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GPV Assumptions Setting And how to pass auditor review

Suwaphand Sangprakai 30 November 2012 STRONG

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Caveat “…CIFRS is based on gross premium valuation (GPV) approach. Although the methods are not exactly same as the RBC, its principles are indifferent…..” “….Methods as presented in this presentation are not expected to be a standard for the industry. Using the different approaches doesn’t mean they are wrong…..” “…The purpose of presentation is for experience sharing.

Methods to set the Best estimate assumptions can be varied, depending on the experience of the insurers…..”

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Agenda

Before setting assumptions Mortality / Annuity Morbidity Discontinuance Expenses Dividend Bulk Reserve Basis Change Auditor’s review

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Before setting assumptions

Read the Actuarial Guidance Note Key information from the Note: Note cannot cover every situation. Actuary must rely on professional standard and aware the risks effect to the company solvency Data quality – it is responsibility of actuary to ensure that the data used in BEA setting are in good quality.

Source of data (in order) Company experience – but may not be credible Industry experience – but may have to be weighted average with the company experience Third party – such as reinsurers, consulting firms, other Bus etc.

Past experience may not be good representative to the future !!!

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Mortality / Annuity

Measured by A/E ratio.

Calculation formula total actual death / total expected death. expected death = expected mortality rate x exposure exposure = proportion of time that the data is in study period

Example :- Male age 35 with 1,000 inforce policies (100k each) at the beginning of the year. No new business and lapse. 2 deaths during the year. exposure = 1,000 x 100,000 = 100m expected death = 0.003 x 100m = 300k A/E ratio = 200k / 300k = 67.7%

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Mortality / Annuity

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Mortality / Annuity Question #2. Can we assume mortality improvement ?

It is cleared that mortality rates in TMO08 are improved from the rates in TMO97.

In addition, TMO97 has lower rate than TMO86.

Is it possible to assume mortality improvement in the BEA ?

For annuity product For life product

“Yes” and it is normally assumed.

Normally “No”.

— It is not allowed due to conservative purpose — If allowed, how much of the improvement rate ?

— May be difficult to proof.

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Mortality / Annuity Question #3. Do we have to set mortality assumption by sub-categories ?

Mortality by duration Smokers vs non-smokers Medical vs Non-medical The more sub-categories, the more complicated model.

Mortality by duration may require if the selection factors are applied

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Morbidity

Using loss ratio to determine UPR and URR. Calculation formula LR = Actual Claim / Earned Premium Earned Premium = exposure x premium received

It is suggested to determine the BEA from the trends of loss ratio or the expected loss ratio.

For conservative purpose: Trend up – adjust the loss ratio up if significant Trend Down – keep the loss ratio unchanged unless significant

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Discontinuance

Discontinuance includes Lapse, surrender, withdrawal, death etc.

Calculation formula Lapse Rate = Number of Lapsed AP in the duration Number of inf AP at the beginning - Death

Example: Inforce AP at the beginning of duration 2 is 100m. At the end of duration 2, lapsed AP is 15m and death is 1m.

Lapse Rate =

15

= 15.2%

99

Compute lapse rates by duration and repeat for several years.

Can be varied by product types / distribution channels / Mode etc.

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Discontinuance Question #1. What is definition of discontinuance ?

Should we count ETI / RPU as discontinuance ?

How do we treat ‘not taken’ policies or cancel free look ?

How do we treat paid-up policies ?

In actuarial term, discontinuance means the policies not inforce.

ETI / RPU should be counted as lapse in a duration but still have a discontinuance rate if it is allowed to be surrender ‘Not taken” or cancel free look should be taken out from the calculation Paid-up policies should be taken out from the lapse calculation in a duration but still have a discontinuance rate if it is allowed to surrender.

Be careful : Lapse definition can be varied by its purpose.

Death is included into the mortality rate 11

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Discontinuance Question #2. Assumption for Lapse Supported Plans (LSP) ?

What is definition of Lapse Supported Plans ?

How do we set its discontinuance rate ?

Original term : LSP means the plans that more lapse will generate higher profit. However, this may not be true for GPV

GPV Term : LSP means the plans that customer behavior will have lower lapse rate than normal plan due to the product features.

In general, product with high guaranteed cash payment after the policy paid-up (earlier) can be viewed as lapse supported plans.

Discontinuance rates for LSP should be lower than normal plans.

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Discontinuance Question #3. Can we take out the outlier ?

If we have experience as below, can we take out the outlier ?

Company Z 1999 2000 2001 2002 2003 2004 2005 2006 2007 Propose

FY Lapse Rate 23.4% 16.7% 24.4% 34.8% 24.5% 20.2% 25.9% 26.2% 23.1% ???

There is no standard of practice to keep it or take it out.

The answer can be “yes” if strong reasons support that it should not

be repeated in the future.

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Expenses

May be the most difficult assumptions Derived from Expense allocation methods Split by Acquisition and Maintenance then allocate to — Per policy expenses — Per premium expenses — Per sum assured expenses

Source of expenses data Latest actual cost Budget for next year Can we take out the one-off items ?

Include premium tax ?

Target expenses / fully allocated expenses Expense over run / under run

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Expenses Allocation method.

Assuming that we want to have expense assumption by channel (agency / Banc) Step 1. Classify work areas into three groups and allocate to each cost centers.

Group 1. work areas that their cost are directly related to an aspect of sales such as Agency, Bancassurance etc No allocation Group 2. work areas that back offices to support Group 1. Allocate cost to group 1.

Group 3. work areas that their cost are overhead in nature such as HR, CEO, IT support etc are overhead allocate to other cost centers

Step 2. Allocate each cost center to Agency / Banc then split them into Acquisition and Maintenance

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Expenses Allocation method.

Step 3. Determine the allocated cost whether it is fixed, step variable or variable.

Step 4. For step variable, see whether it should be determined as per policy or per premium according to the nature of work areas.

Type of Expenses Fixed – a non discretionary and not related to NB or INF Step Variable – Short term discretionary but long-term non-discretionary Variable – directly related to NB or INF

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Expenses

Per Policy Agency

Cost Center Group 1.

Cost Center Group 3.

Agency Allocated Exp. Group 1.

Cost Center Group 2.

Exp by Acq / Maintenance

Per Prem Agency Fixed Exp. Step Variable Exp. Variable Exp.

Allocated Exp. Group 2.

Cost Center Group 2.

Per Policy Bancassurance Bancassurance Per Prem Bancassurance

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Expenses Question #1. Using Target Expense or Fully Allocated Expenses

What is definition of Target Expenses ?

How do we set Target Expenses assumptions ?

Target expense means the expenses level that a company can meet “economy of scale”.

Non-scale companies can use Target expense for valuation but will have an expense overrun.

To get target expense assumptions : cost, sales and inforce block must be projected to the future.

Do expense allocation but using the numbers as at the “scale” date.

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Expenses Question #1. Using Target Expense or Fully Allocated Expenses Industry expenses ratio (roughly) :

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Expenses Question #2. Expense Over run / Under run

What is expense over run or under run ?

How do we know we have over run or under run ?

What should we do if over run or under run ?

Normally, using the target expense will create expense over run.

Checked by Per policy acq * number of new business policies Per prem acq * number of new business premium Per policy maintenance * number of average inforce policy Per prem maintenance * number of average inforce premium Sum of the above must be equal or closed 20

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Expenses Question #2. Expense Over run / Under run

If we have expense over run, the guidance note has stated clearly that the GPV must be adjusted for the discounted value of the over run.

This is called “Expense Deficiency Reserve (EDR)�.

If we have expense under run, See whether it is under run in short term or long term.

Short Term under run Keep the assumptions unchanged Long term under run revise the expense assumption down

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Dividend

In principle, dividend rate as used in the valuation should be what the Company expect to pay in the future.

Dividend based on projected long term investment rate Dividend as illustrated to the customer Dividend as per past experience Dividend as per valuation interest rate Dividend as per asset share

Dividend is non-guaranteed benefit. RBC allows to value on additional yield up to 6%.

The discounted rate for dividend can be set by: If fixed income assets are higher than reserve for guaranteed benefits, it is implied that the dividend is funded by equity market Using past experience return of the equity portfolio to derive the discounted rate

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Bulk Reserve

Additional reserve at the portfolio level may be required.

Expense Deficiency Reserve (EDR) may be set up for expense overrun.

Data Integrity Reserve (DIR) may be set up for data quality issues.

Bulk reserve can be a percentage of the GPV reserve. However, it should not be too high for financial reporting purpose.

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Basis Change

GPV is principle base approach. Assumptions can be changed any time.

Change in assumption can be performed if the Actuary believe that the current assumptions are not good representative for the future. This can be caused by: New information exist and change what we assumed in the current assumptions Business will be changed.

Error correction

It is a professional conduct that we change the assumption because of the updated information, not for financial reporting purpose.

In Manulife, assumptions must be reviewed (and changed) once a year with a good reason for change.

Note that change in the assumption will result to GPV change, hence impact to profit/loss immediately.

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Auditor’s review From experience, the followings are what Auditors want to see:-

Firstly, they strict to the regulation……RBC rules and guidance note are important.

Clear papers how the assumptions are derived and approved.

Valuation control process are in place: Inclusion control – to ensure that the data feed into the model are accurate and complete Movement analysis – to explain how the reserve change Segregation of duty – to avoid any human error Reserve spot checking – to avoid the model risk Change in the model, methodology and key personnel Experience vs assumption – to see whether the assumptions are updated

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Auditor’s review

Avoid judgment as much as you can. All assumptions should be backed by good reasons / statistic / information.

Materiality Standard may be required Deal with the auditor before year-end. Interim audit is suggested so that the problem can be solved on time.

Note that 2011 is the first year of RBC……

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Caveat “…CIFRS is based on gross premium valuation (GPV) approach. Although the methods are not exactly same as the RBC, its principles are indifferent…..” “….Methods as presented in this presentation are not expected to be a standard for the industry. Using the different approaches doesn’t mean they are wrong…..” “…The purpose of presentation is for experience sharing.

Best estimate assumptions setting can be varied, depending on the experience of the insurers…..”

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Thank you

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