casualty actuaries of new england (cane) september 26, 2008 dispelling the fog: erm, solvency ii...

Casualty Actuaries of New England (CANE) September 26, 2008

Dispelling the Fog: ERM, Solvency II & IFRS

CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS September 26, 2008

FOG

A state of mental dimness and confusion.

PricewaterhouseCoopers


ERM can provide a solid foundation for many key aspects of IFRS implementation, as well as synergies to help ease the cost of compliance with other forthcoming risk/capital management directives, including Solvency II.

Regulatory challenges include overcoming the continuing uncertainty with respect to insurance reporting under IFRS and gearing up for the forthcoming Solvency II. Increased pressure from regulators and rating agencies alike sees more focus on ERM.



Agenda

Introductions

Overview of ERM

Solvency II Update

Overview of IFRS

Linkages between ERM, Solvency II, and IFRS

Company perspective

Q&A



Navigating Through Fog

Stay Calm

Slow Down

Avoid Braking Often

Avoid Distractions


Section One

ERM Overview


Does ERM matter?

“Risk management adds value not only to individual companies, but also supports overall economic growth by lowering the cost of capital and reducing the uncertainty of commercial activities.”

James Lam“Enterprise Risk Management – From Incentives to Controls”



ERM Overview

The benefits of ERM are derived from integration:

1. an integrated organization, which often includes a centralized risk management unit reporting to the board, CEO or CFO with responsibility for broad risk policy setting across risk taking activities;

2. an integration of risk transfer strategies (considering all risks, and any diversification benefits between them); and

3. the integration of risk management into business processes, optimizing performance through risk adjusted pricing, resource allocation, and enhanced business decision making.

Enterprise Risk Management

Source: James Lam – Enterprise Risk Management – From Incentives to Controls



ERM Overview

An ERM infrastructure must be developed…

1. risk management governance;

2. risk management policies and procedures;

3. risk assessments and audits;

4. systems and financial models;

5. measures and reports; and

6. risk limits and exception processing.

Develop from the top down!




ERM Overview

…however, ERM benefits will only be realized when companies:

1. build risk awareness through senior management commitment;

2. create a culture for risk management;

3. facilitate open communication;

4. identify and/or develop talent; and

5. reinforce behavior.




Reporting Measurement

and ControlOperations

Risk assessment/Response

Business mission and strategy

Risk strategy Value proposition Risk appetite

Risk awareness/Identification

Organisation and people

Limits and controls

Methodologies & Models Systems Data Policies Reporting

Culture Training CommunicationPerformance

measuresReward

StrategyProcess

Infrastructure

Environment

Validation/re-assessment

ERM Overview – An Illustrative Framework




Integration of Enterprise Risk Management




ERM Infrastructure – Organization and people

• Centralized independent risk management function• CRO or senior executive with risk role• Oversight committees at the Board / senior management levels• Risk awareness, culture and values• Risk training• Talent management• Linkages between risk and compensation


Limits and controls

Methodologies & Models

Systems Data Policies Reporting




ERM Infrastructure – Limits and Controls

• Define corporate-wide and product-specific risk appetites• Risk assessments• Risk inventories• Exposure limits and triggers• Risk controls• Risk escalation


Limits and controls






Risk Appetite• A measure of the potential financial impact that the

company is willing to take in exchange for a targeted return• ERM programs may have multiple definitions for risk

appetites- Capital (Ruin focus)- Earnings (Volatility focus)- Rating (May be driver of probability choice)

• Alignment with product pricing

ERM Terminology




Risk Tolerance• Relates to management strategies

Risk Limits• Defining risk limits - connection with the company-wide risk

appetite, approval processes• Risk escalation processes• Procedures used for monitoring and responding to limit

breaches• Automatic triggers, risk dashboards


ERM Terminology



Process in Place to Define Risk Appetite




Process in Place to Deal with Breaches of Limits




ERM Infrastructure – Methodologies & Models

• Insurance, market, credit and operational risk management

• Economic capital models & capital allocation

• Risk analytics, including scenario analysis, risk indicators, risk-adjusted returns

• Risk transfer strategies

• Linkage of planning and risk strategy

• Linkages to product pricing

• Performance management

• Capital management


Limits and controls






Economic capital models

Economic Capital

Liabilities

Assets available for required

capital

Assets covering liabilities

“Excess” Capital

Key areas where survey respondents identified benefits of implementing an economic capital model:

• Better allocation of capital than under a regulatory capital model

• Definition of risk appetite

• Freeing up of capital for use in the business

• Changes in the pricing of products to better reflect risk

• Changes in strategic direction after assessing risk-adjusted performance




Economic capital models (cont’d)

Aggregate Economic Capital Model

Market Risk

Insurance Risk

Credit Risk

Operational Risk

Inte

r-se

gm

en

t D

ive

rsifi

catio

n

Inter-risk Diversification

BU 1

BU 2

BU 3

Corporate & Other

Types of models • Factor based• Stress tests• Combination models (usually a

combination of factor based models with either stress testing or stochastic modeling)

• Fully stochastic models

Range of risks• Insurance risks — typically

modeled using stress tests for life business and stochastically for non-life business

• Market risk and credit risk — often modeled stochastically

• Operational risk — factor based or “scenario driven models” are common




Source: 2008 PwC survey covering ERM in the global insurance industry

Risk categories explicitly captured in economic capital models

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Insurance Credit Market Operational Strategic

Risk category

Per

cen

tag

e o

f re

spo

nd

ents

Confidence level applied when managing VaR

95%

99%

99.5%

99.7%

99.9%

99.95%

Risk measures managed within economic capital models

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

VaR TVaR CTE Earnings atRisk

EmbeddedValue

Other

Risk measureP

erc

en

tag

e o

f re

sp

on

de

nts

Economic capital models (cont’d)




Model Development Timeline




Traditional Operational Risk Management - Separate Silo Risk Management for:• IT Risks• HR Risks• Regulatory & Compliance Risks• Fraud Risk• Internal Controls• Reputation Risk• Business Continuity• Distribution Risks• Outsourcing/Vendor Risk

Operational Risk




Enterprise ORM – leading to Strong ORM assessment by S&P usually associated with:• Comprehensive assessment of risks & control capabilities• Identification of risks not adequately controlled by existing

programs• Prioritization• Development of key risk indicators, tracking process & problem

resolution system

Excellent ORM assessment usually associated with: • Repeated application• Refinements of controls & KRIs • Response programs

Operational Risk Management




ERM Infrastructure - Systems

• ERM supporting technology

• System interface, mapping tools, middleware

• Risk registers

• Exposure analytics, drill-down capabilities

• Risk reporting tools


Limits and controls






ERM Infrastructure – Data

Risk and portfolio data requirements:• Access• Common definitions• Quality assessments • Cleansing

• Data warehouses

• Industry data

• Benchmarking data


Limits and controls






Rating Data Management Expenditures




ERM Infrastructure – Policies

• Market, credit, insurance, operational risk policies and procedures, including:

• Risk rating policies;• Exposure management policies;• Risk limit policies;• Monitoring and review policies;• Risk transfer policies;• Management and board reporting policies.

• Overall risk policies• Emerging risk policies


Limits and controls






ERM Infrastructure – Reporting

• Board reporting, including enterprise view on aggregate losses, risk incidents, policy exceptions, key exposures, KRIs

• Key risk indicators that quantify major trends and risk exposures

• Limit exception reporting

• Risk dashboards

• ERM disclosures

• Finance effectiveness – exploiting synergies between requirements for financial reporting, ERM, Solvency II, and IFRS


Limits and controls






Does ERM matter?

Through improved…• Coordination• Communication• Financial discipline• Transparency



Section Two

Solvency II Update


Solvency II – EU taking a global lead in insurance regulation

“This is an ambitious proposal that will completely overhaul the way we ensure the financial soundness of our insurers. We are setting a world-leading standard that requires insurers to focus on managing all the risks they face and enables them to operate much more efficiently.”

Charlie McCreevyInternal Market and Services Commissioner

Speaking at the launch of the Solvency II draft Framework Directive

Solvency II



Is Solvency II likely to have Global impact?

• Principles-based risk sensitive regulation is becoming the norm

- US led the way (RBC models) initially, then Canada (DCAT)

- More recently: Australia, UK (ICAS) and Switzerland (SST)

- Many other jurisdictions are looking at implementing Solvency II or seeking “equivalent regime” status

• NAIC publicly-stated intention to consider options

• However, State-based US system adds significant complexity to regulatory innovation/connectivity with other global regulators; e.g.

- Principles-based reserving discussions likely to take years to finalise

- Policy forms and premium rates still needing regulatory approval

• The Optional Federal Charter solution?

• IAIS has now got real traction

• Global footprint of CFO and CRO Forum members

Solvency II



Solvency &Financial Reporting

EconomicCapital

Economic capital – lies at the heart of Solvency II and at the core of managing your business

Delivering Shareholder

Value

EnterpriseRisk

Management

Rating Agencies

Solvency II



Solvency II – Timescales

Draft Framework Directive published

2007 2008 2009 2010 2011 2012

High Level Principles (Level I Directive) adopted

Solvency II system in operation

(31 October 2012)

Quantitative Impact Study v.3

Quantitative Impact Study v.4

Detailed rules (Level II implementing measures)

EU member states to transpose into law

The above timeline corresponds closely to the current IFRS timescale – but the two projects are not formally linked

Model pre-approval process

Solvency II



PILLAR IQuantitative requirements• Assets and Liabilities –

market consistent valuation • Investments• Solvency Capital

Requirement (SCR):• European Standard

Formula; or• Internal Model

• Minimum Capital Requirement (MCR)

• Own Funds

PILLAR IISupervisor review

• System of governance

• Own risk and solvency assessment (ORSA)

• Supervisory review process

• Supervisory intervention including capital add-on

PILLAR IIIDisclosure

• Public Disclosure – annual solvency & financial condition report

• Information to be provided for supervisory purposes

GROUP SUPERVISION – all pillars applicable to solo entities and groups

Solvency II – Draft Framework Directive - overview

Solvency II



Solvency II – Quantitative requirements

Assets at Market Value

MCR

Solvency Capital Requirement (SCR)

Technical Provisions

Assets available for SCR/ MCR

Market consistent valuation for hedgeable risks

Best estimate

Risk margin

for non-hedgeable risks

Assets covering technical provisions

Proposed framework for Pillar I

Solvency II



Current areas of contention within Solvency II/ outstanding issues

• Group supervision and group support- role of lead versus country supervisor- group support mechanism- Treatment of 3rd countries (e.g. USA, Bermuda, Far East)

• Design and calibration of MCR• Treatment of surplus funds (Germany), equities re: market risk (France)• Proportionality (e.g. should there be a de minimis threshold?)• Public disclosures – extent, timing• Captives and mutuals• Use of internal models• Role of audit (overlap with financial reporting)

Solvency II



Solvency II – Progression from Solvency I

Solvency I Solvency II

Pillar 1

Pillar 2

Pillar 3

• Local GAAP/IFRS• No internal model• RMM

• Supervisory review• No EU harmony

• Group capital assessment (post IGD) – no diversification benefit

• Public Disclosure • FSA Return, IGD data

• Market consistent valuations• MCR, SCR• Internal model optional (use

subject to supervisory approval)

• Supervisory review process• Emphasis on governance and risk management• Capital add on: exceptional• Group capital assessment with diversification benefit • ORSA

• Public Disclosure

Solvency II



Summary of possible implications of Solvency II

Small Large

Multinational

Domestic

• Inability to meet SII requirements?• Disproportionate compliance costs• Reconsideration of operating structure• Seeking merger partners• Industry roll up possibilities• Discontinuation of business• Insolvency

• Reconsideration of HO location• Diversification benefits / reduced capital req.• Reconsideration of operating structure• Acquisition opportunities (e.g. amongst small players)• Strategic re-evaluation of business lines• Disposals or run-off of underperforming / capital intensive books• Capital fungibility challenges

• Seek merger partners to obtain diversification benefits• Reconsideration of operating structure• Acquisition opportunities (e.g. amongst small players)• Strategic re-evaluation of business lines• Disposals of run-off/underperforming books• Capital fungibility challenges

Solvency II



What are we seeing European firms doing at present?• Broad EU industry support for the proposals

• SII approach and level of engagement differs by country and segment

In Europe generally, what are companies typically doing:

• General education and awareness raising

• Companies taking a more proactive stance:

- Impact assessments/gap analyses (see below for typical themes)

- Setting up Solvency II project teams

- Examining specific aspects e.g. risk appetite/ERM framework

- Restructuring ahead of the final Directive wording

- Data warehouse set-up, model specification and build

- Projects covering economic capital, IFRS, MCEV

- Addressing broader finance transformation and actuarial integration

Outside EU, already some regulators and companies looking at same concepts

Solvency II



Market implications - Rating agency interaction with Solvency II

• Capital is just one element of ratings

• Rating agencies not all using DFA models – but moving in that direction

• Agencies stated intention to converge- Consider companies’ internal model (S&P launched limited EC model

review)- Still the option of qualitative add-on for other agency factors- Some major differences in approach (diversification benefits less

generous, no explicit discount for lack of fungibility of capital)

• Calibration differences (SCR is approximate to BBB)

• Agencies and indeed markets will react to any Pillar II add on

• Regulators may expect an integrated approach to calculating capital held

• Increased focus on ERM concepts

Solvency II



Link to ERM - Impact on organisations from the Solvency II risk and governance requirements – Pillar II - ORSA

Key Challenges

• Integration of ORSA into the business’ strategic management

• ORSA expected to serve multiple purposes including regulatory compliance

• Ability to have risk management systems that monitor, manage and report risk on a continuous basis (at individual and aggregate level)

• Use for allocation of capital, consistency between pricing and capital decisions

Solvency II

ORSA

ManagementStrategy

Operations InternalModels

EMBEDDING RISK MANAGEMENT



Regulatory approval of an internal model will require an entity to satisfy three broad tests:• Test 1: Statistical Quality Test (Article 119) – Actuarial model• Test 2: Use Test (Article 118) – Internal risk management• Test 3: Calibration Test (Article 120) – Regulatory capital

In addition, entities must satisfy:• Validation Standards (Article 122)• Documentation Standards (Article 123)

Draft Solvency II Directive:

Solvency II



Internal Models – External Review

Review Element Solvency II FOPI APRA

Partial or Full Models

Scope and granularity

Completeness and consistency

Calibration standards

Stresses and scenarios

Model “use” and linkages

Validation framework

Governance framework

Limitations and development plans

Documentation

Draft regulatory requirements for approval of internal models:

Solvency II



Pillar III - Public disclosure and link to IFRS

Public disclosure

• Annual disclosure of solvency and financial condition report

• Subject to approval groups may disclose only one report

• Systems/ structures required to ensure ongoing appropriateness of information disclosed

Link to IFRS

• Conceptually in line with IFRS approach and timeline

Solvency and financial condition

report to contain information on

• The nature and performance of the business

• Governance systems

• Risk management approach and risk profile

• Valuation basis for assets and liabilities

• Capital management including structure and quality of own funds, MCR and SCR

• Non-compliance with MCR and SCR during reporting period

Solvency II


Section Three

IFRS Update

International Financial Reporting Standards (IFRS)

What is IFRS?SEC RoadmapInsurance Contracts TodayInsurance Contracts Phase 2


Background

• IFRS—International Financial Reporting Standards• Standard setter—International Accounting Standards Board (IASB)

founded in 2001 and based in London• International Accounting Standards Committee (IASC) Foundation

- Appoint IASB members- Exercise oversight- Raise funds- Similar to Financial Accounting Foundation (FAF)

• Predecessor organisation was International Accounting Standards Committee (IASC) founded in 1973

What is IFRS?



Geographical break-down

Europe 6

North America 3

Asia / Oceania 3

Rest of the world 1

IASCFoundation22 trustees

SAC50 members

IFRSHigh quality, enforceable and global

IASBChairman plus

12 members

IFRIC12 members

AppointGovernFund

AppointAppoint

InterpretAdvise

Create

Trustees

Board

Geographical break-down

Europe 8

North America 6

Asia / Oceania 6

Rest of the world 2

Standard setting structure

What is IFRS?



A simpler set of accounting guidance

IFRS • Standards

─ IFRS: 8─ IAS: 29

• Interpretations─ IFRIC: 8─ SIC: 11

• Framework

US GAAP • Standards:

─ SFAS: 106─ APB: 16─ ARB: 4

• Interpretations ─ FSP: 49─ EITF: 108─ FIN: 27

• Concepts Statements: 6• Other

─ FTB: 32─ AICPA Interpretations: 6─ SOP: 51─ AICPA Industry Audit and

Accounting Guides, SABs, DIGs…

2,500 pages 25,000 pages

What is IFRS?



Criteria for

principles-based

standards

Faithful presentationof economic reality

Responsive to users’needs for clarity and transparency

Consistency with aclear conceptual

framework

Based on an appropriately defined scope

Written in clear, concise and plain

language

Allows for use ofreasonable judgment

IFRS Framework

What is IFRS?



When might the transition to IFRS occur in the US?

2008 2010

2009

2012 2014

2007 2011 2013 2015

March 2007 SEC roundtable on US GAAP reconciliation for IFRS filers

July 2007 SEC proposal eliminating US GAAP reconciliation for IFRS filers

August 2007 SEC concept release on use of IFRS for US registrants

November 15, 2007Reconciliation eliminated for IFRS filers

January 2009-2014Voluntary application of IFRS permitted for certain US registrants

January 2014Proposed roadmap targets potential mandatory adoption in 2014-2016?

Reasonable timeline for the US transition to IFRS

December 2007SEC roundtable on IFRS in the US

August 27, 2008Roadmap was issued

During 2011SEC will reconvene to decide whether a mandatory conversion date should be set

SEC Roadmap



Proposed Roadmap

• Targets potential mandatory adoption of IFRS in the U.S. beginning in 2014 (or 2014-2016)

• Lays out several milestones that would need to be achieved prior to the SEC mandating use of IFRS for all U.S. issuers

• Proposed rule for certain qualifying domestic issuers to use IFRS as early as 2009

SEC Roadmap



Requires Future SEC Action

SEC would reconvene in 2011 to decide whether:• Milestones have been achieved• Mandatory IFRS conversion date should be set for all issuers• Option to early adopt IFRS should be expanded to a larger

population of issuers

SEC Roadmap



Milestones

• Continued improvements to IFRS accounting standards• Independent funding of the IASC Foundation • Enhanced ability for interactive data (XBRL) to accept IFRS

data• Sufficient progress in IFRS education and training in the U.S.

SEC Roadmap



Optional Early Adoption of IFRS in the U.S.

• The SEC proposal would permit early adoption of IFRS by a limited number of eligible U.S. issuers. The issuer would need to meet the following two criteria in order to qualify for early adoption of IFRS:- The issuer would need to be among the 20 largest companies,

measured by market capitalization, in their industry group and- IFRS must be used by the majority of the 20 largest companies,

measured by market capitalization, in that industry group

• Early adoption requires approval of the SEC Division of Corporation Finance

• SEC estimates that at least 110 U.S. multinational companies in 34 different industries would be eligible for early adoption

SEC Roadmap



IFRS 4 Measurement

Does the contract need to be unbundled?

Are any discretionary participation features

present?

Insurance Component

Deposit Component

Yes YesNo

Does contract contain significant insurance

risk?

Investment Contract(IAS 39)

Investment Contract with discretionary participation

features

Insurance Contract

No

NoYes

Use existing valuation

Amortized Cost or FVLiability or equity

Insurance risk = Risk other than financial risk transferred from the holder of the contract to the issuer.

= No requirement for underwriting and timing risk.

Significant = Where an insured event could cause an insurer to pay significant additional benefits in any scenario, excluding scenarios that lack commercial substance, irrespective of the likelihood of such event.The “additional benefit” is measured in comparison to that whichwould be paid if the insured event did not occur.

Insurance Contracts Today



IFRS 4 Disclosures

General disclosure principles• Principle 1: Identify and explain significant amounts in financial statements

- Accounting policies and significant assumptions- Changes in amounts and assumptions

• Principle 2: Help users understand future cash flows - Objectives managing risks & policies for mitigating risks- Terms and conditions and affect on cash flows- Insurance risks - sensitivity analysis, concentrations, loss development- Interest rate and credit risks

Sensitivity analysis • Actual changes in financial results for changes in key assumptions• Sensitivity of financial results for changes in all variables that have a material

impact on assets, liabilities, income and expenses (e.g. interest rates, inflation rates, equity markets, mortality, persistency, frequency and severity )

• Companies have not historically not provided sensitivity analysis in audited financial statements

< - Will need to determine data requirements < - Will need to benchmark / emerging practice

Insurance Contracts Today



Status Update

Current IFRS situation for accounting for insurance contracts is inconsistent across jurisdictions

Results in too much diversity, less relevance and reliability

The IASB started with a clean slate to develop Phase 2

FASB may pursue joint project with IASB (IFRS/US GAAP convergence)

Phase II work begun

Jul 04

Discussion Paper

published May 07

Comment period ends

Nov 07

Phase II Exposure

Draft published Late 09?

Phase II IFRS

published 2011?

Phase II IFRS

effective 2013?

We are hereFASB ITC

Aug 07

Insurance Contracts Phase 2



Technical Overview – key features

Exit vs. Entry value – illustration:

• 10 year single premium policy sold by insurer X for $1,000 • Insurer X expects to realize a profit of $250• Insurer Y prepared to purchase policy from X for $900 (after allowing for risk)

Entry value liability = $1,000 Initial profit is $nil (before or after acq. costs?)

Exit value liability = $900 Initial profit is $100

Single accounting model

Exit Model

•Discounting for non-life business•Strong opposition from US non-life industry•Prospective cash flow model

•Controversial (inside and outside IASB)•Possible day one gains•Obligation may arise on contract signing




Building blocks of the IASB current exit value

IASB rationale for current exit value:• More faithful representation of insurer obligations and rights• Conveys more useful information about amounts, timing, uncertainty of

cash flows • Current estimates and use of explicit rather than implicit assumptions

require insurer to actively consider whether circumstances have changed• Explicit rather than implicit risk margin• Avoids need for separate liability adequacy test• More coherent framework for complex contracts such as multi-year, multi-

line, or stop loss contracts, avoiding need for arbitrary rules





IASB rationale for current exit value (cont):• Eliminates need to separate embeddeds• Consistent with IAS 37 and IAS 39 which require current

estimates of future cash flows• Reduces motivation to use reinsurance to recognize

previously unrecognized gains• No need for arbitrary criteria to distinguish amendments to

existing contracts from new contracts• Reduces possible accounting mismatches between assets

and liabilities





Opponents of exit value approach:• Exit value places too much reliance on hypothetical transactions that rarely

occur (i.e. transfers)• Entry value reflects real transaction – price charged to PH• No conceptual basis for Day 1 gains• Market-consistent cash flow assumptions and market-consistent risk

margins are not observable or attainable – introduces more subjectivity and non-comparability into the estimates

• Some believe discounting of non-life liabilities is not appropriate due to unpredictable nature of cash flows

• Current exit value inappropriately implies a greater measure of precision in the estimate that just isn’t there




Technical Overview – key features cont’d

Core liability measurement

Current, unbiased, market consistent, probability weighted estimates of contractual cash flows

Current, not past conditions• Market participant vs entity specific• Modelling demands • Expected mean value, not deterministic

most likely– More complex (stochastic?) models

• What cash flows to include? Contractual?

Current marketdiscount rates

Risk margin

• Liability moves with market rate changes• Insurer’s investment strategy not relevant,

except for par business

• Estimate of market risk margin• Limited guidance on calculation• Controversial feature, due to lack of market• Key driver of day one profit

Service margin • Amount of expected future market-based service profits



Section Four

Linkages Between ERM, Solvency II, IFRS


Review of the Common Features

Linkages Between ERM, Solvency II, and IFRS

Company Solvency II IFRS

ERM ORSA

Economic Capital Models

Internal (EC) Models

Public Disclosures Public Disclosures Public Disclosures

GAAP, Fair Value, Market Consistent

ValueMarket Consistent

ValueExit Value


Section Five

Company Perspective

September 26, 2008

ERM & Capital Modeling

• ERM Stochastic Modeling

• GAAP equity

• Statutory surplus

• Economic capital

• Other measures

Company Perspective – ERM, Solvency II, IFRS

September 26, 2008

IFRS and GAAP Balance Sheet Accounting

• Key Difference

• GAAP Full value loss reserves

• GAAP Full value loss reservesIFRS Fair


September 26, 2008

IFRS & Solvency II – Two Sides of One Coin

• IFRS = Fair value = (Economic value) concept• Convergence of economic and accounting values• Aim: IFRS net assets = Available economic capital

• Solvency II = (Fair) value-at-risk concept• One-year time horizon• 99.5% confidence level

• Aim: (IFRS) Net Assets VaR99.5% Required economic capital



Questions

Do you have any questions regarding what you have learned in this session?


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© 2008 PricewaterhouseCoopers LLP. All rights reserved. "PricewaterhouseCoopers" refers to PricewaterhouseCoopers LLP or, as the context requires, the PricewaterhouseCoopers global network or other member firms of the network, each of which is a separate and independent legal entity. The information contained in this document is provided 'as is', for general guidance on matters of interest only. PricewaterhouseCoopers is not herein engaged in rendering legal, accounting, tax, or other professional advice and services. Before making any decision or taking any action, you should consult a competent professional adviser. Although we believe that the information contained in this document has been obtained from reliable sources, PricewaterhouseCoopers is not responsible for any errors or omissions contained herein or for the results obtained from the use of this information.


ADDENDUM - IFRS


Premium Cash Flows – Conceptual Framework

Definition of an asset per the Framework• “…a resource controlled by the entity as a result of past events

and from which future economic benefits are expected to flow to the entity”

Definition of a liability per the Framework• “…a present obligation of the entity arising from past events,

the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits.”

Internally developed intangible assets are generally not recognized except in business combinations



Premium Cash Flows

Premiums relate to an intangible asset: portion of customer relationship with the policyholder

IASB decided to present it together with insurance liability

Re-pricing the policy makes it a new contract from accounting perspective and therefore not eligible for asset recognition• e.g., short duration property/casualty contract



Premium Cash Flows

Future premiums on existing contracts recorded as part of customer relationship if any of the following 3 criteria met: • Policyholder must pay premium to retain guaranteed

insurability - Guaranteed insurability = right that permits continued

coverage without reconfirmation of PH risk profile and at price that is contractually constrained

• Insurer can compel policyholder to pay premium (rare)• Including the premiums and resulting policyholder benefit will

increase the measurement of liability



Building blocks of the IASB current exit value – 1st

Determining expected present value: • Identify each possible scenario• PV cash flows in that scenario• Make unbiased estimate of probability of that scenario• Insurer might develop estimates of each scenario by:

- identifying individual scenarios- developing a formula that reflects insurer estimate of shape

and width of probability distribution, or - by random simulation




Market-consistent vs. entity specific cash flows:• Should not capture cash flows due to synergies between

insurance liability and other assets or liabilities• But should capture specifics of portfolio being measured• For unobserved variables (e.g., frequency/severity of claims,

mortality), rarely persuasive evidence that insurer’s own estimates differ from estimates other market participants would make




Reflect market participant (not entity specific) efficiency• Use servicing costs that market participants would incur• Don’t use entity specific servicing costs that reflect synergies

others don’t have• Don’t use costs reflecting inefficient servicing system (e.g.,

antiquated claims administration system)

But reflect characteristics of contract; strategy for handling• Level and type of service provided• Approach to claims management



Building blocks of the IASB current exit value – 2nd

Discount rates• Consistent with observable current market prices• For cash flows whose cash flows match those of insurance

liability in terms of:- Duration- Liquidity- Currency

• Discount all liabilities (long and short duration)• Not insurer’s investment yield rate



Building blocks of the IASB current exit value – 3rd

Risk Margin• Explicit and unbiased estimate of margin that market

participants require as compensation for bearing risk • Reflects uncertainty in timing and amount of estimated future

cash flows- Not a “cushion”

• What a third party would require to assume risk- Not calibrated to premium- But premiums provide reasonableness check




Risk margin is portfolio rather than entity specific, reflecting pooling of liabilities• Unclear about market participant diversification across

portfolios or negative correlation that different portfolios could provide

No specific method prescribed; example approaches provided• Confidence level, CTE, TVaR, cost of capital




Characteristics of the risk margin will likely include the following:• The less that is known about the current estimate and its

trend, the higher the risk margin• Risks with low frequency and high severity will have higher

risk margins than risks with high frequency and low severity• For similar risks, long duration contracts will have higher risk

margins than those of shorter duration• Risks with a wide probability of distribution will have higher risk

margins than those risks with a narrower distribution• To the extent that emerging experience reduces uncertainty,

risk margins will decrease, and vice versa




Service Margin• Market consistent margins for rendering services

- e.g., investment management services- Unit-linked and variable contracts, universal life

• Income (loss) recognition on Day 1 if insurer receives fee higher (lower) than market participants would demand

• Differs from current revenue recognition under IAS 18 based on stage of completion



Reinsurance – Cedent Perspective

• Reinsurance asset follows same model as direct reinsured liability (exit value approach)

• Risk margin for reinsurance assets equals risk margins for corresponding part of direct reinsured liability- Because one can’t transfer rights of indemnification of reinsurance

contract without underlying liabilities’ rights and obligations • Reinsurance asset is adjusted for expected default and disputes• Recognize contractual right, if any, to obtain potentially favorable

reinsurance rates- e.g., existing non-cancellable prospective reinsurance contract on

future negotiated direct contracts


casualty actuaries of new england (cane) september 26, 2008 dispelling the fog: erm, solvency ii...

Documents

integration of risk

risk limits

procedures risk assessments

broad risk policy

benefits of erm

erm benefits

erm matter

erm infrastructure