MCCSR Review Subcommittee. MCCSR Review Subcommittee. Volatility Risk Individual Products ASSESSMENT TYPES OF RISK

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1 General Meeting Assemblée générale November novembre, 005 Toronto, Ontario Implications of New MCCSR for Group Insurance Session 103 (B. Gordon Challes) MCCSR Review Subcommittee Focus on Life Insurance Mortality Risk Review Current Factor-based Approach Research Alternatives Test Alternatives with Industry Data Make Initial Recommendations Survey Companies for Impacts & Feedback Revise for Feedback (Practical Issues) Prepare Report MCCSR Review Subcommittee OBJECTIVES Assess continued appropriateness of current mortality factors Develop alternatives for consideration by regulators: Theoretical framework Modeling approach Formula simple, depictive Survey Follow up 1

2 MCCSR Review Subcommittee ASSESSMENT Current mortality factors should be updated Mortality improvement Shifts in insured population distribution Evolution of products No recognition of portfolio profile (standard deviation, duration of cash flows) Reinsurance risk reduction not adequately reflected MCCSR Review Subcommittee TYPES OF RISK VOLATILITY CAPITAL CATASTROPHE CAPITAL (Partly) MISESTIMATION POLICY LIAB PERMANENT DETERIORATION POLICY LIAB Volatility Risk Individual Products Modeled using Monte Carlo simulation Initial data from CIA Inter-company Mortality Study Canadian, individual Product assumptions Model portfolios Reinsurance added Focus on guaranteed products

3 Volatility Risk - Group Approximation Modeled using Monte Carlo simulation Data from Statistics Canada Distribution of ages and salaries in working age population Calculated standard deviations under a number of scenarios Found close relationship between std. dev. and projected claims over 1 months and the number of lives Volatility Risk - Findings Results are sensitive to: Claims distribution (policy size, age) Size of block Lapse assumption (individual policies) Some blocks may end up with higher requirements than current factors, others less Volatility Risk - Findings Reinsurance can alter the claims distribution and have a dramatic effect As per current rules, accidental deaths should attract lower factors 3

4 Formula Development Key Drivers deviation of net claims Duration of net claims Expected claims NAAR Reduction for adjustable products Fit improved overall with a multiplicative element (.5) Total Required Capital: RC + Basic Death AD&D RC The formula for Required Capital for each block of business (or set) is : RC =.5 RC =.5 Standard Deviation Component = q(1 q) NetDeathBenefit Group Approximation (insufficient data) ExpectedClaims 39 NumberOfLives 4

5 RC =.5 Duration Factor: 1 max ln( D),1 for sets of adjustable and participating policies that meet the criteria for reduced factors DurFctr = max( ln( D),1) for all other sets of policies D = Macaulay duration of proj. net death claims (at 5%) t t v cfdt D = Projected death claim at time t t v cfd t RC =.5 Duration Factor: Group Approximation: 1 for adjustableand par productsthat meet thecriteriafor reducedfactors, DurFctr and for productshavinga mortality guaranteeduration of yearsor less for allother products RC =.5 Multiplicative Factor (.5) used to improve the fit of the modeled results NAAR Total Net Amount At Risk for the set of policies Total Net Amount for the set of policies 5

6 AD&D Approx. for RC (if data unavailable) 0.3 RC NAAR AD & D NAAR BasicDeath Comparable Basic Death RC is the volatility component for the comparable collection of basic death sets. NAAR-AD&D is the net amount at risk of the set of AD&D products; and NAAR-BasicDeath is the total of the net amounts at risk of the sets of basic death products. Group AD&D Approximation for (if data unavailable for previous approximation) ExpectedClaims StdDev 78 NumberOfLives Individual AD&D approximations limited to immaterial blocks of products Catastrophe Risk US Mortality in 0th Century Mortality per ' Year 1918 Spanish Influenza crude age adj 1940 age adj

7 Catastrophe Risk Size of Spike Recommended 10% be used (CTE95) for non-adjustable products. Table type Crude Age Adj 1940 Age Adj 1990 Worst 9% 4% 13% Average of worst 5 yrs 10.6% 9.1% 6.9% Catastrophe Risk Formula RC = Factor Claims NAAR 0.05 for sets of adjustable and par policies that Factor = meet the criteria for reduced factors 0.1 for all other sets of products Claims is the projected value of the upcoming year s total net death claims NAAR is the total net amount at risk for the policies in the set, and is the total net face amount for the policies in the set AD&D Approximation Catastrophe AD&D (if insufficient data for Claims) 0.15 RC NAAR AD& AD NAAR Death Comparable BasicDeath Sum of collection of sets of comparable basic death products, and RC is the Required Capital for the set. NAAR-AD&D is total net amount at risk of the set of AD&D products whose cat. risk requirement is being estimated; and NAAR-Death is total net amount at risk of the sets of basic death products 7

8 Adjustments for Group Business The subcommittee encouraged the regulators to review the adjustment for hold harmless and similar agreements, especially when the agreement was with a government. The result: The scaling factor to be used is 0.05 if the group policyholder is the Canadian Government or a provincial or territorial government in Canada, and 0.15 for all other policyholders. Adjustments for Group Business The subcommittee made a recommendation relating to the credit given to policyholder deposits such as Claim Fluctuation Reserves, but this was adjusted by the regulators to ensure that credits could not exceed the capital requirements for the group. The new approach may not give full credit in many cases. Other Adjustments There is a special formula to determine the Credit for Reinsurance when the direct premiums are guaranteed but the reinsurance premiums are adjustable. There is now a provision for companies to use models to determine the Credit for Stop Loss Arrangements, replacing the former 40% limit on such credits. 8