CIA DCAT

1. AA should investigate at least once a year of insurer's recent and current financial position and financial condition as revealed by DCAT
2. AA should report each investigation in writing to Board, id'ing possible actions for dealing with threats to satisfactory financial condition that investigation reveals.
3. AA should also make an interim investigation on any material adverse changes in insurer’s circumstances.
4. investigation should be current and consider recent events and operating results of insurer
5. investigations should be done frequently enough to support timely corrective actions by mgt and Board

1. Allows AA to inform mgt about implications business plan has on capital and provide guidance on significant risks insurer will be exposed to
2. To help set internal target capital ratios

• Develop base scenario
• Analyze impact of plausible adverse scenarios
• Effectiveness of corrective mgt actions to mitigate risks
• Report results and recommendations to mgt and Board
• Opinion signed by AA incl financial condition of insurer

1. Review operation results for recent years and financial position at end of each year
2. Develop and model base scenario for forecast period (normally consistent with business plan)
3. Select plausible adverse scenarios
   • Model the ones with most significant potential impact on surplus
   • Model ripple effects caused by changes in assumptions triggered by adverse scenarios.
   • Stress-test adverse scenarios, e.g. reverse stress testing
   • Select >=3 scenarios with greatest surplus sensitivity and id possible corrective mgt actions and regulatory actions
4. Report results of analysis

• >= 3 years
• The review would incl:
  • IS and source of earnings
  • Financial position at the end of each year, incl BS and the results od regulatory tests of capital adequacy
  • AA would analyze the trend if any

• Begin at the most recent available fiscal YE BS date. 
• Sufficiently long to capture the effect of a scenario's adversity and the ability of mgt to react. 
• >=3 fiscal years.
• For some adverse scenarios, it may be necessary to use a longer forecast period in order to measure properly the full effect (incl ripple effects) of an adverse scenario on the financial condition

• The size of the company.
• The financial position of the company. more rigorous in examining a base scenario where capital adequacy is closer to regulatory target
• The nature of the regulatory test. e.g., if the regulatory test is measuring required capital, the materiality standard might be expressed as % of the required capital.

• realistic set of assumptions used to forecast financial position over the forecast period.
• financial results flow logically from 1 year to next, and there is continuity from actual results of most recent year
• Normally consistent with business plan.
• If inconsistent, actuary would report any material inconsistency btw the base scenario and the business plan

Due to difference in timing btw business plan and starting BS date for DCAT,

1. Factual changes: events -> changes in assumptions incl ripple effects
2. Subjective changes: differences in opinion -> dif base scenario assumptions from business plan. may still be consistent while recognizing:
   • dif distribution assumptions
   • Recent mgt decisions not anticipated
   • Impact on future experience from recent decisions.

• Business plan / base scenario (If following capital injections are intended):
  1. rapid growth supported by capital injections
  2. intending to raise capital externally to support new initiative
• Adverse scenarios: if 'adverse' factors are under mgt’s control (much higher sales than planned), capital injections beyond base scenario may be appropriate.

• A scenario that is >= 95th percentile (adverse) but <=99th percentile (plausible).
• e.g. 2% chance that unpaid claim would increase by 20% due to CAT

1. For relevant risk categories,
   1. When stochastic models are available, model 95th to 99th percentile of outcomes.
   2. For risks where no stochastic models available, use historical data and consider the variability and credibility of data in selecting plausible adverse scenarios (95th to 99th).
2. Reverse stress testing

• Defn: Determine how far the risk factors would have to change to drive surplus to negative during forecast period, then evaluate if degree of change is plausible.
• Purpose: used to:
  • define plausible adverse scenarios
  • understand correlation between risks and discovering hidden risks
  • assess whether certain risk factors need to be tested, given that they are not likely to deteriorate to the point that become a threat to financial condition

• Defn: an event that occurs when an adverse scenario triggers a change in >=1 interdependent assumptions or risk factors.
• Examples:
  • Adjustments to assumptions in base scenario that are longer appropriate;
  • insurer’s expected response to adversity;
  • p.h. actions;
  • Regulatory actions, when failing below min capital required
  • Rating agency actions, when significant changes in capital or surplus
  • Likelihood of changes in planned capital injections

• Repricing the insurance products,
• Suspending dividend
• Raising additional capital within a reasonable timeframe
• Strengthening risk mgt practices,
• Mitigating the risk causing the capital shortfall

• Adverse scenario that results when >=2 adverse scenarios are combined.
• May combine low-probability scenarios, or high and low.
• May reflect correlated or uncorrelated risk factors but must produce results at 95th to 99th percentile

Financial results would flow logically from one year to the next; continuity from the actual results of the most recent year to the first projected year and subsequent years

• Stochastic: risks that follow stat distributions and percentiles for results readily determined (capital markets)
• Deterministic: adverse scenarios selected judgmentally based on variability in historical results or credibility of data.
• Combination: modelled stochastically and results used to derive deterministic scenario that reproduces desired stochastic results

• Automatically generated by the model
• Manually created by AA by modifying the appropriate assumptions.
• e.g. model is built such that reinsurance rates will automatically increase in the year following CAT; or AA may manually modify the relevant parameters.

• Mgt structure: units and cost structures, which mgt reports, plans and decision-making are centered around
• Product: similar characteristics
• Investment: asset categories.

Communicate to board and sr mgt:

• significant risks insurer is exposed to
• Possible actions that could be taken to reduce or eliminate exposure to those risks.

If throughout forecast period,

• Under all scenarios, capital / equity > 0
• Under base scenario, MCT >= 100%

• Regulatory formula(s);
• For insurers subject to target capital req'ts under multiple jurisds, rationale for using selected formula;
• Target req't used in projections and rationale. can refer to regulator to confirm supervisory target capital req'ts

• Claim Frequency and Severity Risk
• Policy Liabilities Risk
• Inflation Risk
• Premium Risk
• Reinsurance Risk/Counterparty Risk
• Investment Risk
• Government and Political Risk
• Off-Balance-Sheet Risk
• Related Company Risk

financial condition sensitive to increases in claim costs and LAE, and future claims costs and LR can differ significantly from base scenario

• Single CAT
• Single LL
• Multiple CATs
• Multiple LLs
• Other frequency and severity
• Social inflation: inflation from changes in claimants bringing suit, size of awards, or attitudes of claimants towards settlement (affect unpaid and furture NB/RN)

• Reinsurers insolvency
• Increased liabilities from adjustable reinsurance contracts
• Loss of reinsurance coverage
• Increases in reinsurance rates
• Post-CAT inflation
• Post-CAT inflation in regions not directly affected by it;
• Forced sale or liquidation of assets
• increase in PACICC assessment
• rating agency downgrade

• Review reinsurance coverage
• Rate increases;
• Restrict writing in hazard-prone areas;
• Review target MOB
• Review type of products, e.g.write more subscription policies
• Sell or reinvest assets

underestimation may adversely affect financial condition, also concomitant effect on estimates of future claims (LT)

• Class actions
• Change in MOB with shift to LT
• Claims paid faster than assumed, esp LLs
• Actual return on investments lower than base scenario

• Increases in policy liabilities on adjustable reinsurance contracts
• Increases in ultimate claim costs on runoff / future NB & RN
• Forced sale or liquidation of assets
• Rating agency downgrade

• Settle claims faster
• Review reserving and claim settlement practices
• Rate increases
• Review target MOB

inflation affects insurance environment

• significant increase in general inflation (from rapid increase in market interest rates)
• eco recession (from sustained increase in general inflation, unemployment, or market interest rates)
• significant increase in labour and material cost following CAT (dif from freq/sev risk which only affects CAT claims)

• rapid increase in market interest rates;
• Increase in operating expenses;
• Increase in rates on adjustable reinsurance contracts

• Review reinsurance coverage
• Rate increases;
• Review target MOB
• Review type of products
• Sell or reinvest assets

financial condition affected by differences between actual business volume, type, mix and assumed in business plan, from UW and marketing environment, inadequate pricing, vulnerability of insurer given size, marketing plan, and strategies.

• Entry of strong competitor
• Increased competitiveness
• Loss of a key distributor / client;
• Unable to implement rate changes
• Action by influential entity

• increase in LR
• increase in fixed expense ratio
• change in MOB due to lost business
• increase in reinsurance costs as % of premium
• Forced sale or liquidation of assets

• Reduce expenses
• Find other distributors
• Rate changes
• Change target MOB
• Change reinsurance coverage
• UW actions in markets subject to increased competition

• Withdrawal of major competitors
• Rates too low
• Appoint a key distributor;
• Unexpected NB from large client
• Unexpected success in a new market
• action by any influential entity

• higher LR on NB due to inadequate pricing
• change in MOB due to NB
• Higher expenses (from hiring)
• increased PACICC assessment
• Increased $ reinsurance costs.

• Rate changes
• UW actions in unprofitable markets;
• Review distribution channels
• Reinsurance to mitigate capital strain.

1. Reinsurer insolvency:
   • impact reflect an assumed 'recoverable %' of assets to liabilities of failed reinsurer
   • impact may be mitigated by right of offset and deposits or LOC
   • may be reinsurer-specific or industry; need to consider:
     • Rating of reinsurers
     • Registered vs. nonregistered (access to deposits more difficult)
     • Concentration of reinsurance
     • Affiliated versus non-affiliated reinsurers
2. Systemic increase in reinsurance rates due to overall environment
3. Reduction in capacity
4. Disputes over policy conditions

• Increase in reinsurance rates from new reinsurer
• Reduced availability of reinsurance.

• Change reinsurance structure;
• Diversify reinsurers
• Change reinsurers
• Retain more
• Reduce primary policy limit

Changes in eco conditions can impact financial situation (deterioration in asset values), from rapid changes in interest rates, exchange rates, eco growth leading to changes in MV of debt and equity securities, default, match between A & L CFs, creditworthiness of derivative counterparties.

• significant change in yield curve
• increase in default rate on debt securities;
• decrease in returns or value of equities / real estate
• significant change in forex rates;

• Forced sale or liquidation of assets;
• Significant positive or negative CFs impacting liquidity
• Rating agency downgrade;
• Default by counterparty on derivatives;
• Change in discount rate used for discounting policy liabilities.
• liquidity crisis caused by large, sustained default losses

• Sell or reinvest assets;
• Change investment strategy;
• Rate increases
• layoffs

implementation of changes in gov policies or regulations occurs quickly and unforeseen and made retroactive.

• Rate freeze or rollback
• restricting use of certain rating variables
• Nationalization or privatization of a LOB
• increase in taxation rates
• increase in regulatory capital requirements
• gov prescribes levels of insurance coverage

• Deteriorating LRs
• Reduced availability of insurance
• Increased industry pool assessments;
• Increased regulatory monitoring
• Forced sale or liquidation of assets;
• Increased policy liabilities on adjustable reinsurance contracts
• Increased reinsurance rates

• Reducing business volume
• Create separate company
• Review target MOB
• Review reinsurance coverage

• Structured settlement: default risk of annuity company
• LOC: default risk of lending company
• Derivatives: market risk, default risk, mgt risk, and legal risk
• Pension Underfunding

1. Market risk:
   • Liquidity risk: not able to cancel or unwind contract when desired or at a favourable price.
   • Basis risk: derivative’s price behaviour not as expected (undoing hedging benefits)
2. Default risk: default in making full payments when due.
3. Mgt risk: loss on derivatives due to inadequate mgt supervision, systems, controls
4. Legal risk: derivative agreement is not binding as intended.

• Forced sale or liquidation of assets
• Significant positive or negative CFs, affecting liquidity position

• Change pension plan from DB ro DC
• Sell or reinvest assets;
• Change reinsurance strategy;
• layoffs
• Rate increase

adverse scenarios based on org structures.

• Reduced reliance on parent company for financial support
• Increase in financial support to parent
• High level of dependency on group operational resources
• Rating agency downgrade

• Mgt focus on group rather than company priorities, delaying remedial actions
• Need to provide for service disruptions
• Regulator action to protect local p.h.'s.

• Find alternative funding
• Review reinsurance coverage to mitigate capital strain
• Review target MOB;
• Review type of products
• Sell or reinvest assets.