p2 – 2 (life) the appointed actuary and changing times simon curtis executive vice president &...
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P2 – 2 (Life)
The Appointed Actuary and Changing Times
Simon CurtisExecutive Vice President & Chief Actuary
September 17th, 2009Toronto
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Focus of Work Has Fundamentally Shifted
Before Economic After Crisis
SOLVENCY
Financial Reporting &Earnings Analysis
SOLVENCY
FinancialReporting &Earnings Analysis
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Demands on Time Have Significantly Increased
The shift in work emphasis has been driven primarily by an increase in solvency related demands rather than any reduction in other demands
Ramping up of IFRS related activities over next 12 months will increase time demands even further
Financial staff are suffering from “crisis fatigue”
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What are the Increased Solvency Demands?
Significantly increased face time with management, board, regulators and rating agencies
Significant increases in stress testing demands and requirements
Significant increases in capital ratio analysis and projections
Significant increases in capital mobility / planning
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Increasing Capital Adequacy MIS
MIS needs to support regulatory capital management have increased significantly
Company Example
Before Economic Turmoil Began
New World
Annual 5 year “DCAT” projection of consolidated capital ratios under base and stress scenarios with some local ratio stress testing
5 year annual DCAT stress testing will now comprehensively reflect all consolidated and local ratios
Ability to run ad hoc tests between DCATs
Actual capital ratios updated quarterly
Key capital ratios all estimated weekly or monthly with sensitivity analysis
Ad Hoc ability to do limited capital projections between DCAT cycles
Monthly 5 quarter rolling forecast of all key capital ratios
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Increasing the Focus on Downstream Silo Capital In benign market conditions, managing interactions of
multiple levels of regulatory requirements (consolidated versus local regulatory solvency versus rating agency) is a relatively stable exercise
However, in a volatile/stressed environment the multiple levels of constraints: introduce complexity issues in accurately modeling complex
interactions create pockets of trapped capital/unexpected capital calls that can
make consolidated capital requirements higher than may be perceived by looking to p-down
create real issues in moving capital around the organization
Key learning is that models/tools focus on downstream needs and fungability not just top down requirements
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Stress Testing
Stress testing has emerged as key area of increased focus as an essential tool Management and boards Rating agencies Regulators
Appointed Actuaries are uniquely placed through DCAT tools and infra-structure to take on significant portion of this work
OSFI is setting out increased stress testing expectations (Guideline E18) Wants insurers to use DCAT structure Likely to mandate at least one “OSFI” scenario annually Discussing removal of AA “financial condition” opinion with CIA
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What has Last 18 Months Taught Us About Our DCAT Tools and Process?
Strengths Weaknesses
Was generally robust in modelling consequences of economic downturn that was experienced – good predictive tool
Not nimble (complex and time consuming to run for ad hoc analysis)
Generally good at capturing 2nd order effects (e.g. local capital adequacy) and very effective tool for capital planning projections
Overly focussed on discharging policy obligations rather than ongoing entity viability
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Importance and Role of Stress Testing
Recent economic turmoil appears to be highlighting a fundamental difference between professional requirements of stress testing (e.g. DCAT) and regulatory/management focus
Professional Focus Regulatory Focus
Ability to honour policy obligations in stressed scenarios
Ability to maintain capital at levels to meet targets in stressed scenarios (“viability”)
Single catastrophe focus Effectively double catastrophe focus
Focus on financial condition opinion (positive equity in stress scenarios)
Significant focus on management plans to restore capital
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Key Concerns Emerging from Financial Crisis Volatility of Capital Regimes
Confidence is created by stability More risk centric / advanced stochastic techniques can introduce
more systematic volatility in capital ratios Key shortcoming is pro-cyclicality, partly due to models and literature
not calibrating to where you are in the economic cycle Result is regimes that release significant capital in good cycles and
accrue significant capital needs in bad times – a poor capital management paradigm
IFRS Phase II and Future Solvency Regime Implications The directional model of assets at fair value and liabilities discounted
at current risk free rates would have led to widespread solvency failures if in place during the recent financial crisis due to transitory credit spread widening
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Key Concerns Emerging from Financial Crisis … cont’d What is Right Level of Capitalization?
Limited acceptance by key constituents (not just regulators!) for companies to report reduced capital ratios during crisis conditions
Suggests companies will need to be capitalized at higher levels relative to historic and long term targets during good times in the economic cycle
Implications of Widening Credit Spreads At the height of crisis fixed income spreads on A bonds widened from 100-150
bps historic levels to 400 bps plus in 2008, but have now largely returned to historic levels
Did fixed income spread widening reflect true fundamental credit concerns or transitory liquidity preference for risk free assets?
Significant implications for actuarial valuations both under current CGAAP and IFRS
CALM starts with fair value offset but has implications for credit loss assumptions in reserve
IFRS Phase 2 has no fair value offset but likely will have liquidity adjustment to risk free discount rates. Unless liquidity adjustment captured most of 2008 widening, virtually all companies would have been insolvent under IFRS basis
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IFRS Phase 2
Assets SupportingLiabilities
Liability
Reported at fair value capturing risk free rates and spread changes
Liability cashflows discounted at risk free rates plus “adjustment”
Potential mismatch between liability “adjustment” and asset spreads
Proposals for “adjustment” include zero, own credit, funding spread and liquidity premium