Transcript 05_S Wason_Best Estiimate TP-FSI

Best Estimate of the
Technical Provisions
Seminar on Risk-Based Supervisory Practices and
Regulatory Capital
Stuart Wason, FSA, FCIA, CERA
Senior Director, OSFI
September 7, 2011
Agenda
• Objectives and main building blocks of
quantitative solvency assessment
• Valuation of technical provisions
• Moving forward: from regulation to
supervision
Objectives and Main Building
Blocks
• Overall goals of solvency assessment under IAIS
ICP 14
– Valuation of assets and liabilities on consistent
bases,
– Shall recognise specific risk-profile of each
undertaking
– Principles-based calculations allowing flexible
approaches
– Based on sound economic valuation principles
– reveal the true financial position of insurers
• increase transparency
• increase confidence in the whole sector
Main Building Blocks
Available Capital
Resources
Risk margin
Total Assets
Base Estimate
Technical
Provisions
Current/best
Estimate
IAIS ICP 14
The supervisory regime establishes
requirements for the valuation of assets and
liabilities for solvency assessment purposes.
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Valuation addresses recognition, derecognition and
measurement of assets and liabilities.
Valuation of assets and of liabilities is undertaken on
consistent bases.
Valuation of assets and liabilities is undertaken in a reliable,
relevant and transparent manner.
Valuation of assets and liabilities is an economic valuation.
An economic valuation of assets and liabilities reflects the
risk-adjusted present values of their cash flows.
Value of technical provisions and other liabilities does not
reflect the insurer’s own credit standing
Valuation of technical provisions exceed the Current
Estimate by a margin (Margin over the Current Estimate or
MOCE).
IAIS ICP 14 continued
The supervisory regime establishes requirements for
the valuation of assets and liabilities for solvency
assessment purposes.
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Current Estimate reflects the expected present value of all
relevant future cash flows that arise in fulfilling insurance
obligations, using unbiased, current assumptions.
MOCE reflects the inherent uncertainty related to all relevant
future cash flows that arise in fulfilling insurance obligations
over the full time horizon thereof.
Valuation of technical provisions allows for the time value of
money. The solvency regime establishes criteria for the
determination of appropriate interest rates to be used in the
discounting of technical provisions.
Solvency regime requires the valuation of technical
provisions to make appropriate allowance for embedded
options and guarantees
Inconsistent bases?
Solvency
value?
Available Capital
Resources
Risk margin
Total Assets
At Market Value
Base Estimate
Technical
Provisions
Current/best
Estimate
Using Fixed
Assumptions
Economic valuation –
Solvency II – an example
Market consistent valuation of assets and liabilities
Available Capital
Resources
Risk margin
Total Assets
Base Estimate
Technical
Provisions
Current/best
Estimate
Economic valuation –
Solvency II - an example
Market consistent valuation of assets and liabilities
SCR
Free assets
Available Capital
Resources
MCR
Risk margin
Total Assets
Base Estimate
Technical
Provisions
Current/best
Estimate
Current estimate
• ICP 14 – “Current Estimate reflects the
expected present value of all relevant
future cash flows that arise in fulfilling
insurance obligations, using unbiased,
current assumptions.”
• Key words:
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Expected present value
All relevant future cash flows
Fulfilling insurance obligations
Unbiased, current assumptions
Reference: Measurement of Liabilities for Insurance
Contracts: Current Estimates and Risk Margins, IAA
2009
Expected present value
• An economic principle for the
measurement of insurance contracts is
the recognition of the time value of
money
• Future cash flows can be valued to the
present using observed discount rates
• Discount rate based on portfolio of
assets with cash flows suitable to
provide for insurance obligations
All relevant future cash flows
• Expected financial effect of all
contractual rights, obligations,
guarantees and options included
• Probability weighted best estimate of all
scenarios
• Not always possible to develop
distributions – expert judgement
required
Fulfilling insurance obligations
• Measurement approach should be
consistent with the application (eg sale
of portfolio, financial reporting, run-off,
pricing)
• Convergence (at least among IASB and
IAIS) appears to be towards fulfillment
measurement approach
• Projected cash flows are to be
appropriate to an on-going operation
Unbiased current assumptions
• Unbiased
– Neither conservatism nor lack of it
• Current
– Appropriate over the term of the cash flows being
projected
– Appropriate to the obligations being valued
– Based on market inputs to the extent possible
(eg industry wide data or prices where relevant
and useful)
– Using non-market inputs (eg credible insurer
experience) where appropriate
– Historical data to be updated based on trends
Unbiased current assumptions
• Data issues (eg mortality rates)
– Does the insurer merge data from a variety of
systems (how clean and consistent is the data)
– Does the data from certain years contain unusual
one-off events (eg flu spike)
– Does the data contain the impact of changes in
claims handling or underwriting practices (latter
more important for health and general insurance
in the short term)
– How will changes in the economy or health care
affect the rate mortality improvements
– Actuarial function plays a key role
Unbiased current assumptions
• Inter-related (eg lapse and mortality
rates)
– Typically a valuation of technical provisions
involves the specification of many assumptions
some of which inter-relate to each other (eg
renewable term insurance where the mortality
experience depends on the lapse experience at
renewal)
– Careful attention must be paid to these linkages
in the valuation
Valuation of Technical Provisions
• General principles
– Economic and market-consistent valuation
– Calculation to be based on current and credible
information and realistic assumptions
– Flexible and principle-based framework
– “Best Estimate + Risk Margin” approach
– achieve better comparability and transparency
– consistency with with valuation of assets and
other liabilities
– alignment with IFRS
Include a risk margin for
each assumption
Available Capital
Resources
Risk margin
Total Assets
Base Estimate
Technical
Provisions
Current/best
Estimate
IASB Stage II Insurance Contracts recap
Risk + residual margin, or composite margin?
ED called for an explicit risk margin,
plus a locked-in residual margin to
eliminate day one profits.
Comment letters: Risk adjustment
plus residual margin, or composite
margin?
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Risk adjustment plus residual margin
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Strong support in Europe as this is
consistent with Market Consistent
Embedded Value and Solvency II
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Supported by Australia and Canada as
they already have a risk adjustment
included in the measurement of insurance
liabilities
Composite margin
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Supporters concentrated in the United
States, Japan and China
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Supported for the perceived subjectivity
involved in determining this risk
adjustment
In June, IASB tentatively decided to allow for
some re-measurement of residual margin
Valuation of Technical Provisions
• Valuation of technical provisions is not just
about a number, it is a process requiring
expert judgement
Assessment &
Validation
Methodologies
Data
Assumptions
Valuation of Technical Provisions
• The valuation process has to be consistent
with regulatory and other requirements
Valuation Process
Valuation
Requirements
• regulatory
• professional
• financial
reporting regime
Assessment &
Validation
Methodologies
Data
Assumptions
Valuation of Technical Provisions
• And has to be embedded into the
undertakings system of governance…
Valuation Process
Assessment &
Validation
Methodologies
Data
Assumptions
Governance general
requirements:
•Risk management
system, including
•Data policy
•Claims
management
procedures
•Validation of
technical provisions
•Documentation
•Internal reporting
and communication
•Internal control
Valuation of Technical Provisions
• Challenges
– Consistency and coherence of conceptual
framework
– Appropriate calibration (interest rate curve and
CoC factor)
– Compatibility of framework with IFRS
– Insurers’ ressources: Data, IT, actuarial expertise
– Application of valuation methodology: setting
assumptions and selecting methods
– Ensure that valuation is embedded in insurer’s risk
management: proper validation and assessment is
key!
– Appropriate use of judgement
– Supervisory review and assessment
Valuation of Technical Provisions
• Conceptual framework – issues at
debate
– Risk margin
• Recognition of unavoidable market risk
• Extent of allowance for diversification
effects
• Simplifications
– Discounting
• Illiquidity premium
• Extrapolation of the risk-free curve
• Credit risk in swaps
IASB Stage II Insurance Contracts recap - Discount rate
Comment letters: Should a liability based
discount rate be used?
Current direction is that discount rate
will not be based on assets held:
•Major change for Canadian (and US)
lifecos
•Potential for substantial mis-matches
and earnings volatility
Comment letters: What method for the rate?
More controversy than consensus:
•Those with long duration liabilities advocate
for asset-based rates, locked-in rates or
some combination
•Many alternatives presented to IASB
IASB Stage II Insurance Contracts recap
Discount rate
Asset
rate
ED: “Bottom up”
approach
“Top down”
alternative
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Credit
default
?
Liquidity
premium
Riskfree rate
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Tentative decisions:
– Reflect the characteristics of the liability; no
linkage to assets
– No “locking in” of the rate
– Allow a “top down” approach (IASB ‘clarification’)
Applying the “top down” alternative
– Deduct risks not present in the liability, e.g.
investment risks that can’t be passed to the
policyholder (expected and unexpected defaults)
– IASB: bottom up and top down should essentially
get to the same place - ?
– Might reduce but not eliminate problems of
volatility and losses at inception
Valuation of Technical Provisions
• Carrying out the calculation – main practical
difficulties
– In setting of assumptions with regard to
Policyholder behaviour (e.g. lapses)
– Expenses
– Management actions and future discretionary
benefits
– Use of economic scenario generators
– In applying valuation methods:Options &
guarantees
– Stochastic modelling in life insurance
– Use of economic scenario generators
– Reinsurance recoverables
– Premium provisions in non-life insurance
Valuation of Technical Provisions
• Carrying out the calculation – main practical
difficulties
– In setting of assumptions with regard to
Policyholder behaviour (e.g. lapses)
– Expenses
– Management actions and future discretionary
benefits
– Use of economic scenario generators
– In applying valuation methods:Options &
guarantees
– Stochastic modelling in life insurance
– Use of economic scenario generators
– Reinsurance recoverables
– Premium provisions in non-life insurance
Valuation of Technical Provisions
• Method selection – general considerations
– Underlying assumptions of method must be clear
and explicit
– Data must be verifiable and sufficiently granular
– Assessment and communication of uncertainty
and sensitivities in estimate is key
– Stress & scenario testing have important role to
play
– Weight to be given to losses with low probability
and high cost
– Stochastic methods are not a panacea – if
deterministic methods fail then stochastic
methods will normally also fail
– Limitations of the valuation must be understood
Valuation of Technical Provisions
• Data used in the calculation of technical
provisions
– Insurers need to implement internal processes and
procedures to ensure appropriateness,
completeness and accuracy of data used
• This includes:Implementation of wellorganised IT data system
• Data policy
• Compilation of a directory of data used
– Supervisory reporting requirements set minimum
standard on granularity of data
– Data can be internal or external
– However insurer needs to be able to demonstrate
adequacy of external data against own risk profile
Valuation of Technical Provisions
• Use of external data for benchmarking
– Insurance market data can provide “benchmark”
information
– Useful for validation and assessment of valuation
• In non-life can e.g. be represented
as:development parameters/factors per line of
business
• aggregate summary statistics per line of
business
– In life insurance comprises e.g. tables on mortality
risks
– Insurance market data could be provided through
supervisory authorities, industry or actuarial
associations
Valuation of Technical Provisions
• Supervisory considerations
– Pillar I verification
• “use” vs “rely”
• External actuarial review
• External auditor actuarial staff
– Pillar II
• Benchmarking
• Stress testing
• ERM
• ORSA
– Pillar III
Selected references
• Measurement of Liabilities for Insurance
Contracts: Current Estimates and Risk
Margins, International Actuarial Association,
2009
• IASP 5 – Current Estimates, International
Actuarial Association
• ICP 14 – Valuation of Assets and Liabilities
for Solvency Purposes, International
Association of Insurance Supervisors
Questions