PD-22: CLIFR Update - Institut canadien des actuaires

November 2009 General MEETING – Ottawa (PD-22) PD-22: CLIFR Update
TR-22 :
Mise à jour de la CRFCAV
MODERATOR / MODÉRATEUR: Edward Gibson
SPEAKERS / CONFÉRENCIERS:Rebecca Rycroft
?? = Inaudible/Indecipherable
ph = phonetic
U-M = Unidentified Male
U- F = Unidentified Female
Moderator Edward Gibson: Good morning everyone.
Bonjour mesdames et messieurs. Je m’appelle Edward Gibson et je suis l’actuaire chef d’Empire Vie.
Malheureusement, je ne parle pas le français and therefore I’m going to finish the rest of the presentation
in English.
I’d like to start by introducing Rebecca and myself. This is Rebecca Rycroft. She is a senior consultant at
Oliver Wyman. She unfortunately has her Bachelor of Science from Western University. She didn’t see the light
early enough, right? She also spent some time at GGY, most of her career at Oliver Wyman, but did spend a few
years at GGY working in the client support team and she is also a valued member of CLIFR. I really do appreciate
that she joined us because she wasn’t originally supposed to be here. She actually did a variation of this presentation at the Appointed Actuary’s Seminar and my other speaker couldn’t make it and she graciously accepted. So
thank you very much Rebecca for doing that.
My name is Edward Gibson and I’m the Chief Actuary at Empire Life and I’m also the Vice-Chair
of CLIFR.
This is our agenda today. I’ll be covering the first four topics and Rebecca will handle the remaining five
topics. So there’s a list of them but I’ll just launch into them. I don’t know if I already said this but this is sort of
a status update for CLIFR so we’re going to touch on various items that CLIFR is involved with.
So mortality improvement. The status as of today is we’re working on three sets of documents. The first set of
documents relates to the changes that we are proposing for the Standards of Practice and we’re working through
that with the Actuarial Standards Board. We published a notice of intent in June 2008 and we have an exposure
draft that’s going through the due process and we hope to have it approved at the December ASB meeting and
I’ll go into some details of what’s in that exposure draft in this presentation.
In addition, we have a separate document that relates to the promulgation of the improvement rates and
in fact the exposure draft will say let’s change the Standards of Practice to allow mortality improvement as per
promulgated rates and then the promulgated rates will be coming out in a separate document again from the
Actuarial Standards Board. That’s a relatively new due process that has been created for promulgation documents.
In previous years we would have done promulgations in the fall letter or let’s say an educational note or something
like that but on a going forward basis all promulgations will be coming from the Actuarial Standards Board and
they will have the force of standards. So they will be sort of an add on to the standards.
Finally, we’ve done some work on what started as an educational note but really is more of a research paper
and the idea of the research paper is to give the actuary some background and rationale as to why we are proposing
what we are proposing with respect to the standards as well as the rates that we are proposing to be promulgated.
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So that document is underway as well and that will go to the Practice Council and hopefully be approved by the
Practice Council.
So those are the three sets of documents that are underway.
The changes themselves that we’re proposing, the first set of changes relates to insurance mortality, which
are Sections 2350.06 and .07 in the Standards of Practice. The approach that we’re proposing, I guess a way to
think of it is a minimum valuation basis, minimum reserve if you like or minimum policy liability valuation
basis with respect to mortality improvement. Mortality improvement, we’re treating it as its own assumption and
we’re establishing a minimum valuation basis no matter which direction the risk is. So for example, if you have
regular life insurance business a lower mortality improvement rate is where your risk is. So what we’re proposing
is a starting point basis and then a margin in the direction that brings it down. If you have death supported life
insurance business or if you have annuity business we have the same starting point and the margin takes it in the
up direction because in those situations it’s riskier for the company to have higher mortality improvement. So
that’s the approach that we devised and the way the standards are set up is the standards will reference a minimum
prescribed basis but we’re leaving some flexibility for the actuary to determine what they think is an appropriate
best estimate.
So the Appointed Actuary can still establish what they feel is an appropriate best estimate and an appropriate
margin as long as the combination of those two produces a policy liability that’s at least as conservative as what
we’re outlining in the prescribed standards. So that’s the approach that’s in there and with respect to insurance
mortality we’re preserving the low and high margins per 1,000 at the 3.75 and 15, in that range. That margin
there is really from misestimation of the mean and we believe that we’re covering the deterioration of the mean
with the margin that we’re building into mortality improvement.
So the next two sections that are affected are the annuity mortality sections. These aren’t affected quite as
much but we are changing the wording again to reference this promulgation document and it is going to be the
same kind of approach. It’s a minimum reserve basis that is being referenced and again the actuary is free to set
what they think is an appropriate best estimate and an appropriate margin as long as it’s at least as conservative
as the prescribed basis. The prescribed basis is not outlined in the standards; it’s outlined in this promulgation
document. What that allows the ASB to do is periodically they can review the promulgation approach that they’ve
taken and update it if they think that’s appropriate.
This one here, we are actually changing the low and high margins per 1,000 for adverse deviation that is
applying to the base assumption. The existing range was 5 to 15 percent and the existing range included a margin
for misestimation of the mean and a margin for deterioration of the mean. We’re now putting in a margin for
deterioration of the mean right in the mortality improvement assumption. So because of that, we focused this
particular margin on just misestimation of the mean and we’ve come up with a revised range of 2 to 8 percent
that should cover that off.
Now, the approach that we’re doing in the promulgation document is that we have a set of proposed base
mortality improvement rates. These rates will apply to all of your business in force. They will be the same for males
and females. The approach that we’re using here is that if the mortality improvement decreases liabilities then the
margin goes in the direction that makes it more conservative. So for example, the maximum improvement rates
in that situation would be equal to 50 percent of the base rates.
Just for clarification, you could actually use for example zero percent of the mortality improvement base rates
which would actually be the basis that we’re using today for a life insurance business. So in addition, the maximum
duration of improvements for products where improvement decreases the liabilities would be 25 years, but again,
the actuary is free to choose 10, 15 or 20 or even zero based on their judgment and based on their understanding
of the blocks that they’re valuing.
Now where the mortality improvement would increase the liability we have the other side of the coin. Now
we have a minimum improvement rate that has to be established and it’s 150 percent of the base rates and the
minimum duration of improvements is 25 years. So for example, an annuity block you take the proposed base
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November 2009 General MEETING – Ottawa (PD-22) rates and you take 150 percent of them and that’s the prescribed minimum basis. You don’t have to use it, but
whatever you do choose to use has to produce a liability that’s at least as conservative as that.
By the same token you don’t have to use 25 years duration, you can run it out for life but I will tell you that
when we did some testing on our sub-committee for most annuity blocks the difference between 25 years and
life was actually very small. But there may be annuity blocks out there that have let’s say a younger average age
or something like that … certainly, when we tested several annuity blocks among the participants, we found that
it was actually quite small because there was some discomfort among some actuaries saying: “Oh, for annuities
you’re only doing it for 25 years? You should do it for life.” You can still do it for life.
I have a chart here that demonstrates the proposed valuation basis compared against the existing promulgation for annuities. I will remind everyone for 2009 the modified AA scale is still the promulgated basis for
annuities. So what we’re really looking at here is a proposal for 2010. As you can see—I’m actually colour blind
so I can’t see it, but hopefully you can see—the proposed valuation is more conservative and it’s because it has
an explicit margin. We’ve used historical experience and added a margin of 50 percent. So that’s where the basis
comes from.
The next few slides I’m going to talk about how the proposed basis was evolved from the study results that
we were looking at. We looked at Louis Adam’s study, we looked at the Chief Actuary study from the CPP, we
looked at smoking transition information, we looked at a lot of different information. But by far the most robust
report we looked at was Mary Hardy and a team of researchers at Waterloo prepared a study. I think it’s available on the network, and I think it’s available on the CIA website. Actually she did two sets of studies. She did a
population based study and an insurance population study. What I’m showing you here is actually the population
improvement rates over I believe it was a 75 year period, so most of the 20th century is represented with these
mortality improvement rates by age.
I will also tell you that during the sub-committee discussions there were some discussions about “Okay, I
get using this population base for annuities but maybe we should use the insurance results for insurance business
because maybe this is too aggressive for insurance because it’s higher than maybe what I was expecting. So let’s
use the insurance study results for insurance business?”
The problem with that is if we superimpose the insurance results over this they are actually higher. So if we
use the historical, and it’s not as robust as she has indicated in her report, but if we did choose to use the data
and there are valid points to doing that, it would actually generate a more aggressive position with respect to life
insurance business.
I guess intuitively it would have been nice because as actuaries we like to be conservative and so on and so
forth. But frankly there was some discomfort saying well let’s use this insurance set of rates for the insurance
business because they were actually higher. I just wanted to reassure you of that information because the instincts
of frankly most of our sub-committee is “Well, if we look at insurance results, maybe they’d be lower and then
we could use those and it wouldn’t be quite as much of a change from the status quo?”
But in fact, we did go with the population base and there is something sound that the population base gets
rid of some of the noise that you get from underwriting or potential mortality improvements from underwriting
improvements over time and so on. So we do feel that having a population base as a starting point for all business
under consideration is the most appropriate.
So if we were just using the population studies we would end up with a line that looks something like what
I’ve demonstrated on the screen here. But again, we’re conservative actuaries because the other debate that we
got into is we said the reason why we should use the lower starting point of mortality improvement rate because
we want to preserve conservatism. And the thing that we always had to remember is it’s a two-sided risk. Low
mortality improvement is not always conservative. It’s not conservative for annuity business and it’s not conservative for death supported life insurance business.
So when you’re coming up with a starting point you try to be as reasonable as possible and as unbiased as
possible. Don’t try to create a bias in your thinking saying well let’s go with the lower rate because for regular
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insurance that’s more conservative, or whatever. It’s just a starting point. The margin is there to bring the conservatism in.
But even so, we did compromise a little bit because as you can see between this and the next slide we did pull
down the improvement rates up to age 30 to 40 and frankly this really doesn’t affect annuity business and it does
make life insurance business a little bit more conservative than the study results.
So again, I did want to make sure that everybody was aware that these conservative biases that actuaries tend
to bring whenever they look at things, they kind of creep into this process, but hopefully in a reasonable fashion
and hopefully in not too material a way.
So that’s the population studies and that’s our proposed base rates. Then what do we say? We say look at your
business and if mortality improvement helps you then you have to use 50 percent of those rates or less. If mortality
improvement hurts you or increases your reserve you have to use at least 150 percent of those base rates.
So one of the questions that we had when we were sending out some of this information was you look at a
chart like this and you say: “Well I don’t really know what that means. Like what does that really mean in terms
of the assumption that we’re making about the people that we’re insuring or the annuities that we’re insuring?”
Hopefully, this table gives a little bit of perspective on that. It’s the life expectancies calculated for three
different ages here. I’ll focus on age 50 just to have a point of reference. Let’s suppose that your starting point
happened to be, because we needed a starting point, 80 percent of the CIA table, what would the life expectancy
be for a 50 year old, male, non-smoker? It would be 82.4. So what we’re saying today is when you value a regular
life insurance client you are effectively assuming that they’re going to live on average to 82.4 years old. That’s
what the standards impose on you.
Now, then the next question becomes okay if it’s an annuitant what do the standards say in that situation?
Well then you go to the modified AA scale and you say now that person has to live at least 84.4 years when you
do your valuation.
So your next question might be well what if it’s a death supported life insurance policy? What do the standards say in that one? And actually the standards don’t say anything in that one. They don’t give you any guidance
with respect to how to treat a death supported life insurance policy.
So one of the changes that we’re introducing here is giving more explicit guidance to say that at an appropriate level of aggregation, your life insurance business is either death supported or it’s not death supported and
depending on which the answer is you have a margin of plus 50 percent or minus 50 percent on your improvement rates.
So if we go to the three middle points, if you go to the proposed scale, it would be 100 percent of scale and
what this basically says is if I apply the last 80 years of history for the next 25 years, then what will the life expectancy of that 50 year old be? It will be 84.2. We’re saying we think that’s a better estimate of the life expectancy
than any other number that we could come up with. We won’t know what it will be for sure until 80 years from
now or 50 years from now or whatever, but we think based on the data and evidence that we have today that’s
the best estimate.
We’re not saying that every appointed actuary has to say that. You still have the flexibility to establish your
own best estimate but for the prescribed basis we’ve used that as our base, 84.2.
Now you need a margin. Is it death supported business? Well then you should be at a 150 percent of the
scale, then you have to assume that they live an extra year. If it’s regular life insurance business you back it off a
year. You’re at 50 percent of the scale. You’re at 83.3 and that’s the maximum that you can assume and in fact
the next slide shows this graphically.
The base is 80 years of historical data on mortality improvement. The current basis for insurance is on the
left and for annuities is on the right. We’ve effectively recalibrated the maximum for life insurance and the
minimum for annuities to this historical mortality improvement rates and in fact there is some strengthening
there on the annuities side. And I say it’s a minimum for annuities, it’s also a minimum for death supported life
insurance business.
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November 2009 General MEETING – Ottawa (PD-22) So the proposed annuity margins, the proposed range that we have is 2 to 8 percent and again, the rationale
there is that the MfAD is now needed just for the misestimation of the mean because the deterioration of the
mean margin is now that 50 percent margin that we established earlier.
So what we did is we did some calculations and we developed a range that approximates a life margin because
we felt that the life margin was an appropriate margin for misestimation of the mean. We actually dabbled with
the idea of using a k/ex approach for annuities and we did some exploration among the industry and that wasn’t a
well received approach although theoretically we thought it might have been appropriate. But it can be reasonably
approximated with a proposed range of 2 to 8 percent so that’s what we have in here.
The effective date is proposed to be October 15, 2010 for valuations after that date and early adoption would
not be permitted in this circumstance. I said here in the slide there will be likely additional capital requirements.
Bernard Dupont at the OSFI update—which probably a lot of you were at anyway—further clarified that
that the starting approach for OSFI with respect to this issue is to do an offset probably to available capital that
is MCCSR neutral. So if your MCCSR was 220 percent and you did an adjustment for mortality improvement,
they would do an adjustment to the available capital and your MCCSR would still be 220 percent.
That’s probably an interim measure to give a little bit more time to do QIS-type studies and so on. I think
Bernard actually said probably the official basis would be more like 2012 which is probably consistent with what
they were talking about with market risk and credit risk and some of the other MCCSR changes.
So that’s the approach with respect to required capital which in theory in CLIFR we don’t care about, right?
But we care.
The next topic is currency risk and for this one here we published a notice of intent at the end of 2007.
We did an exposure draft earlier this year, received some comments. We had our final standard approved at the
August ASB meeting and it has been released and it’s effective October 15th, 2009. At this point we’re finalizing
an educational note which is consistent with the proposed change of standards and just gives a little bit more
flavour for how they will be applied in practice.
The next few slides will drill down a little bit on this change. First of all, the existing standards say to assume
that the current exchange rates stay the same forever. If you have a Canada/U.S. type of situation where your
assets are in Canada, liabilities in U.S., maybe that’s not bad because they kind of float around each other. But if
you have a situation of let’s say Jamaican dollar liabilities and Canadian assets, frankly, assuming the current rates
stay the same forever has really no economic basis and doesn’t make a lot of sense.
In fact, for several years now we’ve been putting in the CLIFR fall letter we really don’t think you should
do that. We really think you should do some kind of a currency forward rate or risk free interest rate differential
approach that is more economically sound. So our first proposal was let’s just use that and that’s our base scenario
and then we’ll add a margin of 5 to 50 percent depending on how those markets are integrated.
So we went out with that and did an exposure draft and we received feedback and some significant concerns
and we do respond to feedback so we actually changed our proposal and modified it.
The key feedback that we received was there was a concern that we were double counting the margin. There
was a concern that there was an implicit margin in the currency forward approach that we were treating as our
base and that if we then added a margin on top of that that in certain situations the margin became excessive. We
kind of understood the rationale there and went back to the drawing board and re-thought our approach and said
okay well maybe what we should do is a slightly different approach.
So what we did is we did an alternative scenario approach. So we said we still believe that the base scenario
using forward rates was an appropriate starting point and we’re encouraging that as the starting point for actuaries
to set their margins. So we still preserved that, but in addition we created an additional scenario and the additional
scenario basically uses historical trends and volatilities of exchange rates to project forward in the future and
project what we think is a reasonable margin that’s appropriate for a policy liability.
So we focused on that additional scenario and the approach that we were saying is your policy liability should
be based on this additional adverse scenario but it should be at least a margin of five percent over what you had
developed using the base scenario. So that’s probably the better way to think about it.
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So in most situations your policy liability will actually be based on the additional scenario, this additional
adverse scenario, and I’ll give a couple of examples to hopefully demonstrate what we’re proposing. The examples
are actually outlined in the educational note that we’ll be releasing shortly. So the educational note is additional
guidance. It applies to unhedged currency risks in valuation and you must look at the underlying cash flows to
assess whether or not the currency risk exists and there are some practical applications outlined in it.
So now a little bit more about this adverse scenario that we’ve created in round two of the currency note.
You look at the volatility over historical periods and if your outlook is if you have a ten year mismatch liability,
you look backwards and look at ten year volatility periods. Then what we’ve proposed is that you use one standard
deviation of change in an adverse direction. The direction will depend on what you’re matching with assets or
liabilities. So it could be an increase to the exchange rate or it could be a decrease. It’s whichever is more conservative. In addition, if strong economic evidence is that exchange rates will move then you use the expected mean of
the movement and we have examples of that.
But just before I get to the detail, Canada and U.S., there’s really no strong indicator that over the next ten
years hopefully the U.S. will be worth twice as much as the Canadian dollar. You know there’s movement and
there’s volatility but there’s no clear direction that might be indicated there.
On the other hand, if you’ve got a Canadian dollar and a Jamaican dollar it’s highly likely that the Jamaican
dollar will devalue relative to the Canadian dollar over a ten year period and it’s actually built into the whole
economic framework that there will be higher inflation and there will be devaluation.
So if your valuation is let’s say focused on Canadian and U.S. and you have Canadian liability, U.S. asset or
vice versa, you’re really focused on the volatility and make sure you have a provision for the volatility. But when
you project currency rates for Jamaican versus Canada you really have to take the direction into account as well
or the anticipated direction.
So example one is U.S./Canada. There’s a historical period there from 1975 to 2008 and you can see it’s kind
of bouncing up and down there and it’s fairly volatile. So as an example, we say we’ve got a liability of $1,000 of
Canadian payable at the end of ten years and you can do two things: you back it with a Canadian asset and then
you don’t have to worry about currency risk; or you decide to back it in a U.S. asset and the reality is you’ve not
exposed yourself to currency risk between Canada and U.S. You look at the risk free rates at the valuation date;
they’re pretty close. So economic theory suggests that the exchange rate probably won’t change a lot at least based
on what the market thinks and in fact the exchange rate at the valuation date is just under $1.06 Canadian for
each dollar in the U.S.
So we start doing the number crunching. The first thing we need is the base scenario. So the base scenario
says based on the risk free rates, because of the interest rate differential that Canadian rate is a little bit lower than
the U.S. rate, that means the market thinks there will be a little bit of appreciation in the Canadian dollar relative
to the U.S. dollar but not much. So for example, the implied currency exchange rate ten years from now drops
from $1.059 to $1.048, not much of a change and that’s our base scenario.
Now we look at the volatility and we say the volatility is around 17 percent over ten year periods in the past.
That’s the volatility that you saw on that graph there, and if you take the volatility there you say: “Okay but I’ve
got a mismatch risk and I don’t want to just do a best estimate now of what the exchange rate is going to be.
I want to have a reasonable certainty that I’ve covered the risk that I’m exposed to in this exchange rate.”
So now what we do is we say: “You’re investing in U.S. dollars. So what would be a bad thing to happen?”
Well a bad thing to happen would be the U.S. devalues relative to Canada and you’ve still got that Canadian
dollar liability. So if you use one standard deviation which, I can’t remember the statistics, I think it’s 70 or 80
percent confidence interval, you want to have a provision that allows you to support an exchange rate drop from
$1.059 to 0.877 cents. The difference between the two is the one standard deviation.
So here are the results of this process. The first one there we just have for comparison purposes. If you assume
that the current exchange rate continues you’d hold a liability of $686. We don’t think that’s an appropriate
liability, it’s just there for comparison. Our base is actually fairly close to that because it says on average they kind
of bounce around each other and they’ll probably be the same out ten years from now.
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November 2009 General MEETING – Ottawa (PD-22) But now we do the adverse scenario and we say: “Oh but it could drop by as much as 17 percent because that
has been the historical volatility. Well now, in order to cover that provision I need $829.”
So reserve option one if you like is $829. Reserve option two is: go back to the base scenario, add a margin of
five percent and what does that get you? It’s $730. So I pick the higher of those two and that’s my policy liability.
So in this example it would be $829 leaving a margin of $135.
So what does that look like? You have a PfAD as a percentage of the base scenario that is 19.5 percent and
that PfAD is always going to be at least five percent because of our alternative minimum, but in a lot of situations
the adverse scenario kicks in.
That was example number one.
Now example number two is a little bit trickier. Now we’ve got the Canadian/Jamaican and you can see there
is a clear trend of currency devaluation in the Jamaican dollar which is anticipated to continue into the future.
So now we have $1,000 Jamaican payable at the end of ten years and I’m backing it with Canadian assets.
The risk free rates are quite a bit different and as of valuation date one Canadian dollar bought $72 Jamaican.
So first of all, the implied movement in the exchange rates from the risk free differentials is that there would be a
significant devaluation of the Jamaican dollar over that ten year period.
So the base scenario says the exchange rates are going to move from $72 to $170. They may or may not move
there but that’s kind of what the economic theory says is a best estimate for the exchange rate in the future.
So that’s our base scenario but we also look at the historical mean and volatility of the change in exchange
rates and we say okay in this situation we’re investing in Canadian dollars. So what’s bad that could happen in
this situation? Well actually the bad thing in this situation is that the Jamaican dollar doesn’t devalue as much as
you think it will or as much as the market thinks it will and it’s actually a pretty significant standard deviation
because it’s a very volatile currency relative to Canada.
So what happens there is effectively you replace this future projected exchange rate of $170 with a much
lower one of $118. But notice that it’s still increasing because there is definitely an average improvement that is
being implied in the market through both historical and looking going forward. In the U.S./Canada example,
that mean was effectively zero, it didn’t enter into the equation, but for the Jamaican dollar example it does come
into play.
So now we’ve got the results in Jamaican dollars. The current approach actually says you should hold at least
$694 because you assume that there’s no devaluation in the Jamaican dollar which again, we actually think is by
far too conservative in this particular example because the best estimate or base currency scenario actually says the
liability should be about $294.
When we run that adverse scenario that I described in the previous slide it jumps it up to $424 and then we
apply the five percent minimum margin to make sure it’s satisfied. Yes, it’s well below the 424 so therefore the
424 is the liability.
Then you look at the margin, its 129 and it’s 44 percent. Then you say does that seem reasonable? Yeah it
seems reasonable relative to the base scenario. It’s a pretty risky currency mismatch but it’s well above the five
percent, of course.
So those are just two examples. I don’t know if I’d call them extreme but they might be extreme examples of
how this would be applied in practice and they’re outlined in detail in the educational note.
Long term equity returns. We’re developing an educational note for establishing investment returns for nonfixed income assets. We’re primarily focused on equities but we’ve got some pieces in there dealing with real estate
as well. We expect to publish it in early 2010.
There is really nothing new here, we’re not really changing guidance. We’re really just providing more
details and insights and here are different indexes you can use for different world markets that we feel are reliable
indexes. So it really is an expansion of guidance and advice on how to apply the standards around non-fixed
income assets.
Segregated funds. There are two things underway this year for segregated funds.
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One has already been released which is this exposure draft here and it really deals with the term of the liability.
It has been approved by the Actuarial Standards Board and it was published early this year. The final standard was
approved in the summer and it’s effective in October. This one is really a clarification of practice. We think, generally speaking, good practice was to do this anyway. What it is if you read a literal interpretation of the Standards
of Practice, you actually could convince yourself to treat fully guaranteed contracts more aggressively than those
with no material guarantees which actually doesn’t make a lot of sense and was not intended. But sometimes you
get caught up in the words as products change and evolve over time.
So really what we were doing is changing some of the wording to make it clear that the term of liability for
both types of contracts should be applied consistently, that you have effectively the zero floor when you value
these things other than the DAC or the deferred acquisition cost for seg funds. Then you would extend it beyond
the maturity date to maximize the liability.
So really the clarification was to just make sure no matter how your contract is structured, you should do this
treatment. There was a potential interpretation of the standards that said if you actually had a fully guaranteed
contract with your client you could ignore the zero floor. We didn’t feel that was the intent of the standards with
respect to segregated funds.
The other change was that the current Standards of Practice didn’t really deal with hedging and the impact
of hedging. And where this is tricky is again, it’s because of the zero floor that comes in that you sometimes get
strange results if you’ve got the value of hedged assets are moving up and down and they’re supposed to offset the
moves up and down of the liability. Generally speaking they do as long as they’re both positive numbers but as
soon as you run into a zero floor with the liability you get strange net income results on the asset side.
So what this clarification did is allow you to appropriately recognize the movement in liabilities so that it
aligns with the movement of the asset values. Frankly, actuaries can’t do anything about the movement of asset
values because the accountants say what their values are and how they come through the net income, so we were
just more appropriate aligning those two.
Then the other change related to segregated funds. This is an ASB designated group headed up by John
Brierley that is really cleaning up a lot of the educational material and other guidance into the Standards of
Practice and it’s things that we’ve been doing and we put educational notes out for but they didn’t necessarily
make it into the Standards of Practice. Key areas like: stochastic modelling principles, the whole contract versus
bifurcated method wording, stochastic model calibration criteria. So it’s things that are already in our practice but
haven’t necessarily been explicitly outlined in the standards. Those are the changes there.
Speaker Rebecca Rycroft: I don’t think I’m going to be as technical as Edward has been. Maybe that’s good
news? I don’t know.
So I’m just going to do the last couple of things that were on the list; again just general updates.
The group note is technically a new educational note but it’s actually just the revised version of the original
research paper. It’s the paper from May 2000 and it’s going to be published once it’s translated, but it’s 60 pages
long so that could take a little bit longer still.
Much of the paper is similar to the original research paper but it has been updated to reflect current standards
and group practices including some additional guidance on the 3855 impact on CALM. Also, they’ve added an
experience rating refund section which expands and clarifies the current practice.
So then we’re on to the calibration of stochastic interest rate models.
The Calibration Working Group was tasked with establishing calibration criteria for stochastic interest rate
models. They adopted a multi-phased approach as we probably know by now.
The phase one focused on criteria for the long term risk free rates. The phase one educational note has been
approved by CLIFR and the Practice Council and should be published shortly. It’s just going through the last
couple of stages of completion.
Work has begun on phase two which will focus on the short and medium term risk free rates and the correlation between the short, medium and long rates. We expect the phase two work to be done in 2010. The detailed
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November 2009 General MEETING – Ottawa (PD-22) criteria have been presented already more than a few times at previous meetings so I wasn’t planning on going
into the details today.
After phase two is completed there will be some later phases. They are considering focusing on: credit spreads
which are a concern given the recent spread activity; other markets; or a correlation of interest rates with equities
or currencies.
After the work on phase one was mostly completed there were two significant events: one was the financial
crisis; and the other one was the publication of the calibration criteria from the AAA. So they had a quick look or
review to make sure that the calibration criteria still made sense.
So the financial crisis produced the lowest rates that we have seen in half a century and high volatility that
appears to be unique in modern financial history. But the working group believes that the recent events confirm
the calibration criteria is still appropriate; specifically: the use of long history and that included the 1930’s and the
1940’s; supplementing the historical information with judgment to ensure extremes are appropriately reflected;
and calibrating directly to observed rates rather than indirectly to a model calibrated to historical rate changes
in the development of the criteria. Also, the financial crisis has highlighted the fact that the actuary should be
cautious if liabilities are sensitive to short term exposure to high volatility.
So the AAA paper that was published included 10,000 interest rate scenarios based on the September 30th,
2008 U.S. Treasury curve, a scenario picking tool, an interest rate generator and a consistent stochastic scenario
set and then in addition the Academy used their scenario picking tool and selected 1,000 scenarios that were
consistent with their suggested calibration criteria limits.
The working group did an overview comparison of the CIA versus the AAA criteria but it wasn’t very indepth. We don’t actually plan to review every country’s calibration criteria but generally the CIA method is
independent of the current environment, which is not the case for the AAA method. So the two methods may
be broadly consistent now but as the environment changes that may or may not be the case. You can find the
Academy’s report on their website. It was produced by the Academy’s Economic Scenario Working Group. Other
country’s calibration criteria may be used if either the criteria themselves are broadly consistent or the approach
taken to develop the criteria is broadly consistent with the CIA’s calibration criteria.
The tax note. The Future Income and Alternative Taxes Educational Note is being reviewed and updated as
we speak, in order to be consistent with the federal tax changes which are now substantively enacted and we are
expecting it in early 2010. So it’s coming soon.
The last thing is the fall letter and it has been published. November 11th you should have got your email. I’ll
just go through some of the highlights, some of the changes in the fall letter.
In the fall letter you know we do “in brackets” whether it’s new or modified or slightly changed so I’m just
going to comment on that.
This section is technically new, though we’ve just grabbed it from another part of the letter and stuck it into
its own section. This is where we’re going to highlight which studies have been published or are expected to be
published. The annuitant mortality experience study and the life mortality study have been published and we’re
expecting the LTD termination study before year end.
The next section is the insurance mortality. Edward has already discussed the mortality improvement rates
and the effective date of October 15th, 2010 and the fact that you can’t early adopt. So there is really no adjustment here except that we once again say that you need to offset any mortality improvement in the MfAD and
we’ve added an additional note encouraging you to improve your mortality from the mid-point of your mortality
study to the valuation date. The annuitant mortality study is very much the same as last year except it talks about
how October 15th, 2010 is when the new mortality improvement scale comes into play.
Section four. This section has been modified a little bit. We reiterate the importance of testing premiums
for default risk at 50 and 200 percent of those at the balance sheet date. We comment on the fact that the lower
bound used in creating deterministic prescribed scenarios is dropping and we are going to describe situations
where stochastic interest rate models can be used to calculate reserves.
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Since the phase one paper will be out shortly we’ve added the new guidance to the paper to reflect that. So you
can use the stochastic interest rate models to calculate reserves at CTE 60 or up to CTE 80 level if: your reserves
are not sensitive to short and medium term interest rates since phase one only covers long term; the stochastic
interest rate model meets the phase one interest rate criteria; and the interest rate model is risk free. If the model
does include spreads then you need to hold at least scenario (9) which is really back to the old guidance.
Section five: Value of the minimum interest rate guarantees and embedded options. This section is unchanged
from last year. We left the section in so it’s appropriate in the continued low rate economic environment and we
still need to highlight the value of the guarantees and options may not be captured by the deterministic scenarios
alone. So last year’s Section five Consideration for amounts on deposit and claims provisions under 3855 has been
deleted. It’s still relevant; it’s just not new anymore.
Section six, Implications of 3855 on future income and alternative taxes is slightly modified from last year
just to reflect the now substantively enacted tax legislation. The guidance on what to do in the interim is withdrawn and we remind you that the impact of 3855 would be determined as at the start of the first taxation year
that begins after October 1, 2006 and that the change will be spread evenly over the five year period starting at
that point.
We added something for HST; we simply suggest that you should discuss with your auditors and your
accountants whether to reflect it in your valuation.
And Equity returns, the section has been reintroduced and slightly modified. When updating your historical
benchmark we suggest the lag between the valuation date and calculation date would ideally be short and would
not exceed 12 months. We draw your attention to the impact of the 2008 results on the 30 year average return.
Also, consider that the economic downturn of the last 12 months has generally increased the volatility of historical
returns for most indexes. While the volatilities of historical returns generally remain comparable to those determined for previous years the actuary would consider whether the relative volatilities are still appropriately reflected
in the 25 to 40 percent range for the assumed change in the non-fixed income assets for valuation.
And that is the fall letter and that’s the end. So if there are any questions?
Moderator Gibson: We have time for some questions so we’d be pleased to answer any.
Mr. Dave Congram: I was encouraged by the fact that the Institute has introduced a currency risk standard. I’d
be interested if you can provide just a little bit more insight into interrelationship between the currency risk and
also other assumptions. I’m particularly thinking of inflation and I’m particularly thinking of those countries
where potentially there is a managed float and the way that the currency risk may actually occur is through the
actual inflation rate that arises in the country and how you’ve addressed that particular topic. Is that going to be
in your educational note?
Moderator Gibson: Yeah, probably not explicitly. We’ve had some discussions around the ancillary issues around
currency risk and what they are. I mean the other debate that we had is how does your currency risk projections
integrate with just your regular CALM projections is actually where we’ve spent more time talking about. So what
was the explicit … ? I didn’t quite catch all of what you were saying about the foreign exposure risk with respect
to inflation of local expenses?
Mr. Congram: Well, you used Jamaica as one example but Trinidad is another example. In Trinidad you have
what they call a managed float. I’m not quite sure what that means, but the effect is that the inflation rate basically reflects the particular risk of changes in the underlying value of the currency. So you need to really consider
exactly how the inflation rate is going to affect your interest rate and your assumption with regard to currency if
you have mixture of assets supporting a particular liability.
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Moderator Gibson: I guess I would have to say that we probably did not give explicit guidance with how to deal
with that kind of situation.
Speaker Rycroft: I think countries other than countries where it’s easy to find the information, we try and give
guidance but you’re sort of left to your own devices to figure out a good method anyway. I mean in Trinidad
you’re going to have trouble finding a good yield curve anyway, aren’t you?
Moderator Gibson: Yeah. I think it was really the principal that we were trying to get away from is to fix the
existing standards where it’s current exchange rates forever, but we probably didn’t expand a lot of the guidance
to cover ancillary issues around having liabilities or assets in foreign jurisdiction. I thought there was some reference about the projection of expenses and depending on where your expenses are and just be careful where your
expenses are. You could have some currency exchange risk if your expense is a liability in a different currency than
the asset you’re backing. People don’t always think about that but that’s a more simplistic concept then what you
are describing. Any other questions, comments, jokes?
U-F: I just wondered if you could speak a little bit more about in your mortality improvement derivation, how do
you either ignore or take into account significant improvements related to stopping smoking and other healthcare
or pharmaceutical influences? Do you recognize those or do you try to strip them out?
Moderator Gibson: Part of the reason that we used the long period of time is because a lot of our deliberations
were depending on the period of time … because we did look at different time periods and say “Well what if we
just look at the last 25 years?” or something like that. What we found was, depending on the time period that you
looked at, you had different influences like the smoking, non-smoking transitions and there were female health
improvements earlier in the century, that kind of thing. What we decided on is the actuary can try to take those
into consideration but there was so much noise behind the mortality improvement rates. We almost went back
to first principles and said: “You know what? We’ve got a long period of time and over a long period some of the
noise kind of balances out.”
One thing that I should say is that the approach we are using is for Canadian business because we are aware
that if you have United Kingdom business there are some significant cohort issues that you should be paying
attention to. We do have a little bit of a blurb—I think it was in the research paper—that says if you have international business you should be at least as conservative as the Canadian approach unless you have evidence to the
contrary. There is some evidence on the UK side that we did not include in the notes but the companies that have
that exposure should pay attention to it.
Going back to your issue, we basically said there is so many influences and so much uncertainty about influences about health improvements and medical improvements and direction and are we going to square the curve
and all those kind of things, let’s just go with an extended historical population period as our base. It’s as good
an estimate as any and better than some, and implicitly it includes all of those things over an extended period of
time and a lot of things like that will continue to emerge in the future.
It’s very difficult to nail down exactly what will or won’t happen so we declared: “Okay, that’s our base. And
make sure you’ve got a margin because it’s not going to be the base. It’s going to be either higher or lower and
depending on the business that you have at risk, you better have a margin for it.”
So I don’t know if that answers the question but it did take a lot of time to have those discussions around all
of the things that have influenced mortality improvement over the last 90 years, but it was very difficult to say:
“Okay, what does that mean for the next 25 or the next 50 or the next 75?”.
There were no clear answers for that.
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U-M: Could you comment on the reverse of that? When you have a pandemic, what influences, how you brought
that into your thinking?
Moderator Gibson: Actually, we did not explicitly bring that into our thinking.
Clearly, the pandemics that have occurred since 1920 or whenever the study started, would have indirectly
influenced the results. But we did not have an explicit measure for that. I guess there is some question as to
whether that’s something that you build into the liabilities or something that you build into capital and actually
to be fair we didn’t really have extended discussions around pandemic and I don’t know whether that’s because
we implicitly thought it was almost more a capital issue. It’s hard to reserve for, yeah.
Okay, well I guess I’ll declare this session closed, thank you very much.
(Applause)
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