Target surplus: developing an industry approach

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Target surplus developing an industry approach

• Kent Griffin
• Robert Baillie

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What is target surplus?
Assets
Surplus
Capital reqts
Liabs
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Key issues

• Target surplus is an integral component of a
  holistic risk and capital management framework
  for a life insurance company in Australia.
• The target surplus policy will impact many
  aspects of the business including value, pricing
  and financial strength.
• The concept is recognised in many markets
  globally.
• There is considerable variation across the
  industry as to how it is defined, formulated,
  applied and monitored.

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Regulatory context

• The current regulatory environment within
  Australia does not explicitly require a company
  to have a target surplus policy, or indeed to
  hold surplus assets above the regulatory minimum.
• APRA can (under Section 68 of the Life Act) give
  direction, with the agreement of Treasurer, to
  retain a higher level of capital if there are
  reasonable grounds to believe liabilities will
  not be met as they fall due.

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The target surplus level

• It would generally reflect the greater of at
  least the following considerations.
• The amount of risk-based (or economic) capital
• An amount to ensure compliance with regulatory
  capital in adverse conditions and
• An amount required to support a specific
  financial strength rating.

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Proposed definition

• Target surplus is the amount of capital that a
  life insurance company aims, in the long term and
  in normal market conditions, to maintain above
  regulatory capital requirements, as part of a
  holistic risk management framework, balancing the
  interests of stakeholders.

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Ownership

• A companys board should have ultimate ownership
  of the target surplus policy, with regard to
• the risk tolerance of the company and
• the interests of the stakeholders.
• Policy should
• be set by the company and not be subject to
  regulation
• the policy should reflect the risk
  characteristics of the specific company and
• incorporate the management actions which a
  company would take, which are specific to the RBE
  of policyholders, disclosure policy terms and
  conditions, and the management philosophy.

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Disclosure

• We believe it is best practice for a company to
  clearly articulate target surplus policy, and
  publish externally the target relative to actual
  surplus
• This could be included as part of the annual
  results presentation, or as a note to the life
  company accounts.

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Managing a target

• Target surplus should be viewed as a target,
  not as a minimum.
• There will be periods when actual surplus will
  fall below the target.
• It requires a regular management control cycle in
  terms of
• setting and revising policy
• setting a target consistent with the policy
• monitoring actual surplus
• pro-active management of the level of capital
  resources

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Developing a policy principles

• A target surplus policy should clearly articulate
  the boards agreed level of risk tolerance.

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Risk tolerance (example)

• Mathematically, this could be expressed as
• Targets surplus is such that
• under a wide range of conditions
• total assets exceed an agreed minimum level

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Developing a policy principles

• When setting the risk tolerance, consider
• what is the implied risk of ruin of the minimum
  level?
• what are the likely consequences of breaching
  this level?

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Developing a policy principles

• The policy should clearly identify
• which risks are included and, if material, which
  risks have been excluded (and why).
• the time horizon
• the management actions that are assumed to occur
  under certain conditions
• the treatment of any offsets.

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Developing a policy principles

• The design of the policy should
• reflect the different risks and considerations
  for different lines of business
• have a target level that is reasonably stable
  under normal conditions and
• recognise that it is a target and not a minimum.

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Modelling issues

• Issues to consider when quantifying the target
  surplus level
• how to model the range of conditions
• deterministic
• probability approach
• how to model the financial impact.
• including modelling the management actions and
  policyholder reactions

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Role of the actuary

• Actuaries are well suited to advising on and
  managing to a target surplus policy.
• Target surplus impacts many areas that already
  require actuarial advice
• financial condition investigations
• profit and capital distributions
• product profitability.

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Recent APRA comments

• APRA has been investigating the methodologies
  and rationale behind the development of target
  surplus by life insurers and found the practice
  varies widely.
• APRA expects boards of life insurers to have
  developed and considered a target surplus policy
  on the advice of the appointed actuary.
• APRA also expects the appointed actuary to
  disclose a life insurers target surplus policy
  in its financial condition report.

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Professional requirements

• There is no explicit requirement for a target
  surplus in the IAAust profession standards or
  guidance notes, nor any support on advising on a
  target surplus policy.

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Recommendation (1)

• We propose that the Institute form a working
  group to develop a guidance note to support and
  strengthen the appointed actuarys role in
  providing advice on a target surplus policy.

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Recommendation (2)

• We also suggest that some revision to PS 200 be
  considered to clarify the role of the appointed
  actuary, as part of the financial condition
  report, to specifically comment on a target
  surplus.

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Process

• The institute's process may include
• seeking views from current appointed actuaries on
  a confidential basis
• working with APRA to incorporate regulatory
  views and
• seeking generally the views of the profession.

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Target surplus developing an industry approach

• Kent Griffin
• Robert Baillie