Transcript Canadian Institute of Actuaries L’Institut canadien des

Canadian
Institute
of
Actuaries
2007 General Meeting
Assemblée générale 2007
Montréal, Québec
L’Institut
canadien
des
actuaires
2007 General Meeting
Assemblée générale 2007
Pricing for Cost of Capital
Presenter: Stéphane Levert, FSA, FCIA
Pricing for cost of capital
•
2007 General Meeting
Assemblée générale 2007
•
What is Cost of Capital?
How to Price for Cost of Capital
x
•
ROI  Capital
 i  Capital 
1 t
Example:
ROI = 15%
Capital = 18% (12% x 150%)
t = 30%
i = 4%
x = 3.1% of premium
•
•
This is the profit charge needed
Based on MCCSR
Pricing for cost of capital
•
Purpose of MSSCR
2007 General Meeting
Assemblée générale 2007
•
Definition
•
•
–
•
•
Art. 515(1) of Insurance Companies Act
Says a company shall maintain adequate capital
and adequate and appropriate forms of liquidity
Intended to absorb fluctuations above PfAD
Risk-based
Measurement is formula-based
Pricing for cost of capital
•
Some situations...
2007 General Meeting
Assemblée générale 2007
•
•
•
•
•
Benefits other than Life and LTD
ASO
Reinsurance ceded
Reinsurance assumed
Aggregate stop-loss insurance
Pricing for cost of capital
•
Benefits other than Life and LTD
2007 General Meeting
Assemblée générale 2007
•
MCCSR factors
•
•
•
•
12% for Health and Dental
9% for Weekly Indemnity
Which one is more risky, really?
Lack of recognition that WI may be longer
term?
Pricing for cost of capital
•
ASO business
•
Main assumption in industry:
2007 General Meeting
Assemblée générale 2007
•
•
•
•
Reality:
•
•
•
ASO benefits expose carriers to no risk
Required capital = 0
However carriers usually charge profit & risk
charge
Risk that client will default
Risk that admin. charges don’t cover actual
expenses
Solution:
•
Use 8% MCCSR factor as for receivables?
Pricing for cost of capital
•
Reinsurance ceded
•
Industry practice:
2007 General Meeting
Assemblée générale 2007
•
•
•
Credit risk of Canadian reinsurers not
recognized
•
•
100% capital credit for registered reinsurers
OSFI/AMF require additional guarantees for
non-registered reinsurers
Especially vulnerable in case of catastrophe
Compliance with Investment Policy (IP)
•
Sometimes, exposure to a single reinsurer
exceeds IP’s guidelines re: exposure to credit risk
of a single issuer
Pricing for cost of capital
•
Reinsurance assumed
2007 General Meeting
Assemblée générale 2007
•
Industry practice:
•
•
•
•
Sometimes use primary carrier’s reserves
Poor reflection of assets backing reserves under
CALM
Risk exposure data not always current
Assumes that pricing done properly
Pricing for cost of capital
•
Aggregate stop-loss insurance
•
Example: Life Insurance
2007 General Meeting
Assemblée générale 2007
•
•
•
•
•
•
•
For a client, pool aggregate claims in excess of
120% of premium
Monthly rate = $0.18/$1,000
Close to 3,000 employees
Average volume = $70K
Group Life Premium = $425K
“notional” cost of capital = 6.1% of premium
Pricing: Stop-loss charge = 12%
•
•
… in this case
= $51K
Pricing for cost of capital
Aggregate stop-loss insurance
Distribution of paid claims (10,000 simulations)
10%
Distribution
Meeting
2007 General
Assemblée générale 2007
9%
Aggregate limit
8%
7%
6%
120% = $511K
Premium
Stop-loss risk
= $425K
5%
premium = $51K
4%
3%
2%
1%
0%
$25 000
$275 000
$525 000
$775 000
$1 025 000
$1 275 000
$1 525 000
$1 875 000
Paid claims
Pricing for cost of capital
Aggregate stop-loss insurance
Distribution of paid claims (10,000 simulations)
Aggregate limit
9%
120% = $511K
Distribution
Meeting
2007 General
Assemblée générale 2007
10%
Aggregate limit
8%
7%
6%
150% = $638K
Premium
= $425K
Stop loss risk
5%
4%
3%
2%
premium = $30K
Stop-loss (120%)
premium = $51K
1%
0%
$25 000
$275 000
$525 000
$775 000
$1 025 000
$1 275 000
$1 525 000
$1 875 000
Paid claims
Pricing for cost of capital
•
Aggregate stop-loss insurance
•
2007 General Meeting
Assemblée générale 2007
•
MCCSR - Current practice varies widely
Case can be made that MCCSR should be
equal to that which would have been help in
absence of the aggregate stop-loss
mechanism
•
•
•
Purpose of MCCSR…
Carrier is really assuming most of the risk
Impact on pricing
•
•
•
Current S-L charges: 1% to 20% of premium
Required Cost of Capital “should” be between
4% and 8%
Adequately recognized in the market?
Pricing for cost of capital
•
Measure of risk?
2007 General Meeting
Assemblée générale 2007
–
–
–
–
•
To some extent
For some benefits, current MCCSR
formula may not be sufficient
For others, formula more than sufficient
Overall, probably a good relative
measure of risk
Alternatives?
–
–
Currently: deterministic approach
Future: stochastic modeling?
Pricing for cost of capital
•
Measure of capital?
2007 General Meeting
Assemblée générale 2007
–
–
Typically, shareholders must invest more
than MCCSR
Examples:
•
•
•
–
Systems and infrastructure
Human resources (including training)
Off-balance sheet risks
Extremes: what if only ASO?...
Pricing for cost of capital
•
Conclusion
2007 General Meeting
Assemblée générale 2007
–
–
MCCSR is only a formula
Important to think and evaluate each
situation according to its circumstances
Questions?