Download City County Insurance Services Administrative Trust June 30

James Marta & Company
Certified Public Accountants
Accounting, Auditing, Consulting, and Tax
Funding Your Pool During
Difficult Times:
How Payout Patterns and Investment
Earnings are Affecting Your Bottom
Line
Presented by
James Marta CPA, ARPM
Our current environment
Economy
 Interest rates
 Benefit costs

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How is your JPA facing tough
times?
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Is your pool cutting its
funding margin?
Is your discount rate your
using much larger than what
you will be earning in the
next few years?
Are you returning net
assets?
Are your members cutting
back on risk management?
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Funding Your Claims
In risk financing your learn you can fund
claims at different points
 Before the loss
 During the loss
 After the loss
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Risk financing and sharing allows
pools to smooth losses
Among members
 Through fiscal years
 This smoothes costs over time

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Facing declining rates
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CalPERS discounts at 7.75%
Cuts its rate to 7.50% through vote of the board.
It earned 1.1% in 2011 and 1% in 2012
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Discounting

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Recognizes that you could pay $1 of claims with 80
cents.
Contemplates payout patterns
Should contemplate default risk
Should only discount the claim liabilities, not assume
future earnings on the entire portfolio.
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History of Discounting
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Casualty loss and loss adjustment reserves
were not discounted except in narrowly defined
circumstances.
1986, with tax reform act, IRS prescribed
discounting claim liabilities for tax purposes
The National Association of Insurance
Commissioners (NAIC) has been opposed to
discounting except in specific circumstances
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How sensitive is your equity to your discount
assumption?
Exhibit 1
Rate
0.0%
Funding needed (M)
$
Equity (M)
(M) = Millions
$
81.30
1.0%
$
(37.90) $
75.00
2.0%
$
(17.90) $
69.70
3.0%
3.5%
4.0%
5.0%
$
65.20
$
63.20
$
61.30
$
58.00
(4.20) $
4.20
$
8.10
$
10.00
$
13.30
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Effect of lower current earning rates
Exhibit 2
Earnings Rate future pattern
B
C
D
A
E
Period(s)
1
2
3
4
5
6
7
8
9-36
1.00%
1.00%
2.00%
2.00%
2.00%
3.00%
3.00%
3.00%
8.86%
1.00%
1.00%
2.00%
2.00%
3.00%
3.00%
4.00%
4.00%
8.25%
1.00%
1.25%
1.75%
2.25%
2.75%
3.25%
3.75%
4.25%
8.16%
1.00%
1.50%
2.00%
2.50%
3.00%
3.50%
4.00%
4.50%
7.66%
1.00%
2.00%
3.00%
4.00%
5.00%
5.00%
5.00%
5.00%
5.77%
Periods 9-36; rate you must earn over the remaining 27 years to fund claims
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Will you ever be able to catch up?
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Remaining investment balances
Investment Balances
70,000,000
60,000,000
Percent
50,000,000
Balance
40,000,000
30,000,000
20,000,000
10,000,000
0
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37
Years
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Payments and Liabilities
90,000,000
80,000,000
70,000,000
60,000,000
50,000,000
40,000,000
30,000,000
20,000,000
10,000,000
-
Cummulative Paid
34
32
30
28
26
24
22
20
18
16
14
12
10
8
6
4
2
Liabilities
0
Dollars
Summary of Liabilities and Cummulative Paid
Years
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Investment earnings
Rolling 3 Year - Yield to Maturity Comparison
9.00%
8.00%
7.00%
6.00%
5.00%
4.00%
3.00%
2.00%
1.00%
Fe
bSe 9 1
pAp 91
rNo 92
v9
Ju 2
n9
Ja 3
n9
Au 4
g
M -94
ar
-9
O 5
ct
M -95
ay
De 96
c9
Ju 6
l-9
Fe 7
bSe 9 8
pAp 98
rNo 99
v9
Ju 9
n0
Ja 0
nAu 01
g
M -01
ar
-0
O 2
ct
M -02
ay
De 03
c0
Ju 3
l-0
Fe 4
bSe 0 5
pAp 05
rNo 06
v0
Ju 6
n0
Ja 7
nAu 08
g
M -08
ar
-0
O 9
ct
M -09
ay
De 10
c1
Ju 0
l-1
1
0.00%
BAML Government 1-5 Year Index
BAML Government 1-10 Year Index
BAML Treas, Current 5 Year
BAML Treas, Current 10 Year
BAML Corp/Gov 1-5 Year, A & Above Index
Contributed by Martin Castle, Chandler Asset Management
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James Marta & Company, CPAs
06/30/11
08/31/10
10/31/09
12/31/08
02/29/08
04/30/07
06/30/06
08/31/05
10/31/04
12/31/03
02/28/03
04/30/02
06/30/01
08/31/00
10/31/99
12/31/98
02/28/98
04/30/97
06/30/96
08/31/95
10/31/94
12/31/93
02/28/93
04/30/92
06/30/91
08/31/90
10/31/89
12/31/88
Date
Yields over time
Yield to Maturity
12
10
8
6
4
2
0
Yld to Mat
5 year government and corporate note yields
Contributed by Martin Castle, Chandler Asset Management
15
What have been your recent rates?
Analysis of Investment Earnings
9
8
7
Percent
6
5
Rate of return incl. change FMV
4
Rate of return excl. change in FMV
3
2
1
0
2004
2005
2006
2007
2008
2009
2010
2011
Fiscal Year
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What assumptions should you use?
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A. You could average the past 10 years
B. Assume yields will improve
C. Assume yields will continue to erode
D. Assume yields will stay the same.
E. Don’t discount your claim liabilities
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Financial Statement Affect
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Earnings GAAP: if you assume you will earn 5% and you
only earn 2% then that difference will hit the financial
statements as follows.
you will have less earnings
your claim liabilities for the older years will increase.
This is known as “Unwinding of the discount” and gets
buried in the claims development.
Everything else being normal, you would have a
reduction of net assets
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Why discount?
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Rewards:
Contemplates the time value of
money
Allows the pool to efficiently price
claims and coverage
Improves stated financial
position
Future earnings contribute to the
expected cash flows and claim
funding
Competitive rates
Attract and maintain members
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Why you shouldn’t discount?
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Risks:
Ruin
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You are fired
Assessment
Increase in rates
Decrease in ability to compete
Variability
Members leave
Adverse risk pool
Give back money when you shouldn’t
Set rates too low
Based on assumptions you maintain too
little capital
Failure in ability to match rates with costs
on an incurred or accrued basis
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Actuary Role
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Client picks a rate assumption, the actuary
disclaims any opinion on it
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Really? How can the actuary disclaim on such an
important component of the estimate factors?
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Actuary: Well, because we have limited background in
finance and investments. And, the same reason that
accountants and risk managers do not opine on IBNR
reserves.
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Actuary provides a range of claim valuations
at various discount rates
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Starts the discussion
Gives you information to value using different
assumptions.
You could use this information along with other advisor’s
information.
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Actuary recommends a particular discount
rate
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Industry experience and an understanding of the longterm cash flows.
However, you don’t always have sufficient information on
the actual investment portfolio and how the planned
investments will affect earnings.
Actuary: we have told clients that their discounts are too
high. But no, we cannot pick it for them.
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Actuary recommends or uses a risk free rate
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Roger G. Ibbotson and Rex. A . Sinqefiled analyzed
treasury bills, long-term bonds and corporate notes and
found that the inflation adjusted returns:
 Treasury
near zero
 Long-term government bonds near zero
 Long-tem corporate notes .5%
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Actuary recommends not to discount
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Most conservative
May be preferred if there are more volatile factors.
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Example disclosure
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The board has elected to discount claims liabilities at the 3.0% rate. The
discounting assumption contemplates that if the value of discounted claim
liabilities are invested at the assumed rate, earnings will be sufficient to
provide for funding the claims at full value. The current portfolio has been
yielding between 1% and 2% and near 1% for new investments. The actual
earnings rate may vary from the assumed rate. The chart below shows the
claim valuation at different assumptions and the resulting affect on net
assets.
Discount Factor
Claims Liabilities
Net Asset Balance
0%
1%
2%
3%
$ 15,031,258 $ 15,020,265 $ 14,007,515 $ 13,152,596
$ 7,177,556 $ 7,188,549 $ 8,201,299 $ 9,056,218
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Should we discount?
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Variables:
Claim experience
Claim cost drivers
Legislation
Timing of payments
Are your claims and
payments predicable enough
to throw in another significant
variable?
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What your auditor might say
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We are concerned about the achievability of the discount
rate assumptions included in the actuary report.
We will consider the factors and your supporting data
when evaluating the interest rate assumptions implicit in
the discount rates applied to your claim liabilities.
Changes in these assumptions could be material to your
financial statements.
Are your financial statements fairly stated?
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Are you putting your pool at risk?
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Low rates
Dividends
Lower confidence levels
Is your discount rate achievable?
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Conclusions
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Remember:
be conservative
think long-term stability
don’t fall behind by
ratcheting down rates
overtime
don’t get caught off guard
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Questions?

What will you do now?
James Marta CPA, ARPM
Principal
James Marta & Company
Certified Public Accountants
916-993-9494
[email protected]
www.jpmcpa.com
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