Earnings by Source
John McGarry PhD
Kevin Pledge FIA
28 June 2002
Canadian Institute of Actuaries
Annual meeting
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Agenda
Introduction to EBS
EBS and Data Warehousing
Summary of Proposed Method
Formulae Development
Sources of Earnings
Conclusion
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Introduction to EBS
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What is EBS?
Used to explain earnings
Reconcile assumptions
Can be based on Statutory or
Management Reserves
EBS is a Management Tool
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Explains Earnings by identifying
Impact of Sales
Variations from Assumptions
earnings implicit in the reserves
variation in rates not amounts
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Statutory Reserve Basis
Allows impact of statutory reserves
on earnings to be explained
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Management Reserve Basis
Allows sources to aid in managing
business
The impact of sales is the profit at
issue
The variations can indicate
assumptions need to be changed, or
action may need to be taken
(withdrawals, expenses, investments,
reinsurance).
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EBS as a Management Tool
Decision Tool
Profitability of New Business
Impact of Reinsurance
Profitability by Product Line,
Demographic or Sales Office
Profit is a collaborative effort
Accessible
Understood across organization
Objectives and Goal Setting
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Limitations of current approaches
Often analyzed at fund level, with a
substantial degree of approximations.
Generally not divisible over time
Approximations may not be
understood
Static – prevents analysis by product,
sales office or demographic
Different approaches by line of
business
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Compounding Assumptions
Experience in earlier periods impacts
perceived results in later periods
Illustrated with simple example
Mortality as expected
Withdrawals 50% of expected for 1st
three quarters
Expected values in Q4 based on
artificial population
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Projection at outset vs changing
88,000
90,000
92,000
94,000
96,000
98,000
100,000
102,000
Start Q1 Q2 Q3 Q4
expected actual
Understatement
of Inforce
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Actual vs. Expected Mortality
340
350
360
370
380
390
Q1 Q2 Q3 Q4
Actual Expected
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EBS and Data Warehousing
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What is a data warehouse?
“Complete analytical infrastructure”
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EBS and Data Warehousing
A data warehouse with policy level
reserves and earnings allows:
knowledge discovery with regard to
profitability and performance by product,
sales office or client segment
can lead to successful management
action
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Data needed
For EBS
Policy data, reserves, transactions
and expected rates
For Analysis of EBS
Product Structure and attributes
Sales structure and attributes
Client attributes
Must be unitized to allow alternate
aggregations
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Requirements of an EBS report in
a Data Warehouse
Accessible across organization
Explain components
Integrate with other reports
Flexible over time
Analysis by product, sales office,
demographic etc
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Summary of Method
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General Method
Statutory or “management” reserve
bases
Gross or net premium valuation
methods
Lines of Business; Life, Disability etc.
No Approximations
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Monthly Recognition of Sources
Impact of sales recognized in month
of issue
Reserves released as at month of
exit
Premiums and expenses at start of
month, claims at end of month
Monthly sources accumulated using
Fund return
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Monthly Recognition of Sources
Flexible over time
yearly results are easily accumulated from
quarterly results.
Simple formula
Reduces compounding and interaction
Contingency sources are based on the
immediate impact of the event
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Monthly Recognition of Sources
Gives immediate impact of Sales
New Business Strain on Statutory
Profit at Issue on Management
Not at a “variable” point in the future.
After the month of issue, policies are
included in the “in-force” analysis of
variations.
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Reserves Released on Exit
Projected ending reserves
Survivors and exits
Assumed in derivation
May not equal actual ending reserves
Starting reserves may be used
These may be more easily available
Introduces known approximation
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Unitized Earnings
Requires investment return and
expenses to be unitized for policy
level analysis.
Investment return as a rate,
Expenses as a per-policy unit factor
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Unitized Earnings
Allows analysis at any level:
product, sales office, demographic.
Exp’ d amounts
from valuation system, or if not,
more accurately and easily defined
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Report Structure
Linear Report
Grid Report
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Linear Report
Normal Profit
Issue Profit
Issue Margins
Release of Margins
Experience Variations
Interest
Premium
Expense
Mortality
Withdrawal
Change of Basis
Total Earnings
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Grid Report
Statutory Mgmt Margin
Sales Impact X X X
Variations
Interest X X X
Premium X X X
Expenses X X X
Mortality X X X
Withdrawal X X X
Total Variations X X X
Basis Changes X X X
Total Earnings X X X
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Formulae Development
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Method
Define calculation order
Begin with actual earnings exp’n
Modify 1st var. from “act’l” to “exp’d”
Subtract modified from initial exp’n
Modify 2nd var. from “act’l” to “exp’d”
Subtract modified from prior exp’n
Continue through sources
Final earnings = zero
mgmt earnings on mgmt reserves
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Order of Sources
Basis Change
Sales Impact
Release of Margins
Interest Variation
Cash Flow Variation
Contingency Variation
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Sources of Earnings
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Sales Impact
Issue Profit
Capitalized Future Profits + Cash Flows
Expected profit at issue
Should be at time of issue
Acquisition Expenses, Initial Commission
Issue Margins
Impact of setting up reserves
New
Deaths
New
Issued
New
Suviviors
m S
E
P
V
1
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Release of Margins (RoM)
Acc’d Starting – Ending Margins
(Act’l) RoM ≠ Expected Earnings
Exp’d Earnings = Exp’d RoM
≠ Act’l RoM unless A = E
“Exp’d Earnings adjusted for act’l
experience on margins”
“Actual earnings before variations”
RoM by source/assumption
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Interest Variation
Act’l interest on Cash-flows + Res.
– Exp’d interest on Cash-flows + Res.
Initial
Beginners
m
a
a
a
m i
i
E
P
V
0
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Cash flow Variations
– (Act’l Expenses – Exp’d Expenses)
accumulated on Expected Interest
Total exp’d exp’s will change every
month.
Reconcile unit expenses, not total
Initial
Beginners
m
m
a i
E
E 1
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Contingency Variations
Mortality - Life Insurance
– (Actual Strain – Expected Strain)
Initial
Beginners
m
m
Initial
Deaths
m V
S
q
V
S
0
,
1
0
,
1
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Contingency Variations
Mortality - Disability Insurance
Actual Gain – Expected Gain
Initial
Beginners
m
m
Initial
Deaths
m V
q
V
0
,
1
0
,
1
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Contingency Variations
Disablement
Actual Gain – Expected Gain
Gain = Reserve Released
– Reserve Set Up
Healthy
Beginners
m
D
m
H
m
Healthy
ts
Disablemen
m
D
m
H V
V
d
V
V
0
,
1
0
,
1
0
,
1
0
,
1
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Reconciliation
Reconciliation to both actual
earnings and planned earnings
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Reconciling to Actual Earnings
Sum of Sources = Actual Earnings
No approximations necessary
Known approximations due to data
availability
Magnitude can be estimated
Modeling Variation
Also acts as an error- check on the
calculation
or an order-check on approximations
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Reconciling to Planned Earnings
Planned Earnings
Earnings target set by Management
usually each year
Based on expense budgets, sales and
investment targets, as well as projected
policy behavior.
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Reconciling to Planned Earnings
Reconciliation
First, restate Planned Earnings on
Actual Sales over the year.
The difference between Original and
Restated Planned Earnings is the
impact of sales variations.
Compare Restated Planned Earnings
with Normal Profits (Issue Profit + Issue
Margin + Release of Margins).
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Reconciling to Planned Earnings
Issues
Planned Earnings may be carried out in
aggregate
Planned Earnings may use different
methods
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Conclusion
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Conclusion
EBS can be an effective
management tool
Continuous approach
No approximations required
Performance can be monitored over the
year
Meaningful explanation of results helps
decision process
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Further Information
The Analysis of Insurance Earnings
Formulae
Proofs
www.insightdecision.com