2007 Annual Meeting ● Assemblée annuelle 2007 Vancouver 2007 Annual Meeting ● Assemblée annuelle 2007 Vancouver Canadian Institute of Actuaries Canadian Institute of Actuaries L’Institut canadien des actuaires L’Institut canadien des actuaires

2007 Annual Meeting Assemblée annuelle Annual Meeting Assemblée annuelle 2007 Modelling standards

Risk Assessment Models Will be released as a Research Paper this summer General guidance is applicable to all models, but focused is on risk assessment models Fairly comprehensive list of considerations Not yet a “how to” model primer Expected to evolve as other Working Groups develop methodologies 2007 Annual Meeting Assemblée annuelle Annual Meeting Assemblée annuelle 2007

Contents Model Design Questions to consider early in the model building process Model Implementation Assumptions, IT systems, data and processes Model Validation Validation and calibration Governance Internal models for capital purposes are only appropriate when the risk management practices are adequate Reporting Results must be reported in a manner appropriate for the purpose and the intended stakeholder 2007 Annual Meeting Assemblée annuelle Annual Meeting Assemblée annuelle 2007

Capital Model Considerations Extreme scenarios Measuring tail risk with a valuation model may be like measuring time at the North Pole with a sundial Aggregating stand-alone results Must consider diversification, risk dependencies, risk interactions and risk concentrations Practical implementation of framework Nested stochastic framework requires approximations Need for “pervasive use” Capital models should be actively and regularly used for decision-making 2007 Annual Meeting Assemblée annuelle Annual Meeting Assemblée annuelle 2007

2007 Annual Meeting Assemblée annuelle Annual Meeting Assemblée annuelle 2007 ALM / Market risk working group Early modelling results

Summary An overview of some examples based on potential market risk “Advanced” methods Very simple product – but some complex messages Scope - risks arising as a result of companies’ investment and matching strategies: –Interest rates (risk free) –Equity markets –Real estate values –Foreign exchange rates –Inflation 2007 Annual Meeting Assemblée annuelle Annual Meeting Assemblée annuelle 2007

Potential ‘Advanced’ methodologies One year projection period –Real world terminal value at various CTE levels – Risk neutral terminal value Run-off 2007 Annual Meeting Assemblée annuelle Annual Meeting Assemblée annuelle 2007

Product and investment strategies Simple GIC – 1 benefit cashflow, 5 years from now ALM strategies a)Matched - 5yr zero coupon bond b)Short - 3yr zero coupon bond (On maturity of the bond, a 2yr bond will be purchased.) c)Long - 7yr zero coupon bond. (After 5 years, the bond will be sold to provide the funds needed to make the payment to the policyholder) 2007 Annual Meeting Assemblée annuelle Annual Meeting Assemblée annuelle 2007

2007 Annual Meeting Assemblée annuelle 2007 Summary of cashflows

2007 Annual Meeting Assemblée annuelle 2007 Results * Capital is expressed as (TBSR – Best Estimated Liability) / Best Estimated Liability

2007 Annual Meeting Assemblée annuelle 2007 One year real world (CTE0)

2007 Annual Meeting Assemblée annuelle 2007 One year real world method (CTE50)

2007 Annual Meeting Assemblée annuelle 2007 One year risk neutral method

2007 Annual Meeting Assemblée annuelle 2007 Interest rate distribution

2007 Annual Meeting Assemblée annuelle 2007 Interest rate distribution

2007 Annual Meeting Assemblée annuelle 2007 Run-Off method

Sensitivity tests Results were reproduced for the same product using the same ESG, but with different starting yield curves. Historical dates chosen were: –July 1989 – high interest rates and inverted yield curve –May 1992 – steep upward sloping yield curve 2007 Annual Meeting Assemblée annuelle Annual Meeting Assemblée annuelle 2007

2007 Annual Meeting Assemblée annuelle 2007 Sensitivity tests

2007 Annual Meeting Assemblée annuelle Results

2007 Annual Meeting Assemblée annuelle Results

Conclusions Complex dynamics – even for this simple product and strategies Products and strategies can drastically affect ALM capital – modelled approaches can recognise this Choice of method can have a significant impact on capital - method and framework must be carefully evaluated and defined 2007 Annual Meeting Assemblée annuelle Annual Meeting Assemblée annuelle 2007