Transcript Canadian Institute of Actuaries L’Institut canadien des

2007 Annual Meeting
Assemblée annuelle 2007
MCCSR in Canada:
What Comes Next?
PD 11 – Vancouver CIA Meeting
June 28th, 2007
2007 Annual Meeting
Assemblée annuelle 2007
Today’s Agenda
1. The Evolving Landscape for RBC in
Canada
- Simon Curtis
2. Update on CIA Advanced Modeling
Work
- Michael White
3. OSFI Perspective on Key Issues
- Allan Brender
2
2007 Annual Meeting
Assemblée annuelle 2007
The Evolving Landscape for
Risk Based Capital
Adequacy
Simon Curtis
June 28th, 2007
2007 Annual Meeting
Assemblée annuelle 2007
Why is the Landscape
Changing?
 Factor based models are no longer viewed as
adequate





are too inflexible to accurately capture most risks
do not capture emerging product or risk issues
do not give sufficient information on level of risk covered
provide limited information to management
do not capture diversification/aggregation impacts on risk
 Tools are becoming available to more accurately
model risk
 stochastic tools that can generate and process thousands of
scenarios to generate probability distribution of outcomes
 advanced probabilistic models based capital frameworks are
frequently called “economic capital” frameworks
4
1
2007 Annual Meeting
Assemblée annuelle 2007
Where is Pressure for Change
Coming From?
Company Management
Companies require models for
internal capital/risk
management
“Economic Capital”
Bank Sector
Banking has moved to
more advanced capital
models for Solvency
(Basel II) and internal
management
Rating Agencies
Rating agencies are requiring
development and wide
internal use of advanced
models to sustain high ratings
and are moving to use these
models themselves
Advanced
Probabilistic
Models
International
Insurance Solvency
Existing Framework
Limitations
European Insurance
Industry/Regulators are
adopting advanced models
as part of “Solvency II”
framework
Existing framework
increasingly incapable of
reflecting advanced products
and risk mitigation
OSFI
OSFI wishes to move
industry towards advanced
models/enhanced risk based
framework consistent with
international insurance and
banking developments
5
2
2007 Annual Meeting
Assemblée annuelle 2007
Key Attributes of Economic
Capital Models
 Comprehensive coverage of all risks
measured on a consistent basis
 Risk distributions modeled or determined for
all risks
 stochastic models used where significant tail risks
 analytic techniques may be used for simpler risks
 specific quantifications of confidence levels
 Focus is generally on total balance sheet
requirement for risks
 “capital” falls out as “total requirement – balance
sheet provisions”
 Risk diversification/aggregation reflected
6
3
2007 Annual Meeting
Assemblée annuelle 2007
What does Economic Capital
Achieve?
 Enable better business decisions through:
 consistent measurement of risk and return for existing
and emerging risks
 understanding which products are adding value and the
value contribution of various businesses
 understanding the impact of diversification/aggregation of
risk
 Allows companies to appropriately set internal and
regulatory capital targets
 consistent measurement and explicit risk quantification
allows understanding of key solvency risk exposures
 target capital levels linked to financial strength objectives
and desired credit rating
 Influence regulators and regulatory capital
developments
7
4
2007 Annual Meeting
Assemblée annuelle 2007
Industry Development of
Economic Capital – Current State
5
 Most large insurers are developing economic capital
frameworks
 Frameworks reflect all risks although degree of
sophistication in the modeling often varies by risk
 Total Balance Sheet approach is typically used
 Primary risk measure is either CTE or percentile
(VaR)
 Time Horizon used by many companies is 1 year but
some use a lifetime horizon – Terminal provision is
critical in a 1 year horizon
 the confidence level is higher for shorter time horizons, e.g.
if CTE95 is a reasonable capital level using a lifetime
horizon, a 1 year horizon might use CTE99 for the first year
with a CTE70 terminal provision calculated at the end of8 the
year for the remaining life of the business
2007 Annual Meeting
Assemblée annuelle 2007
Industry Development of
Economic Capital – Current State
 Risk mitigation and pass-through are typically reflected
 need to consider effectiveness of mitigation in the tail scenarios
(e.g. will the instruments required for hedging be available and at
what cost?)
 Companies are reflecting diversification benefits and risk
concentrations – typically using correlation matrices or
copulas rather than integrated models
 Stochastic techniques are used for investment related
financial risks (market and credit), particularly risks with
skewed distributions
 Stochastic techniques are being contemplated, but generally
not yet developed for insurance risks
 Less advanced scenario techniques are typical for
policyholder behaviour risks and little consensus in how to
determine capital for operational risk
9
6
2007 Annual Meeting
Assemblée annuelle 2007
Evolving the Regulatory Capital
Framework
 OSFI/CIA jointly have established MCCSR
Advisory Committee (MAC) to develop framework
for how regulatory capital regime in Canada can
evolve to reflect emerging capital adequacy
measurement techniques
 Goals of industry/CIA include
 reasonable consistency between economic and revised
regulatory capital frameworks for life insurance
 ensuring the Canadian industry/profession keep pace
with international developments in this area
 adoption of a framework that appropriately measures all
risks and appropriately reflects impacts of risk
aggregation/diversification and risk management
10
7
2007 Annual Meeting
Assemblée annuelle 2007
Key Committees in Canada Established to
Oversee Development of New Solvency
Framework
Regulatory Capital
CIA Risk and Capital
Committee Task Force
(“SFSC”)
Technical work on advanced
modeling framework
Joint industry/Regulatory Committee
assessing direction and advising on
longer term solvency framework for
Life Insurers
Supported by companies and
regulators through making
technical resources available
8
MCCSR
Advisory Committee
(“MAC”)
Senior representation from industry,
regulators, Assuris
Industry
Economic Capital
11
2007 Annual Meeting
Assemblée annuelle 2007
Key Milestones
2006
 Agreement on solvency framework principles
 Agreement on working framework for “technical” aspects of the
capital model (time horizon, confidence level, terminal value
measure, role of risk neutral vs. real world basis, risk mitigation
2007
 Agreement on advanced modeling best practices guidelines
 Agreement on “Vision” for structure of future regulatory solvency
regime
 Finalize market risk advanced approach
 Substantially complete work on framework for risk aggregation
across risks (diversification, covariance)
2008
 Finalize credit risk advanced approach
 Finalize framework for risk aggregation across risks (diversification,
covariance) for advanced approach
2009
 Finalize insurance risks and operations risk advanced approaches
12
9
2007 Annual Meeting
Assemblée annuelle 2007
10
Key Principles for the Solvency
Framework Agreed Between
Stakeholders
1. Consider all risks
2. Determine assets and liabilities on a consistent basis for risk
measurement purposes
3. Be practical, but technically sound
4. Reflect existing risks ongoing concern basis and consider
winding-up and re-structuring
5. Use measures (e.g. CTE) that are comparable across risks
and products
6. Ensure that capital is prudent
7. Encourage good risk management
8. Adapt international principles and best practices
9. Allow comparison of similar risks across Financial
Institutions
10. Be transparent, validated and based on credible data
11. Use reliable processes with assumptions sustainable in time
of stress
13
12. Be part of intervention levels for supervisory action
2007 Annual Meeting
Assemblée annuelle 2007
MAC “VISION” for Life Insurer
Solvency Framework
Minimum Asset
Requirement
Target Asset
Requirement
regulatory control level
threshold investment grade
security level – regulator going
concern level
determined using “standard”
approach
determined using “advanced”
approach or scale up of standard
approach minimum
likely to target 1 year CTE(99)
sufficiency level
14
11
2007 Annual Meeting
Assemblée annuelle 2007
MAC “VISION” – Advanced vs.
Basis Approaches
12
Advanced Approach
• uses company models
• sophisticated scenario modeling
integrated with insurer risk
management
• measures all risks, including risk
mitigation
• risk dependencies within and
between risks modeled (correlation,
concentration)
• use of advanced approaches
requires regulatory approval
• advanced approach to be
encouraged for large insurers,
technically able insurers, and
insurers with complex risks
• selection of advanced vs. standard
approach may be made separately
for credit, market, insurance and
operational risk
Standard Approach
• industry formulaic or factor based
• while not as advanced, developed
to be consistent and reflect all key
risks and risk mitigation of
advanced approach
• risk dependencies within risks only
partially recognized
• designed to produce appropriate
requirement across the industry
15
2007 Annual Meeting
Assemblée annuelle 2007
MAC “VISION” - Technical Framework
– Total Asset Requirement
 Required capital is determined indirectly as
difference between modeled total asset
requirement and balance sheet provisions
Required
Capital
=
Total Asset Requirement
Assets
Balance Sheet
Policy Liabilities
Liabilities &
Capital
required capital
solvency
buffer
margins
total asset
requirement
expected
asset
requirements
best
estimate
policy
liability
CGAAP policy
liabilities
16
13
2007 Annual Meeting
Assemblée annuelle 2007
MAC “Vision” - Technical Framework
- Total Asset Requirement
14
 Key Advantages of Focus on Total Asset
Requirement
 automatically adapts to different accounting regimes
 takes into account levels of conservatism in policy
liabilities
 removes disconnects between liabilities/capital
 Key Challenges
 disclosure metrics need to be thought through carefully (a
company with relatively more conservatism in margins may
appear to be “capital light” when looking only at capital):
disclose margin + capital?
 increased model risk for total asset requirement approach
as opposed to stand alone capital
 difficulty in developing “simple” standard approaches to a17
total asset requirement as opposed to stand alone capital
2007 Annual Meeting
Assemblée annuelle 2007
MAC “Vision” - Technical Framework
- One Year Stress Test Metric
 Total asset requirement is determined as assets
required to withstand extreme event over one
year period with residual value sufficient to run-off
or sell the business
 One year approach with residual value can be
calibrated to consistent level of general
conservatism as a lifetime run-off approach –
appropriate determination of residual value is key
One Year
CTE99 Metric with
CTE(60-80)
Residual
Lifetime CTE95
Run-Off Metric
18
15
2007 Annual Meeting
Assemblée annuelle 2007
MAC “Vision” – Technical
Framework
- One Year Stress Test Metric
 Both One Year and Lifetime Perspectives Have
Advocates
One Year
• consistent with broader risk
management (e.g. Basel II, VAR)
• focuses risk analysis and
management on actionable
timeframe
• appropriate residual value
methodology can reflect long term
risks
16
• long term models overweight very
subjective analysis of catastrophic
long term risk modeling
Lifetime
• consistent with traditional
actuarial approaches (e.g.
Segregated fund guarantees)
• some long term risk exposures
cannot truly be captured in
shorter term metric
• it is difficult to develop reliable
residual values for 1 year metric
19
2007 Annual Meeting
Assemblée annuelle 2007
MAC “Vision” - Technical Framework
- One Year Stress Test Metric
 Technically proposed framework for residual values requires
a “stochastic on stochastic” calculator since first year paths
and residual value on each path should be determined
stochastically
Year 1 Path
Take CTE(99) result
with residual values
Path dependent
Residual values
Run off at
CTE(60)-CTE(80)
result is based on
CTE(99) outcome
of 1 year paths
with calculated
residual values
20
17
2007 Annual Meeting
Assemblée annuelle 2007
MAC “Vision” – Technical Framework
- Residual Value
 Residual value based on available close
out strategy for the risk
availability of robust
market prices
directly use these prices (e.g.
risk neutral prices for certain
market risks)
lack of robust market
prices
actuarial modeling using “real
world assumptions:
21
18
2007 Annual Meeting
Assemblée annuelle 2007
MAC “Vision” – Technical Framework
- Residual Value
 Accepted that first year paths must be
generated stochastically
 Practitioners suggest need for practical
compromise in developing approximations
or closed form solutions to residual values
because of complexity of stochastic on
stochastic
 Does this need to approximate residual
values call into question the one year
approach given risks are long term?
22
19
2007 Annual Meeting
Assemblée annuelle 2007
Looking Forward – Where are
Current Initiatives Going?
20
 Progress has been slow
 advanced frameworks taking significant time to develop
 credit and market risk unlikely to be fully completed until 2008,
insurance, aggregation and operational risks not until 2009
 resource crunch (a few companies providing most of resources)
 no agreed plan yet on how “standard” approach will be
developed
 momentum has slowed
 The regulatory burden for adopting advanced techniques is
likely to be heavy
 significant independent vetting
 significant parallel testing
 significant calibration and on-going control/reporting
requirements
 unclear how regulator will resource to meet its needs and
whether companies will view the trade off of effort versus benefit
23
favourably
2007 Annual Meeting
Assemblée annuelle 2007
Looking Forward – Where are
Current Initiatives Going?
 Updated framework may need to be implemented “risk” by
“risk” rather than big bang approach
 risk by risk approach leads to difficulties in assessing end state
impact, and there may be tendency to move on items leading to
capital increases rather than reductions first
 Current “moratorium” on MCCSR changes is leading to
significant backlog of issues
 reinsurance counter-party risk
 currency risk
 Others
 Credit for risk diversification is likely to be contentious issue
between industry and regulators
 has already emerged as issue in Europe in both Basel II and
Solvency II
 regulator reluctant to give credit for risk diversification in tail
scenarios (to what extent do observed correlations survive in tail
events)
24
21
2007 Annual Meeting
Assemblée annuelle 2007
Looking Forward – Where are
Current Initiatives Going?
 2011 and the expected move to IASB
accounting standards is likely a “hard”
date for a significant change to
existing MCCSR
 IASB reserves will not consider C1/C3
risk and will not be asset adequacy
based
 Regulatory RBC (MCCSR) will likely
need to make up for this gap up
25
22
2007 Annual Meeting
Assemblée annuelle 2007
Key Papers
CIA – Risk & Capital Committee
• Time Horizon Paper (lifetime vs. 1
year)
• Risk Measure Paper (CL vs. CTE)
• Terminal Provision Paper
OSFI/MCCSR Advisory Committee
• Initial Communication to
Industry on establishment of
Advisory Committee, key
principles and timeline (April
2006)
• Canadian Vision for Life Insurer
Solvency Assessment (May 2007)
• Key Principles for Reflecting Passthrough and Risk Mitigation
• Guidance Note for Risk Assessment
Models
Available on CIA website
Available on OSFI website
26
23