canadian institute of actuaries pd-2
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Canadian Institute of Actuaries PD-2. L’Institut canadien des actuaires TR-2. Sources of Earnings - Group. October 2007 - committee formed to develop Group-specific Sources of Earnings (SOE) guidance. Chair is Tom Strickland Committee representation : 9 Group insurance - PowerPoint PPT PresentationTRANSCRIPT
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Canadian Institute
of Actuaries
PD-2
Canadian Institute
of Actuaries
PD-2
L’Institut canadien desactuaires TR-2
L’Institut canadien desactuaires TR-2
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08Sources of Earnings - Group
• October 2007 - committee formed to develop Group-specific Sources of Earnings (SOE) guidance.
• Chair is Tom Strickland• 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
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08Why is Group SOE 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 SOE 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)
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08Implications of Group Valuation for SOE
• 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)
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Characteristics of Group BusinessShort 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
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Characteristics of Group BusinessUnderwriting/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
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08Definition 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
• The first policy period is typically 15 months, but could be longer (especially for Life and LTD)
• Committee strongly recommends analyzing first policy period results vs renewal period results separately
• Where to classify first policy period results in SOE?
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08Definition of New Business
• Option 1: expected earnings (until the first repricing opportunity) in first policy period classified as New Business Gain
– Advantage: Aligns well with the way the business is underwritten and managed (separate initial and renewal underwriting processes)
– Disadvantage: Inconsistent with definition of NBG used in life and wealth businesses
• Option 2: Group New Business gain is impact at time zero only
– For most group benefits, no initial reserve is established hence NBG will be $0
– If option 2 adopted Committee recommends that expected earnings and experience gains be split into first policy period and renewal year components
• Feedback would be appreciated!
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08Types 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 retention accounting vs actual– Interest credits on policy reserves/deposits vs actual
– Reinsurance ceded - recommend gross SOE with fairly simple reinsurance adjustments
– Reinsurance assumed - depends on data available
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08Preliminary 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
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08Treatment 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
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08Profit & Loss Statement Year 1 Year 2 Year 3 Year 4 Year 5 Gross Premium 1,000,000 0 0 0 0
Investment Income 24,000 44,000 32,000 26,000 22,000
Disability Benefits -53,000 -170,000 -121,000 -84,000 -68,000 Change in actuarial reserve -1,009,000 265,000 152,000 102,000 64,000 Commissions -134,000 0 0 0 0 Gross premium tax -20,000 0 0 0 0 Operating Expenses -34,000 -4,000 -3,000 -2,000 -1,000
Premium Less Expenses -226,000 135,000 60,000 42,000 17,000Reserve Net reserve - padded 1,009,000 744,000 592,000 490,000 426,000
- unpadded 780,000 627,000 529,000 466,000 416,000Profit Rate Profit as a % of premiums -22.6% 13.5% 6.0% 4.2% 1.7% Cumulative profit % -22.6% -9.1% -3.1% 1.1% 2.8%Inforce & Movements Incidence (per 1000) 5.30 0 0 0 0 Termination % 21% 66% 46% 41% 11%
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08% Premium Earnings by Policy Year% Premium Earnings by Policy Year
1 2 3 4 5
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%
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08Typical Group SOE Report
• + Expected profit on inforce operations• + new business gain (loss)• + Experience gains• + Changes in assumptions and other
changes• = Earnings on operations
Option 2, NBG measured at t=0, assumed
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08Expected Profit on Inforce Operations
• Profit margin on first policy period business premiums (including expected release of PfAD)
• + Profit margin on renewal business premiums (including expected release of PfAD)
• + Expected gain on interest• + Expected gain on commission, expenses, and
premium taxes• + Expected gain on fee income
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08Develop Margin Gains (Beginning of Year)
• Identify expected % gain for various sources of earnings:– Potential source for assumptions below: prior pricing, Business
Plan, last year’s SOE– 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
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08Calculate Expected Profits (Quarterly Reporting)
• From net risk and profit margin = actual premium received * (net risk and profit as % premium)
• Split between first policy period 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)• First policy period expected profits are just net risk and profit
margin – remainder are inforce (renewal) items for simplicity • Seasonality in claims experience could be reflected in
expected earnings
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08Comparison to Plan
• SOE 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 SOE process
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08Experience Gains & Losses
• + Claims experience gain: renewal business• + Claims experience gain: first policy period• + Investment income experience gain• + Expense experience gain• + Commissions experience gain• + Premium taxes experience gain• + Fee income experience gain
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08Experience Gains and LossesClaim Experience Gain
• Usually the biggest source of experience gain• Split between first policy period 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
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• 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
Experience Gains and LossesClaim Experience Gain
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08Experience Gains and LossesInvestment 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
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08Experience Gains and LossesExpense 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
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08Experience Gains and LossesOther Expenses Experience Gain
• Commissions experience gain• Premium taxes experience gain• Fee income experience gain• Calculated using same principles as
expense gain, except no reserves
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08Other items
• Other SOE items can generally be treated same way as for regular life SOE
• Of particular interest are:– Changes in assumptions– Other changes and management actions
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08Feedback
• Questions or comments?
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Short Form MeaningIS
P1 + R Total
EBS items that offset to zero are noted in the "Offset I tems" column IE Offset item 1 in Expected Profits and Offset item 1 in Experience Gains (actual net profit loads) net to zero in EBS
Income StatementExpected Profits Policy Offset Experience Gains Policy Offset
Period I tems Period I tems
IS premium Actual net profit loads P1 + R 1 None
= Actual premium times net profit margin
IS investment income Expected gain on interest Total 2 IS investment income Total= Mean liabilities times (expected investment income %
minus required interest %)Minus actual required interest on claim and expense
liabilities Total 7Minus expected gain on interest Total 2
IS fee income Expected gain on fee income Total 3 IS fee income Total
= Actual fee income times expected % gain on fee income Minus IS allocated expenses (ASO groups) TotalMinus expected gain on fee income Total 3
Minus IS claims IS Premium P1 + RMinus IS change in claim
reserves Minus IS claims including change in claim reserves P1 + RPlus actual required interest on claim liabilities P1 + R 7
Minus actual commission loads P1 + R 8Minus actual premium tax loads P1 + R 9
Minus actual expense loads (non-ASO groups) P1 + R 10Minus actual net profit loads P1 + R 1
Minus IS commissions Expected gain on commission Total 4 Actual commission loads Total 8
= Actual premium times commission margin as % premium times expected % gain on commission margin Minus IS commissions Total
Minus expected gain on commissions Total 4
Minus IS expenses Expected gain on expenses Total 5 Actual expense loads (non-ASO groups) Total 10Minus IS change in expense reserves
= Actual premium times expense margin as % premium times expected % gain on expense margin
Minus IS allocated expenses (non-ASO groups) including change in expense reserves Total
Minus expected gain on expenses Total 5Plus actual required interest on expense liabilities Total 7
Minus IS premium tax Expected gain on premium tax Total 6 Actual premium tax loads Total 9= Actual premium times premium tax margin as % premium
times expected % gain on premium tax margin Minus IS premium tax TotalMinus expected gain on premium tax Total 6
Earnings By Source
Comparison of I ncome Statement Presentation to Earnings By Source Presentation
From the Income StatementSplit between first policy period (new bus) and renewal(s)
Not split by policy period