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P2 – 2 (Life) The Appointed Actuary and Changing Times

P2 – 2 (Life) The Appointed Actuary and Changing Times. Simon Curtis Executive Vice President & Chief Actuary September 17 th , 2009 Toronto. Focus of Work Has Fundamentally Shifted. Before Economic After Crisis. Financial Reporting & Earnings Analysis. SOLVENCY.

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P2 – 2 (Life) The Appointed Actuary and Changing Times

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  1. P2 – 2 (Life)The Appointed Actuary and Changing Times Simon Curtis Executive Vice President & Chief Actuary September 17th, 2009 Toronto

  2. Focus of Work Has Fundamentally Shifted Before Economic After Crisis Financial Reporting & Earnings Analysis SOLVENCY Financial Reporting & Earnings Analysis SOLVENCY

  3. Demands on Time Have Significantly Increased • The shift in work emphasis has been driven primarily by an increase in solvency related demands rather than any reduction in other demands • Ramping up of IFRS related activities over next 12 months will increase time demands even further • Financial staff are suffering from “crisis fatigue”

  4. What are the Increased Solvency Demands? • Significantly increased face time with management, board, regulators and rating agencies • Significant increases in stress testing demands and requirements • Significant increases in capital ratio analysis and projections • Significant increases in capital mobility / planning

  5. Increasing Capital Adequacy MIS • MIS needs to support regulatory capital management have increased significantly Company Example

  6. Increasing the Focus on Downstream Silo Capital • In benign market conditions, managing interactions of multiple levels of regulatory requirements (consolidated versus local regulatory solvency versus rating agency) is a relatively stable exercise • However, in a volatile/stressed environment the multiple levels of constraints: • introduce complexity issues in accurately modeling complex interactions • create pockets of trapped capital/unexpected capital calls that can make consolidated capital requirements higher than may be perceived by looking to p-down • create real issues in moving capital around the organization • Key learning is that models/tools focus on downstream needs and fungability not just top down requirements

  7. Stress Testing • Stress testing has emerged as key area of increased focus as an essential tool • Management and boards • Rating agencies • Regulators • Appointed Actuaries are uniquely placed through DCAT tools and infra-structure to take on significant portion of this work • OSFI is setting out increased stress testing expectations (Guideline E18) • Wants insurers to use DCAT structure • Likely to mandate at least one “OSFI” scenario annually • Discussing removal of AA “financial condition” opinion with CIA

  8. What has Last 18 Months Taught Us About Our DCAT Tools and Process?

  9. Importance and Role of Stress Testing • Recent economic turmoil appears to be highlighting a fundamental difference between professional requirements of stress testing (e.g. DCAT) and regulatory/management focus

  10. Key Concerns Emerging from Financial Crisis • Volatility of Capital Regimes • Confidence is created by stability • More risk centric / advanced stochastic techniques can introduce more systematic volatility in capital ratios • Key shortcoming is pro-cyclicality, partly due to models and literature not calibrating to where you are in the economic cycle • Result is regimes that release significant capital in good cycles and accrue significant capital needs in bad times – a poor capital management paradigm • IFRS Phase II and Future Solvency Regime Implications • The directional model of assets at fair value and liabilities discounted at current risk free rates would have led to widespread solvency failures if in place during the recent financial crisis due to transitory credit spread widening

  11. Key Concerns Emerging from Financial Crisis … cont’d • What is Right Level of Capitalization? • Limited acceptance by key constituents (not just regulators!) for companies to report reduced capital ratios during crisis conditions • Suggests companies will need to be capitalized at higher levels relative to historic and long term targets during good times in the economic cycle • Implications of Widening Credit Spreads • At the height of crisis fixed income spreads on A bonds widened from 100-150 bps historic levels to 400 bps plus in 2008, but have now largely returned to historic levels • Did fixed income spread widening reflect true fundamental credit concerns or transitory liquidity preference for risk free assets? • Significant implications for actuarial valuations both under current CGAAP and IFRS • CALM starts with fair value offset but has implications for credit loss assumptions in reserve • IFRS Phase 2 has no fair value offset but likely will have liquidity adjustment to risk free discount rates. Unless liquidity adjustment captured most of 2008 widening, virtually all companies would have been insolvent under IFRS basis

  12. IFRS Phase 2 Reported at fair value capturing risk free rates and spread changes Liability cashflows discounted at risk free rates plus “adjustment” Potential mismatch between liability “adjustment” and asset spreads Proposals for “adjustment” include zero, own credit, funding spread and liquidity premium

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