/Consulting Actuaries

• Roles and responsibilities of an actuary
• Reporting
• Dynamic Capital Adequacy Testing (DCAT)
• Professional Standards and OSFIs role
• Most jurisdictions now require that a qualified
• actuary attest to the adequacy and
  appropriateness of the insurers loss reserve

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Appointed/Consulting Actuaries

• Roles and responsibilities of an actuary
• OSFIs expectation for the Appointed Actuary
• To produce sound, consistent (so that two
  actuaries considering the same fact situation
  arrive at results that are not materially
  different), and appropriate work, monitored by
  the CIA
• The responsibilities of the actuary are spelled
  out in legislation

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Appointed/Consulting Actuaries

• Roles and responsibilities of an actuary
• The actuary will value
• 1) the actuarial and other policy liabilities of
  the company as at the end of a financial year
  and
•  2) any other matter specified by OSFI (e.g. as
  per the AA Memo)
• The actuary's valuation shall be in accordance
  with generally accepted actuarial principles
  unless otherwise specified by OSFI.

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Appointed/Consulting Actuaries

• Roles and responsibilities of an actuary
• DCAT provision The actuary will meet with the
  directors/audit committee at least once during
  each financial year in order to report, in
  accordance with GAAP and under any other
  specifications by OSFI, on the financial position
  of the company and its expected future financial
  condition.
• Whistle blowing provision If the actuary comes
  across any matters that have a material adverse
  effect on the financial condition of the company
  and require rectification, the actuary will
  report in writing the CEO, CFO and directors. If
  suitable action is not being taken to rectify the
  matters, the actuary will send a copy of the
  report to OSFI.

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Appointed/Consulting Actuaries

• Roles and responsibilities of an actuary
• Report on the policy liabilities in Annual Return
• Report to the shareholders and policyholders not
  less than 21 days before the companys annual
  meeting
• State whether the annual statement fairly states
  the valuation results
• Meet with and report to the directors or the
  chief agent on the companys future financial
  position (DCAT report)

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Appointed/Consulting Actuaries

• Appointed/Consulting Actuarys Report
• Detailed actuarial report submitted to
  regulator
• Contains the opinion of the actuary concerning
  the fairness and adequacy of the figures for
  policy liabilities included in the insurers
  annual statements
• Contains detailed commentary and exhibits of data
  and calculations supporting the opinion
• Filed within 60 days of companys year-end 105
  days for reinsurers

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Appointed/Consulting Actuaries

• Appointed/Consulting Actuarys Report
• Purpose
• To give OSFI a comprehensive report documenting
  the work done by the AA to calculate the policy
  liabilities. OSFI does not release the Report.
  However, companies may release the Report for
  special purposes e.g. to rating agencies or to
  investment bankers

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Appointed/Consulting Actuaries

• Contents of the Appointed/Consulting
• Actuarys Report
• Introduction and Scope
• Company, date, author
• Description of company operations
• Description of the type of data provided and the
  review and verification procedures
• Description of the procedures and/or methodology
  to transform data
• Description of the procedures to ensure the data
  is sufficient, reliable and accurate
• Disclosure of AAs compensation and bonus
  structure

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Appointed/Consulting Actuaries

• Appointed/Consulting Actuarys Report
• Expression of opinion
• includes the liability figures (both claim and
  premium liabilities) of the AA and that booked by
  the company
• includes a statement regarding the data
  reliability, sufficiency and consistency
• may be a qualified opinion

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Appointed/Consulting Actuaries

• Appointed/Consulting Actuarys Report
• Comparison of actual experience with expected
  experience in the previous year-end valuation
• a comparison is provided for 5 years (general
  insurers)
• A comparison for insurance policy and contract
  liabilities for 3 years (life insurers)

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Appointed/Consulting Actuaries

• Appointed/Consulting Actuarys Report
• General Insurers
• Commentary
• description of case reserving process
• any significant changes in assumptions or
  techniques from the previous valuation report
• the principal characteristics of each line of
  business
• changes in the companys marketing strategy, mix
  of business, level of retention, reinsurance,
  methods of recording data

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Appointed/Consulting Actuaries

• Appointed/Consulting Actuarys Report
• General Insurers
• Commentary (contd)
• expected ultimate claims and claim ratios for
  each accident year
• impact of industry pools
• impact of inter-company pooling agreements
• treatment of mass tort and environmental
  liabilities
• provision for adverse deviation (PfAD)

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Appointed/Consulting Actuaries

• Appointed/Consulting Actuarys Report
• General Insurers
• Database and exhibits
• exhibits should be provided for each line of
  business on a gross and net basis
• cumulative paid loss data by (accident year)
• case reserve by (accident year)
• reported claim counts by (accident year)
• open claim counts by (accident year)
• any other derived exhibits

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Appointed/Consulting Actuaries

• Appointed/Consulting Actuarys Report
• General Insurers
• Other
• the extent to which the Actuary uses the work of
  the Auditor must be discussed in the Report
• any reliance on or use of the work of another
  Actuary should be indicated
• reinsurance amounts recoverable must be stated
• any known problems in the collection of
  reinsurance should be specified

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Appointed/Consulting Actuaries

• Appointed/Consulting Actuarys Report General
• Insurers
• Review of claims liability data
• Operational changes and external influences
• changes in underwriting practice
• changes in claims handling including case
  estimate practice
• changes in data processing
• changes in accounting
• changes in judicial, regulatory and legislative
  environment
• economic variables such as inflation

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Appointed/Consulting Actuaries

• Appointed/Consulting Actuarys Report
• General Insurers
• Review of claims liability data
• Homogeneity and credibility of the data
• data is usually divided into lines of business to
  increase homogeneity
• the data set should be large enough to be
  credible otherwise the actuary may use industry
  data to make selections
• Reinsurance limits
• Collateral sources e.g. salvage, subrogation,
  loss transfer

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Appointed/Consulting Actuaries

• Appointed/Consulting Actuarys Report
• General Insurers
• Review of claims liability data
• Different valuation methods
• most often, the actuary will calculate at least
  two or more methods, compare them and then select
  valuation results from one or a combination of
  methods

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Appointed/Consulting Actuaries

• Appointed/Consulting Actuarys Report
• General Insurers
• Review of premium liability data
• The claims estimates
• Premium development
• The rate level underlying the unearned premium
• Reinsurance
• Seasonality of losses
• Trend factors

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Appointed/Consulting Actuaries

• Appointed/Consulting Actuarys Report
• Life Insurers
• Asset Liability Management (ALM)
• report on each interest sensitive asset segment
• report on interest sensitivity of the liabilities
  cash flow

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Appointed/Consulting Actuaries

• Appointed/Consulting Actuarys Report
• Life Insurers
• Sources of earnings
• analysis of a companys earnings by source in a
  prescribed format

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Appointed/Consulting Actuaries

• Appointed/Consulting Actuarys Report
• Life Insurers
• Participating policies
• review allocation of investment income and
  expenses
• transfers to shareholders from participating
  account
• divided policy

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Appointed/Consulting Actuaries

• Appointed/Consulting Actuarys Report
• Life Insurers
• Minimum Continuing Capital and Surplus
  Requirement (MCCSR)
• review cases where actuarial judgement is
  required
• e.g. negative reserves excess cash value
• indexlinked policies

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Appointed/Consulting Actuaries

• Dynamic Capital Adequacy Testing (DCAT)
• Definition
• the process of analyzing and projecting the
  trends of a companys capital position under a
  variety of future scenarios, to identify risk and
  threats and to suggest actions to take
• Purpose
• to inform management and the Board of Directors
  about the potential threats to the solvency of
  the company

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Appointed/Consulting Actuaries

• Dynamic Capital Adequacy Testing (DCAT)
• Usefulness
• alerting OSFI as to where there are risks of
  insolvency
• showing the variability of the business plan
• understand the risk profile of the company
• OSFI requires the production of the report but
  according to CIA standards
• The report must be sent OSFI within 30 days of
  presentation to the Board
• Also applies to companies in runoff
• The reports are an important component of a
  companys risk management process

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Appointed/Consulting Actuaries

• Dynamic Capital Adequacy Testing (DCAT)
• Process of DCAT
• review of recent operations
• development of a base scenario
• examination of the risk categories
• stress testing of the risks
• selection of those scenarios requiring further
  analysis
• The base scenario will usually be the companys
  financial plan

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Appointed/Consulting Actuaries

• Dynamic Capital Adequacy Testing (DCAT)
• General Insurers
• 11 risk categories
• Frequency and severity
• Pricing
• Misestimation of policy liabilities
• Inflation
• Interest rate
• Premium volume

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Appointed/Consulting Actuaries

• Dynamic Capital Adequacy Testing (DCAT)
• General Insurers
• 11 risk categories (contd)
• Expense
• Reinsurance
• Deterioration of asset values
• Government and political action
• Off-balance sheet

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Appointed/Consulting Actuaries

• Dynamic Capital Adequacy Testing
• (DCAT) Life Insurers
• 10 risk categories
• Mortality risks
• Morbidity risks
• Persistency risks
• Cash flow mismatch risk (C-3 risk)
• Deterioration of asset values (C-1 risk)

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Appointed/Consulting Actuaries

• Dynamic Capital Adequacy Testing
• (DCAT) Life Insurers
• 10 risk categories (contd)
• New business risks
• Expense risks
• Reinsurance risks
• Government and political action
• Off-balance-sheet risks

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Appointed/Consulting Actuaries

• Dynamic Capital Adequacy Testing
• (DCAT) General Insurers
• 11 risk categories (contd)
• (1) Frequency and severity
• catastrophic loss earthquake, windstorm, flood,
  hail
• multiple catastrophic losses
• multiple large losses
• loss ratio being much higher than usual (about 10
  points)

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Appointed/Consulting Actuaries

• Dynamic Capital Adequacy Testing
• (DCAT) General Insurers
• 11 risk categories (contd)
• (2) Pricing
• rate freeze
• increased competition
• (3) Misestimation of policy liabilities
• reserves being at too low a level
• especially for long-tailed lines there may be
  inflation or court decisions that were not
  factored in originally

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Appointed/Consulting Actuaries

• Dynamic Capital Adequacy Testing
• (DCAT) General Insurers
• 11 risk categories (contd)
• (4) Inflation
• at least 3 percentage points over that in the
  base scenario for five consecutive years
• yield curve shifts up by at least 150 based
  points
• at least half of all future payments will inflate
  at the higher trend factor

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Appointed/Consulting Actuaries

• Dynamic Capital Adequacy Testing
• (DCAT) General Insurers
• 11 risk categories (contd)
• (5) Interest rate
• a parallel shift of 300 bases points in the yield
  curve
• (6) Premium volume
• a reduction of up to 30
• a significant increase in volume

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Appointed/Consulting Actuaries

• Dynamic Capital Adequacy Testing
• (DCAT) General Insurers
• 11 risk categories (contd)
• (7) Expense
• low premium volume but fixed expenses
• technology changes
• severe inflation
• court decisions related to market conduct
• (8) Reinsurance
• reinsurer insolvency
• increase in reinsurance rates
• disputes over policy conditions

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Appointed/Consulting Actuaries

• Dynamic Capital Adequacy Testing
• (DCAT) General Insurers
• 11 risk categories (contd)
• (9) Deterioration of asset values
• increase of 150 bases points
• decline in equities of 25
• 50 decline in real estate
• 75 decline in the largest subsidiary
• (10) Government and political action
• increase in premium tax
• increase in assessments
• entry of new distribution channels
• (11) Off-balance sheet
• defaults on letters of credit

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Appointed/Consulting Actuaries

• Dynamic Capital Adequacy Testing (DCAT)
• Examination of the risk categories
• scenarios that are tested should have a 1 to 5
  probability of occurrence
• Stress testing of the risks
• how far the risk factor has to change in order to
  drive the companys surplus negative
• helps to determine sensitivity to certain risks
  and helps fix the scenarios

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Appointed/Consulting Actuaries

• Dynamic Capital Adequacy Testing
• (DCAT)
• Selection of scenarios requiring further analysis
• at least 3 scenarios must be examined in detail
• ripple effect and management action must be
  included in scenario testing

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Appointed/Consulting Actuaries

• Dynamic Capital Adequacy Testing (DCAT)
• Actuarys opinion
• Financial condition is satisfactory if throughout
  the forecast period, the company meets all its
  future obligations under the base scenario and
  all plausible adverse scenarios and under the
  base scenario, it meets the minimum regulatory
  capital requirement

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Appointed/Consulting Actuaries

• Dynamic Capital Adequacy Testing (DCAT)
• Actuarys report
• Must report any plausible adverse scenarios that
  cause the insurer to fall below the minimum
  regulatory capital requirement
• If the capital is less than the companys target
  level but greater than 100 the actuary must
  comment on the possibility that the regulator
  would exercise its authority to impose
  restrictions which would affect the companys
  ability to successfully execute its business plan

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Appointed/Consulting Actuaries

• Principles to keep in mind
• OSFI relies on the AAs opinion
• Canadian Institute of actuaries (CIA) develops
  appropriate standards
• CIA standard of professional conduct applies
• OSFIs role
• verify that the actuarys work is reliable and in
  compliance
• identify concerns with a companys liabilities
• identify risk and threats
• take action when necessary

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Appointed/Consulting Actuaries

• OSFIs review of DCAT
• compliance with CIA Standards
• format of the report
• appropriateness of adverse scenarios
• recommendations
• follow-up on issues previously raised
• other financial condition, type of business,
  structure of company, effectiveness of management

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Thank You