Transcript Capital Adequacy Calculations for Financial Conglomerates

Risk Based Capital Tests
Life and General Insurers
OSFI International Advisory Group
IAIS-FSI-ASSAL Training Seminar
Regional Seminar on Capital Adequacy and Risk-based Supervision
6 – 11 May 2007
Rio de Janeiro, Brazil
Ralph Lewars
Senior Advisor
International Advisory Group
Capital
A.
B.
C.
D.
E.
F.
G.
Why is capital important?
What is risk?
Risk Based Capital calculations
Risks included in capital tests
Supervisory framework/risk assessment
Dynamic capital adequacy testing
Future developments
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Capital
A.
Why is capital important?
Policyholders pay money up front for
a promise to pay in future.
Capital especially important for
financial institutions
3
Capital
A.
Why is capital important ?
For supervisors capital is an
important measure to determine
where to allocate supervisory
resources
Good overall measure of safety and
soundness
Provides the opportunity to reduce
on-site supervisory activities
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Capital
A.
Why is capital important ?
Cushion to absorb
unforeseen/unanticipated losses
Losses accrue firstly to shareholders
rather than policyholders
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Capital
A.
Why is capital important ?
Accounting capital vs regulatory capital
Accounting capital = assets – liabilities
Regulatory capital = adjusted accounting capital
Balance Sheet
Liabilities
Assets
Capital
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Capital
B. What is risk?
Definition “ a chance of encountering
harm or loss; hazard; danger”
Insurers are in the business of
accepting risks
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Capital
B. What is risk?
In the context of capital tests a
financial loss resulting in the reduction
of capital available to absorb
unforeseen/unanticipated losses
Reduction in the cushion available to
safeguard policyholder funds
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Capital
B. What is risk?
Insurance owners/executives risk
appetite usually greater than
supervisors which creates challenges
when discussing level of risks and
need for margins in capital tests
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Capital
C. Risk Based Capital Calculations
What is required to calculate ????
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Capital
C. Risk Based Capital Calculations
Requirements
1. Instructions
2. Regulatory capital return
3. Regulatory balance sheet
4. Details balance sheet assets,
liabilities and off balance sheet
exposure
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Capital
C. Risk Based Capital Calculations
1. Instructions
legislation
regulation
guideline
other written document i.e. circular
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Capital
C. Risk Based Capital Calculations
1. Instructions
OSFI instructions in guidelines
guidelines/instructions available for
banks, life and general insurers
guidelines available on OSFI website
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Capital
C.
Risk Based Capital Calculations
1. Instructions
Facilitate similar approach to risks
among banks, life and general
insurers
Facilitate similar risk weights for
similar risks
Guidelines ensure flexibility
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Capital
C.
Risk Based Capital Calculations
1. Instructions
General insurers (MCT)
approximately 50 pages
Since 2002
Minimum
Capital
Test
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Capital
C.
Risk Based Capital Calculations
1. Instructions
Life insurers (MCCSR) approximately
160 pages
Since 1992
Minimum
Continuing
Capital
Surplus
Requirement
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Capital
C. Risk Based Capital Calculations
2. Regulatory capital return – General
Insurers
MCT – 1 page with approx 10
worksheets
Return included with financial
statement return
Filed quarterly
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Capital
C. Risk Based Capital Calculations
2. Regulatory capital return – Life
insurers
MCCSR – approx 35 pages
Separate return not included with
financial statement return
Filed quarterly
Year end return verified by
external auditor and appointed
actuary
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Capital
C. Risk Based Capital Calculations
3. Regulatory balance sheet – General Insurers
standard format
Assets – approx 25 items
Liabilities – approx 20 items
Capitals retained earnings – approx 5
items
GAAP - GROSS BASIS - BEFORE
REINSURANCE
year end balance sheet audited
technical reserves certified by appointed
actuary
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Capital
C. Risk Based Capital Calculations
3. Regulatory balance sheet – Life Insurers
standard format
Assets – approx 15 items
Liabilities – approx 15 items
Capitals retained earnings – approx 5
items
GAAP - NET BASIS - AFTER
REINSURANCE
year end balance sheet audited
technical reserves certified by appointed
actuary
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Capital
C. Risk Based Capital Calculations
4. Details – balance sheet assets,
liabilities, and off balance sheet
exposures
General & Life Insurers
• Some details are provided in
standard returns while others
reviewed while on site
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Capital
C. Risk Based Capital Calculations
Target ratio for both Life and non-life
150% (Metric)
Capital available / Capital required * 100
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Capital
C.
Risk Based Capital Calculations - Capital
available
Balance Sheet
A
L
C
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Capital
C.
Risk Based Capital Calculations - Capital
available
Capital 3 main features:
• Permanent
• Subordinated
• Free of mandatory charge
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Capital
C.
Risk Based Capital Calculations - Capital
available
Capital Spectrum
Tier 1
Best
Tier 2 (c)
Good/Acceptable
General vs Life insurers
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Capital
D.
Risks included in capital tests - Capital
required
Risks in assets reported on balance
sheet
Risks in off balance sheet
transactions/ contracts
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Capital
D.
Risks included in capital test – Capital
required
Balance Sheet
A
L
C
Off Balance Sheet exposure
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Capital
D. Risks included in capital tests – Capital
required
Asset default applies to life and
general insurers balance sheet
assets
Calculate margins (capital required)
for potential losses due to asset
default
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Capital
D. Risks included in capital tests – Capital
required
The higher the probability of default
the higher the margin (capital
required) for asset default
Asset default factors have been
developed for all types of assets
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Capital
Asset
Value
Factor
Capital
Required
Cash
100
.00%
0
Corporate bonds (I/G)
100
2.00%
2
Preferred shares (I/G)
100
4.00%
4
Commercial mortgage
100
8.00%
8
Common shares
100
15.00%
15
Oil and gas properties
100
35.00%
35
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Capital
D. Risks included in capital tests – Capital
required
Actuarial estimates/provisions are
underestimated applies to life and
general insurers
Calculate capital required for
potential losses due to actuarial
estimates/provisions being
underestimated
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Capital
D.
Risks included in capital test – Capital
required
Balance Sheet
L
A
C
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Capital
D. Risks included in capital tests – Capital
required
Two largest actuarial
estimates/provisions for general
insurers are:
Unearned premiums and unpaid
losses risks
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Capital
Actuarial estimate
Unearned premiums
Property
Value
Factor
Capital
Required
100
8.00%
8
Liability
100
8.00%
8
Unpaid losses
Property
100
5.00%
5
Liability
100
15.00%
15
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Capital
D. Risks included in capital tests - Capital
required
The actuarial estimates/provisions
for life insurers are:
Segregated funds risk
Mortality risk
Morbidity risk
Lapse risk
Interest margin pricing risk
Changes in interest rate environment
risk
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Capital
D. Risks included in capital tests - Capital
required
Segregated funds….risk of loss
arising from guarantees embedded in
segregated funds
Factor-based; Modelling approach
allowed upon OSFI blessing
Type of fund money market vs exotic
aggressive equity
Resets/ratchets
75% - 100% guarantees
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Capital
D. Risks included in capital tests - Capital
required
Mortality/morbidity/lapse risks,
assumptions will be wrong
Guaranteed term mortality cost cannot
be changed
Length of the premium guarantee
remaining
Length of benefit period remaining
Duration of policyholder liabilities
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Capital
D. Risks included in capital tests - Capital
required
Interest margin pricing risk, interest margin
losses with respect to investment and pricing
decisions on in force business
Factors .5% or 1% on policy liabilities
Communication problems investment and
pricing personnel
Lack of sufficient volumes new bonds and
mortgage investment opportunities
Change in investment spread relationship
between different investments
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Capital
D. Risks included in capital tests - Capital
required
Changes in interest rate
environment, loss resulting from
asset depreciation arising from interest
rate shifts
Factors from .5% to 10% on policy
liabilities
Factors vary by product type and
premium guarantee period
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Capital
D.
Risks included in capital tests - Capital
required
Balance Sheet
A
L
C
Off Balance Sheet Exposure
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Capital
D. Risks included in capital tests - Capital
required
Off balance sheet commitments
risk, major risk is credit risk
Guarantees, letters of credit, forward
agreements, put options, etc…
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Capital
D. Risks included in capital tests - Capital
required
Off balance sheet commitments risk
Notional amount of instrument is
multiplied by a credit conversion factor
100%, 50%, 20%, etc…
Resulting amount is treated as a
balance sheet asset/instrument and
assigned a counter party risk factor
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Capital
E.
Supervisory framework/risk assessment
Because a regulatory risk based
capital test cannot capture all risks
supervisor cannot rely on capital test
alone
Capital test not forward looking
Supervisor must gather information
on other risks and risk mitigation
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Capital
E.
Supervisory framework/risk assessment
Risk based supervisory methodology
where inherent risks and risk
management control functions are
assessed to come up with an overall
assessment of an insurer
Operational risk, strategic risk and
reputational risks are important risk
not captured in capital tests
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Capital
E. Supervisory framework/risk assessment
To reflect risks such as high
operational risk not captured in capital
test and or weak management control
functions the target capital ratio
(150%) can be increased
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Capital
F. Dynamic capital adequacy testing (DCAT)
Stress testing of basic assumptions
underlying an insurer business
projections
Process developed by Canadian
Institute of Actuaries
DCAT report filed annually
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Capital
F. Dynamic capital adequacy testing (DCAT)
Since 1992 for life insurers
Since 1998 for non-life insurers
Results of DCAT help establish target
capital ratio
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Capital
G. Future developments
Harmonization of insurance capital
tests IAIS
Review of accounting and actuarial
standards required before
harmonization can start
Ongoing refinements with new
products, risks, type of capital being
issued, etc.
MCCSR/Basel II internal ratings
based approach
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Thank you
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