CIA Annual Meeting Vancouver International Developments in Statutory Solvency

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CIA 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
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Presentation 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

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Internationally, where have we come from on
solvency?

• Origins from OSFI
• APRA
• FSA
• Solvency 2
• IAIS

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Capital requirements

• Guidance paper addresses the establishment of
  regulatory capital requirements in a solvency
  regime.
• Current guidance paper draft identifies 7 Key
  Features

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Capital 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.

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Capital 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.

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Capital 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.

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Capital 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.

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Capital 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.

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Capital 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.

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Capital 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.

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Enterprise 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

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Enterprise 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.

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Enterprise Risk Management
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Enterprise 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.

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Enterprise 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.

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Enterprise 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.

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Enterprise 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.

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Enterprise 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.

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Enterprise 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.

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Enterprise 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.

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Internal 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.

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Internal 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.

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Internal 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.

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Internal 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.

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Internal 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.

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Internal 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.

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Internal 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.

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Internal 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.

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Internal 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.

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Internal 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.

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Internal 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.

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Valuation

• 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.

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Valuation

• 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.

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Valuation

• 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.

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Valuation 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.

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Valuation 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.

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Valuation 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

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Valuation 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.

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Solvency 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.

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Solvency 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
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Solvency 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

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Likely 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.

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• Any questions?