Joint Regional Seminar in Asia onPractical Actuaries and Financial ReportingPractical Uses of Local Reporting and/or Finan...
Contents   Meaning of Practical Actuaries and Practical Uses of Reporting   Nature of Insurance Contracts & Risks versus...
Meaning of Practical Actuaries and Practical Uses ofReporting Purpose of Financial Reports:-       To just tell/inform s...
Meaning of Practical Actuaries and Practical Uses ofReporting Implications on Financial Reporting:-       Reporting Focu...
Meaning of Practical Actuaries and Practical Uses ofReporting Meaning of Practical Actuaries:-       First, it depends o...
Nature of Insurance Contracts & Risks versusContemporary Financial Products Emergence of Financial Supermarket leading to...
Nature of Insurance Contracts & Risks versusContemporary Financial Products Financial Management Focus      Insurance Co...
Uses of Financial Reports by Stakeholders Stakeholders:-       Regulator       Shareholders       Management       In...
Impact of IFRS and Solvency II on Asset-LiabilityManagement & Business Solvency I       Formula based Technical Provisio...
Impact of IFRS and Solvency II on Asset-LiabilityManagement & Business HKFRS4 - Phase 1       Fair Value Measures have i...
Impact of IFRS and Solvency II on Asset-LiabilityManagement & Business Market Consistent Embedded Value (for European bas...
Impact of IFRS and Solvency II on Asset-LiabilityManagement & Business Impact of IFRS and Solvency II       Implications...
Impact of IFRS and Solvency II on Asset-LiabilityManagement & Business     Potential Pitfalls          Mechanism = Techn...
Financial Statements versus Financial Analyses   Financial Accounting Statements are to present the financial results ove...
KPIs and Company Valuation   Internal management used to focus on KPIs not Financial Statements   KPIs help simplify the...
Focus of Actuaries on Financial Reports versusRisk Management   Actuary : Expert on Risk Management   In usual operation...
Focus of Actuaries on Financial Reports versusRisk Management   Financial Risk (Concentrated) & Insurance Risk (Diversifi...
Back to Basics: Product Management Cycle andUse of Influential Power by Practical Actuaries   Effects of Ageing Populatio...
Upcoming SlideShare
Loading in …5
×

Jrs Conference 2009

340 views

Published on

  • Be the first to comment

  • Be the first to like this

Jrs Conference 2009

  1. 1. Joint Regional Seminar in Asia onPractical Actuaries and Financial ReportingPractical Uses of Local Reporting and/or FinancialReports in Hong KongChi-Fai Yam, FSA17 July 2009
  2. 2. Contents Meaning of Practical Actuaries and Practical Uses of Reporting Nature of Insurance Contracts & Risks versus Contemporary Financial Products Uses of Financial Reports by Stakeholders Impact of IFRS and Solvency II on Asset-Liability Management & Business Financial Statements versus Financial Analyses KPIs and Company Valuation Focus of Actuaries on Financial Reports versus Risk Management Back to Basics : Product Management Cycle and Use of Influential Power by Practical Actuaries 2
  3. 3. Meaning of Practical Actuaries and Practical Uses ofReporting Purpose of Financial Reports:-  To just tell/inform situations/issues?  To communicate information/data on an agreed format for all audiences?  To receive information/data by audience?  To understand information/data by audience; or  To help audiences understand the whole picture for informed decisions? (the key objective) Issues on Financial Reports:-  Focus of matters varied by audience  Different audiences require different levels of sophistication of information  Many business factors, variables and issues are inter-dependent and may not be easily expressed in a single or isolated fashion 3
  4. 4. Meaning of Practical Actuaries and Practical Uses ofReporting Implications on Financial Reporting:-  Reporting Focus  Income Statements – Earnings focus, but any small change in Balance Sheet items may introduce significant volatility on income statements  Balance Sheet – Asset-liability management focus, but a lot of risks may not be readily quantified and reflected on the figures  Prospective versus Retrospective Information  Simple extrapolation of the past?  Assessment of Key Performance Indicators to project the future  Financial Statements full of explanatory notes  P&L versus Company Valuation (Accounting versus Economic)  Risk Management Framework  Enforcement of Management Philosophy to minimize surprises  Does the FR create a Level Playing Field amongst financial products? 4
  5. 5. Meaning of Practical Actuaries and Practical Uses ofReporting Meaning of Practical Actuaries:-  First, it depends on which role the Actuary with;  Secondly, the work focus of the Actuary:-  Sophisticated financial modeling;  Efficiency in producing and reconciling financial reports and Compliance of Standards;  Adding value to business (and how?) o via Management of financial information to guide users to make proper business decisions; o Risk Management (or Risk avoidance) & in what form? o Delivery of End Products? 5
  6. 6. Nature of Insurance Contracts & Risks versusContemporary Financial Products Emergence of Financial Supermarket leading to  Integration (or Bundling) of Financial Products  Engagement of different expertise with different financial industry backgrounds working in the same organization  Expectation of a Level Playing Field for Financial Products Insurance Contracts  Insurance Risks : Term, Disability, CI, Income Protection, etc  Financial Risks : (versus Contemporary Financial Products)  Single Premium Short Term Endowments vs Corporate Bonds  Unit Linked vs Unit Trusts/Mutual Funds  Variable Annuities vs Equity Options  Regular Pay Endowments vs Regular Bank Deposits  Lapses versus Future Promises & Guarantees :  Renewal Guarantees, Lifetime Guarantees, Premium Rate Guarantees, Conversion Privileges, etc  Illustrations of Participating Dividends/Future Interest Credits, PRE 6
  7. 7. Nature of Insurance Contracts & Risks versusContemporary Financial Products Financial Management Focus  Insurance Companies : New Business Premium, Embedded Value, New Business Strain  Banks : Expense to Income Ratio, Loan Book, NP Loan Provisions  Fund Managers : Expense to Income ratio, FUM  Investment Banks : Basel II, VaR, Internal Models (Risk Neutral - simulation models & differential equations), Dynamic Hedging, etc in relation to financial risk management Considerations on Insurance Contract Financial Reporting  Are current financial reports sufficiently clear and transparent to reflect all financial risks of insurance contracts?  Which approach (Bundling or Unbundling) relevant to financial reporting for insurance contracts?  If Insurance & Financial Risks are to be separate in financial reports, how about the risks associated with Lapses & Long Term Promises, Conversion Privileges, etc? 7
  8. 8. Uses of Financial Reports by Stakeholders Stakeholders:-  Regulator  Shareholders  Management  Investment Analysts/ Credit Agencies  Tax Department  Policyholders(?) Local Reporting (Current Reporting for HK insurers)  Statutory Reporting (largely Rule-based)  ICO - SAP, Annexes to FCR  Regulations – Solvency Margins, Valuation, Asset Admissibility, etc (Solvency I)  Dynamic Solvency Testing (GN7)  Financial Reporting (in Transition)  HKFRS = IFRS  IFRS4 (Phase 1) = IFRS (Asset Value) + GAAP (Liability Value) + Footnotes, where HK GAAP = HK GAAP, HK SAP, US GAAP, Canadian GAAP, etc & Footnotes may include Company Valuation information (on traditional EV, EEV or MCEV basis), FCR details 8
  9. 9. Impact of IFRS and Solvency II on Asset-LiabilityManagement & Business Solvency I  Formula based Technical Provisions (Minimum Reserves) & Minimum Solvency Requirements  Insufficient quantification of ALM and Long Term Guarantee Risks  Dynamic Solvency Test to partially address the risk quantification shortfall, but different practices/connotations versus Basel II Solvency II  Framework  Solvency Capital Requirements (comparable to other financial products – VaR of 99.5% over 1 year)  Risk Management & Supervisory Review  Disclosure & Publicity  Risk-based philosophy to take account of all potential risks for determining Solvency Capital Requirements  Technical Provisions : Stochastic simulation or Deterministic approach but with explicit Cost of Guarantee for Insurance options and guarantees  Standard Formula : Operational Risk; Insurance Risks (Life, Health & Non-Life); Counterparty Risk & Market Risks (Forex, Property, Equity, Interest, Spread, Concentration)  Dynamic Hedging Strategies not accounted for unless they are part of the management principles & practices of the firm in managing risks 9
  10. 10. Impact of IFRS and Solvency II on Asset-LiabilityManagement & Business HKFRS4 - Phase 1  Fair Value Measures have introduced Asset Value Volatilities  Liability Values depending on Corporate Accounting Practice (HK insurers usually follow their parent company practices)  Higher volatilities on Earnings may result  HKFRS4 - Phase I has not improved comparability amongst local insurers (practical use of current financial reporting!)  Pricing on product guarantees remains different  Corporate profit signature also varied by practices of acquisition cost recognition Phase 2  Liabilities = Best Estimates + Risk & Service Margins  Best Estimates (for Pure Risk Products) can be low or even negative (when allowing for future premiums)  Relevant Margin Carrier (based on management belief ?) as Premium may not be an applicable carrier (e.g. single or limited pay)  Current Exit Value or Fulfillment Value (if Fulfillment Value, concept similar to Australian MOS & Capital Adequacy), and their implications to business 10
  11. 11. Impact of IFRS and Solvency II on Asset-LiabilityManagement & Business Market Consistent Embedded Value (for European based Insurers)  Explicit quantification of Product Guarantee/Option Costs to charge against future cash flows for determining Economic Value  Convergence and Consistency of Measures amongst Solvency II, IFRS4 (Phase 2), MCEV (?) for easy reconciliation between accounting and economic measures  Real World based simulations of future cash flows (requiring calibration of economic return generators)  Comparability of Investment Bank Models (Risk Neutral) versus Insurance Company Models (Real World) (?)  What implications on Product Designs & Business Strategies amongst insurers versus other financial industries under a Level Playing Field?  What implications on Product Management and Reporting/ Communication (transparency versus information overthrow, sensitivity to modeling results?) 11
  12. 12. Impact of IFRS and Solvency II on Asset-LiabilityManagement & Business Impact of IFRS and Solvency II  Implications on Business Management:-  Increased Volatility in Accounting earnings naturally increases risk aversion focus of the business, resulting in additional management constraints  Natural Source of Earnings Volatility – Asset-liability Mismatch/ Long Term Guarantees  Insurance Risk (can be reduced through Diversification) versus Financial Risk (will increase due to Concentration)  Implications on ALM Management:-  Will likely demand increased sophistication on Asset Management and/or A-L Hedging techniques for long term contracts, else pure insurance risk business might be favored (when competing for capital)  Prudent Man Rules on Asset Management may be set based on SCR Standard Formula  Reduce net exposures by Active Hedging (?)  Encouragement of Mitigation of Financial Risks back to Policyholders (?) 12
  13. 13. Impact of IFRS and Solvency II on Asset-LiabilityManagement & Business  Potential Pitfalls  Mechanism = Technical Provisions/Best Estimates (ALM costs) & SCR (Asset quality versus Liability mitigation over 1 year)  Would Management focus be increased on extreme risks (tails at risk), rather than risk management over the whole risk spectrum to reduce ALM costs  May drive attention on opportunistic arbitrages than improvement of risk management  May create a Strong Incentive to use Internal Model than Standard Formula to improve capital management results  How about ownership (& choice) of risk parameters (?) used for the Internal Model  Would the financial models and implications on choices of risk parameters be easily explained or understood by the Stakeholders (?)  Would the whole Financial Reporting mechanism become complex, arbitrary and unclear to most Stakeholders (?)  Would it drive Management to simply run Financial Statements and Models, than Business (?) 13
  14. 14. Financial Statements versus Financial Analyses Financial Accounting Statements are to present the financial results over a measurement period, based on what have been done by business (including those management actions done long time ago before the measurement period). Financial Results as presented on these Statements are affected by Accounting Principles, like  concept of Current Exit Value versus Fulfillment Value;  approach to recognize Acquisition Costs  asset management strategies (buy & hold versus trading), etc which will cause management responses. For long term business, risks evolve slowly (and may not be linear) over time, thus risk management needs to move the focus away from Accounting balance sheet (especially with intangible assets) to Economic balance sheet Financial Analyses (rather than statement reporting) focus on potential risks and uncertainties of business fundamentals as a way to extrapolate future results and assess business sustainability To help analyses, Financial Statements are now contained many Footnotes on business and risk parameters Most of these footnote disclosures have suppose to be part of Insurer’s Financial Condition Report (under the Appointed Actuary system) when assessing business sustainability In summary, current financial reporting is to make more internal management information become public. With more information disclosed and different audiences having different views and focuses, the next issue is how to retain Management focus 14
  15. 15. KPIs and Company Valuation Internal management used to focus on KPIs not Financial Statements KPIs help simplify the whole business performance into a few key messages Normally, the outcomes of KPIs directly impact cashflows Thus, the delivery of KPIs directly link to economic/business value Now, instead of using deterministic cashflows, allowance of risk mitigation costs need to be included when assessing the cashflows for determining value With increased competition, margin for error/underperformance on each KPI has been much squeezed. The allowance of explicit risk charges would further squeeze the margin on each KPI for Management to perform! Management Challenge: Small margin of errors for results versus all sorts of potential uncertainties in business. Risk Management thus becomes a hot topic. How to make it practical! 15
  16. 16. Focus of Actuaries on Financial Reports versusRisk Management Actuary : Expert on Risk Management In usual operations, actuarial is split into 2 streams – Product & Financial Reporting Business = Delivery of KPIs (but KPIs can be interdependent) In a less competitive environment, thicker margins available on KPIs. Thus, able for actuarial to allow conservative margins in pricing or valuation for business mistakes & to isolate the insurance business from direct capital market impact Actuary’s Challenge: Today’s environment (the margins are pretty thin) often provides only a tiny space for feasible business solutions. So what the role of actuaries in Risk Management should be:-  to just communicate risks by highlighting them in financial reports; or  to deliver end products (?) Financial Statements : Technical Provisions (with expected ALM costs, if explicitly recognized), but annual results fluctuate with Volatility (ALM) How to manage psychological reactions of audiences on surprises! 16
  17. 17. Focus of Actuaries on Financial Reports versusRisk Management Financial Risk (Concentrated) & Insurance Risk (Diversified), thus Risk Management naturally leans towards financial risk management (unless for a pure protection risk insurer) Financial Risk Management = Asset Management (Delivery within Mandates) + ALM + Liability Mitigation ability (Driven by Product Design) ALM may mean Liability Driven Asset Strategy (if passive) or Option management (if active) Option management (rho, delta, gamma & vega) versus Traditional dollar averaging or constant proportion concepts (for rho & delta management) Stochastic (on Stochastic) simulations would reflect that financial risks are naturally non-linear. So whether to use capital (passive) or hedging techniques (active) to address Volatility (ALM)? Gamma & Vega management are key in option management Capital markets using Risk Neutral Models (pricing with a risk adjusted rate) versus Insurers using Real World Models (using empirical data to simulate). With further integration between insurance and capital markets, what implications to actuaries on product pricing and delivery? 17
  18. 18. Back to Basics: Product Management Cycle andUse of Influential Power by Practical Actuaries Effects of Ageing Population (Higher Annuity Needs versus Life Protection) & Customer Needs (Product Delivery = Financial Guarantees(?)) What Role of “Appointed” Actuary should take in Product Cycle/Risk Management (?) Does Product Management mean  A one-off exercise, simply for product sign off; or  For on-going delivery (?) Who should be responsible for the proper delivery of the on-going Product Promises – Product Marketing/Product Actuarial; Appointed Actuary; CFO; Asset Manager; ALM Risk Manager; Hedging Desk; or by CEO/Board via Risk Management Framework(?) Ownership/Choices/Delivery of Risk Parameters (Financial Risks versus Business Risks) in the whole Risk Management Framework (?) Use of Influential Power by Practical Actuaries in Product Cycle/Risk Management, especially when involving different expertise of different technical languages in FRM 18

×