Proposed Revision of ASOP No. 20 – Analysis of Property/Casualty Cash Flows, Including Discounting

Section 1. Purpose, Scope, Cross References, and Effective Date

1.1 Purpose

This actuarial standard of practice (ASOP or standard) provides guidance to actuaries when performing actuarial services with respect to a property/casualty cash flow analysis, including discounting.

1.2 Scope

This standard applies to actuaries when performing actuarial services with respect to a property/casualty cash flow analysis, including discounting.

This standard applies to actuaries performing a property/casualty cash flow analysis involving underwriting cash flows, investment cash flows, and other cash flows. Examples include discounted claim estimates, determination of capital adequacy, product development or ratemaking studies, evaluations of investment strategy, financial projections or forecasts, actuarial appraisals, and testing of future charges or benefits that may vary at the discretion of the insurer (for example, policyholder dividends or policy terms for retrospective premiums).

This standard applies to actuaries when performing actuarial services that involve the discounting of cash flows to a present value, including unpaid and future claim estimates. Unpaid claim estimates represent an estimate of the obligation for future loss and loss adjustment expense payments resulting from claims due to past events. Future claim estimates represent an estimate of loss and loss adjustment expenses associated with prospective property/casualty risk transfer or risk retention.

This standard applies to actuaries when performing a cash flow analysis for any class of entity, including self-insureds, insurance companies, reinsurers, governmental entities, and other risk-sharing pools. This standard applies to actuaries when estimating cash flows gross of recoverables (such as deductibles, ceded reinsurance, and salvage and subrogation), cash flows net of such recoverables, and cash flows of such recoverables.

If the actuary is performing actuarial services that involve reviewing a cash flow analysis developed by another party, the actuary should follow the guidance in section 3 to the extent practicable within the scope of the actuary’s assignment.

This standard does not require the actuary to use discounted cash flows or a risk margin in all circumstances.

This standard applies to actuaries when estimating items that may be a function of cash flows, including but not limited to loss-based taxes, contingent commissions, and retrospectively rated premiums.

This standard applies to actuaries when providing actuarial services with respect to health benefits associated with state or federal workers’ compensation statutes and liability policies. This standard does not apply to actuaries when performing actuarial services with respect to unpaid claims under a “health benefit plan” covered by ASOP No. 5; Incurred Health and Disability Claims, ASOP No. 6, Measuring Retiree Group Benefits Obligations and Determining Retiree Group Benefits Program Periodic Costs or Actuarially Determined Contributions; or included as “health and disability liabilities” under ASOP No. 42, Health and Disability Actuarial Assets and Liabilities Other Than Liabilities for Incurred Claims.

If the actuary determines that the guidance in this standard conflicts with an ASOP that applies to all practice areas, this standard governs.

If a conflict exists between this standard and applicable law (statutes, regulations, and other legally binding authority), the actuary should comply with applicable law. If the actuary departs from the guidance set forth in this standard in order to comply with applicable law or for any other reason the actuary deems appropriate, the actuary should refer to section 4.

1.3 Cross References

When this standard refers to the provisions of other documents, the reference includes the referenced documents as they may be amended or restated in the future, and any successor to them, by whatever name called. If any amended or restated document differs materially from the originally referenced document, the actuary should consider the guidance in this standard to the extent it is applicable and appropriate.

1.4 Effective Date

This standard is effective for any actuarial work product covered by this standard’s scope issued on or after four months after adoption by the Actuarial Standards Board.

Section 2. Definitions

The terms below are defined for use in this standard and appear in bold throughout the ASOP. The actuary should also refer to ASOP No. 1, Introductory Actuarial Standard of Practice, for definitions and discussions of common terms, which do not appear in bold in this standard.

2.1 Accounting Date

The stated cutoff date for reflecting events and recording amounts in a financial statement or accounting system. The accounting date is sometimes known as the “as of date.”

2.2 Cash Flow

A receipt, disbursement, or transfer of cash or equivalent assets. Cash flows may include underwriting cash flows, investment cash flows, and other cash flows. Cash flows may include historical amounts or prospective estimates.

2.3 Cash Flow Analysis

A evaluation or projection of cash flows. A cash flow analysis may include discounted cash flows.

2.4 Claim Estimate

An estimate on an undiscounted basis of the obligation for future loss and loss adjustment expenses resulting from claims due to past events or an estimate of loss and loss adjustment expenses associated with prospective property/casualty risk transfer or risk retention. Claim estimates may include elements, such as case reserves, developed by individuals other than actuaries.

2.5 Coverage

The terms and conditions of a plan or contract, or the requirements of applicable law, that create an obligation to pay benefits, expenses, or claims associated with contingent events.

2.6 Discounted Cash Flow

The actuary’s estimate of the present value of a cash flow.

2.7 Investment Cash Flows

All cash flows related to investment operations, including investment purchases, sales, income, and expenses.

2.8 Other Cash Flows

All cash flows not related to underwriting or investment operations. Examples include shareholder dividends, capital contributions, and non-risk bearing fee income.

2.9 Risk Margin

A provision for uncertainty in a cash flow analysis. A risk margin may be implicit or explicit.

2.10 Risk Retention

A risk-management and risk-control strategy for the assessment, management, or financing of retained risk associated with the specific coverage. Examples of risk retention include individual and group self-insurance and large deductible programs.

2.11 Risk Transfer

A risk-management and risk-control strategy, involving legally binding agreements, that shifts responsibility from one party to another or indemnifies one party by another party for the financial obligations associated with the coverage. Examples of risk transfer include insurance, reinsurance, captive insurance, and loss portfolio transfers.

2.12 Underwriting Cash Flows

All cash flows related to underwriting operations, including premiums, claims, claims expenses, and underwriting expenses.

Section 3. Analysis of Issues and Recommended Practices

3.1 Intended Purpose and Identification of Cash Flows

The actuary should identify the intended purpose of the cash flow analysis. The actuary should identify the cash flows and accounting date(s) to be used in the cash flow analysis consistent with the intended purpose. The actuary should identify the date(s) to which the cash flow analysis is discounted, if applicable.

When the cash flow analysis includes

1. expense provisions, the actuary should refer to ASOP No. 29, Expense Provisions in Property/Casualty Insurance Ratemaking.
2. profit and contingencies provisions, the actuary should refer to ASOP No. 30, Treatment of Profit and Contingency Provisions and the Cost of Capital in Property/Casualty Insurance Ratemaking.
3. cash flows related to catastrophes or extreme events, the actuary should refer to ASOP No. 39, Treatment of Catastrophe Losses in Property/Casualty Insurance Ratemaking.
4. unpaid claim estimates, the actuary should refer to ASOP No. 43, Property/Casualty Unpaid Claim Estimates.
5. future claim estimates associated with prospective risk transfer or risk retention, the actuary should refer to ASOP No. 53, Estimating Future Costs for Prospective Property/Casualty Risk Transfer and Risk Retention.

3.2 Methods, Models, and Assumptions

The actuary should select methods, models, and assumptions in the cash flow analysis that are appropriate for the intended purpose. In determining the methods, models, and assumptions appropriate for the circumstances of the cash flow analysis, the actuary should take into account the types of underwriting cash flows, investment cash flows, and other cash flows, the variability of risks associated with those cash flows, and any interactions between these risks.

When selecting methods, models, and assumptions for a discounted cash flow analysis, the actuary should take into account the relative impact of various methods, models, and assumptions on the discounted cash flow analysis versus the undiscounted cash flow analysis. For example, a development factor at an advanced maturity (such as a “tail factor”) has less impact on a discounted estimate than on an undiscounted estimate. Conversely, a change in the timing of loss payments may have a greater impact on a discounted estimate than on an undiscounted estimate.

3.3 Cash Flow Timing and Amount

The actuary should use reasonable assumptions regarding the timing and amount of cash flows. Assumptions may be implicit or explicit and may involve interpreting past data or projecting future trends.

3.3.1 Unbiased Assumptions

The actuary should use assumptions that the actuary expects to have no material bias to underestimation or overestimation of the cash flows, prior to consideration of any risk margins.

3.3.2 Consistency of Estimates

When projecting cash flows using an initial total amount that was not derived using a cash flow analysis, the actuary should confirm that the total projected cash flows are consistent with this initial amount. For example, if discounting an unpaid claim estimate, the cash flow analysis should be consistent with the unpaid claim estimate produced by the unpaid claim analysis.

3.3.3 Consistency with Expected Future Conditions

The actuary should determine estimates of the timing of cash flows that are consistent with conditions expected to prevail during the future period. If conditions are expected to be different from those prevailing during the historical evaluation period, the actuary should make appropriate adjustments to the estimated cash flow timing.

3.3.4 Sensitivity of Assumptions

When discounting cash flows, the actuary should take into account the sensitivity of discounted cash flows to the timing of future payments and may use a range of payment pattern assumptions.

3.3.5 Underwriting Cash Flows

If the cash flow analysis includes underwriting cash flows, the actuary should take into account coverage, accident or policy period, reinsurance terms, and any other features that may have a material effect on the timing and amount of such underwriting cash flows.

The actuary should use assumptions in estimating the timing of underwriting cash flows that are consistent with the assumptions used in developing premiums, underwriting expenses, and claim estimates, when the assumptions are available.

The actuary should take into account the timing and amount of expected recoverables (for example, deductibles, reinsurance, retrospective premium adjustments, ceding commissions, and salvage and subrogation) that may impact the underwriting cash flows to the extent appropriate.

3.3.6 Investment Cash Flows

If the cash flow analysis includes investment cash flows, the actuary should take into account the composition of the projected investment portfolio in terms of type, quality, and maturity. The projected earnings rate of the investments should be consistent with the valuation of the investments (for example, book or market) and the future investment strategy to the extent known by the actuary.

3.3.7 Future Other Cash Flows

If the cash flow analysis includes other cash flows, the actuary should take into account relevant factors, such as historical other cash flows and the entity’s policies, that influence the timing and magnitude of the projected other cash flows.

3.4 Discount Rates

When discounting cash flows, the actuary should use reasonable discount rates. The actuary may use a discount rate that is a single rate or a series of rates, such as a yield curve. The actuary may use a range of discount rates or discount rates that vary by type of cash flow.

3.4.1 Selection of Discount Rates

The actuary should select discount rates that are appropriate for the intended purpose. When selecting discount rates, the actuary should use one or more of the following:

3.4.1.1 Risk-Free Approach

This approach utilizes risk-free interest rates. Risk-free interest rates can be approximated by rates of investment return available on fixed-income assets having low investment risk and timing characteristics consistent with the cash flows.

3.4.1.2 Portfolio Approach

The selected discount rates in this approach are based on the anticipated return from a selected portfolio of assets. The portfolio of assets may reflect the actual assets supporting the cash flows to be discounted. Alternatively, the portfolio of assets may represent a notional portfolio that the actuary deems to be appropriate based on the characteristics of the notional assets in relation to the cash flows to be discounted.

When using the portfolio approach, the actuary should take into account, to the extent appropriate, the relationships between

1. 1. 1. the book value and market value of assets,
      2. the anticipated portfolio rates of return and market rates of return, and
      3. the maturities of the assets and the estimated timing of cash flows.

The actuary should also take into account investment expenses.

3.4.1.3 Discount Rates Provided by Another Party

When using discount rates provided by another party, the actuary should assess the discount rates for reasonableness.

3.4.1.4 Other Approaches

Other approaches, such as discounting to reflect the cost of capital, may be appropriate based on the intended purpose of the cash flow analysis.

3.4.2 Economic Conditions

When selecting discount rate assumptions, the actuary should take into account economic factors over the expected cash flow period including inflation, inflation risk, and macroeconomic conditions. The actuary should consider reflecting short-term versus long-term returns when selecting the discount rate(s), recognizing that long-term returns are generally more uncertain than short-term returns. The actuary should consider adjusting the discount rate(s) to reflect the uncertainty in future economic conditions.

3.4.3 Changing Conditions

The actuary should take into account whether there have been significant changes in conditions that impact cash flows, particularly with regard to claim estimates, that may not be sufficiently reflected in the experience data or in the assumptions used to estimate cash flows. Examples include legislative or judicial changes, operational changes, reinsurance program changes, and changes in the practices used by the entity’s claims personnel to the extent such changes are likely to have a material effect on the results of the actuary’s cash flow analysis. Changing conditions can arise from circumstances particular to the entity or from external factors affecting others within an industry.

3.5 Risk Margins

The actuary should consider including risk margins in a discounted cash flow analysis. The actuary may consider including risk margins in a cash flow analysis that is not discounted, depending on the intended use of the cash flow analysis.

3.5.1 Implicit and Explicit Risk Margins

The actuary may include implicit risk margins through the selection of cash flows (including claim estimates), cash flow patterns, or discount rates. The actuary may include explicit risk margins as an absolute amount (for example, stated percentile of distribution, a fixed amount, or stated percentage load above expected) or through an explicit adjustment to the selected discount rate(s).

3.5.2 Considerations for Discounted Cash Flows

Discounting a reasonable undiscounted cash flow may result in an inadequate discounted cash flow, unless appropriate risk margins are included. When determining the amount of risk margin, the actuary should take into account the increase in uncertainty associated with the discounting calculation due to uncertainties in cash flow timing and discount rate selection.

3.5.3 Applicable Law and Accounting Standards

The actuary should take into account whether applicable law and accounting standards impose constraints or requirements related to the use of risk margins.

3.6 Significant Limitations

The actuary should identify any significant limitations that constrain the actuary’s cash flow analysis if, in the actuary’s professional judgment, there is a significant risk that a more in-depth analysis would produce a materially different result.

3.7 Changes in Methods, Models, and Assumptions

When the cash flow analysis is an update of a previous analysis, the actuary should identify changes in methods, models, or assumptions that the actuary believes to have a material impact on the cash flow analysis and the reasons for such changes to the extent known by the actuary. This standard does not require the actuary to measure or quantify the impact of such changes.

3.8 Reliance on Another Party

When relying on another party and thereby disclaiming responsibility for

1. data and other information relevant to the use of data, the actuary should refer to ASOP No. 23, Data Quality.
2. a model, the actuary should refer to ASOP No. 56, Modeling.
3. assumptions or methods prescribed by another party, the actuary should review the assumption or method for reasonableness and consistency with other assumptions or methods to the extent practicable and appropriate within the scope of the actuary’s assignment.
4. any other item not addressed above (including assumptions or methods provided, but not prescribed, by another party), the actuary should review the item for reasonableness and consistency to the extent practicable and appropriate within the scope of the actuary’s assignment. In addition, the actuary should be reasonably satisfied that the reliance is appropriate, taking into account the following, as applicable:
   1. when the other party is an actuary, whether the actuary knows that the other party is appropriately qualified and has followed applicable ASOPs;
   2. whether the actuary knows that the other party has expertise in the applicable field;
   3. whether the actuary knows the other party’s stated purpose for the item and the extent to which it is consistent with the actuary’s intended purpose; and
   4. whether the actuary knows of differences of opinion within the other party’s field of expertise that are material to the actuary’s use of the item.

3.9 Documentation

The actuary should prepare and retain documentation to support compliance with the requirements of section 3 and the disclosure requirements of section 4. The actuary should prepare documentation in a form such that another actuary qualified in the same practice area could assess the reasonableness of the actuary’s work. The amount, form, and detail of the documentation should be based on the professional judgment of the actuary and may vary with the complexity and purpose of the actuarial services. In addition, the actuary should refer to ASOP No. 41, Actuarial Communications, for guidance related to the retention of file material other than that which is to be disclosed under section 4.

Section 4. Communications and Disclosures

4.1 Required Disclosures in an Actuarial Report

When issuing an actuarial report, the actuary should refer to ASOP Nos. 23, 29, 30, 39, 41, 43, 53, and 56.

In addition, the actuary should disclose the following in such actuarial reports, if applicable:

1. the intended purpose of the cash flow analysis (see section 3.1);
2. the accounting date(s) of the cash flow analysis (see section 3.1);
3. the date(s) to which the cash flow analysis is discounted (see section 3.1);
4. any material differences between the methods, models, and assumptions underlying the cash flow analysis and the discounted cash flow analysis (see section 3.2);
5. the cash flow timing assumptions and the basis for those assumptions (see section 3.3);
6. specific significant risks and uncertainties, if any, with regard to actual timing and amount of cash flows (see section 3.3);
7. the basis of the range of cash flow analysis results, if the actuary provides a range (see sections 3.3 and 3.4);
8. the discount rate assumptions, the basis for those assumptions (including any material economic or operational changes from current conditions), and the treatment of any investment expenses (see section 3.4);
9. when the discount rate was provided by another party, the party that provided the discount rate, the reasonableness of the discount rate, and the basis for the determination of reasonableness (see section 3.4.1.3);
10. whether the cash flow analysis includes a risk margin, and the basis for any explicit risk margin (see section 3.5);
11. any significant limitations that constrained the actuary’s cash flow analysis (see section 3.6);
12. changes in methods, models, or assumptions that the actuary believes to have a material impact on the cash flow analysis and the reasons for such changes to the extent known by the actuary, if the cash flow analysis is an update of a previous estimate (see section 3.7); and
13. when assumptions or methods other than the discount rate are prescribed or provided by another party, the party that prescribed or provided them, and, to the extent practicable, the reasonableness of the method or assumption (section 3.8).

4.2 Additional Disclosures in an Actuarial Report

The actuary also should include disclosures in an actuarial report in accordance with ASOP No. 41 for any of the following circumstances:

1. if any material assumption or method was prescribed by applicable law;
2. if the actuary states reliance on other sources and thereby disclaims responsibility for any material assumption or method selected by a party other than the actuary; and
3. if in the actuary’s professional judgment, the actuary has deviated materially from the guidance of this standard.

4.3 Confidential Information

Nothing in this standard is intended to require the actuary to disclose confidential information.

APPENDIX

Background and Current Practices

Note: This appendix is provided for informational purposes and is not part of the standard of practice.

Background

Discounting Claim Estimates

Prior to the issuance of ASOP No. 20, Discounting of Property and Casualty Loss and Loss Adjustment Expense Reserves, there was no standard of practice concerning discounting of property and casualty loss and loss adjustment expense reserves. Since then, the ASB has issued ASOP No. 36, Statements of Actuarial Opinion Regarding Property/Casualty Loss and Loss Adjustment Expense Reserves, and ASOP No. 43, Property/Casualty Unpaid Claim Estimates. The 2011 revision of ASOP No. 20 provided more consistency with the language in these two ASOPs and updated guidance for the increased use of discounting related to fair value calculations.

In 2017, the ASB issued ASOP No. 53, Estimating Future Costs for Prospective Property/ Casualty Risk Transfer and Risk Retention, to provide guidance for actuaries engaged in loss accrual determinations, premium setting, and ratemaking assignments. The introduction of ASOP No. 53 highlighted the need to extend the guidance of ASOP No. 20 to these types of actuarial work products in a manner similar to the relationship between ASOP No. 20 and ASOP No. 43. In practice, a wide variety of loss reserving and loss funding or ratemaking assignments are performed concurrently using the same data and similar methods and assumptions. In the context of ratemaking, this standard may provide guidance on the discounting of the loss and loss adjustment expense components.

One challenge related to discounting is that the appropriateness of discounting varies greatly depending on the line(s) of insurance coverage, the type of risk financing or risk retention mechanism, the applicable financial reporting and accounting standards, and even the intended use of the work product (for example, insurance company valuation versus statutory loss reserving). As a result, the use of discounting is inexorably tied to the context of the assignment. Traditionally, for admitted U.S. property/casualty insurance companies, unpaid claim estimates have not been discounted except in certain narrowly defined circumstances. However, in a wide and growing variety of other circumstances discounting is commonplace. In 1986, the U.S. Congress passed legislation prescribing discounting procedures for income-tax purposes. In the past, most state insurance departments prohibited discounting; some departments have permitted discounting for some lines of business. While the National Association of Insurance Commissioners (NAIC) has consistently been opposed to discounting except in certain specific circumstances, other regulators have moved to requiring discounting. The various applicable accounting standards organizations have taken a similarly divergent set of positions in their standards.

Historically, the issue of reserve discounting has been closely related to the issue of risk margins. Undiscounted reserves are often considered to contain a needed implicit risk margin in the difference between undiscounted reserves and discounted reserves. If discounted reserves were incorporated into financial statements, many would argue that an explicit risk margin would become necessary. Suggestions for the treatment of that risk margin include treatment as a liability item, a segregated surplus item, or an off-balance-sheet item.

Unpaid claim estimate discounting calculations are commonly performed in conjunction with valuations of insurance companies for purposes such as acquisitions or mergers, commutations, transfers of portfolios of unpaid claims, or other reinsurance transactions. In these instances and for other reasons, actuaries are being asked to determine or evaluate discounted unpaid claim estimates more frequently.

Other Cash Flow Analyses

In 2024, the ASB decided to remove property/casualty actuarial practice from the scope of ASOP No. 7, Analysis of Life, Health and Property/Casualty Insurance Cash Flows. This revision of ASOP No. 20 expands the scope to incorporate the elements of ASOP No. 7 that previously applied to property/casualty actuarial practice. This expansion in scope provides guidance on both discounted and undiscounted cash flow analyses.

Current Practices

Property/casualty actuaries use cash flow analyses in a wide variety of work products. These include discounted claim estimates, insurance program valuations, reinsurance pricing (such as loss portfolio transfers); premium deficiency reserve estimates; death, disability, and retirement (DD&R or “free tail”) reserves; capital adequacy testing; expected reinsurer deficit (ERD); expected adverse deviation (EAD); and pro forma financial statements. These cash flow analyses sometimes, but not always, involve discounting to a present value. Cash flow analyses can include underwriting cash flows, such as premiums, losses, loss adjustment expenses, and underwriting expenses. They can also contemplate investment activities (such as purchase and sale of assets, investment returns, and expenses) and other cash flows (such as capital contributions and payment of shareholder dividends). Many cash flow analyses involve more than solely discounting unpaid claim estimates. For example, insurance program valuations and pro forma financial statements commonly reflect a comprehensive set of all cash flows for the insurance entity.

Discounted Claim Estimates

Actuaries are currently guided by ASOP No. 20, Discounting of Property/Casualty Claim Estimates. Other principal standards issued by the ASB pertaining to property/casualty loss and loss adjustment expense estimates are ASOP No. 43 and ASOP No. 53. In addition, disclosures related to discounting are required by the NAIC, and guidance may be forthcoming as part of new International Financial Reporting Standards that are currently under development.

Numerous educational papers relevant to the topic of discounting and risk loads, including those published by the Casualty Actuarial Society, are in the public domain. While these may provide useful educational information to practicing actuaries, they are not actuarial standards of practice and are not binding.

The data, methods, models, and assumptions used for discounting claim estimates are becoming more complex due to a variety of forces. Varying laws, regulations, and judicial precedents apply differing rules to discounting claim estimates in different situations. Non-actuaries, such as investment managers and finance departments, are often involved in providing discount rates. A variety of discount rates or other scenario tests are often requested depending on the intended use of the analysis.

Other Cash Flow Analyses

Actuaries are currently guided by ASOP No. 7. Cash flow analysis can be used in a variety of ways, such as analyzing the performance of a particular asset or product under certain specified scenarios or evaluating the solvency of the entire company. Cash flow analyses involving cash flows other than claim estimates may or may not involve discounting. Those not involving discounting, such as many pro forma financial statements, are guided by ASOP No. 7 and not ASOP No. 20. Discounted cash flow analyses, including claim estimates and other cash flows (e.g. premiums), are guided by both ASOP No. 7 and ASOP No. 20.

Because the cash flow analyses performed by property/casualty actuaries almost always include claim estimates, ASOP No. 20 is often viewed by practitioners as the primary guidance for discounted cash flow analyses, even if the analysis includes cash flows other than claim estimates. ASOP No. 7 applies to life, health, and property/casualty actuaries, while ASOP No. 20 applies only to property/casualty actuaries. As a result, the two standards often use materially different terminology that at times makes applying both standards challenging.