Title: CIA Annual Meeting Vancouver International Developments in Statutory Solvency
1CIA Annual Meeting VancouverInternational
Developments in Statutory Solvency
- Rob Curtis
- Chair, Solvency Actuarial Issues Sub Committee
- IAIS
- Head of Insurance Technical Risk
- FSA
28 June 2007
2Presentation overview
- Internationally, where have we come from on
solvency? - Capital requirements
- Enterprise risk management
- Internal models
- Valuation of assets and liabilities
- Solvency 2 framework
- Likely future solvency work
3Internationally, where have we come from on
solvency?
- Origins from OSFI
- APRA
- FSA
- Solvency 2
- IAIS
4Capital requirements
- Guidance paper addresses the establishment of
regulatory capital requirements in a solvency
regime. - Current guidance paper draft identifies 7 Key
Features
5Capital requirements
-
- Key Feature 1 - Purpose and Definition of
Capital - Regulatory capital requirements should be
established such that, in adversity, an insurers
obligations to policyholders will continue to be
met as they fall due. - These requirements should be defined such that
assets will exceed technical provisions and other
liabilities with a specified level of safety over
a defined time horizon.
6Capital requirements
- Key Feature 2 - Purpose and Definition of
Capital (Cont.) - A total balance sheet approach should be used to
recognise the interdependence between assets,
liabilities, regulatory capital requirements and
capital resources and to ensure that risks are
appropriately recognised.
7Capital requirements
- Key Feature 3 Solvency Control Levels
- The solvency regime should include a range of
solvency control levels which trigger different
degrees of intervention by the supervisor in a
timely manner. - The solvency regime should have due regard to the
coherence of the solvency control levels and any
corrective action that may be at the disposal of
the insurer, and of the supervisor, including
options to reduce the risks being taken by the
insurer as well as to raise more capital.
8Capital requirements
- Key Feature 4 Approaches to Regulatory Capital
Requirements - The solvency regime should allow a range of
approaches for determining regulatory capital
requirements, including standardised approaches
and, subject to approval by the supervisor, the
use of internal models.
9Capital requirements
- Key Feature 5 Approaches to Regulatory Capital
Requirements (Cont.) - The solvency regime should require an insurer to
undertake periodic, forward-looking continuity
analysis and modelling of the insurers ability
to meet its regulatory capital requirements under
various conditions.
10Capital requirements
- Key Feature 6 Determining Regulatory Capital
Requirements - The solvency regime should be explicit as to the
risks addressed in technical provisions and in
regulatory capital requirements, or partially in
both. The regime should also be explicit as to
how risks are reflected in regulatory capital
requirements.
11Capital requirements
- Key Feature 7 Supervisory Reporting and Public
Disclosure - The solvency regime should be open and
transparent as to the regulatory capital
requirements that apply, and be explicit about
their objectives and the basis on which they are
determined (including the level of safety, risk
measures used and time horizon that underpin
them). - The solvency regime should be supported by
appropriate public disclosure and additional
confidential reporting to the supervisor.
12Enterprise Risk Management
- Guidance paper provides guidance on the
establishment and operation of an enterprise risk
management framework, and its importance from a
supervisory perspective in underpinning a robust
solvency assessment. - Current draft identifies 8 Key Features
13Enterprise Risk Management
- Key Feature 1 Governance and ERM
- An insurer should establish, and operate within,
a sound enterprise risk management framework as
part of its overall governance structure. The
framework should be integrated with the insurers
business operations, reflecting desired business
culture and behavioural expectations and
addressing all reasonably foreseeable and
relevant material risks faced by the insurer in
accordance with a properly constructed risk
management policy. - The establishment and operation of the ERM
framework should be led and informed by senior
management and overseen by the insurer's board. - For it to be adequate for capital management and
solvency purposes, the framework should include
provision for the quantification of risk for a
sufficiently wide range of outcomes using
appropriate techniques.
14Enterprise Risk Management
15Enterprise Risk Management
- Risk Management Policy
- Key Feature 2
- An insurer should have a risk management policy
which outlines the way in which the insurer
manages each relevant and material category of
risk, both strategically and operationally, and
describes the linkage with the insurers
tolerance limits, regulatory capital
requirements, economic capital and the processes
and methods for monitoring risk.
16Enterprise Risk Management
- Key Feature 3 Risk Tolerance Statement
- An insurer should establish and maintain a risk
tolerance statement which sets out its
quantitative and qualitative tolerance levels
overall and defines tolerance limits, taking
into account each relevant and material category
of risk and the relationships between them. The
risk tolerance statement should outline how the
insurers risk management policies and procedures
embed the defined tolerance limits in the
insurer's on-going operations. - The risk tolerance levels should be based on the
insurer's strategy and be actively applied within
the insurer's enterprise risk management
framework and under the insurer's risk management
policy.
17Enterprise Risk Management
- Key Feature 4 Risk Responsiveness and Feedback
Loop - The insurer's risk management should be
responsive to change. - The ERM framework should incorporate a feedback
loop, based on appropriate and good quality
information management processes, which enable
the insurer to take the necessary action in a
timely manner in response to changes in its risk
profile.
18Enterprise Risk Management
- Key Feature 5 Own Risk and Solvency Assessment
(ORSA) - An insurer should perform its own risk and
solvency assessment, encompassing all reasonably
foreseeable and relevant material risks
including, as a minimum, underwriting, credit,
market, operational and liquidity risks and
identifying the relationship between risk
management and the level and quality of
financial resources needed.
19Enterprise Risk Management
- Key Feature 6 (ORSA Cont.)
- The insurer should apply its own risk and
solvency assessment to determine the financial
resources it needs to manage its business given
its own risk tolerance and business plans, and to
demonstrate that supervisory requirements are
met. - The insurer's risk management actions should be
based on its own risk and solvency assessment and
both its economic capital and regulatory capital
requirements.
20Enterprise Risk Management
- Key Feature 7 Continuity Analysis
- An insurer should analyse its ability to continue
in business and the risk management required over
a longer time horizon than typically used to
determine regulatory capital requirements. - Such continuity analysis should address a
combination of quantitative and qualitative
elements in the medium and longer term business
strategy of the insurer and include projections
of the insurer's future financial position.
21Enterprise Risk Management
- Key Feature 8 Role of Supervision in Risk
Management - The supervisor should undertake regular reviews
of an insurer's risk management processes, and
its financial condition according to the nature,
scale and complexity of the insurers business. - The supervisor should use its powers to require
strengthening of risk management in relation to
solvency assessment and capital management, where
necessary.
22Internal Models
- The guidance paper sets out a high-level
framework for supervisors to use in the
assessment of internal models used by insurers. - Outlines 10 key features which should be
encouraged for all insurers using internal models
for solvency assessment and capital management
purposes.
23Internal Models
- Key Feature 1 Using an Internal Model to
Determine an Insurers Economic Capital - An insurer's internal model should be one of its
main strategic and operational decision-making
tools which integrates the processes of risk and
capital management to assess the risks faced
within its business, and assist in determining
the capital needed to meet those risks, where
appropriate.
24Internal Models
- Key Feature 2 - Using an Internal Model to
Determine an Insurers Economic Capital (Cont.) - An insurer's internal model should be calibrated
on the basis of defined modelling criteria which
the insurer believes will determine the level of
capital appropriate and sufficient to meet its
business plan and strategic objectives, ensuring
as a minimum, that the insurer can continue to
meet its policyholder liabilities as they fall
due. - This level of capital should be responsive to the
risk profile of the insurer.
25Internal Models
- Key Feature 3 Criteria for the Use of an
Internal Model to Determine an Insurers
Regulatory Capital Requirements - Where a supervisory regime allows the use of
internal models to determine regulatory capital
requirements, the supervisor should establish
appropriate modelling criteria to be used for
that purpose, which would ensure broad
consistency between all insurers within the
regime.
26Internal Models
- Key Feature 4 Construction of the Internal
Model - Model Design - The type of internal model used should be
appropriate to the nature, scale and complexity
of the insurer's business. In constructing its
internal model, an insurer should adopt risk
modelling techniques and approaches which are
most appropriate to the nature, scale and
complexity of the risks incorporated within the
insurer's risk strategy and business objectives,
and which are suitable for use as part of its
risk and capital management processes and
procedures.
27Internal Models
- Key Feature 5 Model Design (Statistical
Quality Test) - As part of its internal validation process for
internal models, an insurer should conduct a
'statistical quality test' which assesses the
base methodology of the quantitative model. An
insurer should consider the model inputs,
parameters, assumptions used and the
appropriateness of the methodology as part of
this test process, and ensure that the data used
in the model is of sufficient quality and
robustness.
28Internal Models
- Key Feature 6 Model Design (Calibration Test)
- As part of its internal validation process for
internal models, an insurer should conduct a
'calibration test' to assess that the output
produced by the model is consistent with the
modelling criteria established by the insurer to
satisfy its risk strategy and business
objectives. - Where the insurer also uses its internal model
for determining its regulatory capital
requirements, it should recalibrate the model to
the modelling criteria specified by the
supervisor, where these are different from its
own modelling criteria. The insurer should then
conduct a further calibration test to confirm the
validity of the model outputs for this purpose.
29Internal Models
- Key Feature 7 Governance and Communication
(Use Test) - In order to successfully validate its internal
models for use as part of risk and capital
management, an insurer should conduct a 'use
test' to ensure that the internal model, its
methodologies and results, are fully embedded
into the risk strategy and operational processes
of the insurer. - The insurer's board and senior management should
have overall control of and responsibility for
the construction and use of the internal model
for risk management purposes, and ensure that
they have sufficient understanding of the model's
construction, outputs and limitations, in
particular its consequences for risk and capital
management decisions.
30Internal Models
- Key Feature 8 Supervisory Approval of the Use
of an Insurers Model for Regulatory Purposes - Where an insurer is allowed (or required by the
supervisor) to calculate its regulatory capital
requirements using an internal model, as part of
an overall assessment into the insurer's
financial position, the use of the internal model
for regulatory capital purposes should be subject
to a prior approval process by the supervisor. - In considering the review of an insurer's
internal model, the supervisor should ensure that
it remains fit for purpose in changing
circumstances against the criteria of the
statistical quality test, calibration test, and
use test, and that the model has robust
governance and internal controls in place.
31Internal Models
- Key Feature 9 Supervisory Responsibilities
- The supervisor should ensure that it has access
to the necessary skills, competencies, and
resources in order to enable it to adequately
assess an insurer's internal model for regulatory
purposes. - The supervisor may wish to examine reviews
conducted by relevant external specialists. In
such instances, the supervisor would have
ultimate responsibility for approving the use of
the insurer's internal model for regulatory
capital purposes.
32Internal Models
- Key Feature 10 Supervisory Reporting and
Public Disclosure - An insurer should provide information on its
internal models for both supervisory reporting
and public disclosure. The information should
include details of how the model is embedded into
the insurer's governance and operational
processes and risk strategy, as well as
information on the risks assessed by the model
and the capital assessment derived from its
operation. - The supervisor should have the power to require
insurers to report information necessary for
supervisory review and ongoing approval where
appropriate. The supervisor should consider the
appropriate level of public disclosure having due
regard to any proprietary or confidential
information.
33Valuation
- Current position of IAIS is to issue a position
paper in conjunction with the IAIS response to
the IASB Discussion Paper - Valuation of Assets and Liabilities General
Requirements - The valuation of assets and liabilities for
solvency purposes should be undertaken on a
market consistent basis.
34Valuation
- In line with a market consistent valuation
approach, observable inputs from deep and liquid
markets should be used to the fullest extent
possible in the valuation of technical
provisions. -
- In the absence of deep liquid secondary markets
that provide sufficiently robust values of
insurance obligations, elements of insurance
obligations should be valued using cash flow
models or other methods that reflect the
settlement of the insurance obligations and
accord with principles, methodologies and
parameters that the market would expect to be
used. Such valuations could be considered to be
"market consistent.
35Valuation
- Valuation of technical provisions
- Technical provisions should be valued in a
prudent, reliable and objective manner to allow
comparison across insurers worldwide. - An exit model is preferable for the valuation of
technical provisions, noting that the value of
technical provisions includes a risk margin and
that any profit on inception should be recognised
only where the valuation has provided for an
appropriate and sufficiently reliable risk
margin. - The credit standing of an insurer should not be
considered in the valuation of its insurance
liabilities.
36Valuation of Assets and Liabilities
- Components of the Technical Provisions
- Technical provisions comprise two components
the current estimate of the costs of meeting the
insurance obligations (Current Estimate) and a
margin for risk (Margin over Current Estimate or
MOCE). - Given the intrinsic uncertainty of insurance
obligations, the technical provisions need to
include a risk margin over the current estimate
of the cost of meeting the policy obligations.
37Valuation of Assets and Liabilities
- Components of the technical provisions (Cont.)
- The risk reflected in the risk margin in
technical provisions relates to all liability
cash flows and thus to the full time horizon of
the insurance contracts underlying these
technical provisions. - The current estimate should be determined as an
unbiased estimate of the future cash flows that
are expected to arise from each policy or
contract, reflecting the time value of money.
That is, the current estimate is the expected
present value of probability weighted cash flows
using current assumptions.
38Valuation of Assets and Liabilities
- Components of the technical provisions (Cont.)
- The MOCE should be determined using market
consistent principles, methodologies and
parameters, such that the technical provisions
reflect the value that an insurer would be
expected to require in order to take over the
obligations
39Valuation of Assets and Liabilities
- The determination of the technical provisions
should take into account, on the basis of
credible current assumptions, any embedded
options or guarantees for the policyholder or the
insurer, including the possibility of policy
lapse and the payment of a surrender value.
40Solvency 2 Framework
- Commission level 1 draft text includes high-level
principles for the new solvency regime. - CEIOPS has published various Consultation Papers
providing advice on the details. - Further development in level 2 implementing
measures to now occur and the QIS results to be
analysed.
41Solvency 2 Framework
Use of internal models to calculate regulatory
capital (SCR)
Use of internal models as part of own risk
solvency assessment
Disclosure of internal model information
42Solvency 2 Framework
- Solvency 2 uses the same basis as the IAIS
except - Confidence level comparable with a minimum
investment grade level approximately equating to
a 99.5 VaR calibrated confidence level over a
one year timeframe - Risk margin Cost of capital approach
- Groups proposal
43Likely Future Solvency Work
- IAIS committed to publishing standards in 2008.
- Tentative moves now being examined regarding
Group solvency requirements and mutual
recognition. - In Solvency 2, CEIOPS will focus on level 2
implementing measures following approval of the
draft Commission text in July. - Other jurisdictions now actively in the process
of changing their solvency regimes e.g. Japan and
Australia. - Industry consultation will be ongoing.
44