RMAD _ RISK OF MATERIAL ADVERSE DEVIATION A Regulator

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RMAD _ RISK OF MATERIAL ADVERSE DEVIATIONA
Regulators Viewpoint

• CASUALTY LOSS RESERVE SEMINAR
• September 10-11, 2007
• Wendy Germani, FCAS, MAAA
• (retired) Texas Department of Insurance

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WHAT IS MATERIALITY?

• AAA Task Force on Materiality developed a
  generalized description of the concept of
  Materiality.
• ASOP 36 and other Standards of Practice dont
  define it per se.
• Materiality ASOP 36 Considerations for the
  Practicing Actuary - CAS
• NAIC APPM has a definition.
• SECs definition is similar to the NAICs.

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According to NAIC Accounting Practices
Procedures Manual

• A omission or misstatement of an item in a
  statutory financial statement may be material if
  it is of such a magnitude that it is probable
  that the judgment of a reasonable person relying
  upon the statutory financial statement would be
  changed or influenced by the inclusion or
  correction of the item.

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Know Your User !!!

• Principal User
• Intended User
• Unintended User
• Different Users have different expectations
  regarding materiality.

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Considerations in Materiality Standard for
ReservesFrom Materiality ASOP 36

• Would the misstatement put the insurer in danger
  of a breach of covenant or regulatory
  requirement?
• RBC Trigger?
• Minimum Capital Requirement
• IRIS ratio failure
• Turn profit into loss?
• Relative size is usually more important than
  absolute size.
• Lines of business written by company

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Possible Standards of Materiality

• of Surplus
• of Reserves
• Reinsurance (Zero Net Reserve Companies)
• Minimum of of Surplus, of Reserves and/or
  Amount to trigger an RBC action level.
• Other

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Standards Used in 2006For CT IL NY OH PA TX
Domestics
Type Count Percentage
Surplus 552 62
Loss LAE Reserves 112 13
Combination 161 18
Reinsurance 28 3
Other 33 4
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Standards Used for Texas Domestics 2004 to 2006
Type 2004 2005 2006
Surplus 64 61 59
Reserves 9 10 5
Combination 5 10 21
Reinsurance 1 6 8
Others 20 12 7
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Standards Used for Pennsylvania Domestics 2004
to 2006
Type 2004 2005 2006
Surplus 64 68 54
Reserves 15 9 10
Combination 17 20 31
Reinsurance 0 0 0
Others 4 4 5
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General ObservationsMateriality Standards

• Appears to be a general trend to consider
  multiple measures of materiality
• More combinations of materiality bases in
  Opinions.
• Less Opinions with a single basis of materiality.

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Combination Example 1

• In determining the materiality standard, I note
  the Opinion is a tool of solvency regulation.
  Thus, the selected standard is oriented towards
  the potential impact a misstatement of reserves
  would have on surplus levelsand is a minimum of
  three values (1) 20 of surplus, (2) 10 of loss
  and LAE reserves after pooling and (3) difference
  between surplus less Company Action Level RBC.

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Combination Example 2

• Based on my understanding of the use of this
  (Opinion), I evaluated materiality in the context
  of 15 of loss and LAE reserves, 25 of surplus,
  and action/control level from RBC, of which the
  minimum was selected as a materiality standard.

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Consideration of RBC Position

• I have considered a MAD to be one in which the
  actual net outstanding loss and LAE exceed
  carried reserves by an amount greater than 10 of
  surplus... I also verified that a 10 deviation
  in the Companys net reserves would not reduce
  the Companys Total Adjusted Capital to below the
  Company Action Level Capital.
• May be MORE appropriate to include this for
  companies with RBC scores at lower end of
  spectrum vs. healthy RBC scores.
• Regulators do not necessarily have to see this in
  all Opinions.

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• Is there a Risk of
• Material Adverse Deviation?

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• I do not believe that there are significant risks
  and uncertainties that could result in material
  adverse deviation in the loss and loss adjustment
  expense reserves.

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Is there a risk of MAD

• The actuary should explicitly state whether or
  not he or she reasonably believes that there are
  significant risks and uncertainties that could
  result in material adverse deviation.
• Exhibit B for 2007 Actuarial Opinions has a box
  to check Yes or No if there is RMAD.

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So is there RMAD?Using data from CT, IL, NY, OH,
PA, TX
Count Percentage
No 565 64
Yes 317 36
Undeterminable 5 1
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Relevant Comments should allow a regulator to
answer these questions

• Is there a Risk of Material Adverse Deviation?
• What amount of adverse deviation does the actuary
  consider material?
• Why does the actuary consider that amount to be
  material for this company?
• Do I understand why the actuary believes that
  material adverse deviation is or is not a risk
  for this company?

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Is there a risk of MAD for Zero Net Reserve
Companies?

• The opining actuaries concluded that 95 of the
  companies in Ohio, Pennsylvania and Texas with
  zero net reserves do not have a risk of RMAD.
• Reinsurance and/or rapid growth are cited as
  reasons for possibility of RMAD.

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Companies with zero net Reserves 2006OH PA TX
Domestics
Type Count Percentage
Surplus 51 50
Loss LAE Reserves 2 2
Combination 24 24
Reinsurance 15 15
Other 9 9
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CRUSAP Report Observations on Communication

• ..many users of actuarial services dont
  adequately understand the inherent variability
  and uncertainty that attach to actuarial opinions
  and projections.
• This is ..one of the most significant
  communication problems the profession currently
  faces.
• placing too much emphasis on the variability
  of actuarial results could undermine the
  perceived value of actuarial services in the eyes
  of the users.

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Materiality and Link to Actuarial Opinion Summary

• What if actuary said no to RMAD, yet company
  carried reserves in lower end of actuarial range?
• Consideration given to surplus and RBC levels. If
  low, appointed actuaries should expect a call
  from the domestic regulator.
• Why is there no RMAD?
• Is the Materiality threshold possibly set too
  high?

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Questions ?????