Transcript BMA Power Point Template

EBS/BSCR Trial Run Presentation
16th April 2015
Agenda
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•
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Trial Run Timetable
Economic Balance Sheet (EBS)
– Assets / Other liabilities
– Technical Provisions
• Best Estimate
• Risk Margin
– Discount Rates
BSCR
– EBS as basis for BSCR
– Other changes proposed in 2nd April Consultation Paper
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Timetable
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•
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Trial Run
– Launched: 2nd April
– Industry meetings: 14th –16th April
– Responses due by: Friday, 29th May
– BMA analysis of results in: June
Prudential Standards Rules changes completed by: end June
European Commission ‘Equivalence’ recommendation expected in:
September
Email all questions to [email protected]
– Answers to Frequently Asked Questions posted on website
– http://www.bma.bm/market-trial-runs/SitePages/Insurance.aspx
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EBS – Basic Principles
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Based on audited GAAP balance sheet
– Using ‘fair value’ options wherever possible
– Certain Intangible Assets disallowed
– Produced on a Consolidated Basis
• Change from existing SFR basis
– Technical Provisions on a new ‘EBS’ approach
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See EBS Framework document for more details
– and additional Guidance material
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Legislative approach
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Currently Statutory Financial Statements in the Insurance Accounts
Regulations (or Insurance (Group Supervision) Rules)
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The existing SFR basis will be amended to GAAP from end 2016
– Project due to commence shortly
– May be some adjustments (e.g. eliminate Goodwill etc)
– Results in reduced audit costs for many insurers
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EBS is Schedule XIV in the Prudential Rules
– Draft legislation issued 22nd January
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Assets and Other Liabilities- EBS
Valuation Hierarchy
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Use of GAAP fair values for Assets and Liabilities other than
Technical Provisions :
– Assets and liabilities (except Technical Provisions) valued at ‘fair
value’ under GAAP (not any non-economic valuation option)
– Consolidation approach
When GAAP does not require an economic valuation approach:
– Use quoted market pries in active markets for the same or similar
assets or liabilities;
– Where not possible use quoted market prices in active markets
for similar items with adjustments to reflect differences;
– If no quoted market prices use mark-to-model techniques ;
– Make maximum use of observable inputs;
– No account of own credit standing when valuing liabilities
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Guidance for selected Balance Sheet
Lines
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Intangible Assets and prepayments
– Goodwill to be valued at nil
– Other intangibles to be measured at a value other than zero only
if they can be sold separately and expected economic value will
flow to the insurer
– If the value cannot be measured reliably should be valued at nil
Contingent Liabilities
– To be recognised and valued based on expected present value of
future cash flows
– Use option pricing models or other models for cases with
asymmetrical expected outcomes
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Guidance for selected Balance Sheet
Lines
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Income Taxes
– Deferred tax assets and liabilities valued on the basis of
differences between tax values and EBS values
– Deferred tax assets only recognised where it is probable that
future taxable profits will be available against which the deferred
tax asset can be utilised
Investment in affiliates
– Apply GAAP consolidation principles
– Apply EBS valuation principles to consolidated and equity method
affiliates
– Quoted market price or EBS valuation hierarchy for affiliates
where insurer has neither control nor significant influence
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Guidance for selected Balance Sheet
Lines
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Insurance Risk Transfer
– Insurers allowed to apply deposit accounting in line with GAAP
Deferred Acquisition Costs
– DAC now implicitly included in technical provisions
Contractual Liabilities treated as Capital in SFR under sections 6C
and 56
– Similar treatment may be adopted for the EBS.
Supplementary Notes
– Some of the disclosure is for information required for the eligible
capital schedule
– Some require more detailed explanation as an attachment
– Reconciliation of GAAP equity to Economic capital and surplus to
be done under schedule V(e)
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Schedule V (e)
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More details??
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EBS Technical Provisions
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Best Estimate + Risk Margin
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Best Estimate
– based on assessment of cash flows required to satisfy the
insurance obligations:
– No margins for prudence
– Discounted using the relevant risk-free discount curve
– Gross of reinsurance with separate assessment of reinsurance
recoveries on a consistent basis
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Risk Margin
– Reflects uncertainty associated with Best Estimate
– To be based on ‘Cost of Capital’ approach
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What is a Best Estimate?
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Probability weighted average of future cash flows:
– Reflect the full range of potential outcomes
• Allow for Events Not In Data (ENID)
– Does not REQUIRE the use of stochastic techniques
– Uses unbiased, current assumptions
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Assessed gross of reinsurance
Reinsurance effects considered separately
Does not include any allowance for prudence
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Cash Flows
Cash flows to be taken into account until the insurer:
• is no longer required to provide coverage
• has the right to reassess the risk and set a price that fully reflects the
risk, either at individual policy level, or at portfolio level
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Cash flows to be included:
– Benefit payments / claims costs
– Expenses, including investment costs
– Premiums
– Reinsurance (both to and from reinsurer)
– Other items
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Split by Currency
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Risk Margin
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Reflects the uncertainty inherent in the best estimate
– Business with more uncertainty attracts a higher risk margin
– Longer tailed lines will tend to attract a higher risk margin than
shorter tailed lines
Cost of Capital approach to be used
– Assess how much capital needs to be held each year (on an
expected basis) until the business runs off
• Capital is the ECR capital requirement for insurance risk,
credit risk and operational risk
– Apply a 6% ‘cost’ to this capital
– Discount the costs back to the valuation date at the risk free
discount rate
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Risk Margin – Example
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Suppose ECR assessed at:
– Valuation date :
– Valuation date + 1 year :
– Valuation date + 2 year :
1,000
300
100
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Cost of Capital (6%) is
– 60 for year 1;
– 18 for year 2;
– 6 for year 3
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If the risk free discount rate is 2% per year, the risk margin would be:
– 60 + 18 / (1.02) + 6 / (1.02)2
– = 83.4
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Risk Margin - 2
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Separate amounts required for P&C and LT business
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Within these levels, no need to further subdivide
– Not split between Gross and Net
– Not split between Premium and Outstanding Claims (P&C)
– Not split between lines of business
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Takes full account of diversification benefits included in the ECR
calculations
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No allowance made for any Market Risks
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Long-term Risk Margin Calculator
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EBS reporting requires insurers to include a risk margin in addition to
the best estimate technical provisions
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The required risk margin is to be determined using the Cost of Capital
approach and a cost of capital of 6%.
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Some insurers are unfamiliar with this method. The Risk Margin
Calculator is provided as a demonstration of how an insurer might
determine an appropriate risk margin.
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Long-term Risk Margin Calculator
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Summary of Approach
– Step 1: For each relevant capital risk, the current and future base
amounts are projected (i.e. reserves for longevity risk).
• Future capital requirements for each risk component are
proportionate to the current capital requirement for that
component.
– Step 2: For each future year, the total required capital is the sum
of the individual components recognizing diversification credit (i.e.
using the square root of the sum of the squares approach).
– Step 3: For each year, the cost of capital for that year is 6% of
total required capital. The risk margin is the cost of capital for
each year discounted at the appropriate risk-free rate.
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Long-term Risk Margin Calculator
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Required Components
– Counterparty Credit Risk
– Insurance Risk – Mortality
– Insurance Risk – Stop Loss
– Insurance Risk – Riders
– Insurance Risk – Morbidity and Disability
– Insurance Risk – Longevity
– Insurance Risk – Variable Annuities
– Insurance Risk – Other
– Operational Risk
• All other capital requirement components are omitted
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Long-term Risk Margin Calculator
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Example Step 1: Current BSCR capital requirements
Current Bermuda Solvency Capital
Requirement
Credit Risk
500,000
Mortality
500,000
Stop Loss
5,000
Riders
Morbidity & Disability
Longevity
Variable Annuities
Other Insurance Risk
Operational Risk Factor
3.0%
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Long-term Risk Margin Calculator
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Example Step 1: Project Future Base Amounts
Credit Risk
Mortality Risk
Stop Loss
T
Future Net
Amount At
Risk
t
Future Stop
Loss Annual
Premiums
0
10,000,000
500,000
0
25,000,000
500,000
0
20,000
5,000
1
8,000,000
400,000
1
22,500,000
450,000
1
16,000
4,000
2
6,000,000
300,000
2
20,000,000
400,000
2
12,000
3,000
3
4,000,000
200,000
3
17,500,000
350,000
3
8,000
2,000
4
2,000,000
100,000
4
15,000,000
300,000
4
4,000
1,000
5
0
5
12,500,000
250,000
5
0
6
0
6
10,000,000
200,000
6
0
7
0
7
7,500,000
150,000
7
0
8
0
8
5,000,000
100,000
8
0
9
0
9
2,500,000
50,000
9
0
10
0
10
0
10
0
11
0
11
0
11
0
12
0
12
0
12
0
13
0
13
0
13
0
t
Future Credit Risk
Credit Risk capital
Amounts
requirement
Mortality capital
requirement
Stop Loss capital
requirement
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Long-term Risk Margin Calculator
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Example – Step 2 Total Required Capital in Future Years
t
Total BSCR
BSCR (excl
adj and OR)
BMA
Insurance
Operational Counterparty
Approved
Risk Risk
Credit Risk
Adjustments
Mortality
Insurance
Risk - Stop
Loss
0
731,971
710,651
21,320
500,000
500,000
5,000
1
623,227
605,075
18,152
400,000
450,000
4,000
2
517,475
502,403
15,072
300,000
400,000
3,000
3
416,996
404,851
12,146
200,000
350,000
2,000
4
326,692
317,177
9,515
100,000
300,000
1,000
5
257,500
250,000
7,500
0
250,000
0
6
206,000
200,000
6,000
0
200,000
0
7
154,500
150,000
4,500
0
150,000
0
8
103,000
100,000
3,000
0
100,000
0
9
51,500
50,000
1,500
0
50,000
0
10
0
0
0
0
0
0
11
0
0
0
0
0
0
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Long-term Risk Margin Calculator
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Example Step 3: Determine Cost of Capital and Discount
Risk Margin
Cost of Capital
Currency
USD
t
0
1
2
3
4
5
6
7
8
9
10
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Yield curve
N/A
0.465%
0.989%
1.460%
1.815%
2.076%
2.293%
2.471%
2.636%
2.774%
2.896%
2.965%
189,664.0
6.00%
Discounted
CoC
Total BSCR
N/A
43,715
36,665
29,727
23,283
17,688
13,485
10,419
7,528
4,831
2,323
0
731,971
623,227
517,475
416,996
326,692
257,500
206,000
154,500
103,000
51,500
0
0
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Long-term Risk Margin Calculator
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Additional Considerations
– The Risk Margin Calculator is intended as a demonstration of an
approach that might be used by long-term insurers to determine
risk margins by the cost of capital method. (i.e. it is a tool to help
understand and get comfortable with the CoC method).
– Insurers may to use the tool directly, use their own processes to
determine components of the future risk margins and enter them
into the model or determine risk margins using their own
processes entirely.
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Interest Rates and Scenarios
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Discount Rates
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Current practice:
– Long-Term reserves are typically calculated by discounting future
cash flows at a single interest rate – perhaps specified by
regulation or loosely tied to the assets supporting the liabilities.
– P&C claims reserves typically are not discounted
Economic Balance Sheet:
– Discounting will be used for all best estimate liabilities
– A full yield curve will be used that is based on risk-free interest
rates in the appropriate currency
– Thus, the one year spot rate will be used to discount cash-flows
one year hence, the two year spot rate for cash-flows two years
hence, etc.
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Risk-free Rates
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We have developed risk-free yield curves for eight major currencies
(USD, EUR, GBP, CAD, CHF, JPY, AUD, NZD)
– The rates have been built using interest rate swaps of various
durations up to 30 years
– We have targeted an Ultimate Forward Rate (UFR) of 4.2% at
year 60 with spot rates then extended to year 100
– The results have been calibrated against EIOPA rates for USD at
12.31.2014 and are generally within 1bp over the first 30 years
– Our approach is technical, highly automated and consistent
across all currencies; as a consequence, it makes use of
sovereign bond information where swap data is thin;
– We do not expect it to be replicated; companies needing to use
risk-free yield curves in other currencies may use other
approaches (subject to disclosure / BMA approval)
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1 Year
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100 Years
97 Years
94 Years
91 Years
88 Years
85 Years
82 Years
79 Years
76 Years
73 Years
70 Years
67 Years
64 Years
61 Years
58 Years
55 Years
52 Years
49 Years
46 Years
43 Years
40 Years
37 Years
34 Years
31 Years
28 Years
25 Years
22 Years
19 Years
16 Years
13 Years
10 Years
7 Years
4 Years
Sample Yield Curve
Yield Curve United States
4.0%
3.5%
3.0%
2.5%
2.0%
1.5%
1.0%
0.5%
0.0%
Liquidity Adjustment
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Long-term insurer liabilities are in practice fairly illiquid.
As a result, insurers invest in a variety of corporate bonds and other
higher yielding instruments.
– Over time, the spreads should exceed the costs of defaults and
ratings class transitions
Therefore, we have included a liquidity adjustment as an increment to
the risk-free yield curve.
– This is based on a portfolio of high grade bonds that broadly
reflects the Bermuda market
Liquidity adjustments for eight currencies have been provided that
reflect yields as 31st December, 2014 and historical default costs
(increased by an uncertainty factor)
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Reserves - Standard Approach
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Under this approach, companies would determine their best-estimate
liabilities using: (i) best-estimate assumptions and (ii) cash flows
discounted at the risk free rate plus a liquidity adjustment
For purposes of the Trial Run, default costs are based on EIOPA
statistics increased by a 35% uncertainty factor:
– The EIOPA default statistics are significantly higher than the raw
data provided by S&P, and there have been claims that the
EIOPA method appears to contain some double counting of
ratings transitions; we are continuing to study the statistics and
may refine our approach.
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Reserves – Scenario-based Approach
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Many Bermuda reinsurers have highly sophisticated models for
managing asset and liability cash-flows.
The scenario-based approach has been designed to recognize the
degree to which assets and liabilities have been matched.
Under this approach, companies would first estimate their base-case
best-estimate liability by determining the amount of assets that
provide cash flows to meet the insurance obligation in each future
year
– For this purpose, asset sales and reinvestments are assumed in
accordance with the company’s investment guidelines
– This exercise is repeated under eight alternative scenarios
– The reserve is the highest measure among the scenarios
• The effective spread under the discount rate is then easily
determined
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Reserves – Scenario-based Approach
(continued)
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The eight alternative scenarios cover a range of yield curve
movements (up, down, reverting to normal, various twists, etc.), and
have been calibrated at approximately one standard deviation from
the base scenario using an economic scenario generator.
The scenarios are designed so that the reserve will reflect the degree
to which liability and asset cash-flows are matched:
– To the extent that the assets and liabilities are less than perfectly
matched, future asset sales or reinvestments will be required
– Under certain scenarios, this will prove more costly than under
the base case
It is easily seen that a perfectly matched block of business would
generate the same reserve under all scenarios
Under this approach, companies will be responsible for estimating the
default costs for each class of assets
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Reserves – Which Approach?
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The standard approach is fairly straightforward, and will be
appropriate for companies with general business and for smaller
blocks.
The scenario-based approach will be generally appropriate for
companies that already have an asset-liability modeling and cashflow testing capability.
Because the standard approach is one-size-fits-all, it is by necessity
somewhat conservative. We anticipate that the scenario-based
approach would generally generate lower (and more accurate)
reserves for liabilities that are substantially matched.
The choice of approach is with the company and can be varied by
block of business.
– However, for business with significant optionality, we may require
use of the scenario-based approach.
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Implications for BSCR
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BSCR
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ECR capital requirement will be calculated based on the EBS
Eligible Capital will be based on the EBS
•
The Trial Run is important to assess the implications of this change
on the industry
… and on the BSCR itself
– May be necessary to consider recalibration of some risks in future
•
•
Certain premium / reserves / asset information will continue to
requested on the existing unconsolidated basis (except for Groups)
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Examples
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Form 4EBS
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Form 4 & Unconsolidated schedules
1. Regular method of reporting
2. No Capital Charge
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Form 4EBS and Consolidated schedules
1. Forms include new accounts for EBS reporting
2. Capital Charge is applied
37
BSCR
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ECR capital requirement will be calculated based on the EBS
•
Eligible Capital will be based on the EBS
•
The Trial Run is important to assess the implications of this change
on the industry
… and on the BSCR itself
– May be necessary to consider recalibration of some risks in future
•
•
Certain premium / reserves / asset information will continue to
requested on the existing unconsolidated basis (except for Groups)
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Form 4EBS Example
New EBS Accounts
Regular Schedules
New EBS Schedules
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BSCR New Risk Charges
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There new risk charges for:
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Currency Risk
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Concentration Risk
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Cash and Cash Equivalents
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Currency Risk
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New Risk charge for assessing the risk an insurer’s liabilities may
exceed its assets if currency exchange rates move adversely
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Required to report at least 95% of Form 4EBS total of Assets &
Liabilities and split by currency
•
Provide Liability and ECR Charge for previous last three years
Note: Liability to ECR Charge is based on the greater of prior year value
and average of last three years
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Currency Risk Example
95% Threshold
Liability to ECR Charge / “BSCR Proxy”
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Concentration Risk
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New Risk Charge to identify largest ten independent exposures to all
instruments
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Cash & Cash Equivalents and Bonds & Debentures are allocated by
BSCR Rating 0-8, remaining balances will be applied BSCR factor
charge
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For exposures that have more than one BSCR rating, report each
BSCR rating separately
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Concentration Risk Example
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Cash and Cash Equivalents
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Provide more risk sensitive charge that is similar to the methodology
used for the Particulars of Ceded Reinsurance
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Required to report at least ten largest counterparty exposure and
apply a BSCR Rating 0-8
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Remaining balance to be consolidated by BSCR Rating
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40% diversification factor charge
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Cash and Cash Equivalents Example
Largest ten exposures
Consolidated Exposures
Diversification Adj.
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QUESTIONS?
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