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Solvency II – San Diego


  • pg 1
                    – San Diego

Glen Barnett
David J. Oakden
Ming Roest

12 September 2007



                                    and UK


Australia                     (main focus on liability side)
• Brief History
- before late „90s, supervision under Insurance &
   Superannuation Commission
- Replaced by Australian Prudential Regulation
   Authority (APRA - www.apra.gov.au) - responsible
   for supervision of financial institutions: Banking (&
   other deposit-takers), Insurance, Superannuation.
   Fully operational in 1999.
- Drafted new standards, which were under public
   comment and review, when…
- 2001 failure of HIH (large failure!).
- Review process halted, new standards put
  in place (some changes from late rounds
  undone - a number of identified problems
  with the wording remained)

- Royal Commission:
  primary cause of failure -- under-reserving
 2002 liability valuation basics:
- outstanding claims; premiums liability
- account for many sources of uncertainty:
  process variability, parameter uncertainty, &
  many other sources of risk
- reflect the future liability process and its
  uncertainty (predictive distribution)
- discount at market rates
 2002 liability valuation
Minimum liability:
- max(75th %ile, mean+½std.dev.)


                               75th percentile
                                         (upper quartile)

 Predictive distribution of liability – must hold at least
 upper end of one-tailed PI (not a CI for the mean)
 2002 liability valuation:

- Not required to use probabilistic models in
  estimating the relevant aspects of that
  distribution – but easier to justify the
  probability-distribution calculations with a
  probabilistic model

• Some improvements were made to
  GPS210, e.g. in 2004
  Current situation:
Recent (2006) major update: GPS310
                           2006-07 phase-in

Outlines roles & responsibilities of:
• Approved Auditor
• Approved Actuary
• Approved Auditor
- audits yearly statutory accounts and annual review of
  other aspects of the operations. Provides a certificate and
  a report on these to the Board. May also be required to do
  other things (e.g. special purpose review)

• Approved Actuary
- assess overall financial condition
- advise on the valuation of insurance liabilities
- Financial Condition Report (FCR)
- Insurance Liability Valuation Report (ILVR)
  … annually to the Board (then on to APRA)

 - Actuarial peer review of ILVRs

• Basic rule
- unchanged minimum: max(75th%ile, µ+½)
- but focus is more on modeling, looking to the
  particular circumstances of the individual insurer,
  (- information in FCR&ILVR)

• Requirement to follow the “relevant professional
  standard” (PS300 for liabilities) where no conflict
   - so wording of that also important.
  (Where there is overlap, generally very similar)

• Discounting:
 - observable, market-based rates
  (sovereign risk securities matching
   liabilities currency and term profile)

- rates derived from a yield curve either directly,
  or as a suitable average rate
 Financial Condition Report
• business overview;
• summary of key results of ILVR

• Assess:
  - recent experience & profitability,
  - adequacy of past estimates
  - asset & liability management, investment strategy
  - current & future capital adequacy, approach to
   capital management;
- pricing, premium adequacy;
- reinsurance arrangements (suitability, adequacy)
- risk management framework
  Financial Condition Report
- value liabilities on prospective basis, both net and
   gross of reinsurance and recoveries.
- value with regard to individual circumstances, but
   must be at least greater of:
   - 75% sufficiency for liabilities
   - mean + ½ std. deviation of liabilities (incl. uncert.)
- overall and by class of business,
  but diversification benefit applies to calculations by class
(generally provisions are higher than minimum)
[Valn of liabilities also needed for Minimum Capital Requirements]
  Insurance Liability Valuation Report
For each class of business
- value of insurance liabilities
- assumptions used; extent experience-based
- availability & appropriateness of data
- significant aspects of recent experience;

- methodologies used to model mean
- indication of the uncertainty; standard deviation
  Insurance Liability Valuation Report
- sensitivity analyses;
- description of probability distributions and
   parameters, (or how uncertainty estimated
- risk margins that relate to the inherent uncertainty

Describe assumptions and methods so another
actuary can understand valuation process, results,
limitations & key risks
  Capital Adequacy (GPS110)
- Either Internal Model (with approval) or Prescribed Method

• Prescribed
  analysis of 3 main risk types
  - insurance risk (risk GPS310 value is inadequate)
     – generates a capital charge
     (liabilities x factor for class of business
        9-15% for direct-insurance outstanding;
        more for premium liability, and for inward reinsurance)
  - investment risk
     – also a capital charge
         (value x factor
         1.2% for cash… 100% for loans to directors)
  - concentration risk (related to Maximum Event Retention)
  Capital Adequacy (GPS110)
• Internal Model

- covers at least those risks + more (operational risk, etc)

- determine capital to reduce probability of default
  within 1year to < ½%

(lots about valuing capital and justifying model that I won‟t
   cover here)

Two tiers of capital (divided and then subdivided by quality)
- specified minimum proportions in higher subtiers,
  maximum amounts in lower subtiers
  Risk Management (GPS220)
• Must submit annual Risk Management Stratregy
- Systems for identifying, assessing, mitigating and
  monitoring risks that may affect its ability to meet
  obligations to policyholders.
- Have dedicated risk management function

• 3 year business plan

• Annual Risk Management Declaration

• Financial Information declaration
- model based for assets and liabilities (if approval),
  but underlying minimum prescriptive

- assets and liabilities discounted at market rates

- implicit margins replaced with explicit risk margins
- recognition that insurer is subject to risk of the actual
   liability process, not just its mean
      (process variation major component of liability risk)

- regulator expects, & insurers do:
   · use model based approaches;
   · be more conservative than the prescriptive minimums
      (e.g. holding more reserves and capital)

- possible in practice to determine appropriate reserves
  incorporating process variability, parameter risk, etc etc

- possible in practice to determine appropriate reserves
  incorporating discounting at market rates

- avoidance of implicit margins
   → better understanding of risk

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