Transcript None - O I C

Enhancing Insurance Regulation and
Supervision
David Richardson
Director
Asia Actuarial Services
PricewaterhouseCoopers
8th September 2008
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HISTORICAL BACKGROUND
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HISTORICAL BACKGROUND
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Insurance legislation designed to try to ensure solvency through implicit margins
and conservative assumptions
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Assets at lesser of book or market value
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In Singapore/Malaysia, property taken into account at a value 30 years ago
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This was thought safe – the safer the better
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Taxation authorities didn’t help since a property revaluation would lead to a tax bill
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For life companies, this was coupled with a statutory net premium valuation of
liabilities
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Net premium valuation involves calculating premiums based on prescribed
mortality, morbidity and discount basis and then subtracting the present value
future net premiums from the present value of the sum assured and attaching
bonus, if any, on the prescribed basis
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HISTORICAL BACKGROUND
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No explicit account is taken of management expenses, surrenders, lapses or
distribution expenses. No explicit account is taken of expected future bonuses
paid to policyholders or expected future dividends to be paid to shareholders
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The prescribed discount rates were what were thought to be low interest rates
at the time so as to be safe and implicitly provide for future reversionary and
terminal bonuses.
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The prescribed mortality rates were deliberately historical so as to implicitly
provide margins
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The prescribed net premium valuation basis for Thailand requires the use of
a discount rate equal to the interest rate used in the pricing of the life insurance
products subject to a maximum of 6% p.a. The prescribed mortality table is
TMO 86 for policies issued before 2002 and TMO 97 for policies issued from
and after 2002.
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HISTORICAL BACKGROUND
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Current mortality experience among a number of life insurers is about 50% of
TMO 97
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A Zillmer adjustment of 5.5% is permitted for ordinary life business and 6.5%
for industrial life business
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The defects are huge lack of transparency and an inability of the insuring public
to compare the financial health of one company with another
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Capital was locked away inefficiently and unrealised investment gains were
passed to neither policyholder nor shareholder
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Without unrealised investment gains in the accounts, insurance was more
expensive than it should have been and insurance company products were looking
increasingly uncompetitive relative to banking and unit trust products
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HISTORICAL BACKGROUND
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The discount rate for the net premium valuation was fixed in times of high interest
rates and could not cope with an economic cycle of low interest rates and what
was thought to be conservative was nothing of the kind
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The same interest rate was prescribed for valuing participating policies as well as
non-participating products – illogical
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“One size fits all” net premium valuation ignored any differences in rates of future
bonuses or in the difference in management expenses, lapses, investment returns
etc between different companies
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Even a mortality margin for life insurance valuations didn’t help the proper
emergence of reversionary bonus because the margin which is based on the
difference between sum assured and reserve decreased with policy duration
whereas reversionary bonus values increase with duration
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Certain risks such as asset/liability mismatching risk and borrower default
risk were not recognised at all and no reserves established to reflect these
risks
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HISTORICAL BACKGROUND
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Governments were becoming increasingly concerned – the demise of Equitable
Life in the UK and HIH in Australia
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Basel 2 provided an impetus for banks to decide on risk charges for borrower
default based on individual risk standing rather than apply a flat 8% across the
board
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Questions were posed:– Is there sufficient capital to support policy guarantees?
– Sufficient capital to support companies with high new business growth
compared to less dynamic companies?
– Sufficient capital to cover mismatching of assets and liabilities?
– Sufficient capital to back the risk of corporate bond default or risk of market
declines for equities and property?
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Change was inevitable. Already happened in Singapore, India, Australia and
Malaysia.
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MALAYSIA/SINGAPORE
DIFFERENCES
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MALAYSIA/SINGAPORE DIFFERENCES
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In Singapore and Malaysia, RBC for general insurers is similar
Both Singapore and Malaysia adopt projected cash flow on the life side to
determine BE and additional PAD ( PRAD in Malaysia). The PAD is to cover liability
fluctuations up to 75% confidence level
With the Par fund in Singapore, there is introduced ‘Surplus Account”. The
allocation to shareholders is by a 90/10 rule by which the shareholders are entitled
to 10/90 x cost of policyholders’ bonuses
Shareholders may withdraw the Surplus Account only if capital requirements are
met. Remaining assets in the Par fund are available to meet policy liabilities.
The policy liability of a Par fund is set to equal the policy assets i.e. assets less
surplus account subject to (a) minimum condition liabilities i.e. the guaranteed
liabilities discounted using a risk free discount rate (b) guaranteed liabilities + nonguaranteed liabilities discounted using the best estimate of the investment return of
the fund ( Singapore) or the yield on A2 rated corporate bond ( Malaysia)
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MALAYSIA/SINGAPORE DIFFERENCES
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In Malaysia, there is no “Surplus Account” concept for the par fund
The liabilities of the par fund in Malaysia are the sum of the present value of
guaranteed benefits (risk free discount rate) and the present value of nonguaranteed benefits i.e. bonuses. There is no adjustment for policy assets
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MALAYSIA/SINGAPORE DIFFERENCES
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The discount rate for the GPV is different. Singapore uses the actuary’s best
estimate of fund investment return. Malaysia uses AA rated bond yield
Minimum CAR =120% ( Singapore) 130% ( Malaysia)
Neither have liquidity tests e.g. assume projected future cash flow income
sufficient to pay out benefits in all circumstances
With regard to general insurance, Malaysia says that if discounting of liabilities is
used, explicit claims escalation assumptions should be used. Singapore just
leaves it to the Actuary to decide
In the calculation of C1, the adjustment to mortality rates for insurance policies
with guaranteed premiums and for annuities refers to a specified mortality table
based on insurance company experience 1997-2002. All other mortality,
expense, dread disease etc adjustments are based on the insurers best estimate
( usually PAD is 50% of the adjustment. On the other hand, in Malaysia, the
adjustments refer to best estimate throughout but at a higher level e.g. nonguaranteed premium 120% of best estimate rates whereas Singapore uses
112.5%.
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MALAYSIA/SINGAPORE DIFFERENCES
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For general insurance liabilities in Malaysia, the maximum diversification effect
i.e. fund PRAD is not less than 50% of the sum of the individual PRAD by line
of business. No such limitation is imposed in Singapore.
Risk free discount rate in Malaysia is based completely on the yields for
Government securities by duration up to 10 years. Thereafter based on the 10
year term.
In Singapore, risk free discount rate is based completely on the yields for
Government securities by duration up to 10 years. Thereafter, a stable long
term risk free discount rate is determined based on the following: (i) compute
the average closing yield of 10 year SGS since inception (ii) compute the
average yield differential between 10 year and 15 year SGS (iii) derive an
estimated long term yield by adding (i) and (ii) (iv) compute average closing
yield of 15 year SGS over past 6 month period (v) allocate 90% weight to the
yield in (iii) and 10% weight to the yield in (iv) and round up to the nearest 25
basis points to arrive at the LTRFDR. Use LTRFDR for durations of 15 years or
more and interpolation between 10 and 15 years
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MALAYSIA/SINGAPORE DIFFERENCES
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If the policy assets are short of either of the 2 floors, assets must come from
surplus account to support the policy assets. This deduction may be recoverable in
future when policy assets exceed the 2 floors
On bonus distribution, Singapore RBC says that the cost of bonus will be calculated
using the MCL basis.
There are 2 capital requirements (a) fund solvency applicable to each insurance
fund and (b) capital adequacy requirement applicable to the insurer overall
There are 3 components to determine capital adequacy requirements.
C1 is the liability risk charge obtained by applying specific risk charges to premium
and claim liabilities ( general insurers) and by applying specific risk margins to the
various assumptions affecting policy liabilities ( life insurers)
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MALAYSIA/SINGAPORE DIFFERENCES
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C2 relates to asset risks based on exposure to bonds, equities etc but it also relates
to asset/liability mismatching risk
C3 refers to concentration risk in certain types of assets, counterparties or groups
of counterparties
Total risk requirement = C1+C2+C3 = TRR
Amount of capital to meet TRR is financial resources
For a fund, the financial resources > TRR
For all insurance funds ( except par funds), financial resources = assets-liabilities.
For a par fund, financial resources in Singapore = balance of surplus account +
liability for non-guaranteed benefits
For Malaysia, each insurer is required to determine CAR in its insurance and
shareholders’ funds to support total capital required
CAR is total capital available/ total capital required
For life insurer with par business in a separate fund, CAR = min (CAR all, CAR all
except par) reflects the ability of life insurers to adjust the level of future bonuses
and also preserves the principal that surplus of par fund cannot support non-par
business
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MALAYSIA/SINGAPORE DIFFERENCES
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Total capital available – Tier 1 + Tier 2 capital in Malaysia Tier 1 is permanent, no
maturity date, cannot be redeemed, non-cumulative, issued and fully paid up.
In Singapore, total capital available = Tier 1 +Tier 2 + provision for non-guaranteed
benefits( in par fund)
In both Singapore and Malaysia, asset inadmissibility rules have been removed (
except for items such as goodwill, future tax credits etc)
In Singapore, operational risk has no risk charges since it was felt that operational
risks can be better dealt with by an insurer’s internal risk management systems and
supervisory effort
In Malaysia, operational risk has a specific risk charge of 1% of total assets
In Singapore and Malaysia, there is a diversification effect by fund for general
insurance liabilities but no diversification effect for life insurance liabilities or for
assets. Solvency II specifies diversification effect for all.
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Characteristics of a good RBC system
and EWS
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Characteristics of RBC system
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Identifies risk faced by insurers and provides a clear framework on how they should
be measured
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Asset risks should include credit risk, market risk and concentration risk
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Life liability risk should include mortality, management and distribution channels
expenses, persistency, discount rates
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Non-life liability should include claims fluctuations through development years and
the sufficiency of premium to cover unexpired risk
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Diversification risk is taken into account
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Initially, the framework should not be too complex. The system can be strengthened
and enhanced over time.
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Characteristics of EWS system
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Able to alert the regulators in good time of insurers who may be having financial
problems
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Should be responsive without being an undue burden on insurers
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The key early warning indicator to the regulator is the Capital Adequacy Ratio
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However, because certain assumptions are based on industry data, additional
indicators may be needed
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Project Plan
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Overall timeline
Design
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Mobilisation and Stock-take
RBC formula
First Consultation with industry
RBC and EWS design
Second Consultation
RBC approval
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RBC market testing
Roll-out
N°
Test
Time in months*
Activity
(Details of each activity has been set
out in section 4)
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RBC roll out planning
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EWS market testing
10
Post implementation review
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Sep
08
SepOct 08
Oct –
Nov 08
Nov –
Dec 08
Dec 08
– Jan
09
JanFeb 09
FebMar 09
MarApr 09
AprMay 09
MayJun
09
Jun
09
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Project phases
Deliverables
Phases
1. Mobilisation and Stock –take
2. RBC formula
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3. First Consultation
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New project structure
Agreed understanding of “where
we are”
Agreed Project Plan
RBC training number one, on
international practice
Agreed first draft RBC formula
and asset and liability valuation
rules
Initial industry seminar
Stakeholders views on first draft
proposals
Main Activities
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Formation of enlarged team
Approval of project plan
Workshops to identify outstanding technical issues
Preparation of “where we are now “report
Review Thai regulations and compare with other RBC regimes,
including Malaysia and Singapore
RBC training day on international practice
Draft asset liability proposals
Consider tax, accounting (including IFRS) implications
Approve asset liability proposals
RBC formula benchmark review
Draft RBC formula
Life/non-life RBC formula consistency review
Draft capital and fund solvency requirements
RBC Formula approval
Identify all relevant stakeholders for consultation
Agree consultation format and seminar agenda
Issue consultation invitations and launch seminar invitations
Prepare first consultation paper
Approve consultation paper
Consultation launch seminar
Review first consultation responses
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Project phases
Deliverables
Phases
4. RBC and EWS design
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5. Second Consultation
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EWS preferred approach
RBC proposed formula and
parameters
Transition proposals
Final models
RBC Training number two:
Regulator and industry training
Stakeholders views on final
proposals
Main Activities
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Collect data for parameterisation of RBC formula, including both assets
and liabilities, taking into account possible future developments in asset
classes
Collate international RBC parameters
Life statistical analysis
Review existing non-life statistical analysis and develop as necessary
Consider international approaches to EWS
Define preferred EWS approach
First selection of RBC parameters
Compare international approaches to RBC transition and the issues
which arose
Define EWS information requirements and work flows
Collect data for market impact testing of RBC and EWS
Develop market experience and testing models
Conduct market impact testing of RBC and effectiveness of EWS
Complete EWS design
Complete RBC design
Draft 2nd consultation paper to include RBC and EWS
Finalise draft of second consultation paper
Agree format of second consultation
Plan second consultation logistics
Initiate second consultation
Review second consultation responses
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Project phases
Deliverables
Phases
6. RBC approval
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Approved RBC framework and
transition rules
Draft regulations and actuarial
guidelines
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RBC training number 3
Identified issues for live RBC
environment
8. RBC roll out
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Training and help desk
Functioning RBC system
9. EWS market testing
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Training and help desk
Completed EWS framework
Industry report
10. Post implementation review
To be performed by third party
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RBC market testing
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Main Activities
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Second draft RBC parameters
Revise and finalise RBC framework proposal
Revise and finalise EWS design
Prepare EWS manuals and templates
Ensure necessary approvals
Prepare final RBC regulations and supporting report
Prepare RBC roll out plan
Establish dry run help desk
Conduct training
Review dry runs results
Finalise RBC roll out plan
Amend transitional arrangements in light of all market testing
Establish help desk
Test EWS workflow
Carry out “all market” dry runs
Analyse EWS dry runs
Develop internal report for discussion
Prepare amendments to EWS templates, workflows and manuals
Finalize industry report
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Project Office
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As-Is project office
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To-be project office
* To be determined if necessary
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Barriers to success/Key success
factors
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Success factors
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Market education
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Market buy-in to the proposed framework
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Transition arrangements
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Integration of RBC and EWS
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ASSET RISK CHARGES
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ASSET RISK CHARGES
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The asset value in a RBC regime will be fair value or, for listed equities, market
value
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We can split assets into 2 types: The fist type includes bonds, mortgages and
preference shares for which there is a fixed interest return and a probability of
default according to how risky is the investment.
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The second type includes property and shares which are subject to fluctuations
in rental income, dividends and market values but not to default.
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The fair value of assets corresponds to the best estimate of liabilities and the
probability of default ( for the first type) or of market value fluctuation (for the
second type) enables the actuary to determine the appropriate asset risk
charges to achieve a certain confidence level
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The general question to be answered for each investment type is this:
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ASSET RISK CHARGES
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“ Given the current market value and a risk-free investment rate i.e. the investment
rate generated by Government bonds of appropriate duration, what is the discount
to current market value for which we have a certain level of confidence that the
market value in 12 months’ time will not be below such discounted market value”
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The methodology to answer this question for listed ordinary shares is similar to the
Black-Scholes methodology in the pricing of stock options and derivatives.
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The assumption is that proportional changes in the share price in a short period
of time are normally distributed or that the actual share price at any future time
has a log-normal distribution
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ASSET RISK CHARGES
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The mean of the log-normal of the share price at any time t in future is given by
the formula:
log(n) S(t) = log(n) S + ( µ - σ2/2)t
where S is the current share price, µ is the risk-free investment return rate and σ
the volatility of the share price
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Also the standard deviation of log(n) S(t) = σ√ t
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One of the features of a normally distributed variable is that there is a 95%
probability that it has a value within 2 standard deviations of its mean
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This provides a method of determining a suitable discount to market value at
31 December in any year such that we have 95% confidence that the actual
market value as at 31 December in the following year is greater than such
discounted market value
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It is normal practice with Black-Scholes to use a suitable stock market index as
a proxy to the volatility of a share price
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ASSET RISK CHARGES
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To illustrate the process, how did we generate asset risk charges for insurance
companies in India?
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Tracked the closing prices in the Bombay SENSEX index for each trading day
over a period of 10 years
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Taking the ratio of the index closing price in 1 day to the previous day’s closing
price, we got the inter-day investment return
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We took various time periods such as 90 days, 180 days and 360 days to
determine the average volatility of the investment return – 20%. The volatility itself
was quite volatile – so we conducted a number of sensitivity checks with volatility
ranges from 10% to 30%. The greater the volatility the greater the discount
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The risk-free investment return was the rate of investment return on Indian
Government securities of 364 days duration
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ASSET RISK CHARGES
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The risk free rate was 9.5%. We conducted sensitivity tests using rates 7% - 13%
At 95% confidence interval, the results were:
Volatility
10.0%
Interest Rate
15.0%
20.0%
25.0%
30.0%
Discount to market value
7.0%
9.5%
17.1%
24.3%
31.1%
37.4%
8.0%
8.5%
16.3%
23.6%
30.4%
36.8%
9.5%
7.2%
15.0%
22.4%
29.4%
35.8%
12.0%
4.8%
12.9%
20.5%
27.6%
34.2%
13.0%
3.9%
12.0%
19.7%
26.8%
33.5%
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ASSET RISK CHARGES
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The discount to market value varies considerably by interest rate changes at 10%
volatility but much less so at higher volatility
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The lower the interest rate for a given volatility the higher the discount to market value
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Our best estimate discount against market value was 25%
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For corporate bonds, historical default data from LIC
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Once a bond defaulted on a dividend payment, it defaulted for all payments afterwards
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Simple probability of default
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Most corporate bonds not rated
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Assumed that coupon rate was correlated with rating but cannot group all bonds with
a certain coupon rate over the 10 year period
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It’s the difference between the coupon rate and the risk free rate which determines if
a bond is speculative or not
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ASSET
CHARGES
ASSET RISKRISK
CHARGES
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Next we split the minimum and maximum coupon rates in a year into 7 equal
intervals corresponding to ratings AAA to B-
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Assuming a uniform distribution of default over the bond duration, we obtained
annualised default probabilities
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Similar exercises were conducted for residential and commercial mortgages,
real estate and listed and unlisted preference shares
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GENERAL INSURANCE LIABILITIES
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GENERAL INSURANCE LIABILITIES
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Concept in risk-based capital is liabilities determined on a best estimate basis
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50% chance of being too high and 50% chance of too low
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Margin in Singapore, Malaysia and Australia is to increase the 50% chance of
being too high to 75% chance i.e. liabilities measured at a 75% confidence level.
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On top, we have liability risk charges
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To be consistent with asset risk charges, these should increase the confidence
level from 75% to 95%
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The actuarial determination of claim reserves and unexpired risk reserves is
statistical. It examines historical claim payments to determine trends so that future
claim payments can be estimated
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One actuarial method selects development factors based on an analysis of
historical claims development factors
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GENERAL INSURANCE LIABILITIES
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The selected development factors are applied to cumulative claims data for each
line of business for each accident or underwriting year for which data not yet
developed
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This produces an estimated ultimate claims cost
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The claim reserve is the difference between the ultimate claims cost and
cumulative paid claims
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This is best estimate. 75% confidence level figure – referred to as provision for
adverse deviations (PAD) in Singapore- normally determined by simulation
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Simulation approach is as follows:
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Taking cumulative claim payments throughout development years from an
accident/underwriting year for each business line, we determine the ratio of
cumulative claims paid up to a development year divided by the cumulative
claims paid up to the prior development year
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From the various ratios in a development year, the best estimate is selected
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GENERAL INSURANCE LIABILITIES
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The selected ratios are applied to the cumulative claims data to determine the “fitted”
claims development triangle
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The “fitted” claims data determines the best estimate
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The “fitted” claims data is considered the mean of a normal distribution and actual
claims payments are samples of claim payments taken from the underlying normal
distribution
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If F is the fitted claims data and A the actual claims data, then
(A-F) x 1/√F is a unit normal distribution with mean zero and standard deviation 1
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The simulation – “bootstrapping” – consists in applying random numbers from 0 to 1
to the variable to more closely define the normal distribution
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Usual to run 50 simulations 10 times and take the average of each mean as the best
estimate and the average of the PADs as the PAD
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The average of the PADs is divided by the average of each mean and expressed in
percentage terms
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GENERAL INSURANCE LIABILITIES
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The percentage is applied to the best estimate to determine the appropriate PAD
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The simulation does not depend on the method to get best estimate but depends
on a random selection of the differences between fitted claims and actual claims
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Illustration: Cumulative paid claims from accident year through development years
Converted Triangle Reshaped to Left Cum
Accident Yr
1998
1999
2000
2001
2002
2003
2004
2005
2006
12
1,835,329
2,061,541
2,765,751
1,038,264
1,168,296
1,150,092
794,433
857,856
1,603,512
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24
3,587,773
4,031,489
4,321,197
2,559,271
5,258,246
4,296,560
1,849,857
1,682,861
36
3,932,318
4,127,649
4,557,032
3,192,100
6,665,277
5,799,263
2,386,066
48
3,971,322
4,343,880
4,846,339
3,670,469
7,586,690
5,985,414
60
4,009,753
4,644,558
5,197,292
3,843,598
7,787,041
72
4,101,513
4,737,900
5,238,904
3,868,412
84
4,117,946
4,745,713
5,244,638
96
4,129,419
4,764,792
108
4,131,197
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GENERAL INSURANCE LIABILITIES
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Ratio of cumulative paid claims for one development year to the cumulative paid
claims for previous development year and determine various averages of the
factors
Age-to-Age Factors
Accident Yr
1998
1999
2000
2001
2002
2003
2004
2005
2006
12 - 24
1.955
1.956
1.562
2.465
4.501
3.736
2.329
1.962
24 - 36
1.096
1.024
1.055
1.247
1.268
1.350
1.290
36 - 48
1.010
1.052
1.063
1.150
1.138
1.032
48 - 60
1.010
1.069
1.072
1.047
1.026
12 - 24
24 - 36
36 - 48
48 - 60
60 - 72
1.023
1.020
1.008
1.006
72 - 84
1.004
1.002
1.001
84 - 96
1.003
1.004
96 - 108
1.000
To Ult
72 - 84
84 - 96
96 - 108
To Ult
Averages
Simple Avg
All Yrs
Latest 7
Latest 5
Latest 3
Medial Avg
All Yrs x1
Latest 7x1
Latest 5x1
Latest 3x1
Volume Wtd
All Yrs
Latest 7
Latest 5
Latest 3
Time Wtd Avg
All Yrs
Latest 7
Latest 5
Latest 3
Linear Proj Est
All Yrs
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60 - 72
2.558
2.644
2.998
2.675
1.190
1.190
1.242
1.302
1.074
1.074
1.087
1.107
1.045
1.045
1.045
1.049
1.014
1.014
1.014
1.012
1.002
1.002
1.002
1.002
1.003
1.003
1.003
1.003
1.000
1.000
1.000
1.000
2.400
2.489
2.843
2.329
1.191
1.191
1.268
1.290
1.072
1.072
1.085
1.138
1.048
1.048
1.048
1.047
1.014
1.014
1.014
1.008
1.002
1.002
1.002
1.002
1.003
1.003
1.003
1.003
1.000
1.000
1.000
1.000
2.364
2.440
3.124
2.794
1.184
1.184
1.236
1.302
1.075
1.075
1.086
1.101
1.044
1.044
1.044
1.045
1.014
1.014
1.014
1.012
1.002
1.002
1.002
1.002
1.003
1.003
1.003
1.003
1.000
1.000
1.000
1.000
2.703
2.725
2.892
2.591
1.242
1.242
1.265
1.304
1.085
1.085
1.089
1.099
1.046
1.046
1.046
1.045
1.011
1.011
1.011
1.010
1.002
1.002
1.002
1.002
1.004
1.004
1.004
1.004
1.000
1.000
1.000
1.000
3.119
1.396
1.120
1.048
0.999
0.999
1.003
1.000
PwC
GENERAL INSURANCE LIABILITIES
Development Factor Selection
Prev. Selection
Defaults
Default Weight
User Selected
Selected Result
FacToUlt
Percent of Ult
12 - 24
3.650
2.794
1.000
3.000
3.000
4.437
0.225
24 - 36
1.225
1.302
1.000
1.250
1.250
1.479
0.676
36 - 48
1.100
1.101
1.000
1.100
1.100
1.183
0.845
48 - 60
1.055
1.045
1.000
1.045
1.045
1.076
0.930
60 - 72
1.020
1.012
1.000
1.015
1.015
1.029
0.972
Earned
Premium
5,718,513
5,929,209
6,517,091
5,433,706
8,975,181
9,505,261
5,248,383
3,652,307
6,802,708
57,782,359
Estimated
Ratio
72.75%
81.00%
81.36%
72.19%
89.30%
67.73%
53.79%
68.14%
104.58%
72 - 84
1.003
1.002
1.000
1.003
1.003
1.014
0.986
84 - 96
1.003
1.003
1.000
1.003
1.003
1.011
0.989
96 - 108
1.020
1.000
1.000
1.001
1.001
1.008
0.992
To Ult
1.000
1.000
1.000
1.007
1.007
1.007
0.993
Estimated Ultimate
Accident Yr
1998
1999
2000
2001
2002
2003
2004
2005
2006
Total
Paid
Amounts
4,131,197
4,764,792
5,244,638
3,868,412
7,787,041
5,985,414
2,386,066
1,682,861
1,603,512
37,453,933
Factor to
Ultimate
1.007
1.008
1.011
1.014
1.029
1.076
1.183
1.479
4.437
Estimate of
Ultimate
4,160,115
4,802,943
5,302,492
3,922,818
8,015,007
6,437,866
2,823,078
2,488,850
7,114,492
45,067,662
Estimated Ultimate Reconciliation
Accident Yr
1998
1999
2000
2001
2002
2003
2004
2005
2006
Total
Paid
Amounts
4,131,197
4,764,792
5,244,638
3,868,412
7,787,041
5,985,414
2,386,066
1,682,861
1,603,512
37,453,933
*connectedthinking
Incurred
Amounts
4,160,737
4,798,762
5,278,031
3,987,383
8,545,184
7,206,044
4,346,845
2,738,748
6,537,106
47,598,840
Case
Reserves
29,540
33,970
33,393
118,971
758,143
1,220,630
1,960,779
1,055,887
4,933,594
10,144,907
IBNR
-622
4,182
24,461
-64,565
-530,177
-768,178
-1,523,767
-249,898
577,386
-2,531,178
Estimate of
Total
Reserve
28,918
38,152
57,854
54,406
227,966
452,452
437,012
805,989
5,510,980
7,613,729
Estimate of
Ultimate
4,160,115
4,802,943
5,302,492
3,922,818
8,015,007
6,437,866
2,823,078
2,488,850
7,114,492
45,067,662
PwC
GENERAL INSURANCE LIABILITIES
•
Diversification effect: The best estimate and PAD are obtained separately for each
line of business but the overall PAD is not the sum of the PADs by line of business
•
Combining short-tailed and long-tailed business has the effect of reducing volatility
•
Determined by combining claims data for all lines and running the simulation again
•
The other RBC reserve for general insurance is the unexpired risk reserve
•
Generally obtained by applying best estimate ultimate loss ratio to unexpired
premium reserve. In addition PAD required on the URR
•
Normal distribution assumption applied to assets to determine asset risk charges
at 95% confidence limit
•
The best estimate plus PAD takes us to 75% confidence limit.
*connectedthinking
PwC
GENERAL INSURANCE LIABILITIES
•
Liability risk charges – based on the same normal distribution assumption –
will take us from 75% confidence limit to 95% confidence limit
•
In Singapore, we determined liability risk charges by collecting claims data from
a number of insurers and applied bootstrapping to the best estimate plus PAD
after allowing for the diversification effect for both claim reserves and unexpired
risk reserves
•
This provides the liability risk charges. This is added to the asset risk charges
(both credit risk and market risk)
•
The asset concentration risk charges are simply 100% of an excessive investment
– according to a pre-determined table – in any one asset
•
Adding them up gives the total risk charges for a general insurer
*connectedthinking
PwC
LIFE INSURANCE LIABILITIES
*connectedthinking
PwC
LIFE INSURANCE LIABILITIES
•
Determination of life insurance liabilities follows the same principles as applied
to assets and general insurance liabilities
•
The artificial net premium valuation of liabilities is replaced by an explicit
prospective analysis of future expected cash flows arising from each policy
•
The actuary should project cash flows forward over the expected contract term
taking into account any options which could extend the contract term, such as
term policies with renewable options
•
The approach requires a projection of expected future payments and receipts
taking explicitly into account actual premiums, investment income and investment
expenses, mortality and morbidity benefits, surrender benefits, lapses, distribution
costs, management expenses, claim expenses ( if not in management expenses),
reinsurance premiums and recoveries, tax, options and guarantee costs
*connectedthinking
PwC
LIFE INSURANCE LIABILITIES
•
It should be noted that this cash flow projection takes explicitly into account
expected future bonuses for participating policies and expected shareholders’
future dividends
•
These are on the actuary’s best estimate assumptions. An additional margin is
required to allow for adverse deviation and this would be the actuary’s estimate
of what the assumptions would be at 75% confidence interval.
•
The liability risk charges are such as to increase the confidence limit from 75%
to 95%.
•
The liability risk charges are prescribed percentages to apply to best estimate
mortality, morbidity, renewal expense, persistency etc
•
To illustrate, if the actuary’s best estimate mortality assumption was 50% TMO 97
and his 75% confidence interval assumption were 58% TMO 97, the mortality
component of the liability risk charges would be set at, say, 135% of the best
estimate mortality assumption i.e. 67.5% TMO 97
*connectedthinking
PwC
LIFE INSURANCE LIABILITIES
•
A logical distinction is made between liabilities which are guaranteed (nonparticipating business, basic sum assured, attaching bonus of participating
business) and liabilities which are not guaranteed (future bonuses)
•
The discount rate for guaranteed liabilities would be a risk-free interest rate
i.e. the yield on Government securities of appropriate duration. The question
of appropriate duration provides some difficulties since there are no Government
bonds with durations as long as many of the liabilities
•
Malaysia specifies that the risk-free discount rate should be equal to Government
bond yields for durations up to 10 years and for cash flow after 10 years, the
discount rate is the 10 years Government bond yield
*connectedthinking
PwC
LIFE INSURANCE LIABILITIES
•
The justification is that with a normal yield curve, yields for durations greater
than 10 years would be higher than the yield for 10 years duration
•
Therefore conservative.
•
The discount rate for non-guaranteed liabilities i.e. future bonuses and future
shareholders’ dividends should be greater than the risk-free rate to reflect the
non-guaranteed nature of these liabilities
•
Singapore directs that the best estimate of the investment return of the fund
should be used
•
Malaysia prescribes it a little more by directing the risk-free rate plus a margin
should be used. The margin is the difference between the yield of A rated bond
of same duration and the risk-free rate
*connectedthinking
PwC
LIFE INSURANCE LIABILITIES
•
Solvency II in Europe does it differently. The discount rate is proposed to be the
discount rate which equates the discounted value of future expected asset cash
flows to the current asset market value
•
The fact that liabilities will generally be longer than the asset duration for life
insurers introduces an asset/liability mismatching risk
•
This applies to the value of the guaranteed liabilities and the value of fixed interest
investments.
*connectedthinking
PwC
LIFE INSURANCE LIABILITIES
•
Suppose V is the liability including PAD based on risk-free discount rate and
is the fair value of the assets
•
Calculate V1 and V2 based on increasing and decreasing interest rates
•
Both Singapore and Malaysia specify the increases and decreases in absolute
amount terms by duration – such as 1.5% for 1 year to 0.8% for 20 years + but
it might be an improvement to specify the increases and decreases in percentage
terms by duration
•
Calculate A1 and A2 based on increasing and decreasing interest rates
•
Suppose A-V = S, A1-V1=S1 and A2-V2=S2, the asset/liability mismatching risk
charge = the higher reduction in surplus under the increasing and decreasing
interest rate assumptions
*connectedthinking
A
PwC
LIFE INSURANCE LIABILITIES
•
Total risk charges for life insurers are the asset risk charges
(credit and market risk) plus the asset/liability mismatching risk plus asset
concentration risk plus the insurance liability risk charges
•
Liability risk charges are determined by V*-V where V* is the recalculated value
of the liabilities based on the 95% confidence limit assumptions and V is the
value of the liabilities at the 75% confidence level
*connectedthinking
PwC
CAPITAL ADEQUACY RATIO
*connectedthinking
PwC
CAPITAL ADEQUACY RATIO
•
Key measure of the financial health of an insurer in a risk-based capital regime
is the Capital Adequacy Ratio
•
This is the ratio of capital remaining after taking into account the best estimate
plus PAD liabilities divided by the total of the various risk charges
•
The Capital Adequacy Ratio and the progress of it over the years is an early
warning to the regulator for progressive action
*connectedthinking
PwC
CAPITAL ADEQUACY RATIO
•
Both Singapore and Malaysia have set minimum Capital Adequacy Ratios
•
Capital can be split into permanently available capital such as shareholders’
paid-up capital, retained surpluses and any property revaluation reserve - termed
Tier 1 capital – and other capital of a less permanent nature
•
The key feature of Tier 1 capital is that it is available to policyholders in the event
of liquidation
•
One point is that the investment of such capital has consequential asset risk
charges and these should be added to the total risk charges before determining
CAR
*connectedthinking
PwC
CAPITAL ADEQUACY RATIO
•
The method to determine fair value of assets including derivatives is contained in
IFRS 39. Therefore IFRS 39 should be introduced at the same time as Risk-based
Capital
•
Also IFRS 4 focuses on the differences between insurance and investment
products and the standard of disclosure to assist the layman in assessing the
financial health of the insurer
•
This should also be introduced at the same time.
•
Sufficient time should be allowed for testing the financial impact of Risk-based
Capital to the industry in general
•
It’s also important that the introduction of Risk-based Capital is not regarded simply
as a compliance matter but as a powerful means of improving insurance companies
financially to the benefit of shareholders and policyholders alike.
*connectedthinking
PwC
Thank you
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of member firms of PricewaterhouseCoopers International Limited, each of which is a separate and independent
legal entity. *connectedthinking is a trademark of PricewaterhouseCoopers LLP (US).
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