Transcript Risk-Based Capital Developments Glenn Meyers Insurance Services Office, Inc. CAS/SOA Enterprise Risk Management Symposium July 29, 2003

Risk-Based Capital
Developments
Glenn Meyers
Insurance Services Office, Inc.
CAS/SOA Enterprise Risk
Management Symposium
July 29, 2003
Introduction
A current initiative of the International
Association of Insurance Supervisors (IAIS)
is to develop a global framework for riskbased capital for insurers.
Acting in support of the IAIS, the International
Actuarial Association (IAA) has formed an
Insurer Solvency Assessment Working Party
(WP) to prepare a paper on the structure for a
risk-based solvency assessment system for
insurance.
Terms of Reference of the WP
The WP should describe the principles
and methods involved in the quantification
of the total funds needed to provide a
chosen level of confidence to
policyholders and shareholders that the
insurer’s policyholder obligations will
be met.
Terms of Reference of the WP
The paper should be specific and practical
enough that its recommended principles
and methods could be used as a
foundation for a global risk-based
solvency capital system for
consideration by the IAIS.
Terms of Reference of the WP
The paper should, starting from a coherent
risk framework, identify risk measures
that explicitly or implicitly can be used to
measure the exposure to loss from risk and
also any risk dependencies. The paper
should also identify measures that are not
effective in this regard.
Terms of Reference of the WP
In balancing its focus between practical versus
sophisticated methodologies, the working party
will place greater weight on those
methodologies with the greatest likelihood of
practical implementation. However, since
simple methodologies that can be applied to
many insurers in a territory or across territories
may prove insufficiently reliable or capital
efficient, the working party should consider
whether risk models developed internally by
insurers can provide a useful and reliable
approach.
Who is on the WP?
Allan Brender (Canada)
Peter Boller (Switzerland)
Henk van Broekhoven
(Netherlands) - ViceChairperson
Tony Coleman (Australia)
Jan Dhaene (Belgium)
David Finnis (Australia)
Marc Goovaerts (Belgium)
Burt Jay (U.S.)
R. Kannan (India)
Toshihiro Kawano (Japan)
Sylvain Merlus (France)
Glenn Meyers (U.S.)
Teus Mourik (Netherlands)
Harry Panjer (Canada)
Dave Sandberg (U.S.)
Nylesh Shah (U.K.)
Shaun Wang (U.S.)
Stuart Wason (Canada) Chairperson
Hans Waszink (Netherlands)
Bob Wolf (U.S.)
Represented are several countries, life, health, P/C
insurance company, consultants, regulators and academics.
Contents of Report
Section 3 – The Purpose of Capital
Section 4 – Supplements to Capital
Section 5 – Working Party’s Approach
Section 6 – Risks and Risk Measures
Section 7 – Standardized Approaches
Section 8 – Company Specific Approaches
Section 9 – Reinsurance
Section 10 – Total Company Requirement
Contents of Report
Appendix A – Life Insurance Case Study
Appendix B – Non-Life Insurance Case Study
Appendix C – Health Insurance Case Study
Appendix D – Market Risk
Appendix E – Credit Risk
Appendix F – Lessons from Insurer Failures
Appendix G – Introduction to Insurance Risk
Appendix H – Analytic Methods
Appendix I – Copulas
General Insurance Case Study
Proposal for “Standardized Approach”
Illustrative “Internal Model”
Desirable Properties of a
Standard Formula
Simplicity – The formula can be put on a
spreadsheet. This may allow for some complexity
in the formulas, as long as the objective of the
formulas is clear.
Input Availability – The inputs needed for the
formula are either readily available, or can be
reasonably estimated with the help of the appointed
actuary.
Conservative – When there is uncertainty in the
values of the parameters, the parameters should be
chosen to yield a conservative estimate of the
required capital
A Proposal for a Standard Formula
The formula is sensitive to:
The volume of business in each line of
business;
The overall volatility of each line of
insurance;
The reinsurance provisions; and
The correlation, or dependency structure,
between each line of business.
Features of the Formula
Input for insurance losses
– Expected losses for current business
– Loss Reserves (at expected values of payout)
Parameters - Specified by regulator (??)
– Claim severity distribution by line of business
– Claim count distribution
– Dependency model parameters (see next slide)
Calculates first two moments of aggregate loss
distribution. Using lognormal approximation:
Capital = TVaR99% – Expected Loss
Dependency Model Parameters
Common shock model
– Uncertainty in trend affects all lines simultaneously
– Magnitude of shock varies by line of business
Catastrophes treated separately
Capital = TVaR99% – Expected Loss + Cat PML
Calculate Cat PML with a catastrophe model
Example on Spreadsheet
Big Insurer – ABC Insurance Company
Small Insurer – XYZ Insurance Company
ABC Volume = 10 times XYZ Volume
– Otherwise they are identical
Moving Toward an Internal Model
Recall WP recommendations
– That the “Standard Model” be deliberately
conservative.
Several modifications to the “Standard
Model” are possible.
Insurer internal model are to be subject to
standards for risk-based capital formulas.
Requirements for Internal Models
The insurer should have an independent
internal risk management unit, responsible for
the design and implementation of the risk-based
capital model.
The insurer’s Board and senior management
should be actively involved in the risk control
process, which should be demonstrated as a
key aspect of business management.
Requirements for Internal Models
The model should be closely integrated with
the day-to-day management processes of the
insurer.
An independent review of the model should be
carried out on a regular basis. (Amongst other
considerations, it should be recognised that
evolution of the modelling capabilities is to be
encouraged)
Operational risks should be fully considered
Example of Internal Model
More realistic claim severity distributions
Richer dependency structure
– Parameter uncertainty in claim frequency as
well as claim severity
– Parameter uncertainty in claim frequency
applied across groups of lines.
Example of Internal Model
Calculates aggregate loss distribution
directly rather than by moments
Catastrophe model included directly in
aggregate loss calculation, rather than add
PML.
Additional details to be published in
Summer Forum
– “Aggregation and Correlation of Insurance
Exposure” – Meyers, Klinker and Lalonde
Results
TVaR 99%
Expected Loss
Reserve
Capital
Internal Model
ABC Insurance Company
XYZ Insurance Company
No Reinsurance With Reinsurance No Reinsurance With Reinsurance
2,665,306,927
2,431,822,820
305,543,931
245,968,540
1,215,000,000
1,158,671,051
121,500,000
115,867,105
999,538,735
879,134,113
99,953,873
87,913,411
450,768,192
394,017,656
84,090,057
42,188,024
TVaR 99%
Expected Loss
Reserve
Cat PML
Capital
Proposed "Standard Formula"
ABC Insurance Company
XYZ Insurance Company
No Reinsurance With Reinsurance No Reinsurance With Reinsurance
2,821,018,276
2,580,135,062
304,943,284
260,723,343
1,200,000,000
1,147,246,365
120,000,000
114,724,636
999,538,735
881,230,412
99,953,873
88,123,041
143,000,000
65,000,000
14,300,000
6,500,000
764,479,541
616,658,285
99,289,411
64,375,665
Next Steps
Complete remaining sections of report (focus on
standardized versus advanced approaches; case study
illustrations etc.)
Consider input from IAA Insurance Reg’n Committee and
interested supervisory bodies (e.g. IAIS, EC, etc.)
Issue “discussion” draft report to Insurance Regulation
Committee for email discussion
Issue revised “exposure” draft report to Insurance
Regulation Committee on September 30 for Berlin
meeting
Identify follow-on initiatives required by the IAA and
member associations