Spring 2018 – Q24 – DCAT

February 3, 2019 0 By c.boersma

I’ve highlighted in bold the areas of concern listed below. There are 8 solutions here. 3 parts to each answer: the error, reason, appropriate action – each worth 0.25 points (0.25 x 3 x 4 = 3 points)

This question is important because it highlights a different style of question than before: finding errors vs. giving correct information. To solve this question you almost need to write down the correct procedure and review where there are deviations rather than reading the entire block and trying to find mistakes.

It’s worth pointing out here that the question is 500 words. The average person reads around 200 wpm with average comprehension of about 60%, so you’ll probably need to read it twice (5 minutes). The solutions provided are 200 words and most people write around 13 wpm (15 minutes). The total time to answer this question would be around 20 minutes (for 3 points) or about 6.7 min / point. The exam is 240 minutes for around 70 points or 3.5 min / point (or about 0.25 points per minute).

Question

Given the following information, describe four ways in which the Appointed Actuary (AA) likely did not follow the appropriate standard of practice or educational guidance for the DCAT analysis and briefly describe what the appropriate action would have been in each instance.

Question 24, Spring 2018 Exam 6C

An AA is preparing the DCAT analysis for a federally-regulated Canadian property and casualty insurance company which began operations in 2012.  The most recent fiscal year-end for the company is December 31, 2017 and the AA performs the analysis in July 2018.  The company’s business plan incorporates the actual results through December 31, 2017.

The AA begins by reviewing the operations of the 2017 year, including the statement of income and balance sheet.  The review includes the source of earning and several regulatory measures of capital adequacy.  The AA the prepares the base scenario using the company’s business plan as a starting point.  The forecast period extends from December 31, 2017 through December 31, 2019.  After a review of the results, the AA concludes that the premium growth of the business plan is aggressive and unrealistic given the growth observed in 2017, and materially reduces the assumption.  The MCT ratio of the company remains above 150% throughout the forecast period in the base scenarios.

Next, the AA reviews the various risk categories to which the company may be vulnerable.  The AA decided to first determine how far each risk factor has to be changed in order to drive the insurance company’s surplus negative during the forecast period, then adjusts the level of the risk factor to be consistent with a 95th to 99th percentile range, with most scenarios in the top half of that range.  The AA decided that the reinsurance risk and off-balance sheet risk categories are not relevant and does not perform any analysis on them. The AA applies the risk category changes in the first forecast year to model the plausible adverse scenarios and stratifies the scenarios using their preliminary MCT ratios at the end of the forecast period.  The worst five scenarios are the following

MCT Results as of December 31, 2019

The AA then selected three scenarios: #1, #2 and #3 for further analysis. For these scenarios, the AA considers system-wide interactions, ripple effects, macroeconomic effects and possible corrective actions.  The final MCT ratio results are also included in the table of the previous page.

Finally, the AA produces the DCAT report, including all applicable sections with a disclosure for reasoning for deviating from the business plan’s premium assumption in the base scenario.  The AA included a signed opinion on the insurance company’s financial condition.  Because the Occurrence of Multiple Catastrophic Events scenario’s MCT ratio falls below the minimum requirement prescribed by OSFI, the AA reports that the insurance company’s financial condition is not satisfactory.

Answer

Any four of the following answers were expected:

  1. forecast period: The actuary considers a two year forecast period for all scenarios. Standards state that the forecast period for a typical P&C insurer would not be less than three fiscal years, and so the actuary should forecast to December 31, 2020.
  2. Review period: The actuary reviewed a single prior year of recent operations. Standards of practice state that the investigation would review normally at least three years of operations including the financial position at the end of those years. The actuary should review operations from at least 2015-2016 in addition to 2017.
  3. Further analysis: The actuary only performs further analysis on three scenarios, however all scenarios that cause the insurer to fall below the supervisory target capital level during the forecast period should be subject to further reporting. The actuary should model ripple effects, etc. for the inflation scenario as well.
  4. Regulator action: The actuary studied ripple effects, macroeconomic effects, system-wide interactions and management corrective actions, but failed to consider possible regulator action. Given that four scenarios had the MCT ratio fall below the supervisory target and one fell below the minimum target, it would be reasonable for the actuary to assume that the regulator might step in and restrict or stop the issuing of new policies.
  5. Define satisfactory: The actuary reports that the insurer’s financial condition is not satisfactory. However, the MCT ratio of 91% means that the company still has equity. The requirement for satisfactory financial condition that the insurer meets the supervisory target capital requirement under the base scenario and that the in all scenarios the assets are greater than the liabilities. While it doesn’t mention the MCT in the first forecast year for the adverse scenarios, this appears to be the case.
  6.  MCT Ratio Timing: The actuary stratifies the MCT ratios of the scenarios at the end of the forecast period; however the actuary should consider the MCT ratio throughout the forecast period (and its difference from the base scenario) to measure each scenario’s risk to the insurer. Some scenarios may have been worse at December 31, 2018.
  7. Discussion: If the base scenario is materially different from the business plan and the difference is not due to a re-forecast of the business plan, then the AA should seek confirmation or an explanation of the new assumptions from the directors or senior management

I don’t like this solutions for various reason:

  • Ranking: The AA ranks scenarios according to MCT. The AA should rank scenarios based on surplus sensitivity.

“surplus sensitivity” is not defined and I think many readers could’ve easily missed this minor variation. I assume if the information stated that MCT was used as a measure of surplus sensitivity it would’ve been OK. Not sure what measure is typically used in DCAT reports.