Transcript Solvenz

Swiss Regulation and Supervision of
Reinsurance Companies:
Swiss Solvency Test
Federal Office of Private Insurance
Bern, 4 April 2006
1
Timeline of the SST Development
Task Force BPV to assess shortcomings of regulatory and supervisory framework
2003
2004
2005
2006
2007
2008
Herbert Lüthy becomes new director of FOPI (Federal Office of Private Insurance)
in Fall 2002, reorientation to prudential supervision
Start of Swiss Solvency Test project Mai 2003 with participation of industry,
actuarial and insurance association, consulting companies and others,
conceptual work finished end of 2003
Up to Mai 2004, development of first version of the standard model
Field test 2004 with 10 insurers,
supported by consulting companies
Adaptations and improvements on the standard
model and the methodology of the SST
Further development
underway on
Field test 2005 with 45 insurers
requirements on
covering approx 90% of the market
internal models and
Insurance supervision act implemented 1.1. 2006
group effects
Field test 2006, mandatory for all
large life & nonlife companies
Field test 2007, mandatory for all
large life & nonlife companies
Small companies,
reinsurers and
groups prepare for
full SST calculations
in 2008+
Build-up of FOPIs
staff by 50% over
two years
As of 2008 all companies have to implement the SST, as of 2011
target capital requirement will be in force
2
SST Transition Period
Introduction of VAG / AVO
2006
2007
2008
2009
2010
2011
Plan for implementation of SST
Full SST implementation for all insurers and
reinsurers as of 2008
All
insurers
Life Insurers with
CH-GPV > 1.0 Mia
Target capital
requirement has to
be satisfied
SST has to be done, Swiss business has to be calculated
exactly, for branches approximations can be used
P&C insurers with
CH-GPV > 0.5 Mia
Groups
Full SST implementation
Plan for implementation of
SST with close coordination
with FOPI
Full SST implementation
3
Reinsurance Regulation
Reinsurance companies have to fulfill the same solvency
requirements as direct companies
Solvency Requirements:
• Solvency 1: Compatible with EU
requirements, based on statutory valuation
• SST: Risk based solvency requirements based
on market consistent valuation of assets and
liabilities both on legal entity and group level
Both requirements
have to be satisfied
simultaneously
Corporate Governance and Risk Management requirements:
• Appointed actuary for each reinsurance company
• Risk and capital management requirements
• Fit and Proper, checks and balances, internal controls have to be in
place
4
Inward Reinsurance
Treatment of ceded reinsurance:
Solvency 1:
• Life insurers : provisions have to be held on a gross basis
• P&C insurers: provisions are net of reinsurance
• Limited recognition of reinsurance for Solvency 1 ratio
SST:
• All calculations can be based net of reinsurance, however a
charge is added to the capital requirement based on the
default probabilities of the reinsurers to which risks are ceded
• Proxy for default probabilities: ratings or using risk based
solvency ratios
5
Solvency 1 Requirements for Reinsurers
For P&C business: Equal to Solvency 1
requirements for P&C direct companies 
16% - 18% of written premiums
For life business: 4% (1% if no financial
risks are accepted) of technical provisions
+ 0.1% of the net SAR
All calculations are
net of retrocession
The calculations are based on statutory accounting, reviewed by
audit companies, the statutory technical provisions have to be
determined by the appointed actuary of the reinsurer
Remark: Solvency 1 requirement are not sufficiently
risk sensitive. Risk based solvency ratios were
uncorrelated to Solvency 1 ratios based on results
of a field test conducted with P&C companies
6
SST Requirements
Risk based solvency requirements
have to be calculated by each
reinsurer supervised by FOPI both
on a legal entity level and on a
group level
Each supervised reinsurer has to
develop an internal model satisfying
regulatory requirements
During 2006 and 2007 internal
models are being developed or
existing ones adapted in conjunction
with close supervision by FOPI. As of
2008 all reinsurers will have to do a
full SST based on internal models
Group supervision of
Converium and Swiss Re
Standard models are not
applicable to reinsurers
which have heterogeneous
risks and unique risk
profiles. The same is true
for insurance groups and
conglomerates
7
SST Requirements
To allow for comparability of capital requirements between different
reinsurers, the internal models have to satisfy certain preconditions:
• All calculations have to be based on a
market consistent valuation of assets
and liabilities, taking into account
market, credit and insurance risk
• All relevant risk and capital transfer
instruments (intra- and extra-group)
have to be taken into account
• The model has to be based on a
stochastic methodology
• Capital requirement is given by 99%
TailVaR for a 1 year time horizon
(corresponds to approx. 99.6%99.8% VaR)
• The internal model needs to be
embedded within the companies and
well understood
For group-level models, all
legal entities and web of riskand capital transfer
instruments need to be
modeled consistently
As one of the results of the
calculations, FOPI obtains a
default probability for each
supervised entity
Responsibility lies with senior
management, the
methodology of the model
needs to be publicly disclosed
8
The SST Concept: Principle-Based
1.All assets and liabilities are valued market consistently
2.Risks considered are market, credit and insurance risks
Defines
Output
3.Risk-bearing capital is defined as the difference of the market
consistent value of assets less the market consistent value of
liabilities, plus the market value margin
4.Target capital is defined as the sum of the Expected Shortfall of
change of risk-bearing capital within one year at the 99%
confidence level plus the market value margin
5.The market value margin is approximated by the cost of the
present value of future required regulatory capital for the runoff of the portfolio of assets and liabilities
6.Under the SST, an insurer’s capital adequacy is defined if its
target capital is less than its risk bearing capital
7.The scope of SST is legal entity and group / conglomerate level
domiciled in Switzerland
8.Scenarios defined by the regulator as well as company specific
scenarios have to be evaluated and, if relevant, aggregated
within the target capital calculation
9
The SST Concept: Principle-Based
9.
Defines
How-to
All relevant probabilistic states have to be modeled
probabilistically
10. Partial and full internal models can and should be used. If
the SST standard model is not applicable, then a partial or
full internal model has to be used
11. The internal model has to be integrated into the core
processes within the company
12. SST Report to supervisor such that a knowledgeable 3rd
party can understand the results
Transparency
Responsibility
13. Disclosure of methodology of internal model such that a
knowledgeable 3rd party can get a reasonably good
impression on methodology and design decisions
14. Senior Management is responsible for adherence to
principles
10
The SST Concept: Building Blocks
Building blocks: Market consistent (economic) balance sheet
Free capital
Risk bearing capital
Target capital
Market value of
assets
Wherever possible, marketconsistent valuation is based on
observable market prices (marking to
market)
If such values are not available, a
market-consistent value is determined
by examining comparable market
values, taking account of liquidity and
other product-specific features, or on a
model basis (marking to model)
Market-consistent means that up to
date values are used for all parameters
SCR: Required
capital for 1-year
risk
Market Value
Margin
Market
consistent
value of
liabilities
Best estimate of liabilities
Best-estimate = Expected value of
liabilities, taking into account all up
to date information from financial
market and from insurance.
All relevant options and guarantees
have to be valued.
No explicit or implicit margins
Discounting with risk-free interest
rate
11
The SST Concept: Building Blocks
Building blocks:
Year 0
Year 1
Risk bearing
capital
Market Value
Margin
Revaluation of
liabilities due to
new information
Probability < 1%
New business
during one year
Change in market
value of assets
Market consistent
value of liabilities
Market value
of assets
Probability density of the
change of risk bearing
capital
Claims
Catastrophes
Average value of RBC in the
1% ‚bad‘ cases = Expected
Shortfall = SCR
Best estimate
of liabilities
Economic balance sheet
at t=0 (deterministic)
Economic balance sheet
at t=1 (stochastic)
12
The SST Concept: Market Value Margin
Market Value Margin: to cover policyholders against risks emanating beyond
1 year
• SCR: To cover risks which emanate during a 1year time horizon
• Market Value Margin: To cover cost of capital to
cover risks during the whole run-off of the
portfolio
There should not be doublecounting between SCR and
Market Value Margin
Possible Approaches:
• Statutory: Taking undiscounted reserves, using prudent
assumptions, adding a simple factor on best-estimate etc.
• Quantile: Taking e.g. the 75% quantile of the ultimate
loss distribution of the liabilities: Used by APRA for P&C
liabilities, discussed within Solvency 2.
MVM
Best Estimate
Provisions
• Market Value Margin: the additional amount on top of the best estimate
which is required by a willing buyer in an arms-length transaction to assume
the liabilities the loss reserves are held to meet: Discussed within Fair Value
Accounting, used within the SST.
13
The SST Concept: Market Value Margin
Definition: The market value margin is the smallest amount of capital
which is necessary in addition to the best-estimate of the liabilities, so
that a buyer would be willing to take over the portfolio of assets and
liabilities.
Idea: A buyer (or a run-off company) needs to put up regulatory
capital during the run-off period of the portfolio of assets and liabilities
 a potential buyer needs to be compensated for the cost of having to
put up regulatory capital
Market Value Margin = cost of the present value
of future regulatory risk capital associated with
the portfolio of assets and liabilities
Problem: How to determine future regulatory capital requirement
during the run-off of the portfolio of assets and liabilities?
-> Assumptions on the evolution of the asset portfolio are necessary
14
The SST Concept: Market Value Margin
MVM=CoC   SCR(t)
CoC: 6% over risk free
t 1
ES at t=0 does not enter calculation of the market value margin necessary
at t=0  risks taken into account for 1-year risk capital and market value
margin are completely disjoint and there is no double-counting
Future SCR for years 1, 2, …
t=0
t=1
t=2
SCR: 1-Period (e.g. 1 year) risk capital =
Expected Shortfall of risk-bearing capital
t=3
Years
Future SCR entering calculation of MVM at t=0
15
The SST Concept: Scenarios
For 2006, FOPI expects that groups and reinsurers formulate and evaluate
about 5 scenarios which capture the specific risk situation of the company.
FOPI also expects that the formulation and evaluation of the scenario will not be
a compliance exercise but will entail a detailed and comprehensive discussion
not only of primary but also of secondary and tertiary effects.
Example: A scenario ‘Earthquake in Tokyo’ should not only specify the financial impact
due to loss of life and to the collapse of buildings, but also discuss the implication on the
financial markets (e.g. the collapse of the global financial market for a given duration,
the effect on global markets of Japan having to rebuild the infrastructure, etc.).
Example: A scenario ‘Dirty Bomb in European City’ should not only specify the financial
impact due loss of life but should in addition discuss the impact on real estate prices,
airline travel, financial markets, consumer confidence, long term effects on mortality and
morbidity, …
The formulation of the scenario should comprise
a)
the event occurring during the following year
b)
the effects of the scenario in the future
16
The SST Concept: Scenarios
The valuation of scenarios during the field test was uneven: Some
companies calculated the impact mechanically whereas others did an
in-depth analysis of the consequences of the different scenarios. For
2006 more guidance will be given:
Definition of Scenario (SST Glossary):
Scenarios can be seen as thought experiments about possible future
states of the world. Scenarios are not forecasts. In that they do not
need to predict the future development, but rather should illuminate
extreme but still possible situations. Scenarios are also different from
sensitivity analysis where the impact of a (small) change of a single
variable is evaluated.
Scenarios are especially useful to assess a situation where there is no
historical experience. Hermann Kahn expressed this in the context of
the cold war and studies on possible nuclear war succinctly as “Ersatz
experience is a better guide to the future than the real past and
present.”
17
Internal Models: Challenge
In insurance, models are often assumption
driven: Up to 90% of the economic capital
requirement due to insurance risks emanates
from assumptions and only 10% from historical
data:
•models can often not be back-tested;
•The review has to rely less on formalized
requirements as for VaR market risk engines;
•The assessment of models has to rely more on
experience, comparison with similar models and
embedding of the model within the company
The regulatory review of
models will rely heavily on
discussions with quants and
actuaries, assessment of
company‘s know-how of the
model and its limitations and
public transparency
There are limits on what a regulator can demand from internal models
of insurers and reinsurers:
•Model verification is impossible
•Falsification is in many cases unpractical
•The scientific method can not be formalized.
There can be no set of guidelines codifying
the model approval process
•We need to accept that some properties of
a model can not be ‚proven‘ statistically
(e.g. some dependency structures, some
parameters)
•Models can, however, be persuasive
18
Acceptable and Unacceptable Models
Acceptable Models
• Clearly stated and understood
assumptions
• Clear on idealizations and simplifications
• Transparent on which effects are
neglected
• All relevant risk factors are taken into
account
• The model relies not purely on historical
data but aims to model the future risks
using theory, scenarios, expert opinion
etc.
• The model is tested
Unacceptable Models
• Theory is misapplied
• Pure statistics, no explanation
• Hidden and unclear assumptions
• Too many simplifications
• The model is not tested against
the real world
• Inappropriate or stale parameters
• The model is not sufficiently
understood within the company
•…
• The model is regularly challenged, and
compared against industry best-practice
•…
19
Acceptable and Unacceptable Models
It is the aim of FOPI to promote a wide variety of different models in
order to reduce systemic risk within the market. The main requirement
on the internal model is adherence to the SST principles
Reinsurers should therefore not feel restricted by the SST standard
model methodology
Multi-year models would be acceptable as long as the 1-year risk
measure (TailVar on 99% confidence level) can be backed out.
20
Internal Models: Review
Even worse than having a bad model is having any kind of
model – good or bad – and not understanding it
If internal models are used for
regulatory purposes, it will be
unacceptable if the model is not
understood within the company
Senior management is responsible for
internal models and the review process.
The review of internal modes will be
based on 4 pillars
There needs to be
• Internal Review;
• deep and detailed knowledge by the
persons tasked with the upkeep and
improvement of the model
• External Review;
• Review by the Supervisor;
• Public Transparency.
• Knowledge on the underlying
assumptions, methodology and
limitations by the CRO, appointed
actuary etc.
The regulator is responsible for
ascertaining that the review process is
appropriate
• Sufficient knowledge to be able to
interpret the results and awareness
of the limitations by senior
management and the board
Companies using internal models have
to disclose publicly the methodology,
valuation framework, embedding in the
risk management processes etc.
21
Transition to Full SST
Federal Office of Private Insurance
Bern, 4 April 2006
22
Transition to Full SST
To achieve the successful development and implementation of internal models
satisfying the requirements of FOPI, regular contacts and meetings between
companies and FOPI have to take place between 2006 and 2008
Formulation and
evaluation of scenarios
(30 Sep 2006)*
Discussion of the project plan
together with senior management*
Results from
prototype (if
feasible)
2006
Kick-off Meeting
Formulation and
evaluation of scenarios
(30 Sep 2007)*
Discussions on conceptual
and technical issues
Initial discussion,
identification of issues
and way forward
Draft for future
transparency of
internal model*
Pre-Approval of
internal model
2007
2008
Discussions on conceptual
and technical issues
Depending on the size and complexity of the company, the
frequency of the meetings can vary (monthly or quarterly)
Results from
internal models*
* With senior management
23
Transition to Full SST
FOPI will contact each company and arrange a
sequence of meetings over the next two years:
• Initial discussions on key risk drivers of the
company, existing internal capital models, gap
analysis, first contact with persons responsible for
modeling, quants, actuaries, risk management
• Definition of responsibilities for the model
development and project plan
• Discussion of the project plan with senior
management (CEO, CRO, CFO,…) and project
team, agreement on milestones
• Interim meetings to discuss state of the project,
technical issues, milestones etc.
• At end of 2007, assessment of the acceptability of
the model for SST purposes by FOPI
Deliverables:
End of September 2006
and 2007: Reinsurer
specific scenarios signed
off by senior management
Fall 2007: Trial run of the
internal model
Fall 2007: Draft of public
transparency of internal
models
Spring/Summer 2008 SST
calculation using the
internal model
24
Transition to Full SST
Development of requirements on internal models is being done
by FOPI’s R&D department together with supervisors
• Consistency of requirements can be achieved
• Learning process for regulators, supervisors and companies
• Mix of bilateral discussions (companies and FOPI) and meetings with
all of industry allows for transfer of information and harmonization of
requirements
25