Casualty Actuaries of New England (CANE) September 26, 2008

1. Casualty Actuaries of New England (CANE) September 26, 2008 Dispelling the Fog: ERM, Solvency II & IFRS PwC

2. FOG • A state of mental dimness and confusion. CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS PricewaterhouseCoopers

3. ERM can provide a solid foundation for many key aspects of IFRS implementation, as well as synergies to help ease the cost of compliance with other forthcoming risk/capital management directives, including Solvency II. • Regulatory challenges include overcoming the continuing uncertainty with respect to insurance reporting under IFRSand gearing up for the forthcoming Solvency II. Increased pressure from regulators and rating agencies alike sees more focus on ERM. CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS PricewaterhouseCoopers

4. Agenda • Introductions • Overview of ERM • Solvency II Update • Overview of IFRS • Linkages between ERM, Solvency II, and IFRS • Company perspective • Q&A CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS PricewaterhouseCoopers

5. Navigating Through Fog • Stay Calm • Slow Down • Avoid Braking Often • Avoid Distractions CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS PricewaterhouseCoopers

6. Section One ERM Overview

7. Does ERM matter? • “Risk management adds value not only to individual companies, but also supports overall economic growth by lowering the cost of capital and reducing the uncertainty of commercial activities.” • James Lam • “Enterprise Risk Management – From Incentives to Controls” CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS PricewaterhouseCoopers

8. Enterprise Risk Management ERM Overview • The benefits of ERM are derived from integration: • an integrated organization, which often includes a centralized risk management unit reporting to the board, CEO or CFO with responsibility for broad risk policy setting across risk taking activities; • an integration of risk transfer strategies (considering all risks, and any diversification benefits between them); and • the integration of risk management into business processes, optimizing performance through risk adjusted pricing, resource allocation, and enhanced business decision making. Source: James Lam – Enterprise Risk Management – From Incentives to Controls CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS PricewaterhouseCoopers

9. Enterprise Risk Management ERM Overview • An ERM infrastructure must be developed… • risk management governance; • risk management policies and procedures; • risk assessments and audits; • systems and financial models; • measures and reports; and • risk limits and exception processing. • Develop from the top down! CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS PricewaterhouseCoopers

10. Enterprise Risk Management ERM Overview • …however, ERM benefits will only be realized when companies: • build risk awareness through senior management commitment; • create a culture for risk management; • facilitate open communication; • identify and/or develop talent; and • reinforce behavior. CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS PricewaterhouseCoopers

11. Enterprise Risk Management ERM Overview – An Illustrative Framework Environment Infrastructure Process Strategy Validation/re-assessment Business mission and strategy Risk strategy Value proposition Risk appetite Risk awareness/ Identification Risk assessment/ Response Operations Measurement and Control Reporting Organisation and people Limits and controls Methodologies & Models Systems Data Policies Reporting Culture Training Communication Performance measures Reward CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS PricewaterhouseCoopers

12. Enterprise Risk Management Integration of Enterprise Risk Management CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS PricewaterhouseCoopers

13. Organisation and people Limits and controls Methodologies & Models Systems Data Policies Reporting Enterprise Risk Management ERM Infrastructure – Organization and people • Centralized independent risk management function • CRO or senior executive with risk role • Oversight committees at the Board / senior management levels • Risk awareness, culture and values • Risk training • Talent management • Linkages between risk and compensation CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS PricewaterhouseCoopers

14. Organisation and people Limits and controls Methodologies & Models Systems Data Policies Reporting Enterprise Risk Management ERM Infrastructure – Limits and Controls • Define corporate-wide and product-specific risk appetites • Risk assessments • Risk inventories • Exposure limits and triggers • Risk controls • Risk escalation CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS PricewaterhouseCoopers

15. Risk Appetite A measure of the potential financial impact that the company is willing to take in exchange for a targeted return ERM programs may have multiple definitions for risk appetites Capital (Ruin focus) Earnings (Volatility focus) Rating (May be driver of probability choice) Alignment with product pricing Enterprise Risk Management ERM Terminology CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS PricewaterhouseCoopers

16. Risk Tolerance Relates to management strategies Risk Limits Defining risk limits - connection with the company-wide risk appetite, approval processes Risk escalation processes Procedures used for monitoring and responding to limit breaches Automatic triggers, risk dashboards Enterprise Risk Management ERM Terminology CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS PricewaterhouseCoopers

17. Enterprise Risk Management Process in Place to Define Risk Appetite CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS PricewaterhouseCoopers

18. Enterprise Risk Management Process in Place to Deal with Breaches of Limits CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS PricewaterhouseCoopers

19. Organisation and people Limits and controls Methodologies & Models Systems Data Policies Reporting Enterprise Risk Management ERM Infrastructure – Methodologies & Models • Insurance, market, credit and operational risk management • Economic capital models & capital allocation • Risk analytics, including scenario analysis, risk indicators, risk-adjusted returns • Risk transfer strategies • Linkage of planning and risk strategy • Linkages to product pricing • Performance management • Capital management CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS PricewaterhouseCoopers

20. “Excess” Capital Assets available for required capital Economic Capital Assets covering liabilities Liabilities Enterprise Risk Management Economic capital models Key areas where survey respondents identified benefits of implementing an economic capital model: • Better allocation of capital than under a regulatory capital model • Definition of risk appetite • Freeing up of capital for use in the business • Changes in the pricing of products to better reflect risk • Changes in strategic direction after assessing risk-adjusted performance CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS PricewaterhouseCoopers

21. Aggregate Economic Capital Model Inter-risk Diversification Market Risk Insurance Risk Credit Risk Operational Risk     BU 1 BU 2  Inter-segment Diversification BU 3  Corporate & Other Enterprise Risk Management Economic capital models (cont’d) • Types of models • Factor based • Stress tests • Combination models (usually a combination of factor based models with either stress testing or stochastic modeling) • Fully stochastic models • Range of risks • Insurance risks — typically modeled using stress tests for life business and stochastically for non-life business • Market risk and credit risk — often modeled stochastically • Operational risk — factor based or “scenario driven models” are common CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS PricewaterhouseCoopers

22. Enterprise Risk Management Economic capital models (cont’d) Source: 2008 PwC survey covering ERM in the global insurance industry CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS PricewaterhouseCoopers

23. Enterprise Risk Management Model Development Timeline CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS PricewaterhouseCoopers

24. Traditional Operational Risk Management - Separate Silo Risk Management for: IT Risks HR Risks Regulatory & Compliance Risks Fraud Risk Internal Controls Reputation Risk Business Continuity Distribution Risks Outsourcing/Vendor Risk Enterprise Risk Management Operational Risk CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS PricewaterhouseCoopers

25. Enterprise ORM – leading to Strong ORM assessment by S&P usually associated with: Comprehensive assessment of risks & control capabilities Identification of risks not adequately controlled by existing programs Prioritization Development of key risk indicators, tracking process & problem resolution system Excellent ORM assessment usually associated with: Repeated application Refinements of controls & KRIs Response programs Enterprise Risk Management Operational Risk Management CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS PricewaterhouseCoopers

26. Organisation and people Limits and controls Methodologies & Models Systems Data Policies Reporting Enterprise Risk Management ERM Infrastructure - Systems • ERM supporting technology • System interface, mapping tools, middleware • Risk registers • Exposure analytics, drill-down capabilities • Risk reporting tools CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS PricewaterhouseCoopers

27. Organisation and people Limits and controls Methodologies & Models Systems Data Policies Reporting Enterprise Risk Management ERM Infrastructure – Data • Risk and portfolio data requirements: • Access • Common definitions • Quality assessments • Cleansing • Data warehouses • Industry data • Benchmarking data CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS PricewaterhouseCoopers

28. Enterprise Risk Management Rating Data Management Expenditures CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS PricewaterhouseCoopers

29. Organisation and people Limits and controls Methodologies & Models Systems Data Policies Reporting Enterprise Risk Management ERM Infrastructure – Policies • Market, credit, insurance, operational risk policies and procedures, including: • Risk rating policies; • Exposure management policies; • Risk limit policies; • Monitoring and review policies; • Risk transfer policies; • Management and board reporting policies. • Overall risk policies • Emerging risk policies CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS PricewaterhouseCoopers

30. Organisation and people Limits and controls Methodologies & Models Systems Data Policies Reporting Enterprise Risk Management ERM Infrastructure – Reporting • Board reporting, including enterprise view on aggregate losses, risk incidents, policy exceptions, key exposures, KRIs • Key risk indicators that quantify major trends and risk exposures • Limit exception reporting • Risk dashboards • ERM disclosures • Finance effectiveness – exploiting synergies between requirements for financial reporting, ERM, Solvency II, and IFRS CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS PricewaterhouseCoopers

31. Enterprise Risk Management Does ERM matter? • Through improved… • Coordination • Communication • Financial discipline • Transparency CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS PricewaterhouseCoopers

32. Section Two Solvency II Update

33. Solvency II Solvency II – EU taking a global lead in insurance regulation • “This is an ambitious proposal that will completely overhaul the way we ensure the financial soundness of our insurers. We are setting a world-leading standard that requires insurers to focus on managing all the risks they face and enables them to operate much more efficiently.” • Charlie McCreevy • Internal Market and Services Commissioner • Speaking at the launch of the Solvency II draft Framework Directive CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS PricewaterhouseCoopers

34. Solvency II Is Solvency II likely to have Global impact? • Principles-based risk sensitive regulation is becoming the norm • US led the way (RBC models) initially, then Canada (DCAT) • More recently: Australia, UK (ICAS) and Switzerland (SST) • Many other jurisdictions are looking at implementing Solvency II or seeking “equivalent regime” status • NAIC publicly-stated intention to consider options • However, State-based US system adds significant complexity to regulatory innovation/connectivity with other global regulators; e.g. • Principles-based reserving discussions likely to take years to finalise • Policy forms and premium rates still needing regulatory approval • The Optional Federal Charter solution? • IAIS has now got real traction • Global footprint of CFO and CRO Forum members CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS PricewaterhouseCoopers

35. Solvency II Economic capital – lies at the heart of Solvency II and at the core of managing your business Solvency &Financial Reporting Economic Capital Rating Agencies Delivering Shareholder Value EnterpriseRisk Management CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS PricewaterhouseCoopers

36. Solvency II Solvency II – Timescales Solvency II system in operation (31 October 2012) High Level Principles (Level I Directive) adopted Draft Framework Directive published EU member states to transpose into law 2007 2008 2009 2010 2011 2012 Model pre-approval process Quantitative Impact Study v.3 Quantitative Impact Study v.4 Detailed rules (Level II implementing measures) The above timeline corresponds closely to the current IFRS timescale – but the two projects are not formally linked CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS PricewaterhouseCoopers

37. Solvency II Solvency II – Draft Framework Directive - overview GROUP SUPERVISION – all pillars applicable to solo entities and groups CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS PricewaterhouseCoopers

38. Solvency II Solvency II – Quantitative requirements Proposed framework for Pillar I Assets available for SCR/ MCR Solvency Capital Requirement (SCR) MCR Risk margin for non-hedgeable risks Best estimate Assets at Market Value Assets covering technical provisions Technical Provisions Market consistent valuation for hedgeable risks CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS PricewaterhouseCoopers

39. Solvency II Current areas of contention within Solvency II/ outstanding issues • Group supervision and group support • role of lead versus country supervisor • group support mechanism • Treatment of 3rd countries (e.g. USA, Bermuda, Far East) • Design and calibration of MCR • Treatment of surplus funds (Germany), equities re: market risk (France) • Proportionality (e.g. should there be a de minimis threshold?) • Public disclosures – extent, timing • Captives and mutuals • Use of internal models • Role of audit (overlap with financial reporting) CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS PricewaterhouseCoopers

40. Solvency II Solvency II – Progression from Solvency I Solvency I Solvency II Pillar 1 • Local GAAP/IFRS • No internal model • RMM • Market consistent valuations • MCR, SCR • Internal model optional (use • subject to supervisory approval) Pillar 2 • Supervisory review • No EU harmony • Group capital assessment • (post IGD) – no • diversification benefit • Supervisory review process • Emphasis on governance • and risk management • Capital add on: exceptional • Group capital assessment with • diversification benefit • ORSA Pillar 3 • Public Disclosure • FSA Return, IGD data • Public Disclosure CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS PricewaterhouseCoopers

41. Small Large Solvency II Summary of possible implications of Solvency II Multinational • Reconsideration of HO location • Diversification benefits / reduced capital req. • Reconsideration of operating structure • Acquisition opportunities (e.g. amongst • small players) • Strategic re-evaluation of business lines • Disposals or run-off of underperforming / • capital intensive books • Capitalfungibility challenges • Inability to meet SII requirements? • Disproportionate compliance • costs • Reconsideration of operating structure • Seeking merger partners • Industry roll up possibilities • Discontinuation of business • Insolvency • Seek merger partners to obtain • diversification benefits • Reconsideration of operating structure • Acquisition opportunities (e.g. amongst • small players) • Strategic re-evaluation of business lines • Disposals of run-off/underperforming books • Capital fungibility challenges Domestic CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS PricewaterhouseCoopers

42. Solvency II What are we seeing European firms doing at present? • Broad EU industry support for the proposals • SII approach and level of engagement differs by country and segment In Europe generally, what are companies typically doing: • General education and awareness raising • Companies taking a more proactive stance: • Impact assessments/gap analyses (see below for typical themes) • Setting up Solvency II project teams • Examining specific aspects e.g. risk appetite/ERM framework • Restructuring ahead of the final Directive wording • Data warehouse set-up, model specification and build • Projects covering economic capital, IFRS, MCEV • Addressing broader finance transformation and actuarial integration Outside EU, already some regulators and companies looking at same concepts CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS PricewaterhouseCoopers

43. Solvency II Market implications - Rating agency interaction with Solvency II • Capital is just one element of ratings • Rating agencies not all using DFA models – but moving in that direction • Agencies stated intention to converge • Consider companies’ internal model (S&P launched limited EC model review) • Still the option of qualitative add-on for other agency factors • Some major differences in approach (diversification benefits less generous, no explicit discount for lack of fungibility of capital) • Calibration differences (SCR is approximate to BBB) • Agencies and indeed markets will react to any Pillar II add on • Regulators may expect an integrated approach to calculating capital held • Increased focus on ERM concepts CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS PricewaterhouseCoopers

44. Key Challenges Integration of ORSA into the business’ strategic management ORSA expected to serve multiple purposes including regulatory compliance Ability to have risk management systems that monitor, manage and report risk on a continuous basis (at individual and aggregate level) Use for allocation of capital, consistency between pricing and capital decisions Solvency II Link to ERM - Impact on organisations from the Solvency II risk and governance requirements – Pillar II - ORSA Management Strategy ORSA Operations Internal Models EMBEDDING RISK MANAGEMENT CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS PricewaterhouseCoopers

45. Solvency II Draft Solvency II Directive: Regulatory approval of an internal model will require an entity to satisfy three broad tests: • Test 1: Statistical Quality Test (Article 119) – Actuarial model • Test 2: Use Test (Article 118) – Internal risk management • Test 3: Calibration Test (Article 120) – Regulatory capital • In addition, entities must satisfy: • Validation Standards (Article 122) • Documentation Standards (Article 123) CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS PricewaterhouseCoopers

46. Solvency II Internal Models – External Review Draft regulatory requirements for approval of internal models: CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS PricewaterhouseCoopers

47. Public disclosure Annual disclosure of solvency and financial condition report Subject to approval groups may disclose only one report Systems/ structures required to ensure ongoing appropriateness of information disclosed Link to IFRS Conceptually in line with IFRS approach and timeline Solvency and financial condition report to contain information on The nature and performance of the business Governance systems Risk management approach and risk profile Valuation basis for assets and liabilities Capital management including structure and quality of own funds, MCR and SCR Non-compliance with MCR and SCR during reporting period Solvency II Pillar III - Public disclosure and link to IFRS CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS PricewaterhouseCoopers

48. Section Three IFRS Update

49. International Financial Reporting Standards (IFRS) What is IFRS? SEC Roadmap Insurance Contracts Today Insurance Contracts Phase 2

50. What is IFRS? Background • IFRS—International Financial Reporting Standards • Standard setter—International Accounting Standards Board (IASB) founded in 2001 and based in London • International Accounting Standards Committee (IASC) Foundation • Appoint IASB members • Exercise oversight • Raise funds • Similar to Financial Accounting Foundation (FAF) • Predecessor organisation was International Accounting Standards Committee (IASC) founded in 1973 CANE Meeting – Dispelling the Fog: ERM, Solvency II, IFRS PricewaterhouseCoopers