Materiality Standard Meaning

Thinking of the equation "MS + Reserves < High End of Reasonable Range" and how this implies RMAD exists; I am not understanding the meaning of "Materiality Standard". Is RMAD a good or bad outcome for the company? I interpret this equation as "MS + Reserves" being reasonable since it is less than the upper end of the reasonable range, and thus if something is reasonable, then it would be good for the insurer. However, "risk of material adverse deviation" sounds like it has a bad connotation. Please help. Thanks!

Comments

  • edited July 2022

    First of all: RMAD is bad! (You can remember that because it rhymes!)

    But I completely understand your confusion. At first glance it does seem backwards but here's how I think about it. Let's look at an example:

    • MS = 3m
    • Reserves = 50m

    Scenario 1: high end of reasonable range = 51m (worst case outcome)

    • Reserves + MS = 53m which is GREATER than 51m so no RMAD (according to the way it's defined)
    • The reason is that 51m is the worst possible case, but 51m is only 1m away from the point estimate of 50m, and 1m is within the materiality standard.
    • So if this worst case of 51m actually happens and the CEO asks you whether the deviation was material, you would say: "No. Our materiality standard is 3m and this deviation was only 1m so it is not a material deviation."

    Scenario 2: high end of reasonable range = 55m (worst case outcome)

    • Reserves + MS = 53m which is LESS than 55m so now there is RMAD.
    • The reason is that now the worst possible case is 55m and would represent a deviation of 5m from the point estimate, and 5m is greater than the MS.
    • So if this worst case of 55m actually happens and the CEO asks you whether the deviation was material, you would say: "Yes. Our materiality standard is 3m and this deviation was 5m so it is a material deviation."

    Maybe a better way to think of it is in terms of the deviation of the worst possible outcome from the point estimate.

    • For scenario 1, the deviation of the worst possible outcome is 1m and this is less than the MS so no RMAD.
    • For scenario 2, the deviation of the worst possible outcome is 5m and this is greater than the MS so no RMAD.

    The way it's presented in the source text is like a double-negative. And double negatives aint' no good. :wink:

  • Ok. I see. I was missing the part about a "worst possible outcome" happening and how that relates to the MS + Res. thanks for clearing that up.

  • You're welcome!

  • edited March 2023

    Do we never care about the low end of the reserve range? Since MAD is always unfavorable?

  • In the context of determining RMAD (Risk of Material Adverse Deviation) we don't need to look at the low end of the reserve range. But in other contexts, the low end could be very important. For example, if a company books reserves of 249m, but an external audit firm opined a reasonable range of 255-265m, then the company's value is 6m below the low end of the auditor's range. That would be a (big!) problem.

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