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
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:
Scenario 1: high end of reasonable range = 51m (worst case outcome)
Scenario 2: high end of reasonable range = 55m (worst case outcome)
Maybe a better way to think of it is in terms of the deviation of the worst possible outcome from the point estimate.
The way it's presented in the source text is like a double-negative. And double negatives aint' no good.
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!
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.
Wouldn't it be easier to think of it as if Recorded Reserves - High end of actuary's range > MAD, then there is RMAD? It's rearranging the algebra. But it makes it more intuitive.
That is, if the difference between the recorded reserves and high end of actuary's range is greater than the material standard, there is a risk of MAD.
Your alternative way of thinking about it does seem more intuitive, as it directly compares the difference between the recorded reserves and the actuary's high end range to the materiality standard. By framing it this way, you focus on the actual surplus or shortfall, which can indeed be more straightforward to grasp.
I've linked to this discussion from here in the wiki:
Thanks!
Thanks! I understand the official definition in the text is the other way around, and maybe for the exam they require us to word it that way. would that be correct to assume?
Well, they should accept either on the exam because they are algebraically equivalent. But just in case the grader looks at it and is thrown off (after grading hundreds of other exams!) it might be better to write it out in the standard way.
Thank you! Makes sense.