PD3 Rob Curtis

							CIA Annual Meeting
Vancouver


International Developments in Statutory
Solvency
Rob Curtis
Chair, Solvency & Actuarial Issues Sub Committee
IAIS
Head of Insurance Technical Risk
FSA
28 June 2007
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
Internationally, where have we come from on
solvency?

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

  Guidance paper addresses the
  establishment of regulatory capital
  requirements in a solvency regime.

  Current guidance paper draft identifies 7
  Key Features
Capital requirements


  Key Feature 1 - Purpose and Definition of Capital

 • Regulatory capital requirements should be
   established such that, in adversity, an insurer’s
   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.
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.
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.
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.
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 insurer’s ability to meet its regulatory
   capital requirements under various
   conditions.
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.
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.
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
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 insurer’s 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.
Enterprise Risk Management

                                 Governance and an Enterprise
                                 Risk Management Framework
                                          Feature 1



         Risk Management
                                                                Risk Tolerance Statement
              Policy
                                                                        Feature 3
             Feature 2




                                      Feedback Loop
                                         Feature 4




                         Own Risk and Solvency Assessment (ORSA)
                                         Feature 5




                                      Feedback Loop
                                         Feature 4




                                                                Economic and Regulatory
          Continuity Analysis                                          Capital
               Feature 7                                              Feature 6


                                      Role of supervision
                                           Feature 8
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 insurer’s tolerance
   limits, regulatory capital requirements, economic
   capital and the processes and methods for
   monitoring risk.
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 insurer’s 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.
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.
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.
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.
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.
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 insurer’s business.
 • The supervisor should use its powers to require
   strengthening of risk management in relation to
   solvency assessment and capital management,
   where necessary.
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.
Internal Models

  Key Feature 1 – Using an Internal Model to
  Determine an Insurer’s 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.
Internal Models

  Key Feature 2 - Using an Internal Model to
  Determine an Insurer’s 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.
Internal Models

  Key Feature 3 – Criteria for the Use of an
  Internal Model to Determine an Insurer’s
  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.
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.
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.
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.
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.
Internal Models

   Key Feature 8 – Supervisory Approval of the Use of an
   Insurer’s 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.
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.
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.
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.
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”.
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.
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.
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.
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
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.
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.
Solvency 2 Framework

            Pillar 1:                    Pillar 2:                    Pillar 3:
          Quantitative                Qualitative                     Market
      capital requirements         supervisory review                discipline

      Technical provisions       Principles for internal      Transparency
      Minimum capital             control and risk             Disclosure
       requirement (MCR)           management                   Support of risk-based
      Solvency Capital           Supervisory review            supervision through
       Requirement (SCR)           process                       market mechanisms
      Investment rules


       Market-consistent                                         More pressure from
                                   New focus for                  capital markets
            valuation
                                     supervisor
      Validation of internal                                     More pressure from
                               Level of harmonisation
             models                                               rating agencies




     Use of internal             Use of internal                    Disclosure of
  models to calculate           models as part of                  internal model
   regulatory capital          own risk & solvency                   information
         (SCR)                    assessment
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
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.
Any questions?