cia annual meeting

CIA Annual MeetingCIA Annual Meeting

LOOKING BACK…focused on the futureLOOKING BACK…focused on the future

CIA Annual MeetingCIA Annual MeetingSession 5609 – Sources of EarningsSession 5609 – Sources of Earnings

Speaker: Trevor Howes

GGY

Speaker: Trevor Howes

GGY


• My perspective…• A software vendor with many Canadian

clients• System used for Individual life, disability,

critical illness, LTC and annuity products, Group life and disability claim reserves

• Commenced development of “Earnings by Source” features over 7 years ago

Sources of EarningsSources of Earnings

Sources of EarningsSources of Earnings• What was SOE experience in 2004?• Top-down vs. bottom-up approach• Challenges and questions in implementing

a bottom-up approach to SOE

• What was the experience with required SOE disclosures for 2004 …

• Quality of result?• Approach to development? • Cost of delivery?• Anticipated benefits realized?


• High level issues:• Aggregation and coordination• Approach to analysis for “non-traditional”

lines • Top-down vs. bottom-up approach for

“traditional” PPM reserve lines


• Top-down approach• Establish general formula for analysis of

aggregate earnings by distributing the change in PPM reserve

• Calculate or estimate each component at line of business or block level

• Allocate residual balancing amounts


• Bottom up approach• Each seriatim policy in force in year

theoretically contributes to total actual reserve movement and to actual profit components

• Software builds total change in PPM reserve and resulting earnings for modeled business with no residual unexplained value


• Characteristics of a “good” Sources of Earnings analysis process:

• Easy for users to understand• Can be produced in timely manner• Well documented and validated• Consistently applied from period to period

….


• Characteristics of a “good” Sources of Earnings analysis process:

• Technically robust; consistent explanations of earnings from period to period

• Include all material components of earnings• Identifies the fundamental drivers of earnings


Management use of a good SOE:1. High level reports of overall trends by

line of business and major assumption.

2. Drill down to major blocks for contributions to each gain or loss

3. Experience analysis studies to support revised reserve assumptions


CIA recommended SOE report:

Expected Profit on Inforce XXX

Impact of New Business XXX

Experience Gains and Losses XXX

Changes in Assumptions XXX

Other Changes XXX

Pre-tax Operating Earnings XXX

Earnings on Surplus XXX

Net Income before Tax XXX

Taxes XXX

Operating Earnings XXX


• Advantages of bottom up approach:• Technically robust• Components add up with no approximations• Consistency from period to period• Enables timely production• Assures validity vs. reported reserves

(provided process uses same software or consistency is regularly verified)


• Advantages of bottom up approach• Contributions to earnings available at any

level below reported lines of business• Meaningful experience gains available by

assumption• Seriatim expected and actual movements

available for experience studies


• Software issues of bottom-up approach• Applying the traditional source of earnings

formula to real business• Handle all business lines and all assumptions • Reconcile actual movements of business• Include new business• Cope with reporting delays


• Other challenges of bottom-up approach• Acquiring timely, valid and useable

transaction data consistent with ledger data to feed movement analysis

• Maintaining cost benefit balance in modelling actual business movements

• Applying bottom up approach consistently across business units


• Reconciling actual business movements• Actual vs. actuarial movements

(e.g. reinstatements, NTU, RPU &ETI,policy changes)

• Processing delays within period or over reporting dates

• Fund transactions for fund-based products


• Handling new business• Including early terminations in model• Time zero reserve impact (with/without

PFADs element) vs. experience gains• Reflecting processing delays • Actual issue costs vs. expected• Adjusting investment income


• SOE analysis based on traditional reserve accumulation formula:

V[0] + VP + II – E – q*DB = V[0]+1*(1–q)


• After rearrangement, each profit component in traditional approach is:

Gain = expected benefit cost less actual benefit cost

plus actual release of PFAD

where,cost = benefit cashflowless reserve released from decrements


• For traditional (guaranteed cost) products, profit is mainly experience vs. reserve assumptions

• The primary benefits of SOE analysis are

• validating reserve methodology and assumptions,

• identifying assumptions needing review


• SOE for fund-based products• reserves are more complex • movements are less predictable• profit is driven by spreads achieved• more sensitive to management action• reserve is largely driven by the size of the

policyholder fund• inconsistent with traditional products and

requires a different approach to SOE


• For Universal Life• PPM reserve can be restated as:

Reserve = Fund less PV of future spreads

• Changes in Fund portion may or may not impact profit


• SOE for Universal LifeGain = actual spread gain less expected spread gain plus actual release of PFADs

where,spread gain = charges deducted

less cost of related benefits(i.e. benefits paid net of fund released

less PV of future spreads released)


Challenges of SOE for UL • Reconciliation of actual fund and

reserve movement • “Revaluation” at period end • Compromise vs. exact replication of

fund movement in model• PV of spreads with level COI


• SOE for Disability Income is like traditional life, except for morbidity

• Separate incidence from termination gains• Actual incidence cost based on PV of claim

on DLR basis at date of claim • Termination experience on opening and new

claims reflected in claim payment gain• Recovery to active status with new ALR


• Disability income requires special movement transactions:

• incidence by 2 causes• claim terminations by death, recovery, or

settlement• claim adjustments, suspensions, re-opens?


• A bottom-up approach to SOE• enables the full benefit of the analysis• is complex and costly to implement• may pose questions of consistency across

lines of business, or between companies• involves both theoretical and practical issues

not answered in existing guidance• SOE will evolve over next few years


CIA Annual MeetingCIA Annual Meeting


cia annual meeting

Documents

sources of earningssources

sources of earningswhat

sources of earningsspeaker

sources of earningsbottom

sources of earningstop

sources of earningsadvantages

soecia annual meetingsession

analysis of aggregate