Odo.FinReg

Reading: Financial Reporting Through the Lens of a Property/Casualty Actuary, Casualty Actuarial Society, 2020, Edition 5, Chapters 1-5, 25, 27, and 28.

Authour: Odomirok, K.C., et al.

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Study Tips

Don't panic. The Odomirok text is 475 pages but the syllabus only covers about 50 pages in the chapters listed below. It's mainly a U.S. based accounting text but many of the basic concpets are common to the U.S. and Canada. There is as well as some specifically Canadian content.

• chapters 1-5: basic accounting material (very easy)
• chapter 25: Solvency 2 (also covered in IFA.Solvency2 but not in very much detail)
• chapter 27-28: Canadian content (difficult - calculating the value of commuted claims)

Just to be clear, you can cover chapters 1-5 in about 30 minutes.

Syllabus Update (Mar 3, 2022): The CAS has updated the Exam 6-Canada syllabus to now include Chapter 25 of the Odomirok text (listed as CAS Financial Reporting in the official syllabus) as part of the Solvency 2 material. There is a fairly easy calculation problem that you should learn how to do and there is a web-based problem for practice. There are no old exam problems for this calculation from Exam 6-Canada but there is one from Exam 6-US and it provided further down in this wiki article.

Due to the update described in the box above, please ignore the following: Chapter 25 on Solvency 2 could potentially be a difficult chapter but I don't think you need to spend much time here. The topic of Solvency 2 is listed under Learning Objective C.2 in the Exam 6C syllabus but the Odomirok text (referred to as CAS Financial Reporting) is not listed as one of the references for that topic. I'm not sure if that's an oversight, but a strict interpretation of the syllabus means that questions on Solvency 2 should come only from IFA.Solvency2, referred to as IFOA on the official syllabus. There has also never been a calculation question on Solvency 2. → If such a question appears on the exam, my recommendation is to immediately notify the CAS of a possibly defective question.

Chapter 27 is short, but chapter 28 contains a very difficult calculation problem on commutations. This is where you'll spend the majority of your time in the Odomirok text.

BattleTable

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

• how to calculate the value of the commuted claims in a commutation (hard!!)
• definitions of basic accounting terms
• basic facts about the 2 main types of accounting principles SAP (Statutory Accounting Principles) and GAAP (Generally Accepted Accounting Principles)

Top Questions ← Questions you absolutely need to know!

reference	part (a)	part (b)	part (c)	part (d)
E (2019.Spring #17)	commutation: - compute value
E (2018.Spring #23)	basic accounting terms - liquidation & going-concern	basic accounting terms - accounting principles & accounting rules
E (2017.Fall #14)	see CIA.MfAD, CCIR.ARinstr	basic accounting terms - fair value & historical cost
E (2017.Fall #19)	commutation: - compute value
E (2015.Fall #11)	commutation: - compute value
E (2015.Spring #31)	basic accounting terms - liquidation & going-concern	basic accounting terms - fair value & historical cost	basic accounting terms - accounting principles & accounting rules
E (2014.Spring #23)	SAP v GAAP: - objective	SAP v GAAP: - intended user	SAP v GAAP: - asset recognition	SAP v GAAP: - deferred taxes
E (2013.Fall #18)	commutation: - compute value

In Plain English!

SAP, GAAP, CGAAP

The introductory chapters of this reading cover SAP (Statutory Accounting Principles), GAAP (Generally Accepted Accounting Principles), CGAAP (Canadian Generally Accepted Accounting Principles). These straightforward concepts are covered in the BattleQuiz.

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Basic Accounting Principles/Terms

This reading covers extremely basic accounting concepts. If you've had a university course in accounting, you already know much of the material. Let's get Canadian for a moment! The MaRS website lists the 4 main elements of a financial statement as:

• B/S or Balance Sheet
• I/S or Income Statement
• Statement of Retained Earnings
• CF Statement (CF = Cash Flow)

If you want to know more, check out that page of their website at: MaRS Financial Statements. (Don't know what MaRS is? It's an entrepreneurial incubator located near Queen's Park in downtown Toronto!)

Check the BattleQuiz for terms that have been asked on a prior exam.

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Solvency 2

This chapter (Ch. 25) of the Odomirok textbook is new to the Exam 6-Canada syllabus as of Fall 2017. But Solvency 2 itself is not new to the syllabus. There had been a whole reading devoted to Solvency 2, so it feels like this topic has been downgraded. For this new version of the Solvency 2 reading, there are 2 items you must know:

item 1: what is Solvency 2

Solvency 2 is a principles-based insurance regulatory system for capital levels of insurance companies in the European Union.

item 2: what are the 3 pillars of Solvency 2 [Hint: QGT]

1. Quantitative: sets SCR & MCR (Solvency Capital Requirement & Minimum Capital Requirement)

   - uses a total balance sheet approach

   - SCR corresponds to 99.5% VaR (Value at Risk) meaning that the probability of ruin is < 0.5%

2. Governance: supervisory activities (internal control & risk management, supervisory review process)

   - requires adequate governance for: ♦ internal audit ♦ actuarial ♦ risk management ♦ compliance

   - supervisor identifies high-risk companies and may intervene

   - note that companies are required to perform ORSA (Own Risk & Solvency Assessment) under pillar #2 (see OSFI.ORSA)

3. Transparency: supervisory reporting & public disclosure

   - information from pillars 1 & 2 are given to the supervisor & financial markets

   - purpose is to increase market discipline because companies know their decisions are public

Alice the Actuary told me that the 3 pillars was asked multiple times on past versions of the exam. (You should believe her - she's pretty smart!)

Context for Solvency 2

Note the connection between Solvency 2 and OSFI.MCT. Both are implementations of a capital adequacy framework:

• OSFI.MCT is for Canada.
• Solvency 2 is for the European Union.

One interesting difference between MCT and Solvency 2 is that MCT applies static risk factors whereas Solvency 2 is principles-based. That means that Solvency 2 may be more adaptable to circumstances, but also harder to apply.

ENID

ENID stands for Events not in Data. It is discussed in IFA.Solvency2. The idea is that when setting reserves, it might be prudent to take into account possible events that have not appeared in your historical data. An example might be a pending change in legislation that would retroactively impact claim costs. Anyway, I just wanted to highlight the connection to Odo.FinReg. A good exam question would be to combine concepts from both papers. This will be discussed more fully when you get to IFA.Solvency2.

Comparison to the U.S. Solvency Regime

This is an entirely new section in the source text. Solvency 2 is intended as group-wide solvency regime but this conflicts with the state-based regime in the U.S. Pressure stemming from the 2008 financial crisis however has led the U.S. to modify its state-based approach under something called SMI or Solvency Modernization Initiative. SMI used something called a "Windows & Walls" approach.

Question: briefly describe the "Windows & Walls" approach of the Solvency Modernization Initiative as it applies to Solvency 2

• gives windows for state insurance regulators to look into group-wide operations:

→ enhanced communication between state & group regulators

→ enforcement tools if violations occur

• but maintains the walls at the statutory legal entity level

→ capital cannot be "shared" between legal entities

Regulator Action Under Solvency II

There is a colorful diagram on the first page of chapter 25 in Odomirok. It's an elegant representation of the quantitative pillar. Here's the link:

Solvency II Quantitative Pillar Diagram

The gold rectangle on the left side of the diagram represents IFRS assets available. The right side of the diagram shows 4 separate colored rectangles stacked, representing IFRS assets required and a 5th rectangle at the top representing Free Surplus (if any). Note that SCR is Solvency Capital Requirement and MCR is Minimum Capital Requirement:

quantity	example
Free Surplus (if any)	?
SCR - MCR	50
MCR	250
risk margin	53.07
Best Est. of Liabilities	150

It's odd that the blue rectangle was not labeled in Odomirok, but you can deduce that it must equal SCR - MCR because Odomirok does tell us that:

• SCR    =    aqua + blue
• MCR    =    aqua

Therefore

• SCR - MCR    =    blue

Odomirok also tells us that:

• total technical provisions    =    (Best Est. of Liabilities) + margin    =    red + purple

Now, here's a very simple question:

Question: if IFRS assets available = 850, what action would the regulator take under Solvency II quantitative capital requirements

• To answer this you need to know:

→    SCR assets required    =    (Best Est. of Liabilities) + margin + SCR    =    150 + 53.07 + 300    =    503.07

→    MCR assets required   =    (Best Est. of Liabilities) + margin + MCR    =    150 + 53.07 + 250    =    453.07

• Also:

SCR assets required    ≤    IFRS assets available    → no action

MCR assets required    ≤    IFRS assets available    <    SCR assets required    → regulator will intervene

IFRS assets available    <    MCR assets required    → company is no longer permitted to operate

• It's easy to see we are in the first case:

SCR assets required    =    503.07    ≤    850    =    IFRS assets available    → no action

• And it's trivial to calculate that Free Surplus = 850 - 503.07 = 346.93

2017.Spring #20 (from Exam 6-US)

The numbers from the example in the previous section are from the following exam problem:

E (2017.Spring #20)

This problem is easy except in the Exam 6-US version of the problem you aren't given the risk margin - you have to calculate it and it relies on material that is not covered in the Canadian exam.

• Here's a pdf with my solution but for Exam 6-Canada, but you can ignore the part of the solution that calculates the risk margin. Just assume you're given the risk margin and this makes the problem much easier.

Solution to 2017.Spring #20

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Chapters 27 & 28

• Chapter 27 covers Financial Reporting in Canada
• Chapter 28 covers the Canadian Annual Statement
• These chapters cover roughly 20 pages. Much of it is either very general or covered in other syllabus readings. One big exception is in chapter 28 in the section Commutation of Claims (p372-374.)  (Thx ThrowGrow!)

Commutation

There are three old exam problems, (2017.Fall #19), (2015.Fall #11), (2013.Fall #18a), that were quite difficult, where you had to calculate the value of commuted claims.

Solution to 2017.Fall #19

Solution to 2015.Fall #11

Solution to 2013.Fall #18a

4 Commutation Practice Problems

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BattleCodes

Memorize:

• purpose and main concept for the 3 accounting systems: SAP, GAAP, CGAAP
• side by side comparison of SAP & GAAP (see BattleCards)
• basic terms: (liquidation versus going-concern), (fair value versus historical cost), (principle-based versus rule-based accounting systems)
• Solvency 2: defn, 3 pillars, 3 conditions, 4 functions
• definition of commutation

Conceptual:

• Note how both OSFI.MCT and Solvency 2 are specific implementations of the general framework discussed in ICP17.CapAdeq

Calculational:

• value of commuted claims

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