ec survey erm seminar aug 2011

8/13/2019 EC Survey ERM Seminar Aug 2011

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Economic Capital Survey 2011Indian Life insurance companies

Enterprise and Financial Risks Advisory Group seminar

August 2010


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17 Indian Life insurers participated in the survey

10,025

Rent


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EC survey Participant ProfileIndian Life insurance companies


August 2010


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Profile of the participants - Geography


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Profile of the participants Size of operations

Above 20,000 CrBelow 2,000 Cr Between 5,000 and 20,000 CrBetween 2,000 and 5,000 Cr


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EC Target audience and motivationsIndian Life insurance companies


August 2010


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IRDA is rated as the top audience for Economic Capital

Survey question: What is your target audience while

calculating economic capital?

IRDA

Ratingagencies

Internalmanagement

JV Partner

If one were to look atEuropean companies only,the target audience ratingincreases for the JVpartner

Quite unexpectedly nosignificant correlations

were found with size ofthe insurers


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Current Motivations for calculating economic capital

Solvencyassessment

Value

measurement

Risk adjustedperformance

measurement

Pricing

ALM/reinsurance

Decision making

Survey question: What are your current motivations

for calculating economic capital?


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Current Motivations for calculating economic capitalOverall

Value

measurement


measurement

Pricing

Top motivation for EC calculation is

solvency assessment followed by inputs

to decision making process

However if one were to look at European

companies only, it appears that the usageof economic capital concepts is morewidespread ratings being materially higher

in areas of performance measurement,

pricing and decision making process

For the largest insurers, the motivation foruse of EC is in the decision making

process is very high; second only to

Solvency

ALM/reinsurance

Decision making

Survey question: What are your current motivations

for calculating economic capital?

5.8

1.9

1.9

1.6

1.2

2.2

5.7

2.1

2.5

1.8

1.5

2.7

Solvency

assessment

European JVs


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Future Motivations for calculating economic capitalCurrent

Value

measurement


measurement

Pricing

ALM/reinsurance

Decision making

Survey question: What are your future motivations for

calculating economic capital?

5.8

1.9

1.9

1.6

1.2

2.2

5.4

1.9

2.6

2.5

2.2

2.4

Solvency

assessment

Next 2 -5 years

On an average,

participants plan touse EC concepts in

wider areas infuture

Significant

increase in scores

are seen in areas

of Performancemeasurement,Pricing and

ALM/Reinsurance


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EC financial outcomesIndian Life insurance companies


August 2010


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Financial Outcomes Liabilities , Capital and free assets

For all participants barring one, economic liabilitieswere lower than statutory liabilities

Key reasons could be the margins for adverse deviationand other surrender value/negative value floors that areprescribed in statutory reserving

Survey question: Statutory liabilities Vs economicliabilities Which one is higher?

Statutory > Economic liability

16 participants

Statutory < Economic liability

1 participant


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Financial Outcomes Liabilities , Capital and free assets

For a majority of participants economic capital is higherthan statutory capital

This might be due to the fact that a more holistic set ofrisk factors are explicitly considered in economiccapital assessments

Also a significant portion of the excess economiccapital might also be explained through the release ofprudential margins in statutory reserving which nowflow through in capital

Survey question: Statutory capital Vs economiccapital Which one is higher?

Economic > statutory capital

14 participants

Economic < Statutory free capital

3 participants


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Financial Outcomes On a total balance sheet basiseconomic free assets are higher than statutory

For a majority of participants, economic free assets

were higher than statutory free assets

Putting this in perspective implies that for a majority ofparticipants although economic capital is highercompared to statutory capital; the release of marginsfrom statutory reserves is enough to result in excess

economic free assets

All 3 participants for whom economic position is weakerthan the statutory position belong to sub 2000 Crcategory

Survey question: Statutory free assets Vs economicfree assets Which one is higher?

Economic > statutory free assets

14 participants

Economic < Statutory free assets

3 participants


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Total asset ratios None of the participants exhibit

a ratio less than 1

Above 1.5Less than 1 Between 1.2 and 1.5Between 1 and 1.2

Survey question: What best describes your Totalasset ratio on an economic basis ?

No participant seems to be insolvent on an economic basis

No correlation of TARs with respect to size of the insurer

Size

ofthein

surer


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Financial Outcomes Diversification benefit in the rangeof 25% to 40% for most of the participants

For a majority of participants (12) diversification benefitfell in range of 25% to 40%

There were 3 participants for whom the diversificationbenefits were lower in the range of 0% to 25% - All threehad AUM less than 2000 Cr

One company had a diversification credit of more than40% - This company was out of a handful that employedinternal model methodology

Survey question: Quantum of uncappeddiversification benefit while aggregating risks?

12

3

1

1


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% EC contribution - Risk categories

CreditInsurance OperationalMarket

10%

30%

50%

70%

Survey question: Relative share of risk components

out of total economic capital?

16

1

11

4

1

14

5

5

3

3

4

8

2


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% EC contribution Operational risk & size of operations

Operational risk

10%

30%

50%

70%

Size of the insurer


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Top three sub risk contribution

For a majority of participants (15) Top three sub riskscontributed more than 70% to their EC

One company had this contribution as low as 30%- Thiscompany was one of the few using internal models

Survey question: What is the proportionate

contribution of top three sub risks in your portfolio?

Top three risks contribution > 70%

15 participants

Top three risks contribution < 30%

1 participant


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EC calculation methodologyIndian Life insurance companies


August 2010


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Choice of risk free rates

Survey question: Methodology employed to arrive atthe risk free curve?

Indian Govt yield curve

14 participants

Swap rates

3 participants

For a majority of participants (14 out of 17) Indian

Govt yield curve is the preferred choice to calibratethe risk free curve

3 participants employ swap rates (or variantsthereof) All three are mid to large European JVplayers


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Cost of capital charge

Out of the 13 such participants, there is a wide variation as far as CoC charge is

concerned

Less than

4%, 4

4% to 5%, 2

5% to 6%, 5

Above 6%,

2,

Survey question: CoC charge in case using cost ofcapital approach?


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Methodology for arriving at RCMs

A majority of participants (13 out of 17) use cost of capital approach toassess Risk capital margins

3 participants mention percentile approach to arrive at RCMs. Interestinglyonly one out of the 3 mentions use of internal models

13

3

1

0

2

4

6

810

12

14

16

18

Others

Percentile

COC Approach

Survey question: Methodology employed to arrive atRisk capital margins?


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Cost of Guarantee methodology

All 6 companies that are performing stochastic

simulation techniques for guarantee valuation are atleast 5000 Crs in size

This seems to be a major area of improvement for theindustry

Survey question: What is the method you employ to

evaluate cost of guarantees in your portfolio?

Modest guarantees and hence not

assessed

9 participants

Others

2 participants

Stochastic techniques

6 participants


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IRDA circular mentioned the use of 99.5% VaR as one standard. The survey intended toask whether the participants agreed with the standard or did they believe that theirinternal standard was or would be something different

From the results it appears there is an overwhelming preference for one year 99.5%VaR approach. However, it is also acknowledged that this survey question might not

have probed the intended information by the participants who seem to have respondedas per the IRDA circular

0

2

4

6

8

10

12

14

16

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Time Period Confidence interval

One Year

(16)

Liability Run-off (1)

99.5%

(15)

More than 99.5% (2)

Time period and confidence intervals

Survey question: What is the time period &

confidence interval you employ to assess economic

capital?

One participantemploys TVARmethodology at99.5% which isequivalent to more

than 99.5% VaR


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Almost all participants employ use of covariance/correlation matrices for

aggregating individual risk capital charges

16

1

Covariance/Correlationmatrices

No Diversification

Survey question: What is the method you use to

aggregate risks across categories?

Aggregation methodology


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A majority of participants employ standard formula

approach for calculating economic capital

All 3 participants that employ the internal modelapproach have a minimum size of 5000 Cr

Out of the three one of them employed liability runoff approach and one employed TVaR forcalculation of economic capital

Capital calculation methodology

Standard formula approach

14 participants

Internal model

3 participants

Survey question: Methodology used towards

calculation of economic capital?


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Majority participants (12 out of 14) employed QIS 5 calibrations on one form or the other

9 of these 12 participants made an attempt to allow for local conditions In the stresscalibrations

1 participant seems to be doing internal calibrations. The participants also happens to be

a large insurer with perhaps lot of experience information and wanting to develop internalmodels

Survey question: Methodology used towards

calibration of stress parameters if using standard

formula approach?

Number of participants

Calibration of stress parameters

QIS factors

QIS factors [Overall

adjustments]

QIS factors [Specificadjustments for localconditions]

Others

3

2

2

7


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Operational risk calculation methodology

Survey question: Methodology employed to assessOR capital?

Factor based methodology

15 participants

JV partner/external loss database2 participants

Majority participants (15) use a factor basedmethodology to arrive at operational risk capital

2 participants employed use of external lossdatabase or JV partner loss data base. Both have

European JV partners and size greater than 5000 Cr.These are also the players who employ internalmodels to arrive at overall EC

Not enough internal operational loss data may beavailable. Although survey didnt ask a specificquestion around this but key point is that insurers

above a certain size should start looking at this area


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0 2 4 6 8 10

Premiums

Expenses

Reserves

Capital itself (excluding Ops capital)

Survey question: If using factor approach to estimateOps risk capital, what is your choice (s) of drivers?

Drivers employed to arrive at OR capital assessment

Number of participants


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Principal challenges

Time/Humanresources

Software

Lack of Technical

expertise

Key challenge for the

participants is lack oftechnical expertisefollowed by time and

human resources

For the largest insurers,not unexpectededly, timeand human resources is

less of a challenge. Thepressure on time andhuman resourcesincreases as the size of theinsurers is decreasing

Lack of experience data was rated by 2 insurers as their top challenge

Survey question: Principal challenging in evaluatingeconomic capital?


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Help items from IAI

Survey question: Help items from IAI?

Guidance on areas likeCOGs/risk freerates/assumption

setting

Technical knowledge

through seminarworkshops

Guidance on setingcalibrations/stresses/factors

10 participants

14 participants

15 participants


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There are other topics where participants wanted to

get support

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1 Economic Capital for the participating business

2 Economic Scenario Generator on the basis of Indianconditions

3 Expense Risk calibration and in particular dealing withthe expense over runs

4 Create awareness about Economic Capital so that it isappreciated better

5 QIS for India

6 Without proper understanding it might be perceived asan academic exercise

7


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It is agreed that there many requirements to get full

benefit of Economic Capital

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1 The complexity of the calculation increases with type ofproducts under consideration

2 Data requirements and modeling capabilities vary andincrease with the sophistication of the methods adoptedto quantify the risks

3 They will vary from setting lapse assumptions to the

using of Monte Carlo methods for diversification benefits

4 Traditional non-participating is simple followed by unitlinked without guarantees, with guarantees andparticipating business

5


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but one step at a time

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1 It has taken years for something like QIS, and

2 It takes time for developing methods to quantify risksunder the Indian conditions

3 The capability has to be developed by the individualcompanies while

4 The quantifying methods and guidance to be developed

through co-ordinated efforts from the Profession and theIndustry

5


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and there are few immediate steps that can be

taken by the companies

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1 Identification of all risks and maintaining the risk logrelated to each risk and initiatives taken by the insurancecompanies to manage the risk

2 An internal discussion with the key stake holders on howthese risks can be managed

3 Integrating the risk management in to key areas such as

product development and pricing, business planning andreporting embedded and appraisal values

4 Identifying a road-map for moving from simple ECcalculations to a more complex calculations

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Quantification of risks is important but identifying and managing the risks is more

important


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Thank You

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ec survey erm seminar aug 2011

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