Case Study 3 – Actuarial Valuation Report

Introduction
The following are extracts from an actuarial report (valuation of liabilities and Financial Condition
Report) for Wunda Ltd. Wunda is a composite insurer and writes both general and life insurance
products in Tatooine, a Galactic nation. Wunda’s life products include conventional whole life,
term, endowment and annuity products. It has no group insurance business. The Tatooine
Regulatory Authority (TRA) requires insurers to meet minimum capital requirements. See Case
Study 1 for additional details about Tatooine Regulatory Authority.

You are the supervisor from TRA and have been asked to review this report

Contents
1. Scope
2. Data
3. Methodology and assumptions (GI)
4. Methodology and assumptions (life insurance)
5. Valuation results (GI)
6. Valuation results (life insurance)
7. Financial Condition

1. Scope
WI Actuaries have been commissioned by Wunda Ltd to act as its Appointed Actuary consistent
with the requirements of TRA. The two main duties of the Appointed Actuary are the production
of a valuation report as of 31 December 2020 (including both claims and premium liabilities), and
a Financial Condition Report (FCR). WI has performed similar assignments for the last five years.

Actuarial Certification
(Standard attestation and signature by actuary)

2. Data (Liabilities report)

We were supplied with three databases by Wunda:
1. A database of each individual claim, with details of the policy number, date of claim, date
of reporting, claim number, and details of the claimant.
2. A database of each claim payment, including the date and amount of each payment, the
associated claim number, and details of any excess/deductible for that claim.
3. A database of Wunda’s case estimates. These are estimates of individual claim amounts
made by Wunda’s claims assessors

Other data received included:

4. Electronic data files including all policy data
5. Financial statements for the year
6. Retention policies and reinsurance treaties.
Reliance
We have relied on various documents and data supplied by the Company and assume no
responsibility for the completeness or accuracy of such information.

3. Claims methodology and assumptions (General Insurance)

For the Motor and Property classes, two models are used to estimate the future claims payments
from past accidents:

1. The paid chain ladder assumes consistent patterns of emergence of claim payments as
time since the accident passes. The patterns of emergence are assumed to be similar to
past patterns for this portfolio.
2. A loss ratio method assumes that a percentage of premium will go to the payment of
claims over time. Total claim payments are calculated as premium x loss ratio. The
outstanding payments are the ultimate payments, less the payments to date. The
assumptions for the loss ratio are often made in the pricing of the product.

For the Liability class, payments are made over a longer period than the shorter-tailed Motor
and Property classes. In addition to the two models described above, two additional models
are used to value the future claims payments:

3. A Claim Numbers x Average Claim Size method. This method uses a projection of the
emergence of claims to estimate ultimate claim numbers. The ultimate claim numbers are
then multiplied by an average claim size.
4. One method also incorporates case estimate information on liability claims. Separate
consideration is given to large claims.

4. Methodology and assumptions (Life Business)

As the TRA has no specific requirements for valuing insurance company policy obligations, I have
valued the policy liabilities using the Tatooine Policy Premium Method (TPPM) as is accepted
actuarial practice in Tatooine.

TPPM is a gross premium valuation method which takes account of all policy cash flows,
including premiums, death benefits, cash surrender values, policyholder dividends, renewal
expenses, taxes and reinsurance cash flows. These cash flows are projected into the future for
the entire term of the policies using expected experience assumptions and appropriate margins
for adverse deviation. The resulting cash flows are discounted to the valuation date using a
valuation interest assumption. The valuation liability (reserve) is calculated on a policy-by-policy
basis. In no case is the policy liability less than zero.

(Details on the valuation of other products omitted for this case study)

Summary of Changes in Methods and Assumptions

The most important assumption changes made this year relate to the valuation interest rate due
to an increase in the expected yield on equities of 0.5% per annum (impact -15 million) and a

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strengthening of the lapse assumptions for individual life products (impact +5 million). There
were no changes in method in the prior year.

Expected Mortality Assumption

Due to the lack of an industry mortality table for Tatooine, I made use of the recent 2001 CSO
Galactic Empire Academy of Actuaries (2001 CSO) select and ultimate mortality table for insured
lives and adjusted for Company experience. My study of the Company’s experience was as
follows:

Year 2019 2018 2017 2016 2015

Actual/Projected 37% 55% 21% 57% 78%

For individual life insurance business both par and non-par I used 106% of the 2001 CSO select
and ultimate table with no future mortality improvement.

For individual deferred and immediate annuity policies I used 103% for males and 101% for
females of the 2012 Individual Annuity Mortality (IAM) Tables as the expected experience. I also
included future mortality improvement at the rate of 2% per annum for 10 years (i.e. to bring the
experience current from the date of the study underlying the table).

Valuation Interest Rate Assumption

I have reviewed the portfolio of Company assets in setting the Valuation Interest rate (VIR). In
2019 the average portfolio rate of return for all the Company’s invested assets was 4%.

The mix of assets supporting the policy liabilities is as follows:

Asset Type Proportion

Cash/Term 25%
Deposits
Bonds 30%
Equities/Shares 30%
Property 10%

The same asset portfolio is used to support all product types.

Equities were assumed to continue to earn their dividend rates and yield an additional 4% per
annum. Similarly, properties were assumed to earn their rental income plus 4% per annum.

To allow for asset defaults and investment expenses, deductions from the blended portfolio
yields of 0.10% and 0.15% were made.

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Projection VIR (%) Projection VIR (%) Projection VIR (%)
Year Year Year
1 4.0 8 4.7 15 5.0
2 4.1 9 4.9 16 5.0
3 4.2 10 5.1 17 4.8
4 4.3 11 5.1 18 4.5
5 4.4 12 5.1 19 4.4
6 4.5 13 5.1 20 4.30
7 4.6 14 5.1 21+ 4.25

A recent sensitivity test of the VIR showed that a 1% shift changed the policy liabilities by 115
million.

Valuation Lapse Rate Assumption

I have examined the aggregate lapse experience for all insurance policies for the most recent
year and have chosen the expected experience assumption to be 6% per annum for all durations
and products.

I added a low margin of 10% MOCE to the expected experience assumption by increasing the
lapse rate.

Valuation Expense Assumption

The expected valuation expense assumption for maintenance costs consists of renewal
commissions as well as a flat per policy cost of 300 Galactic Credits. The per policy cost was
derived after review of the Company’s 2020 expense budget and the advice of the Controller on
an appropriate split of those costs between on-going maintenance and first-year sales and
acquisition costs.

An inflation assumption of 1.5% per annum was added to the per policy cost of 300 Galactic
Credits reflective of expected inflation rates in Tatooine.

I added a low margin of 5% to the expected experience assumption.

5. Valuation Results (General Insurance)

Actual vs expected
We perform our analysis under three classes of insurance, Property, Motor and Liability. The first
stage is to look at the claim payments in the last year, compared to that expected from our
valuation reports 12 months ago. Values in the tables below are shown in millions of Galactic
Credits ($GCm).

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Motor and Property
Accident year Actual Payments in Expected payments in Actual/Expected
2020 $GCm 2020 $GCm
2016 & earlier 0 0
2017 0 0.1 0%
2018 0.9 1.2 75%
2019 8.4 8.7 97%
2020 33.0 28.9 114%

Total 42.3 38.9 109%

Liability
Accident year Actual Payments in Expected payments in Actual/Expected
2020 GCm 2020 GCm
2016 & earlier 2.1 1.8 117%
2017 3.1 2.6 119%
2018 4.7 4.0 118%
2019 7.1 7.7 92%
2020 4.2 5.1 82%

Total 21.2 21.2 100%

Central Estimates
The following table shows the central estimates of outstanding claims. All three classes (Motor,
Property, Liability) have been aggregated in this table.
(a) (b) (c) = a - b (d) (e) = c - d
Accident Outstanding Payments Expected Outstanding Adequacy of 2019
year claims 31 during remaining claims 31 Reserves
Dec. 2019 2020 reserve Dec. 2020
$GCm
Pre-2017 4.1 2.1 2 3.1 -1.1
2017 7.9 3.1 4.8 6.4 -1.6
2018 14.0 5.6 8.4 11.7 -3.3
2019 32.7 15.5 17.2 22.1 -4.9
Total 2019 58.7 26.3 32.4 43.3 -10.9
and prior

2020 40.2
Total 83.5

Loss Ratios

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One common way to present claims statistics is the use of loss ratios. These are the ratio of
ultimate claims cost (i.e. paid to date plus outstanding claims) to premium.

The following table shows the loss ratios for each line of insurance by accident year.

Accident Year Motor Property Liability

2016 & earlier 85% 79% 58%
2017 84% 82% 59%
2018 88% 80% 59%
2019 88% 83% 63%
2020 93% 92% 69%

MOCE
The figures in the tables above are central estimates of outstanding claims. They are our best
estimate of an uncertain outcome and should have a 50% chance of being too high and a 50%
chance of being too low.

Usually, we want the liabilities as recorded in the balance sheet to have a higher than 50%
probability of being sufficient. We add a margin over the central estimate (MOCE), leading to
greater confidence in our estimate.

I recommend a MOCE of 8%.

The resulting estimate of Technical Provisions is GC83.5m x 1.08 = GC90.2m.

Commentary

For the Liability class, payments for the earlier accident years were higher than expected. We
also saw increases in case estimates for some claims yet to be settled. These two factors led to
increases in ultimate claims estimates, consistent with a view that this will also occur for the
more recent accident years.

For Property and Motor, claims were close to expected for earlier accident years, but higher than
expected in the most recent year of accident. However, this is not a concern as the premiums
written over 2020 were higher than expected, increasing both premium income and claims cost
estimates.

6. Valuation Results (Life Insurance)

Summary of Valuation Results
(Detailed numbers not needed for this case study except to say that the Company has material
blocks of par whole life, NP whole life, endowment, level term and 5-year renewable term as well
as material blocks of immediate (payout annuities and flexible deposit deferred annuities)

Summary of Provisions for Adverse Deviation (a.k.a MOCE)

The total MOCE for the Company stood at 100 million at December 31, 2019, in part due to a
reduction in MOCE levels for expenses from 10% to 5% (impact -8 million)

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Limitations
I found the staff to be knowledgeable and experienced in the Company’s business and practices
and therefore believe I can rely on their work. I performed my own tests of the reasonableness
of the policy data. I made use of my own proprietary valuation software. I did not independently
confirm the asset data provided to me.

Materiality
I have established a standard of materiality for this valuation of 0.75% of the liabilities.

7. Financial Conditions Report

[Note that only general insurance is included in this portion of the case study. Life insurance was
intentionally excluded]

Wunda Ltd operates in three general insurance sectors, Motor Insurance, Property Insurance and
Liability Insurance.

Motor Insurance covers the drivers/owners of motor vehicles against theft or damage to their
vehicle, other vehicles or other property.

Property Insurance covers the owners of property (homes and businesses) against theft and
damage, particularly from storms or other natural disasters.

Liability Insurance covers the policyholder (individual or business) if they are sued by another
person. It provides for legal costs and damages if a third party suffers a financial or physical loss
due to the action of the insured.

The markets for both Motor and Property are very competitive, with several established local
insurers as well as the recent introduction of some competitors from nearby countries. This has
had the effect of driving premium rates down.

Wunda has been very aggressive in maintaining and growing its market share, so it has cut its
premium rates in order to attract new business. This was successful in 2020, when the market
share climbed from previous years.

The Liability market is smaller, as many insurers rightly view Liability as a more specialised line of
business. The nature of the business is that payments are made over a much longer period than
Motor or Property, reflecting the possibility of legal cases.

Underwriting risks

Perhaps the largest risk facing Wunda is the lower premium rates which have been charged in an
attempt to retain market share. There is a risk that the lower collections of premiums per policy

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may not be sufficient to cover claims costs and expenses while still leaving some profit for
Wunda.

The lower premium rates are one of the reasons for the declining loss ratios, as shown in the
table above.

Further, little is known about the risk profile of new customers. There is a risk that these new
customers represent poorer risks to Wunda as they may have higher claim experience than the
existing policyholders.

Liability risks
We note that there has been some deterioration in the Liability portfolio. Payments are higher
and continue for longer than we had previously allowed for in our models. This adverse
experience in the older accident years has been offset by favourable experience in recent
accident years. However, these recent accident years may have the same poor experience as the
older accident years.

Concentration risks

We note that Wunda insures many properties and motor vehicles in the coastal areas of
Tatooine. These areas are subject to floods, and while a major flood has not been experienced
for several years, a flood could lead to a large number of claims all at once.

Further, global climate change experts hold the opinion that the frequency and severity of such
events shall increase over time.

Asset risks
There is a risk that the value of Wunda’s assets may fall. Wunda has about 15% of its assets
invested in growth assets, with the rest placed in safer assets such as bank accounts and
government bonds. While it is appropriate that some of the assets are longer term, this includes
a greater risk of volatility in returns and a higher possibility of loss of value.