Transcript Market Consistent Value New Business 1Q 2009

Regulatory Change and Enterprise Risk Management
Robert DiRico
February, 2011
Philadelphia Actuarial Club
Topics
• Regulatory Developments
• Dodd-Frank
• NAIC
• International – S2, Insurance Contracts, etc
• ERM
• Views of Risk
• Components of an ERM
• An ERM Framework
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Insurance Regulatory / Industry: Who’s Who
• US insurance regulation
• State-regulated w/ autonomous authority – consumer protection
and insurer solvency
• Companies must be domiciled in one state and licensed in others
• States choose to work cooperatively through the NAIC
• Federal Charter for Insurance – often discussed, little action
• The ACLI is a lobbying entity for insurers to speak in ‘one voice’ in the
insurance regulatory discussion: ‘what’s best for my company’
(LICONY is the NY only equivalent of the ACLI)
• The AAA exists as the professional group for actuaries: ‘what is the
appropriate professional standards for designation’ and ‘what is the
correct answer’
• The SOA/CAS exists to provide the educational component for
actuarial certification: ‘what should an actuary know’
3
Quick Review: Financial Crisis Response
• ACLI – took the lead in developing a package of relief measures put
forward to the NAIC
• Included several reserve and RBC changes that saved companies
millions in redundant or excessive charges
• NAIC – very responsive to the ACLI requests
• Worked hard to balance perception (how things looked to
consumer groups) and reality (what the industry needed)
• Overall the state regulatory framework responded well and
companies, though weakened by the crisis (evidenced by the
numerous rating agency downgrades), remained solvent
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Dodd-Frank: Here come the Feds !
• The Dodd-Frank Wall Street Reform and Consumer Protection Act was signed into Law in
July 2010 with the stated aim “To promote the financial stability of the United States by
improving accountability and transparency in the financial system, to end "too big to fail", to
protect the American taxpayer by ending bailouts, to protect consumers from abusive
financial services practices, and for other purposes”
• The Act requires hundreds of rulemakings and studies, along with the creation and merging
of regulatory agencies in an effort to streamline the regulatory process.
The Act:
 changes the regulatory structure, creating a host of new agencies (while merging and
removing others) to streamline the regulatory process, increasing oversight of specific
institutions regarded as a systemic risk and promoting transparency
 establishes rigorous standards and supervision to protect the economy and American
consumers, investors and businesses,
 ends taxpayer funded bailouts of financial institutions,
 provides for an advanced warning system on the stability of the economy,
 creates rules on executive compensation and corporate governance, and
 eliminates the loopholes that led to the economic recession for certain investment vehicles.
 Compels agencies to report to Congress on an annual (or biannual) basis, to present the
results of current plans and to explain future goals.
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NAIC: Principle Based Approaches (PBA)
•
Captures all of the benefits and guarantees associated with the contracts and their identifiable,
quantifiable and material risks, including the ‘tail risk’ and the funding of the risks.
•
Utilizes risk analysis and risk management techniques to quantify the risks and is guided by the
evolving practice and expanding knowledge in the measurement and management of risk. This may
include, to the extent required by an appropriate assessment of the underlying risks, stochastic
models or other means of analysis that properly reflect the risks of the underlying contracts
•
Incorporates assumptions, risk analysis methods and models and management techniques that are
consistent with those utilized within the company’s overall risk assessment process. Risk and risk
factors explicitly or implicitly included in the company’s risk assessment and evaluation processes
will be included in the risk analysis and cash flow models used in the PBA. Examples of company
risk assessment processes include economic valuations, internal capital allocation models,
experience analysis, asset adequacy testing, GAAP valuation and pricing.
•
Permits the use of company experience, based on the availability of relevant company experience
and its degree of credibility, to establish assumptions for risks over which the company has some
degree of control or influence.
•
Provides for the use of assumptions, set on a prudent estimate basis, that contain an appropriate
level of conservatism when viewed in the aggregate and that, together with the methods utilized,
recognize the solvency objective of statutory reporting.
•
Reflects risks and risk factors in the calculation of reserves and capital that may be different from
one another and may change over time as products and risk measurement techniques evolve, both
in a general sense and within the company’s risk management processes.
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NAIC Developments: Principle Based Efforts
• Life PBR Field Testing – now !
• The Valuation Manual (VM) – standards, governance, disclosures, reporting
• Annuity reserves (AG43) – completed for YE09; recent OW recommendations
• Life reserves (VM20) – planned for YE14?
• Fixed annuity reserves (VM22) – tbd
• Health – tbd, perhaps not necessary
• Typical structure:
• Calculate a value based on a set of deterministic, defined assumptions done
seriatim
• Calculate a stochastic reserve based in part on company assumptions using
modeled approaches that capture all identifiable, quantifiable and material risks
• Hold the larger of the 2
• Risk Based Capital (RBC):
• C3P2 (variable annuities) – completed for YE07
• C3P3 (life products) – YE11?
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NAIC Developments: RBC
• What is RBC – factor based insurance solvency measure begun in the early
90s to identify weakly capitalized companies for life, health and P&C co.
• Asset / Interest rate risk
• Underwriting / Claims / Mortality / Morbidity risk
• Credit risk
• Correlation adjustment
• DTA (ACLI White Paper; AAA Report)
• What are DTA – temporary differences between stat and tax basis
• Old method – 1yr / 10%
• Interim method – 3yr / 15%
• Long term solution - tbd
• CMBS: Commercial Mortgage Backed Securities – re-rated in ‘10 (Blackrock)
• RMBS: Residential Mortgage Backed Securities – re-rated in 2009 (PIMCO)
• Impact: 7.3B lower RBC and 50B lower RMBS holdings within the industry
• MEAF – a factor applied in the RBC calculation related to mortgage defaults
that a company experiences – large impact for small movement
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ORSA / IRMA – Who are these people?
• ORSA – Own Risk and Solvency Assessment Proposal
• IRMA – Internal Risk Management Assessment
• Emanates from the IAIS Insurance Core Principle 16
• Requires ERM Framework:
• to ID and quantify risk under a wide range of outcomes
• that is supported by detailed documentation and explanations
• contains appropriate risk management policies and procedures
• sets risk tolerance levels and limits for day to day ops
• responsive to change in risk profile
• ‘owned’ by the board with a routine ORSA and report
• analyze and report on capital (EC, regulatory) requirements under stress
• NAIC draft document dated Feb. 4, 2011
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International Developments - SII
• Solvency II (SII): a solvency framework developed within Europe with an implementation
deadline of October 31, 2012 – it will be the method for determining local regulatory
solvency for all European Insurance companies.
• SII: objectives
• Establish a principle based solvency system that is better matched to the true risks of an
insurance company and is applied uniformly across the EU with the following goals
(1) Ensure adequate policyholder protection;
(2) Take account of recent developments in insurance activities, globalisation, risk management,
financial methods and reporting;
(3) Increase the supervisory process and to review the level of harmonization including
supervisory powers and methods
• Built on ‘Pillars’
• Pillar I - quantitative requirements for valuation and capital calculations
• Pillar II - supervisory review
• Pillar III - public disclosure requirements
• QIS5 – the latest testing regime for SII
• MS/OW model avg. results show increased volatility and decreased solvency ratios
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Solvency II introduces an economic risk based approach to
determining insurance capital requirements
ASSETS
LIABILITIES
Free surplus
Market
Value of
Assets
Market Value
of Liabilities
(“Technical
Provisions”)
Banking - Investments - Life Insurance - Retirement Services
SCR
Ladder of
intervention
Available
Financial
Resources
(“Own
Funds”)
MCR
• “Own Funds”
based on market
consistent
valuation of assets
and liabilities, with
some restrictions
on types of Capital
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• A Solvency Capital
Requirement (SCR)
based a “1-in-200
year” confidence level
• A Minimum Capital
Requirement (MCR)
represents a threshold
below which
policyholders are
exposed to an
unacceptable degree
of risk, and forced
supervisory
intervention.
• Increasing supervisory
powers (“ladder of
intervention”) between
SCR and MCR
International Developments – IASB/FASB
Insurance Contracts ED
• The proposed changes would replace FAS 60, FAS 97, FAS 120 and FAS
113 and a dozen other statements of US GAAP guidance, as the primary
guidance and a key measurement model by which insurance companies
manage their businesses and establish actuarial models for valuation
•
Increased earnings volatility due to insurance liabilities valued ‘close’ to fair
value with changes reported through the performance statement each period
• Greater transparency and exposure of the full business portfolio due to
increased disclosure requirements at a more granular level
•
Will impact product design, reporting processes/systems and internal controls
• Key dates
• July 2010: IASB ED released (comment period ends Nov. 30 2010)
• Sept. 2010: FASB discussion paper released (3mo. comment period)
• Dec. 2011: IASB deadline for new standard – pushed back to allow FASB to
complete their exposure draft to continue towards convergence (2/9/11)
• 2014: IASB tgt. implementation date (changes recorded to 2012 opening retained
earnings with restatement of 2012 and 2013 earnings likely)
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International Developments – Hot Topics
• Supervision of Insurance Groups:
• The ability to assess the solvency of an insurance group not just an
individual company
• One key issue is diversification
• Requires multi-country cooperation for the review
• US equivalence – recognition of US regulatory solvency structure
• In order for the US to be treated as an ‘equivalent’ solvency system,
certain criteria must be met
• Our 50 state system presents challenges to these criteria
• One critical step is that our current RBC system must be calibrated to
the SII VaR methodology – showing an ‘equivalent’ risk based system
• If equivalence is not granted then US subs of EU companies would
need to hold capital based on S2 model - implications
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PBA vs. S2
•
•
•
•
Review of Solvency II with the current US effort towards PBA
• Some US regulators see a strong correspondence between the 2 systems, but most
see continuing key differences
• There is currently an uncertainty about how those key differences may or may not
get resolved.
• The NAIC currently has a Solvency Modernization Initiation (SMI) that is a high
priority project for the next several years
• Part of the purpose of this project is to assess the current US regulatory structure,
understand the direction of Solvency II and develop recommendations for revisions
to the US framework
Currently, statutory accounting is very different than SII, or any market or economic
based valuation system.
But our ability to pay dividends to investors is based on statutory accounting and capital.
Also, tax accounting tends to be derived from statutory.
So whatever happens, statutory accounting will be critical to us.
Banking - Investments - Life Insurance - Retirement Services
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Typical Insurance Company Risks
• Economic risks
• Interest rate changes
• Unstable equity markets
• Equity movements
• Falling interest rates
• Currency translation
• Inverted yield curves
• Liquidity
• Double digit unemployment
• Operational risk
• Global instability
- Fraud
- Model Risk
• Oil prices
- Continuance
- Disaster Recovery
• Environmental concerns
- Human error
- Reputational
• Population growth and aging
• Business risk:
• Wealth gap
• Mortality / Morbidity / Policyholder behavior
• Poverty
• Regulatory risk
• Counterparty / Credit risk
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How to view and manage risk
Avoid
• Goal is to avoid risk – growth, if it occurs, will likely be slow and steady,
works well in some niche markets
• As long as you can get a reasonable price for the risk take it on
Pay for it
• Take on risk, but to pre-determined levels balancing various risks
Balance
Minimize
• Risk is inevitable, but the goal is to minimize the risk – do what you are
good at and minimize the resulting risk
Maximize
• Profits will only be achieved by taking risk; adverse events are cyclical;
take on risk
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Key Components of an ERM Structure
• Clear, strong reporting line - CRO, Board level reporting structure
• Clearly defined risk appetite/tolerance/limits – the ‘foundation of solid ERM’
• Balanced / flexible approach – no one ‘view’ dominates
• Alignment – must impact compensation
• Standards of Practice – providing guidance, limits, etc.
• Reporting metrics: must decide which are important – Risk Dashboards
• stat earnings; gaap earnings; at-risk measures: earnings, capital;
embedded value; value of new business; market consistent; return on
investment/equity
• Reporting tools – reports, systems, process
• Risk mitigating tools
• hedging; reinsurance; collateralization; securitization; other financial
derivatives and asset alternatives
• Reports needed to measure risk and exposure as well as defined action points
• Qualified Risk Managers
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ERM Components Put into a Framework
Organization
Strategy
Governance
Roles and Responsibilities
Skills and Experience
Culture
 Goals and Objectives
 Scope and Definitions
 Risk Appetite
Process





Tools




Risk identification
Risk quantification
Risk mitigation options
Solution implementation
Monitor and Report
Management
 Leadership
 Communication
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 Involvement
ERM: A Pictorial Summary
Exposure
Events
Controls
Impact
Controls
Human Assets
External
Factors
Manage
Frequency
Internal,
Operating
Factors
Insurance
Physical Assets
Market
Financial Assets
Credit
Manage
Severity
Business
Intellectual Property
Operational
Reputation
Relationships
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Risk strategy
Current ING Risk Governance Framework
ING’s risk governance framework
Risk appetite
Governance
3 lines of defense
Execution

Value creation /
risk taking


1st line
of defense
2nd line
of defense
3rd line
of defense
Business
Risk
Internal audit
Business line
managers have
primary responsibility
for day to day risk
management..
..and bear the
consequences of
losses
In the case of
products, responsible
for appropriate design
and pricing



Formulate high-level
policies, limits, risk
appetite
Provide oversight,
challenge and support to
optimise the risk/reward
trade-off
In the case of products,
ensure adherence to
relevant pricing and
product design
requirements

Assurance of
the overall
effectiveness
of internal
controls
Alignment between risks taken and the Group risk appetite
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