1. Regulatory Guidance to the 2004 Changes to the Actuarial Opinion SWAF Fall 2004 Wendy Germani, FCAS, MAAA Nicole Elliott, Aspiring Actuary

2. 2 Fun Facts (2003) Lead states for 2003 Direct Earned Premium (40% of total): CA, NY, TX, FL, IL Lead states for # of P&C companies: VT (519), NY (257), TX (247), IL (225), PA (217) (32% of total) Texas: 225 P&C domestics; 204 opinions reviewed (interns) 93 different actuaries submitting opinions – two actuaries submitted 15 or more opinions 41 actuaries submitted more than one opinion, 52 submitted one

3. 3 More Fun Facts about Texas

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5. 5 Overview of 2004 Changes: Structure Now includes exhibit summaries Exhibit A: Scope Loss Reserves Premium Reserves Exhibit B: Disclosures Materiality Standard Statutory Surplus Discounting, Salvage, Asbestos, etc.

6. 6 Overview of 2004 Changes: Major Revisions Requires identification of person responsible for providing data used in actuarial analysis Requires auditor to test key data used in opinion Expanded definition and discussion of Actuarial Report Requires explicit statements and consideration for risk of material adverse deviation Requires identification of type of opinion provision (from ASOP 36)

7. 7 Focus DATA MAD REPORT

8. 8 2004 Changes: Data Data Reliance –Identification of data source Reconciliation –Must be included with Actuarial Report New Data Testing Requirements –Independent Auditor must test actuarial data

9. 9 Data Testing Requirements Auditor must obtain an understanding of data identified by the appointed actuary as significant to reserve projections Separate testing may be required This requirement may cause difficulties Early Discussions are advisable Anticipates significant interaction between auditor, company and appointed actuary

10. 10 2004 Changes: MAD Risk of Material Adverse Deviation The opinion must state whether or not there are “significant risks and uncertainties that could result in material adverse deviation” The actuary needs to judge: –Whether the risk is significant –What is MATERIAL Materiality standard must be disclosed in all opinions

11. 11 Materiality Standard General approach is to consider how user will be influenced –An item is material if it would change the user’s interpretation of the situation Thresholds could include amounts: –Above a specified % of Surplus or Reserves –That threaten a change in the company’s RBC level –Sufficient to change an underwriting or operating gain into a loss

12. 12 Other MAD Considerations Degree of precision that is attainable in estimating the judgment item ASOP 36 Amounts arising from abnormal or unusual circumstances Would it trigger an IRIS ratio? What should a regulator think when quarterly reserve development is > 10% of surplus but there was no MAD discussion in the opinion?

13. 13 MAD Disclosure Explanatory paragraph must describe: –Major risk factors –Combination of factors –Particular Conditions underlying the risks and uncertainties Include basis of the materiality standard Should not include broad general statements The list need not be exhaustive

14. 14 MAD in Texas (2003) Number of opinions that included MAD comments/standard: 39 (19%) –Most use Surplus as a measure: 25 (64%) –Reserves as a measure: 5 (13%) –Other (usually dollar amount) as a measure: 8 (20%) –Reinsurance as a measure: 1 (3%)

15. 15 What is Material? SEC: exclusive reliance on quantitative benchmarks is inappropriate NAIC: the dollar amount above which the examiner’s perspective of the company’s financial position would be influenced AICPA: matter of professional judgment Threshold values: rules of thumb Common sense: “reasonable person” test

16. 16 NAIC Bright Line Test Regulators plan to use a bright line test for 2004 in evaluating if there is a risk of MAD If –10% of held reserves is greater than –Difference between Total Adjusted Capital (usually Surplus) and Company Action Level Capital Then regulator expects to see explicit Relevant Comment paragraphs discussing the factors giving rise to the presence or absence of the risk of MAD

17. 17 NAIC Bright Line Test (cont.) Test is not a substitute for the individual actuary’s judgment Does not relieve the actuary of independently establishing own materiality standards Regulators expect that an Appointed Actuary would choose a more restrictive standard in the great majority of situations

18. 18 2004 Changes: Actuarial Report Reminder: Report is to be available by May 1 or within two weeks of a regulatory request Confidential, not intended for public inspection Consistent with documentation and disclosure requirements of ASOP #9

19. 19 2004 Changes: Actuarial Report Narrative: Should provide sufficient detail to clearly explain findings, recommendations, and conclusions as well as their significance Support all assumptions Technical: Should provide sufficient documentation and disclosure for another actuary practicing in the same field to evaluate the work Must show the analysis from the basic data (eg, loss triangles) to the conclusions

20. 20 2004 Changes: Actuarial Report Summary exhibit(s) of actuary’s best estimate, range, or both Extended comments on trends relating to risks and uncertainties that could result in MAD Extended comments on factors that led to unusual IRIS ratios and how these factors were addressed in prior and current analyses

21. 21 IRIS in Texas Failed at least one reserve IRIS ratio: 24 (12%) Failed more than one: 10 (5%) Failed IRIS #10: 9 (4%) Failed IRIS #11: 15 (7%) Failed IRIS #12: 16 (8%)

22. 22 2004 Changes: Actuarial Report Exhibit which ties to the A/S and compares the actuary’s conclusions to the carried amounts Documentation of the required Reconciliation from the data used for the analysis to Schedule P CATF believes that regulators should be able to rely on the Report as an alternative to developing independent estimates

23. 23 Questions for Opinion Writers How can the Instructions be improved? What can regulatory actuaries do to improve their role in solvency monitoring? Do you feel regulators should play a role in ABCD referrals? Would you benefit from a peer review counseling letter? What would you do differently if you were a regulator?

24. 24 Questions for Regulators How can my work product be improved? Are you satisfied with the quality of Actuarial Reports? What do you consider a “Qualified” opinion? Does your definition vary from other states?

25. 25 Final Comments/Contacts Refer to e-mail bulletin in handout Financial Actuarial Division –P&C Actuaries: Wendy Germani, FCAS, MAAA Holmes Gwynn, ACAS, MAAA Nicole Elliott, aspiring to the above –MC 302-3A 333 Guadalupe St Austin, TX 78701 –512-322-5067 main line 512-322-5083 fax