Odomirok.16-17-SAO

• SAO stands for Statement of Actuarial Opinion
  • purpose and organization of opinion
  • types of opinion, standardized language for opinion
  • information about the appointed actuary that must be disclosed
  • when a company is exempt from providing a SAO
• AOS stands for Actuarial Opinion Summary
  • audience for AOS
  • construct exhibits A,B,C,D,E

reference 1	part (a)	part (b)	part (c)	part (d)
E (2017.Fall #22)	SAO opinion: - propose language	SAO opinion: - type of opinion	AOS (A,B,C,D): - construct exhibit	—
E (2016.Fall #22)	appointed actuary: - standards for	appointed actuary: - info in SAO (id section)	appointed actuary: - info to regulator (new appointment)	—
E (2016.Fall #24)	AOS: - construct items A-E	—	—	—
E (2013.Fall #27)	qualified actuary: - definition	long-duration contract: - definition	SAO exemption: - financial hardship	RMAD: - necessary disclosures

¹ This BattleTable is a little different from the BattleTables in subsequent wiki articles. In this article, we'll be focusing on the green highlighted boxes and leaving the red highlighted boxes for later. These exam problems will covered fully in COPLFR.SAO.

In Plain English!

Intro

The SAO, or Statement of Actuarial Opinion, is by far the most important topic on the syllabus. (The AOS, or Actuarial Opinion Summary, is included in this.) On average, questions related to the SAO account for a full one-sixth of the total points on the exam. There are 3 relevant syllabus readings:

• Odomirok.16-17-SAO - a short reading that provides a good intro (that's the subject of this wiki article)
• COPLFR.SAO - main source of info on the SAO (~120 pages)
• ASOP.36 - a short reading with very little information that isn't contained in COPLFR.SAO

Fun Fact 1: All of the information you need is contained in the COPLFR.SAO reading.

Theoretically, you could completely skip chapters 16 & 17 in Odomirok (and the ASOP reading too) and go straight to COPLFR. But the problem is that COPLFR is extremely detailed. If you start with that, you'll be tearing your hair out 15 pages in! Not kidding. It's actually well-written but excruciatingly detailed. Alice needed major beerage her first time through COPLFR.SAO.

Fun Fact 2: If you follow the Plan of Attack outlined below, you'll learn the s**t you need way better and way faster.

Plan of Attack

Our friend, Alice the Actuary, is going to guide you gently through this mountain of information.

Getting Started: Read the brief section (see below) on how the SAO and AOS fit within PART IV of Odomirok and general reporting requirements for an insurer.

Marching Onwards: Work your way through this wiki article on chapters 16 & 17 from Odomirok.

• You should spend a few days on the material below, including the mini BattleQuizzes.
• Note: You don't have to perfectly memorize all the details in the BattleCards before moving on to COPLFR. You will absorb the details as you work through the old exam problems. (The BattleTables in COPLFR have links to all old exam problems.)
• Having said that, however, you definitely should have memorized the purpose and organization of the SAO, and the basic organization of the AOS.

Next Challenge: After finishing this wiki article, you can proceed to COPLFR.SAO. Alice will provide further instructions there!

PART IV (Filings to Accompany Annual Statement) Ch 16-20

The Annual Statement includes the balance sheet, income statement, Schedule P (actuarial triangles), Schedule F (reinsurance), and many other exhibits, schedules, and notes. It is filed with the state department of insurance. Note that the NAIC itself (National Association of Insurance Commissioners) is not a regulator, rather it coordinates regulation of insurance across the U.S.

Unfortunately, filing requirements for insurers don't end with the Annual Statement. There's a bunch more things that are covered in Part IV. It's a total pain to do all these filings, but it's all part of a well-developed regulatory system. Without a good regulatory system, we'd have periodic insolvencies and financial crises. (Wait, we DO have that! Maybe our regulatory systems need improvement! But let's save that discussion for a late-night bull session!)

Anyhoo...some of the more common documents that have to be filed with state insurance regulators are:

• SAO (Chapter 16: Statement of Actuarial Opinion)
• AOS (Chapter 17: Actuarial Opinion Summary Supplement)
• IEE (Chapter 18: Insurance Expense Exhibit)
• RBC (Chapter 19: Risk-Based Capital)
• IRIS Ratios (Chapter 20: Insurance Regulatory Information System)

The first two, SAO, and AOS are covered in this article. (The remaining three are covered later.) Note the filing requirements of each:

SAO: included with the Annual Statement that's sent to the state insurance department

AOS: filed with domiciliary state (if required by that particular state) and separately from the SAO, because the AOS is a confidential document that contains proprietary information

Let's get started! Yippee!!

Chapter 16 (Statement of Actuarial Opinion)

Intro

If we're going to go to the trouble of providing an actuarial opinion, we must as well know why we're doing it.

Question: what is the purpose of the SAO (Statement of Actuarial Opinion)

There are 3 items: OIA

• Opinion: provide the appointed actuary's opinion on reserve amounts for items in SAO scope (reasonable, inadequate, excessive...)
• Inform: inform readers/regulators of significant risk factors regarding reserves
• Advise: advise whether risk factors could lead to MAD in reserves (MAD = Material Adverse Deviation!!)

Alice the Actuary told me this very short story: If you advise that certain risks may lead to Material Adverse Deviation in the reserves, management might get MAD. (That's just another one of those dumb little memory tricks to make you laugh and help you remember all this boring s**t!)

Ok, moving right along...(tough audience!)

Question: describe the organization of the SAO

The SAO conists of 4 sections, and 2 exhibits: ISOR + (A,B) (details in next section)

1. Identification
2. Scope
3. Opinion
4. Relevant comments

• Exhibit A: recorded amounts for items in scope (loss reserves, reinsurance...)
• Exhibit B: disclosure items regarding NET reserves in scope

(To me, ISOR sounds like eyesore. I had a really bad case of pinkeye about 20 years ago, so that's what the SAO always makes me think about! Not fun!)

And here is one last item for the intro to chapter 16...

Question: how might an insurer get an exemption from filing the SAO

Here are the possible reasons: SLuSH

• Size: the insurer is small (less then $1m annual GWP) & (less than $1m gross reserves @ year-end)
• LOB: certain lines of business are exempt
• (u: doesn't stand for anything, but I needed a vowel to make the memory trick SLuSH into a word!)
• Supervision: exempt if insurer is under supervision
• Hardship: if insurer is under financial hardship (cost of SAO is a burden) E (2013.Fall #27)

The answer to the above exam problem is in the first appendix of the COPLFR.SAO source reading, 2016 NAIC Instructions, Section 1B. An insurer may qualify for financial hardship if the cost of the SAO exceeds the lesser of:

• 1% of CY capital & surplus (from latest quarterly statement)
• 3% of GWP for year (projected from last quarterly statement)

This question was from 2013 and has never been asked again. That was the only time (through 2018.Spring) that a question on these SAO exemptions appeared. (You can check the BattleTables in COPLFR.SAO).

Now that you know how the SAO is organized, below is a link to an example SAO prepared by Mr. Smith of Fictitious Insurance Company. Take a moment to look through it, and keep it handy. We'll cover the details in the next few sections.

Mr. Smith's SAO & AOS Note the organization of these 10 pages: (SAO is 8 pages, AOS is 2 pages)

SAO page 1-5: contains ISOR (Identification, Scope, Opinion, Relevant Comments)

SAO page 6: shows Exhibit A (recorded amounts for reserves)

SAO page 7-8: shows Exhibit B (disclosure items)

AOS page 1-2: show the actuary's estimates (this is not shown in the SAO)

Onwards and upwards to the mini BattleQuiz...

mini BattleQuiz 1 You must be logged in or this will not work.

The Boring Details (Yawn)

When you read the source text, you should always be assessing the likelihood of that material being on the exam. That's hard to do on your first pass because you don't have a sense for what's important and what isn't. Let me help you out: The Statement of Actuarial Opinion is consistently and heavily tested. You have to know pretty much all the details. (For less important topics, you can skip large swaths of material, but that is not the case with the SAO.) With that said, let's get started...

Note that I haven't included all the details in the wiki - some of the details are only in the corresponding BattleCards. This avoids duplication and keeps the wiki articles short and sweet! (If I included all the details in the wiki articles, they would end up being as long as the source reading. That would defeat the purpose of the wiki.)

From the previous section, we know how the SAO is organized: ISOR + (A,B). Here we delve into the details. Alice took the verbiage from the source reading and helped me organize it into a nice, pretty table! She's awesome!

section	contents	Alice's helpful comments
Identification	- actuary's name/title + WARD   - Who made appointment   - Affirmation of qualifications   - Relationship to company   - Date of appointment - intended purpose/users	this one is easy!
Scope	must identify: - reserve items in opinion - accounting basis for reserves - review date (also defined in ASOP 36) - data source	see BattleCards for further details: - examples of typical reserve items - defn of 'review date' - data reconciliation statement
Opinion	[A] & [B] statements about laws & actuarial standards [C] type of opinion: R, I, E, Q, or N 1 [D] miscellaneous	see BattleCards for further details: - 5 types of opinion - required wording
Relevant Comments	- comments & disclosures to aid reader's understanding - items 1&2 (of 8): MAD (Material Adverse Deviation)   - materiality standard regarding MAD   - risks that may result in MAD - items 3-8: various	see BattleCards for further details: - items 1 thru 8
Exhibit A	recorded amounts for items mentioned in the scope	no other details, for now
Exhibit B	disclosure items regarding NET reserves in the scope	no other details, for now

¹ The 5 types of opinion are Reasonable, Excessive, Inadequate, Qualified, None (they are defined in the next mini BattleQuiz)

Before I let you loose on the mini BattleQuiz, take a look at:

E (2016.Fall #22).

The answer to part (b) of this exam question is in the table above. The answers to part (a) & (c) will covered later in COPLFR.SAO, but it's good to start getting a feel for the types of questions that are asked.

mini BattleQuiz 2 Identification & Scope

mini BattleQuiz 3 Opinion

Before charging ahead to the next section, take a peek at:

E (2017.Fall #22).

You can answers parts (a) & (b) from what we've covered so far. Part (c) deals with the AOS, which we cover later in this wiki article. It's a good question because it ties things together.

Miscellaneous

We'll close chapter 16 with a few words on items in the Relevant Comments section of the SAO

Question: identify common methods for selecting a materiality standard (item 1, relevant comments)

percentage-based standards:

•  % of loss & LAE reserves (10% is typical & reasonable)
•  % of surplus (10-20% is typical & reasonable)
•  % of net income

regulatory ratio based standards:

• reduction in surplus that would trigger the next RBC action level (See also Odomirok.19-RBC)
• amount that would trigger an unusual IRIS ratio (See also NAIC.IRIS)

There's a fun example from the text p196-197 involving the actuary Mr. Smith. (It's short and sweet!) To see it, click Mr. Smith's adventures in materiality.

Ok, now we have a materiality standard, based possibly on both quantitative and qualitative considerations. Next question...

Question: how is the materiality standard used within the SAO (item 2, relevant comments)

The idea is that Mr. Smith must examine risk factors that could lead to MAD. You can't do that until you've set a specific materiality level.

Pop Quiz!    :-o

Given:

• Mr. Smith has identified 2 major risk factors: mass tort claims, catastrophic weather events
• His range of reasonable reserves estimates is (95m, 105m), with a point-estimate of 100m.

What would he disclose about these risks in the relevant comments section of the SAO if...

1. materiality standard = 4m
2. materiality standard = 7m

Answer:

1. there are significant risks and uncertainties that could lead to MAD in the recorded reserves (because a reserve level of 105m is reasonable and the deviation from his point estimate would be 5m, which is greater than the materiality level of 4m)
2. there are not significant risks and uncertainties that could lead to MAD in the recorded reserves (because the worst reasonable scenario is 105m which is a deviation of 5m, but is less than the materiality level of 7m)

Final Question: what about the other disclosure items in Exhibit B

Unfortunately, Mr. Smith has to comment on those as well. Things like salvage & subrogation, reinsurance collectibility, claims-made or retrospective reinsurance, IRIS ratios etc...

There are a lot of details in the SAO, but this gives you the foundation. (And don't forget to sign the darn thing when you're finished!! Submit with Annual Statement by March 1, assuming a Dec 31 year-end, and put in writing that you'll keep all supporting docs for 7 years.)

mini BattleQuiz 4 Relevant comments

Chapter 17 (Actuarial Opinion Summary Supplement)

Alice the Actuary has math a joke for you: This chapter is easy as π.   :-)

The AOS, as it's called, is barely two pages long. Odomirok has provided Mr. Smith's AOS for a fictitious insurer. It has 5 items (A through E).You can see it here: Mr. Smith's super-awesome AOS. (Since this link opens in the same browser tab as the wiki, you might want to right-click and duplicate this tab to make it easier to toggle between views.)

Question: who is the intended audience for the AOS

• file with regulators of the domiciliary state (Note: do not file AOS with NAIC)
• (the AOS is not a public document because it contains proprietary company information)

Question: how is the AOS organized (Hint: I like to think of it as consisting of 2 things.)

Thing 1: (comparison section, 4 items)

A: range of actuary's reserves (case + IBNR on net & gross basis for all items)

B: point estimate by actuary

C: carried reserves by company

D: difference (company – actuary)

Thing 2: (adverse development section, 1 item)

E: statement regarding whether there has been: 1-year adverse development (relative to prior year surplus) greater than 5% in 3 of last 5 calendar years

• if there hasn't been → actuary must state this fact
• if there has been → actuary should provide sufficient detail so the regulator can determine whether additional regulatory review is required
• If you know about IRIS ratios, you'll see you're really just calculating IRIS Ratio 11.

Possible point of confusion: The SAO includes two exhibits called Exhibit A & Exhibit B, but they are different from items A & B in the AOS. (Alice the Actuary would have definitely used different letters for the AOS to make it less confusing.)

Pop Quiz!    :-o

Question: Where in the Annual Statement is the adverse development of reserves disclosed?

Answer:

• Five-Year Historical Data, line 74 (statutory basis Annual Statement)
• (the raw data comes from Schedule P, Part 2 - Summary)

Question: if there has been adverse development, how could item E in the AOS be worded

Odomirok has a great example of Mr. Smith did this. He organized his statement as follows:

• state that there has been adverse development and for which years
• summarize the reason for the adverse development (strengthened loss reserves)
• explain the reason in more detail (increased exposure – various specific reasons are given)
• mitigate the effects of this adverse development (purchase unaffiliated retroactive reinsurance)

Click here to see his wording and the regulator's possible response: Mr. Smith's well-written item E statement

Before you charge into the mini BattleQuiz, take a look at:

E (2016.Fall #24).

This is a great question to teach you how to construct items A-E of the AOS.

mini BattleQuiz 5 You must be logged in or this will not work.

BattleCodes

Memorize:

Conceptual:

Calculation:

POP QUIZ ANSWERS

this is the answer