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  1. Duties of the actuary
    • make an annual investigation of the insurer’s recent and current financial position as revealed by DCAT for various scenarios
    • make a report of each investigation in writing to the insurer’s BoD with possible actions
    • make an interim investigation if there is a material adverse change in circumstances
  2. Key elements of DCAT
    • development of a base scenario
    • analysis of the impact of adverse scenarios
    • identification and analysis of the effectiveness of various strategies to mitigate risks
    • report on the results of the analysis and recommendations to the insurer’s mgt and BoD
    • opinion signed by the actuary on the financial condition of the insurer
  3. Typical approach
    • review of operations for the recent years (3) and financial position at the end of each year
    • development and modelling of base scenario for the forecast period consistent with the insurer’s business plan
    • assessment of the risk categories and identification of those that are relevant to the insurer’s circumstances, using sensitivity testing
    • selection of plausible adverse scenarios that are likely to significantly impact surplus, including modelling of ripple effects and stress testing (how far risk factor has to change)
    • selection of at least 3 scenarios showing the greatest surplus sensitivity
    • identification of possible management actions and the impact of these on the insurer’s financial condition for each scenario
    • identification of possible regulatory actions for each scenario that causes the insurer to fall below the minimum regulatory capital level
  4. Base scenario
    • realistic set of assumptions used to forecast the insurer’s financial position
    • consistent with the insurer’s business plan
  5. Plausible adverse scenarios
    • scenario of adverse, but plausible, assumptions about matters to which the insurer’s financial condition is sensitive
    • varies among insurers and over time for a particular insurer
    • scenario testing may be required to determine sensitivity to each risk
    • don’t assume additional capital, unless adverse factors are in mgt’s control (e.g. high sales)
  6. Ripple effects
    • event or incident that occurs when an adverse scenario triggers a change in one or more interdependent assumptions or risk factors
    • includes adjustments to assumptions, likelihood of changes in planned capital injections, or expected response insurer / policyholders / regulators / rating agency
  7. Integrated scenarios
    • type of adverse scenario that results when two or more adverse scenarios are combined
    • resulting integrated scenario would be realistic and plausible (95th or 99th percentile)
  8. Stochastic vs deterministic approach
    • stochastic: risk are modelled where loss distribution can be inferred
    • deterministic: adverse scenarios are selected judgementally by actuary
    • combination: model risk and use results to derive deterministic scenario
  9. Satisfactory financial condition
    • insurer is able to meet all its future obligations under base and adverse scenarios
    • insurer meets minimum regulatory capital requirement under base scenario
    • if not met, report with and without capital enhancements and assumed mgt actions
  10. Sections of the DCAT report
    • executive summary: results, risks, commentary on previous recommendations
    • DCAT opinion: signed opinion on future financial condition
    • introduction: role of AA, purpose and scope of DCAT, overview of process / methods
    • capital adequacy measurement: minimum, satisfactory, threat definition, materiality
    • background discussion: nature of business, financial position, key events, market
    • base scenario: model used, assumptions, consistency with business plan, key results
    • adverse scenarios: risk, assumptions, ripple effects, previous year’s comparison, actions
    • conclusions and recommendations: summary of results, highlights of risks
    • appendices: detailed financial results like balance sheet, income statement
  11. Risks associated with derivative instruments
    • market risk: liquidity (cancel when desired or at favourable price) + basis risk (price behaviour not acting as expected, undoing intended hedging benefits)
    • default / credit risk: loss incurred due to default in making full payment when due
    • management risk: inadequate mgt supervision and understanding, systems, controls…
    • legal risk: derivative agreement is not binding as intended
  12. Injection of capital for DCAT in MCT
    • DCAT: ok if satisfied it's the intent of entity making it, and that actuary has no reason to believe that such injections are not within the means of that entity
    • MCT: no, unless adverse factor is more under management control, such as higher sales
  13. Risks - Claims frequency and severity
    • single catastrophic event: natural disasters
    • single large claim: full PML
    • social inflation: inflation resulting from change in likelihood of claimants bringing suits
  14. Risks - Policy liabilities
    • selection of inadequate loss development factors: new product
    • class actions and other mass torts: effective retroactively
    • change in mix of business: shift to longer tailed LOBs
  15. Risks - Inflation
    • significant, rapid and sustained increase in general rate of inflation
    • significant temporary increase in the cost of labour and materials following cat
    • severe recession in the economy
  16. Risks - Premium (lower volume)
    • entry of a new and strong competitor / increased competitiveness
    • loss of a key distributor, or even an entire distribution channel
    • inability to implement planned premium rate increase
  17. Risks - Premium (higher volume)
    • withdrawal or failure of major competitors from a market
    • unexpected new business from a large client
    • premium rates set to low compared to competition
  18. Risks - Reinsurance
    • reinsurer insolvency: (non-)affiliated, rating, (non-)registered, concentration or reinsurance
    • increase in reinsurance rates or reduction in reinsurance commission
    • disputes over policy conditions
  19. Risks - Investment
    • significant change in yield curve
    • increase in the default rate on debt securities
    • decrease in return and/or value of equities/real estate/subsidiary
  20. Risks - Government and political
    • rate freeze or rollback of rates on LOBs in which rates are subject to regulatory approval
    • nationalization or privatization of a LOB in a jurisdiction
    • change to legislation that creates or restricts distribution channels
  21. Risks - Off-balance sheet
    • structured settlement: exposed to credit risk
    • contingent liabilities or losses: tax, litigation
    • letters of credit and pledged assets: default risk
  22. Risks - Related company
    • reduction in reliance on the parent company for financial support
    • increase in the provision of financial support to the parent
    • high level of dependency on group operational resources
  23. Ripple Effects
    • forced sale or liquidation of assets, rating agency downgrade
    • claim frequency and severity: post-event inflation following catastrophe
    • policy liabilities: increase in ultimate claim costs and claim expenses
    • inflation: rapid and sustained increase in interest rates, increase in operating expenses, reinsurance rates on swing-rated contracts
    • premium, lower volume: increase in fixed expense ratio, shift in portfolio mix
    • premium, higher volume: higher loss ratio on new business due to inadequate pricing, shift in portfolio mix, higher expenses short term (hiring employees, increased overtime)
    • reinsurance: increase in reinsurance rates arising from need to obtain replacement coverage, reduced availability of reinsurance
    • investment / off-balance sheet: significant cash flows affecting liquidity, negative change on derivative positions
    • government: regulatory monitoring, increased reinsurance rates or non-availability
    • related company: mgt focus on group rather than company priorities, regulator action
  24. Management actions
    • review reinsurance coverage, type and/or terms at renewal
    • implement rate changes, when possible
    • review target mix of business by LOB or jurisdiction
    • policy liabilities: review reserving and claim setting guidelines
    • premium, higher volume: review distribution channel, restrict / withdraw from markets
    • reinsurance : change the reinsurance structure, retain a greater proportion of business to decrease reinsurance cost, change reinsurers
    • investment / off-balance: sell or reinvest assets, change investment strategy
Card Set:
2014-04-12 20:49:00
Subsequent / DCAT / Stress Testing
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