2008 Town Hall Forum

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2008 Town Hall Forum Powered By Docstoc
					Implication of Asset in
liabilities valuation and
capital requirement

Kin Chung Chan, FSA, FCIA, FLMI
VP & Actuary
Corporate Actuarial
                       December 2, 2008
Topics for discussion
• Implication of assets and investment strategy in Canadian
  Valuation Methodology : Canadian Asset Liability Method
• Asset capital requirement under Canadian Capital
  Framework : Minimum Continuing Capital and Surplus
  Requirements (MCCSR)
• IFRS brings unknown changes
• Policy liabilities calculated under CALM (CIA SOP 2320.02)
    The amount of the policy liabilities calculated under CALM for a
     particular scenario is equal to the amount of supporting assets at the
     balance sheet date which are forecasted to reduce to zero at the last
     liability cash flow in that scenario
• Liability grouping and asset segmentation (CIA SOP 2320.09)
    The actuary would usually apply the Canadian asset liability method to
     policies in groups which reflect the insurer’s asset-liability management
     practice for allocation of assets to liabilities and investment strategy.
     That application is a convenience, however, which would not militate
     against calculation of policy liabilities that, in the aggregate, reflect the
     risks to which the insurer is exposed
CALM (continued)
• Forecast of cash flow (CIA SOP 2320.41)
    In calculating policy liabilities, the actuary would allocate assets
     to the liabilities at the balance sheet date, forecast their cash flow
     after that date, and, by trial and error, adjust the allocated assets
     so that they reduce to zero at the last cash flow.
CALM (continued)
• Scenario assumptions: Interest rates (CIA Sop 2330)
    2330.01 : An interest rate scenario comprises, for each forecast
     period between the balance sheet date and the last cash flow,
      •   An investment strategy, and
      •   An interest rate for each risk-free asset and the corresponding
          premium for each asset subject to default
    2330.04 : The investment strategy defines reinvestment and
     disinvestment practice for each type, default risk classification,
     and the term of the invested assets which support policy
     liabilities. Assumption of the insurer’s current investment
     strategy implies investment decisions of reinvestment and
     disinvestment in accordance with that strategy and hence the risk
     inherent in that strategy.
CALM (continued)
• Prescribed scenarios
   2330.10 : Because future investment returns and inflation rates
    are so conjectural, it is desirable that the calculation of policy
    liabilities for all insurers take account of certain common
    assumptions. There are therefore nine prescribed scenarios
    which follow.
   2330.15 : the prescribed scenarios provide guidance on interest
    rates for sale and purchase of investments and on the type and
    term of investments purchased, but provide no guidance on the
    type and term of investments sold.
CALM (continued)
• Implication of integrating asset and investment strategy in
    Market value changes in assets
      •   The CALM reserve is a cash flow reserve, the changes in market
          value of debt assets in accounting statement would not introduce
          gain/loss as the level of reserve is reported at the market value of the
          Hold-for-trading assets required in calculating the CALM reserve
      •   Change in market value of equity assets does affect the calculation
          of CALM reserve as selling of such assets is per schedule of selling
          in the CALM model
      •   Change in credit spread will be reflected in asset modeling in
          CALM and hence impact cash flows in investing and disinvesting
          on debt assets
CALM (continued)
• Implication of integrating asset and investment strategy in
  CALM (continued)
    Importance of a dynamic governance framework to ensure
     investment practice and investment strategy are synchronised
      •   Given the impact of reinvesting and disinvesting of assets in the
          model, a strong governance is needed to protect the integrity of the
          reserve calculation, yet allow a sound and dynamic investment
    Two examples
      •   In a highly depressed equity market and with a further stressed test
          on the equity by dropping the market value by another 40%, it
          would be considered an unusual situation that warrants judgment to
          change asset purchasing and selling strategy to be inline with
          investment practice
      •   A temporary over-investment in risk free government bonds at a
          time when investing in corporate bonds are deemed risky
Overview of MCCSR
• Minimum Continuing Capital and Solvency Requirement
   Capital Required
     •   5 main categories plus others
     •   Evolving over time as investment assets and insurance products
   Available Capital
     •   Permanent, free of mandatory fixed charges against earnings, and
         subordinated legal position to the rights of policyholders
     •   Separate into Tier 1 and Tier 2, Tier 1 capital with a supervisory
         target ratio of 105%
   MCCSR Ratio
     •   Supervisory target is 150%
Overview of MCCSR (continued)
• Minimum Continuing Capital and Solvency Requirement
   Unregistered Reinsurance treatment
     •   Cannot take solvency credit unless dedicated asset available to back
         ceded liabilities
   Opinion of the Appointed Actuary
     •   Covers both capital required and available capital calculation
Overview of MCCSR (continued)
• Available Capital
    Tier 1
      •   Surplus
      •   Appropriations (subtracted)
      •   Goodwill (subtracted)
      •   Innovative instrument
      •   OCI (negative)
    Tier 2
      •   OCI (positive)
      •   Subordinated debt
      •   Appropriations (added)
      •   Out of Canada Terminal Dividend
      •   Non-life investments and other (subtracted)
Overview of MCCSR (continued)
• Required capital
    asset default risk (C-1)
    mortality/morbidity/lapse Risk
    interest margin pricing risk
    changes in interest rate environment risk
    segregated funds risk
    other risk
    off balance sheet exposures
    indexed linked pass through products
Asset default risk (C-1)
• Asset default factor
   Short-term securities (original maturities of less than one year)
     •   0% - 2%
   Bonds/Loans/Private Placements
     •   Rating based
     •   0% - 16%
     •   Can use company internal rating if external rating not available
Asset default risk (C-1) (continued)
• Asset default factors
   Mortgages
     •   By type of mortgaged property
     •   2% - 8%
     •   asset default risk (C-1)
   Equity and Mutual Fund Instruments
     •   Preferred stocks: from 1% to 15%
     •   Common stocks: 15%
Asset default risk (C-1) (continued)
• Asset Replicated Synthetically and Derivatives Transactions
    Credit Protection Provided
      •   Same as holding the security directly
    Short Positions in Equities
      •   Same as holding the net exposure of the underlying equity
    Futures, Forwards and Swaps
      •   Report the equivalent of the spot position
            Futures contract to purchase equities will report the market value of the
              equities underlying the futures contract
            Swap will report the long position
Asset default risk (C-1) (continued)
• Asset Replicated Synthetically and Derivatives
   Options on Equities
     •   Capital charge determined by a 2-dimensional matrix of changes in
         the value of the option position under various market scenarios
     •   Alternative treatment for purchased option is to deduct the carrying
         value of the option from the available capital
   Options hedge recognition
     •   Allowed if option’s reference asset is exactly the same as the asset
Asset default risk (C-1) (continued)
• Asset Replicated Synthetically and Derivatives
   Equity-Linked Notes
     •   Need to be decomposed into the sum of a fixed-income amount, and
         the value of the option embedded within the note
   Convertible bonds
     •   Capital charge is equal to the charge for the bond’s fixed-income
         component plus the equity option charge for the bond’s embedded
     •   Alternative is treat the full carrying amount of the convertible bond
         as an equity exposure
Evolving capital framework
• Based on November 2008 document
   Target Assets Requirement equals best estimate of its insurance
    obligations plus a solvency buffer
   Four risk categories
     •   Credit
     •   Market
     •   Insurance
     •   Operational
   Issued draft for calculation of solvency buffer for market risk in
    November 2008
Evolving capital framework (continued)
• Approach to calculate solvency buffer for market risk
    Same risk same solvency buffer
    Consistent with future modeling approach
    Deterministic stress tests
    Calibration
    Measure risk by legal entity
    Hedging
Evolving capital framework (continued)
• Market risk categories
   Interest rate
   Interest rate spread
   Equities
   Real estate
   Currency
   Market option
     •   Liability market option
     •   Asset market option
Evolving capital framework (continued)
• Procedure to calculate the solvency buffer
   No reinvestment of cash flows
   Assume cash flow from non-interest sensitive assets are teir
    market value at time zero
   Base scenario is the net present value of the asset and liability
    cash flows
   Calculate the net present value of the asset and liability cash
    flow under 5 prescribed scenarios
   The solvency buffer is the largest negative difference between
    the base scenario and the net present value of the cash flow
• Valuation in phase 2 of IFRS suggested that reserve will
  be calculated using a discounting method instead of
    Asset will not be part of the valuation model
• Capital framework will be changed significantly
    Modeling is needed for calibration
    Total balance sheet approach
• Implications for product design
    Classification of insurance contracts vs. investment contracts
    Capital and income implication
Questions ??