Odomirok.16-17-SAO

Odomirok Chapter 16, Statement of Actuarial Opinion, covers the opinion of a qualified actuary on the reasonableness of the loss & LAE reserves as of December 31 each year.

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Study Tips

The Odomirok text mainly covers accounting principles and over one-third of the points on the exam come from this source. The SAO (Statement of Actuarial Opinion) is covered in Chapters 16-17 of Odomirok, COPLFR.SAO, and ASOP.36, and by itself accounts for another one-sixth of the points on the exam. The SAO is by far the most important topic on the Exam 6 syllabus. If you ad one-third and one-sixth, that that's over 50% the exam comes from just Odomirok and COPLFR. Allocate roughly half your total study hours to these 2 source readings.

Estimated study time: a couple of days (for chapters 16-17 of Odomirok)

(Don't spend too long here because the main SAO material is in COPLFR.SAO. You can come back here to review as needed.)

Meet Alice-the-Actuary: This is a hard exam so I've asked Alice-the-Actuary and some of her friends to help you out. She'll stop by to offer advice from time to time. You'll learn more about her and her friends as you work your way through the wiki articles. I've hidden an Easter Egg in the wiki with a short bio for Alice. See if you can find it. :-)

Source Readings: BattleActs includes all material from past exams in at least 1 of the elements of the system: wiki articles, BattleCards, BattleTables. It also covers significant material that has not appeared on past exams but that I've judged to be important. Still, it's a good idea to spend a portion of your time reviewing the source readings. You may have a different opinion on what's important and what you can skip. You cannot read all 2,500 pages in depth, but BattleActs give you the necessary background knowledge so that the time you do spend on the source readings will be much more efficient. For a little more on this click on Using the Source Material.

BattleTable

We have compiled previous exam questions in a table. You can use this to easily see which topics are tested most frequently.

Based on past exams, the main things you need to know (in rough order of importance) are:

• 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

Note that in the table below, you can click E in the left-hand column to open a PDF with the question and answer from the examiner's report for just that question.

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 table is a little different from the tables in subsequent wiki articles. In this article, we'll be focusing on the green highlighted boxes and postponing the grey highlighted boxes for later. These exam problems will covered fully in COPLFR.SAO.

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

Theoretically you can skip chapters 16 & 17 in Odomirok as well as ASOP 36. The COPLFR reading has everything you need to know about the SAO. It is very well written but it's also very detailed and may not be the best place to start. Alice-the Actuary has gone through all of the SAO material and will gently guide you through.

Plan of Attack

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.

Next Steps: 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.

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 are many more items covered in Part IV. All of this paperwork seems like a lot f bureaucracy but it's all part of a well-developed regulatory system. Without a good regulatory system, we'd have periodic insolvencies and financial crises. (Actually, we do have financial crises quite regularly. Maybe our regulatory systems need improvement, but that's a discussion for another time.)

Anyway, 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 the particular state) and separately from the SAO, because the AOS is a confidential document that contains proprietary information

Chapter 16 (Statement of Actuarial Opinion)

Intro

If we're going to go to the trouble of providing an actuarial opinion, we might 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 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. (It's just a dumb little memory trick to help you remember all this boring information.)

Question: describe the organization of the SAO

The SAO consists 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, which may happen to you from time to time while studying because there is a lot of reading.)

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 than $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...

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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.

The wiki articles explain the material and provide many of the details you need to learn but there are also some facts that are provided only in the BattleCards. This avoids duplication and keeps the wiki articles relatively short. (If the wiki articles listed every detail, they would end up being as long as the source reading and 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.

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 (ASOP.36, section 3.2)	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	6+3 items (see Mr. Smith's example from previous section)
Exhibit B	disclosure items regarding NET reserves in the scope (these disclosure items include type of opinion)	13 items (see Mr. Smith's example from previous section)

¹ The 5 types of opinion are Reasonable, Excessive, Inadequate, Qualified, None (they are defined in the quizzes below.)

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. (Something confusing: In the table above, the "contents" of the OPINION section are labelled [A], [B], [C], [D], but these are different from Exhibits A & B. This labeling is consistent with the presentation in COPLFR.SAO – but I wish COPLFR had used different letters for the contents of the OPINION section.)

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 good example from the text p196-197 involving the actuary Mr. Smith. 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. (Assume his point estimate equals the carried reserves.)

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 the carried reserves 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 from carried 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.)

There's an alternate mnemonic for the second question in this quiz that asks for the item required in the Relevant Comments section. See this forum post. (shout-out to PK!)

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 (Note: there is no requirement to produce both a range and a point estimate)

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.)

Another way of thinking about the AOS is that it provides more detailed information about the actuary's work that the company may not want to be made public.

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 how 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.

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