Evolution of solvency regulation

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Transcript Evolution of solvency regulation

What You Can Expect From ORSA, A Regulatory Perspective Presentation by Arthur J. Schwartz, FCAS, on October 9, 2013, to Casualty Actuaries of the Mid-Atlantic Region (CAMAR) at Mercer Community College, West Windsor, NJ

Disclaimer

My comments represent my personal opinion only. My comments do not necessarily reflect the opinion of anyone at my employer, the North Carolina Department of Insurance. Also, my comments do not necessarily reflect the opinion of anyone at the Casualty Actuarial Society or CAMAR (Casualty Actuaries of the Mid-Atlantic Region).

Value Added Material

My presentation today contains much VAM, beyond anything which may be obtained from publicly available information on the NAIC’s website, which I obtained from verbal discussions with regulators in key states as well as NAIC staff, all of whom are closely involved in the NAIC’s Solvency Modernization Initiative (SMI)

What is the NAIC’s Solvency Modernization Initiative (SMI)?

The NAIC seeks to improve solvency regulation by a) looking inward and improving current tools b) looking outward at international developments and c) identifying potential new tools

Why is SMI happening now?

• • The recent financial crisis occurring in roughly the 2007-2009 years spurred the international Financial Stability Board to recommend to the International Association of Insurance Supervisors that they take steps to minimize the impact of another financial crisis. The International Monetary Fund developed a Financial Sector Assessment Program, which is also pushing international regulators of banks and insurers to improve and strengthen regulatory oversight

Evolution of solvency regulation

• • Out with the old tools In with the new tools

Evolution of solvency regulation

“Ring out the old, ring in the new, Ring, happy bells, across the snow: The year is going, let him go; Ring out the false, ring in the true.” Alfred, Lord Tennyson

Evolving regulation of solvency tools • Older tools are static, publicly available, backward looking (historical data), and easy for regulators to monitor (such as FAST ratios with fixed maximums and minimums which almost never change as economic conditions change) and reserve reviews (which originally required a single number) and Risk Based Capital (RBC is a cookbook calculation of a single number and requires regulatory intervention if capital falls too low, but that is almost always too late to save the company) • Newer tools require stochastic or deterministic testing of hypothetical future scenarios, quantitative and qualitative assessment of future risks, confidential information, and require significant actuarial involvement by regulatory actuaries (reserve reviews with ranges; risk focused exams, and ORSA)

Key change in the SMI

• All insurers are starting to notice that NAIC financial examinations are sifting from a review of historical data, which had limited usefulness for regulators and the managers of regulated insurers, to a risk focused approach

Which insurers have to create an ORSA?

• A key part of the SMI is ORSA which stands for Own Risk and Solvency Assessment. ORSA Summary Reports are required from certain insurers to regulators beginning January 1, 2015. Insurers required to create an ORSA are those with a minimum of $500 million in annual premium per company or $1 billion in annual premium per group.

Which companies are required to submit an ORSA Summary Report?

Although arbitrary, these minimums were intended to capture the larger insurers which could possibly cause a systemic financial crisis. These minimums are considered unlikely to change in the foreseeable future. Smaller companies should be aware of ORSA because the ORSA Model law authorizes the Commissioner to require ORSA of any company including financially distressed companies. In addition, if premium volume grows at ten percent annually for three years, the ORSA requirement will be triggered at current premium of $376 million (company) or $752 million (group), respectively.

Number of Companies or Groups affected by ORSA State Delaware District of Columbia Maryland New York New Jersey North Carolina Pennsylvania Virginia All states Meeting company threshold of $500 Million in annual premium Meeting group threshold of $1 Billion in annual premium 0 0 1 8 0 2 3 1 189 11 0 2 17 4 1 11 2 70 Note> one group in the Delaware total of 11 is equally shared with Pennsylvania

A key part of the SMI is ORSA which ORSA stands for Own Risk and Solvency Assessment. ORSA Summary Reports are required from certain insurers to regulators beginning January 1, 2015.

ORSA is an Enterprise Risk Management process “on wheels”

Rather than a mathematical exercise in capital modeling, regulators are going to want to see that a culture of risk awareness flows through every employee and that everyone’s compensation is tied into risk. In addition instead of merely performing ORSA internally, insurers are going to be responsible for explaining and defending ORSA to regulators.

What’s different than ERM or capital modeling?

Companies or groups subject to ORSA can expect a very significant amount of scrutiny and discussion with regulators including regulatory actuaries (some of whom may be employed by the DOI, while others may be consultants)

What’s different between ORSA and financial examinations?

• • ORSA will be required in addition to financial examinations ORSA Summary Report will be required annually but a financial examination is expected to be required only once every five years.

Who pays for ORSA examinations?

• The cost of the regulatory review of ORSA will be handled by states on the same basis as the cost of financial examinations.

NAIC’s ORSA Guidance Manual (most recently as of March 2013) • • • • Each ORSA report has three sections: Section 1 Describing risk Section; 2 Insurer’s Assessment of Risk; Section 3 Assessment of risk capital and prospective solvency.

Section1

• Regulators are looking for a company to identify the risks its subject to, which may be both qualitative and quantitative risks.

Section 2

• Quantifying or handling the risk. Can risk metrics be established? Can the risk be mitigated? Capital is allocated based on some metric. The results of stress tests are illustrated.

Section 3

• Economic capital is discussed with a 1 in 100 year to 1 in 250 year perspective. “Best practices” include comparing Economic capital; Rating Agency’s capital (such as Standard & Poor’s); AM Best’s BCAR; current capital; and RBC capital. Economic capital is often calculated based on expected cash flows. One surprise to regulators has been the credit that insurers take for writing diverse lines of business; this credit is often as large as 40% to 50% of capital. Some regulators take the view that no credit is due for diversification because of a potential financial crisis situation.

• • Differences between Solvency II’s ORSA and NAIC’s ORSA • the European version is very prescriptive of the types of risks that must be considered and measured and the tests conducted. Solvency II applies to almost all insurers with European regulators believing even small insurers can hire a consultant. • The NAIC path is very flexible and contains verbal guidelines rather than quantitative measures NAIC mostly applies only too larger insurers because of the cost and time which smaller insurers would require

Drawbacks to ORSA

• • Most insurers already have an ERM or capital modeling plan in place. It is not common to open this plan to review by regulators from whom key data or information could leak to competitors or the public. The increased cost to industry, and to top management, who will be required to meet with regulators to discuss their involvement in the ORSA

Benefits of ORSA to Industry

1) the company’s plans may improve through having an outside entity, independent of rating agencies, (regulators) review them 2) there will definitely be a need for increased employment of actuaries and quantitative risk analysts by companies & groups, as well as more examiners and actuaries by DOI’s

Benefits of ORSA to Industry (continued) 3) There will be a need for actuarial consulting forms to create software packages which can handle the quantitative aspects of ORSA 4) through stress testing and examining correlations between lines or products, companies can identify weak areas and make contingency plans --- before they happen

Benefits of ORSA to Regulators

1) through scenario testing and risk focused exams we can see where the company is going rather than a rear-view perspective (which is probably outdated by the time it is completed) 2) the ORSA Summary Report presented to regulators is exactly the same as what they are presenting to their own Board of Directors

How long will it take regulators to review ORSA with a company? Currently, it’s estimated to take about one week and will involve interviews with Board of Directors, C level executives, and possibly other managers.

In the ORSA’s submitted to the NAIC so far what factors distinguish the strong ORSA’s from the weak ORSA’s? • • 1) Strong ORSA Reports show that a culture of risk awareness has been fostered in the employees at all levels 2) Strong ORSA reports list qualitative issues and discuss how the managers would deal with them; for example suppose an immediate capital deficiency occurred

Strong ORSA’s (continued)

• 3) Strong ORSA reports show a feedback loop between different divisions in the company. For example if Marketing identifies an underserved market or Claims discovers an unusually large number of claims with a certain type of injury or Underwriting identifies certain customers posing a higher or lower degree of risk, that info gets passed to pricing and reserving actuaries who can issue guidance back to the other divisions.

Further Reading

• • •

NAIC’s “ORSA Guidance Manual As of March 2013” NAIC’s “ORSA Model Law” NAIC’s “2012 Own Risk and Solvency Assessment Feedback Pilot Project”

If you have further questions or cannot locate a “Further Reading” Arthur J Schwartz, Associate Property and Casualty Actuary, North Carolina Department of Insurance, 919-807-6646