Transcript Ian Tower ARIA ICAS

Development of UK Capital
Adequacy Standards
ARIA Conference, Washington DC
7 August 2006
Ian Tower
The Financial Services Authority
Scope of Presentation
• The need for reform
• Minimum capital
• Individual Capital:
– Objectives
– Approach
– What we have found
• The future – the EU’s Solvency 2
2
The Need for Reform
• Risk management techniques were not as well
developed and less objective in insurance than
elsewhere in financial services
• Boards/senior management not sufficiently engaged
with risk management process
• Statutory capital levels were not sufficiently risk
sensitive
• Wanted to give firms incentive to improve their risk
management techniques
• Needed to develop risk-based approach well before
Solvency II reforms
3
UK insurance sector regulatory reform
– overview
• With-profits: “realistic reporting”; Principles & Practices of
Financial Management; governance
• Financial governance: abolition of the “appointed actuary” role
• Audit of FSA life returns – with actuarial review
• New risk-based prudential capital for general insurance
• New approach to group capital adequacy
• Individual Capital Assessments - ICAS
• New framework for reporting to FSA
• Emphasis on treating customers fairly
4
Minimum capital (Pillar 1): life firms
• Two solvency tests (“twin peaks”) for with-profits (participating)
business –
–
–
–
–
statutory (based on EU directives) and
realistic (FSA’s own test)
different approaches to both reserves/valuation and capital
realistic approach applies only for largest 37 firms (with-profit
liabilities over £500 mn)
• Realistic peak more sensitive to economic conditions, but
provides no incentive for good risk management.
• Non-profit (non-participating) business subject to single
statutory test.
• At 31/12/2005 the realistic peak was higher than regulatory peak
for 32 of 37 realistic reporters.
• For the 32 an extra requirement (WPICC) is added to the
regulatory requirement to ensure regulatory surplus does not
exceed realistic surplus.
5
The Twin Peaks
Regulatory Peak
Realistic peak
WPICC
Risk Capital Margin (RCM)
Resilience capital requirement
MCR
ECR
Long Term Insurance Capital
Requirement (LTICR)
Realistic reserves
Mathematical
reserves
WPICC brings regulatory
peak up to realistic peak
6
Minimum capital (Pillar 1): general/P&C
• Formula: charges based on:
• asset values +
• technical provisions +
• premiums
• Limited to current accounting classes
• Not intended to be a risk based capital –
role of individual capital standards
• It is intended to be better than EU
solvency standard and reflect risks better
7
Pillar 1 - General Insurance
Minimum
Capital
Requirement
Enhanced
Capital
Requirement
Individual
Capital
Assessment
Individual
Capital
Guidance
ICA
ICG
ECR
Directive
minimum
MCR
Can be less than 100% of
ECR in certain cases
May be equal to or higher
than firm’s ICA 8
ICAS – individual capital: overview
• Insurance firms are required to assess what level and
quality of capital they need to maintain
• Should be no significant risk that they are unable to
pay liabilities as they fall due
• FSA reviews ICA, taking into account other
information, forms view of the capital adequate for the
firm's risk profile
• FSA gives individual capital guidance (ICG) - both
quantitative and qualitative
• ICAs are being reviewed over 2 1/2 years 2005-2007
9
Individual Capital - Objectives
• Emphasis on better risk management - as management
problems or governance are at the root of insurer failures
• Capital modelling should improve understanding of risk as the
interactions and causal links have not been well understood
• Risk based capital more relevant to the way businesses are run
• Emphasise senior management responsibility
• Enhance consumer protection and market confidence by
reducing the risk of financial failure
10
ICAS Approach - Modelling framework
•
Firms must undertake an assessment of the
adequacy of their capital resources:
•
•
consistent with the activities and responsibilities of the firm;
to quantify the risk of the firm not being able to meet all its
financial obligations as they fall due; and
to demonstrate a level of solvency which can be compared to a
99.5% probability of failure over one year.
•
•
The assessment must:
–
–
reflect the nature of the firm's assets, liabilities, management
practice and systems and controls; and
use methods of valuation in a consistent fashion throughout
the assessment.
11
Governance, “Use test” etc
• The ICA framework should be embedded in the firm’s
business
• We ask three principal questions:
– Is there senior management engagement, including
the Board?
– How are the ICA principles and models being used
for ongoing management purposes?
– How are ICA results used to influence risk
management goals and prioritise activity?
12
A typical review process
Internal
Planning
Submission
Request
Initial
Review
FSA Initial
View
Discussion
with Firm
Written
Questions
Preview to
Firm
FSA Panel
Process
Formal
Notification
13
ICAS – What we have found
• Variety of approaches taken and ICA numbers vary
across similar firms on same issues
• The quantification of operational risk remains a
challenge for almost all firms
• Measurement of diversification benefit – taking credit
for spread of risks – a common issue
• Major improvement in firms’ - and supervisors’ understanding of the key drivers of risk and capital
• Risk measurement improvements feeding through to
better risk management.
14
The Future - Solvency 2
• EU project to reform insurance prudential regulation
based on the three pillar structure
• Aims to incentivise better risk management and
integrate regulatory capital assessment with firms
capital management processes
• Supervisory adjustment to capital requirements
where justified
• Quantitative Impact study in progress – an important
checkpoint in the design of the new regime
• Framework Directive proposal – due mid 2007
• Implementation 2010?
15
Summary
• Firms have responded well to new UK framework
• More emphasis on risk management and
spreading good practice with ICAS than statutory
approach
• Beneficial for both firms and FSA as both getting a
better understanding of the business and the risks
• Keys challenges for future include improving risk
and capital management and development of
Solvency 2.
16