Solvency Ii Jabran Noor 23 Nov2011

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Presentation on Solvency II to the Gulf Actuarial Association.

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Solvency Ii Jabran Noor 23 Nov2011

  1. 1. Solvency II Jabran Noor, MA FSA FIAPresented to Gulf Actuarial Association 23 November 2011
  2. 2. Agendao Background to Solvency o Economic Balance sheet o Solvency Regimes o Solvency Io Solvency II Concepts o 3 Pillar Approach o Pillar 1 : Quantitative Requirements o Pillar 2 : Supervisory Review o Pillar 3 : Market Disciplineo Solvency II Issues Solvency II, Jabran Noor, 23 Nov 2011
  3. 3. Background to Solvency
  4. 4. Insurance Company’s Economic Balance sheet σA σE Wide range of term Market Value Equity  Correlation between σE Interest Rate Risk of Assets assets and liabilities Credit Risk σL Reinsurer Default Derivatives Complex investment Market Value  Wide range of strategies of Liabilities coverage periods Liquidity Risk σA  Withdrawal risk  Options  Guarantees σL  Interest rate risk  Long tailed claims  Dynamic Policyholder behavior Solvency II, Jabran Noor, 23 Nov 2011
  5. 5. ‘ But it didn’t cost anything, dear! I did it all off balance-sheet! ’ Solvency II, Jabran Noor, 23 Nov 2011
  6. 6. Solvency Regimes Prior USA, Korea Supervision Fixed Ratio Solvency I, Saudi Arabia, Solvency India, Bahrain Models Regimes Retrospective Approach Risk Based USA, Canada, Japan Ex Post Models Supervision Prospective Australia, Finland Approach Complementary Survival Solvency II, Swiss Solvency Test, Approach Models Dynamic Solvency Testing Solvency II, Jabran Noor, 23 Nov 2011
  7. 7. Solvency I (overview)o Simple factor-based modelo Focuses on liability side of the balance sheeto Provides minimum Regulatory Capital Requiremento Concept of Minimum Guaranteed Fund exists Solvency II, Jabran Noor, 23 Nov 2011
  8. 8. Solvency I (issues)o Simplistic and easy to calculate and verifyo Broadly captures risk profile of insurance businesso Disregards actual risk profile of companyo Applies at legal entity level – no consolidation for group of companieso Lower reserves or premium leads to lower solvency requirements which is not the intention of regulationo Limited disclosure requirementso Ignores risks on the asset sideo Does not reflect best practice (e.g. capital requirements for banks) Solvency II, Jabran Noor, 23 Nov 2011
  9. 9. Solvency II Concepts
  10. 10. Solvency IIo Fundamental review of capital adequacy regime for EU insurers and reinsurerso Aims to establish a revised set of EU-wide capital requirements, valuation techniques and risk management standards that will replace current Solvency I requirementso Promote a robust, forward looking risk management framework to guide insurance company’s management and regulatorso Takes a total balance sheet viewo Reduces reliance on capital requirements as an exclusive early warning toolo Principle based rather than rule based Solvency II, Jabran Noor, 23 Nov 2011
  11. 11. 3 Pillar Approach Solvency II Embedding Solvency II in Business Pillar 1 - Pillar 2 - Pillar 3 - Quantitative Supervisory Review Market Disciplines Requirements Internal Controls and Quantitative Transparency sound management Requirements Supervisory Disclosure Technical Provisions intervention Requirements Regulations on Capital Requirements Implementation Control Disclosure Financial Resources Additional Capital requirement for solvency Requirement to disclose Evaluation based on information relating to risk and internal assessment of capital levels, designed to help risks and controls, exert discipline of market influence subject to supervisory review Solvency II, Jabran Noor, 23 Nov 2011
  12. 12. Pillar 1
  13. 13. Pillar 1 – Balance sheet Solvency II, Jabran Noor, 23 Nov 2011
  14. 14. Pillar 1 – Valuation of Assets Valuation of Assets “Prudent Person Principle” applies  Must be able to identify, measure, monitor, manage, control and report the risks involved in investment  Must ensure security, quality, liquidity and profitablity of the portfolio as a whole  Must be appropriate to the nature and duration of liabilities  Derivatives may be allowed if they reduce overall risk or promote efficient portfolio management  Assets should be properly diversified No prescribed quantitative limits No localization requirements No compulsory collateral for reinsurance 1 NOTE Prudent Person Principle Solvency II, Jabran Noor, 23 Nov 2011
  15. 15. Pillar 1 – Valuation of Liabilities and Capital Calculation of Technical Provisions – Hedgeable Risks Calculation of reserves according to the definition of fair value in IFRS Market consistent Valuation for hedgeable risks Hedgeable risks are those risks that can be neutralized by buying or selling a market instrument or engaging in contract with a third party in an arm’s length transaction under normal business conditions. 1 NOTE Market Value Solvency II, Jabran Noor, 23 Nov 2011
  16. 16. Pillar 1 – Valuation of Liabilities and Capital 1 NOTE Calculation of Technical Provisions – Non Hedgeable Risks Best Estimate + Calculation of reserves according to the definition of fair value in IFRS Risk Margin Market consistent Valuation for assets and liabilities Valuation of technical provisions = Best Estimates + Risk Margin Best Estimates  Corresponds to probability-weighted average of future cash flows, taking into account time value of money, using relavent risk-free interest rate term structure  Calculation of best estimate based on up to date and credible information and realistic assumptions and to be performed using adequate, applicable and relevant actuarial and statistical methods  Best estimates would be calculated gross of reinsurance. Risk Margin  Calculated by determining cost of providing an amount of eligible own funds equivalent to Solvency Capital Requirement necessary to support insurance and reinsurance obligations over their life time (i.e. business in run-off)  Cost of Capital would be same for all insurance and reinsurance undertakings and reviewed periodically. Solvency II, Jabran Noor, 23 Nov 2011
  17. 17. Pillar 1 – Valuation of Liabilities and Capital Solvency Capital Requirement - SCR Capital required to meet quantifiable risks on existing business plus one year new business Calibrated at Value at Risk of 99.5% over one year. SCR can be determined using  Standard Formula  Internal Model  Combination of the above two (partial internal model) 2 NOTE 1 NOTE Standard Value at Risk Formula vs as a measure of Internal Model capital adequacy Solvency II, Jabran Noor, 23 Nov 2011
  18. 18. Pillar 1 – Valuation of Liabilities and Capital Minimum Capital Requirement - MCR MCR is the floor below which the company would not be allowed to operate Calibrated at 85% Value at Risk over one year from valuation date Subject to minimum and maximum of 25% - 45% of SCR respectively Subject to absolute monetary floor (similar to Minimum Guarantee Fund) Calculated as linear function of various elements e.g.  Technical provisions  Premiums 1 NOTE  Sum at risk Looks quiet  Administrative Expenses similar to  Deferred Taxes Solveny I Solvency II, Jabran Noor, 23 Nov 2011
  19. 19. Pillar One – SCR Risk Categories Solvency II, Jabran Noor, 23 Nov 2011
  20. 20. Pillar 1 – SCR Risk Categories N ON L I F E UN D E R W R I T I N G R IS K •Premium and Reserve Risk •Catastrophe Risk L I F E UN D E R W R I T I N G R I S K •Morbidity H E A L T H UN D E W R I T I N G •Longevity R IS K •Mortality •Expenses•Premium and Reserve Risk •Lapses•Expense Risk •Catastrophe•Catastrophe Risk Solvency II, Jabran Noor, 23 Nov 2011
  21. 21. Pillar 1 – SCR Risk Categories • Interest Rate Risk • Equity Risk • Property Risk • Credit Spread Risk • Currency Risk • Concentration Risk Solvency II, Jabran Noor, 23 Nov 2011
  22. 22. Pillar 1 – Calculation of SCR Credit Operational SCR Health U/W Basic SCR Non-Life U/W 1 NOTE Life U/W Risk Aggregation and Correlations applied to arrive at SCR Market Solvency II, Jabran Noor, 23 Nov 2011
  23. 23. Pillar 1 – Internal Modelo Standard models are o Crude o Conservative o Inflexibleo An internal model can be designed to o Reflect company’s business o Reflect company’s risk management o Be core of ERM program o Reduce Capital Requirements Solvency II, Jabran Noor, 23 Nov 2011
  24. 24. Pillar 1 – Requirements for Internal Model Solvency II, Jabran Noor, 23 Nov 2011
  25. 25. Pillar 1 – Own Funds (Eligible Capital)o First classification is Basic and Ancillaryo Ancillary must receive prior regulatory approvalo Secondary Classification o Tier 1 o Tier 2 o Tier 3o Quantitative limits apply to the extent to which Tier 2 and Tier 3 can be recognized to cover MCR and SCRo Tier 1 must constitute more than one-third of Eligible capitalo Tier 3 must be less than one-third Solvency II, Jabran Noor, 23 Nov 2011
  26. 26. Pillar 1 – Ladder of Intervention Additiona l F in a n cia l Clos ur e to Author iza tion R epor ting R ecover y N ew W ithdr a wa l P la n B us ines sAdequate CapitalBreach adjusted SCR Required PossibleBreach SCR Required Required PossibleBreach MCR Required Required Required Possible Solvency II, Jabran Noor, 23 Nov 2011
  27. 27. Pillar 2
  28. 28. Pillar 2 Solvency II, Jabran Noor, 23 Nov 2011
  29. 29. Pillar 2 - Governance o Must have an effective system of governance which provides for sound and prudent management o Proportionate to nature, scale and complexity of operations o Specific functions / systems must be in place (operating to prescribed standards) Solvency II, Jabran Noor, 23 Nov 2011
  30. 30. Pillar 2 - ORSA o Must consider o Overall solvency needs allowing for the specific risk profile, approved risk tolerance limits and business strategy o Compliance on continuous basis, with capital requirements, and with requirements regarding technical provisions o The significance with which the risk profile of the undertaking concerned deviates from the assumptions under the SCR o Must have in place (proportionate) processes which enable the company to properly identify and assess the risks o Must be an integral part of business strategy o Clearly ORSA is indirect encouragement to develop internal models Solvency II, Jabran Noor, 23 Nov 2011
  31. 31. Pillar 2 - ORSA o One requirement is to demonstrate a measurable set of business objectives o All actions and strategies are judged against these objectives o This includes reinsurance strategy o Advantages of ORSA o Confidence in sources of risk to business strategy o “Single Version” of truth o Pillar 1 looks at 12 month horizon. ORSA provides more deeper understanding of risks o ORSA policy will capture the entire ERM framework Solvency II, Jabran Noor, 23 Nov 2011
  32. 32. Pillar 3
  33. 33. Pillar 3 – Reporting Requirements 1 NOTE Combination of Quantitative and Qualitative Reporting 2 NOTE3 NOTE Detailed Public 4 NOTE disclosures even for internal models External audit Formats ofrequirements exist Reports are prescribed Solvency II, Jabran Noor, 23 Nov 2011
  34. 34. Pillar 3 – SFCR Structure Executive Summary A – Business and Performance B – System of Governance C – Risk Management D – Regulatory Balance Sheet E – Capital Management Undertakings with an approved internal model Annex – Quantitative Reporting Templates Solvency II, Jabran Noor, 23 Nov 2011
  35. 35. Solvency II Issues
  36. 36. Issueso Data requirementso Development and Approval of internal modelso Disclosure requirements are onerouso Complexity even in standard SCR calculationo Will it provide level playing field?o Developing integrated ORSA is a challengeo Is VaR the correct measure of risk?o Will Solvency II lead to lower or higher capital requirements? Under what conditions? Correctly?o Will it create opportunities for regulatory arbitrage in absence of pre-defined rules?o Role of actuary in Solvency II ? Solvency II, Jabran Noor, 23 Nov 2011
  37. 37. Solvency II, Jabran Noor, 23 Nov 2011
  38. 38. Will a random insurancecompany survive199 times out of 200 against a random event ? Solvency II, Jabran Noor, 23 Nov 2011
  39. 39. 9/11 ? Solvency II, Jabran Noor, 23 Nov 2011
  40. 40. Hurricane Katrina? Solvency II, Jabran Noor, 23 Nov 2011
  41. 41. US RatingDowngrade ? Solvency II, Jabran Noor, 23 Nov 2011
  42. 42. Greece Default ? Solvency II, Jabran Noor, 23 Nov 2011
  43. 43. Spain Default ? Solvency II, Jabran Noor, 23 Nov 2011
  44. 44. 9 / 11 + Hurricane Katrina +Greece Default Solvency II, Jabran Noor, 23 Nov 2011
  45. 45. change is the process bywhich the future invades our lives -> Alvin Toffler Solvency II, Jabran Noor, 23 Nov 2011
  46. 46. Thank You Solvency II, Jabran Noor, 23 Nov 2011

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