Panel 5 Solvency - Valuation of Liabilities & Value at Risk Methodology

1. Panel5Solvency - Valuation of Liabilities& Value at Risk Methodology IAIS-ASSAL Training Seminar 24 November 2009, Lima Peru Jason Park – Principal Administrator International Association of Insurance Supervisors (IAIS)

2. Presentation Overview • Part I : Introduction of the IAIS • Part II : International Solvency Requirements (ISRs) within the IAIS Framework for Supervision • Structure of regulatory capital requirements • Use of internal models for regulatory capital purposes • Value at Risk Methodology in IAIS document • Valuation of assets and liabilities for solvency purposes Solvency - Valuation of Liabilities& Value at Risk Methodology

3. IAIS: a global forum for insurance regulators • Founded in 1994 • Members from more than 190 jurisdictions in over 140 countries Solvency - Valuation of Liabilities& Value at Risk Methodology

4. Convergence Issues papers Application papers Guidance papers Standard setting activities aim at global convergence of supervisory practices Supervisory papers Supporting papers Solvency - Valuation of Liabilities& Value at Risk Methodology

5. Assessment criteria Explanatory notes Essential criteria Advanced criteria ICPs provide globally-accepted framework for insurance regulation and supervision • Benchmark for insurance supervisors • Used to establish new regimes • Used to improve existing regimes • Used in evaluation of supervisory regimes – FSAPs • Applies to all insurers and reinsurers but not intermediaries, unless indicated Insurance Core Principles and Methodology Principles Solvency - Valuation of Liabilities& Value at Risk Methodology

6. ICPs cover all insurance supervisory aspects Solvency - Valuation of Liabilities& Value at Risk Methodology

7. Presentation Overview • Part I : Introduction of the IAIS • Part II : International Solvency Requirements (ISRs) within the IAIS Framework for Supervision • Structure of regulatory capital requirements • Use of internal models for regulatory capital purposes • Value at Risk Methodology in IAIS document • Valuation of assets and liabilities for solvency purposes Solvency - Valuation of Liabilities& Value at Risk Methodology

8. Supervisory assessment LEVEL 3 Supervisory assessment and intervention Common Solvency Structure and Standards Regulatory requirements LEVEL 2 Financial Market conduct Governance the insurance supervisory authority Basic conditions for the effective functioning of Preconditions LEVEL 1 the insurance sector and insurance supervision Framework for Insurance Supervision Solvency requirements are integral in the Framework for insurance supervision Solvency - Valuation of Liabilities& Value at Risk Methodology

9. ISRs: a comprehensive and cohesive set of solvency assessment documentation International Solvency Requirements (ISRs) STANDARDS ISR 1 Capital requirements (adopted) ISR 2 Capital resources (adopted in 2009) ISR 3 Valuation of assets & liabilities (due Oct 2010) ISR 4 Investments (due Oct 2010) ISR 5 Enterprise risk management (adopted) ISR 6 Internal models (adopted) GUIDANCE PAPER ISR 1 Capital requirements (adopted) ISR 2 Capital resources (adopted in 2009) ISR 3 Valuation of assets & liabilities (due Oct 2010) ISR 4 Investments (due Oct 2010) ISR 5 Enterprise risk management (adopted) ISR 6 Internal models (adopted) Solvency - Valuation of Liabilities& Value at Risk Methodology

10. ICPs related to Prudential Requirements ICP 23 Capital adequacy and solvency • Requires insurers to comply with the prescribed solvencyregime. This regime includes capital adequacy requirements and requires suitable formsof capital that enable the insurer to absorb significant unforeseen losses. • Capital Requirements • Capital Resources • Internal Models Solvency - Valuation of Liabilities& Value at Risk Methodology

11. ICPs related to Prudential Requirements ICP 18 Risk assessment and management • Requires insurers to recognise the range of risks that they faceand to assess and manage them effectively. • Internal Models ICP 21Investments • Requires insurers to comply with standards on investment activities. These standards include requirements on investment policy, asset mix, valuation, diversification, asset-liability matching, and risk management. ICP 22Derivatives and similar commitments • Requires insurers to comply with standards on the use of derivatives and similar commitments. These standards address restrictions in their use and disclosure requirements, as well as internal controls and monitoring of the related positions. • Investments Solvency - Valuation of Liabilities& Value at Risk Methodology

12. ICPs related to Prudential Requirements ICP 20 Liabilities • Requires insurers to comply with standards for establishingadequate technical provisions and other liabilities, and making allowance for reinsurancerecoverable. The supervisory authority has both the authority and the ability to assess theadequacy of the technical provisions and to require that these provisions be increased, ifnecessary. ICP 21 InvestmentsEssential criterion b) requires that investments are valued according to a method prescribed by or acceptable to the supervisory authority. ICP 23Capital Adequacy and SolvencyEssential criterion a) requires that the solvency regime addresses the following in a consistent manner: • Valuation of liabilities, including technical provisions and the margins contained therein • Quality, liquidity and valuation of assets • Matching of assets and liabilities, etc. • Valuation of Liabilities and Assets Solvency - Valuation of Liabilities& Value at Risk Methodology

13. Presentation Overview • Part I : Introduction of the IAIS • Part II : International Solvency Requirements (ISRs) within the IAIS Framework for Supervision • Structure of regulatory capital requirements • Use of internal models for regulatory capital purposes • Value at Risk Methodology in IAIS document • Valuation of assets and liabilities for solvency purposes Solvency - Valuation of Liabilities& Value at Risk Methodology

14. Standard & Guidanceon the Structure of Regulatory Capital Requirements • Total balance sheet approach • Recognise interdependence between assets, liabilities, regulatory capital requirements and capital resources • Ensure that determination of available and required capital is based on consistent assumptions for the recognition and valuation of assets and liabilities for solvency purposes • Establishment of a range of solvency control levels • with appropriate supervisory interventions • Allowance of a range of approaches • standardised approaches and more advanced approaches, such as internal models • Determination of prescribed levels of RCRs • MCRs and PCRs • relationships between different levels Solvency - Valuation of Liabilities& Value at Risk Methodology

15. Supervisory assessment of the financial position Public financial reporting capital available capital capital requirement value of assets for supervisory purposes technical provisions risk margin liabilities liabilities current estimate policy obligations assets liabilities and capital requirement financial position assets liabilities Standard & Guidanceon the Structure of Regulatory Capital Requirements Total balance sheet approach to recognise interdependencies Solvency - Valuation of Liabilities& Value at Risk Methodology

16. Standard & Guidanceon the Structure of Regulatory Capital Requirements Solvency Control Levels and Regulatory Capital Requirements Prescribed Capital Requirement (PCR) Capital Resources (CR) Required Capital Minimum Capital Requirement (MCR) Risk Margin (RM) Current Estimate (CE) Technical Provisions (TP) and Other liabilities Other liabilities (OL) Other liabilities (OL) Insurer’s Financial Position Regulatory Capital Requirements Solvency - Valuation of Liabilities& Value at Risk Methodology 16

17. Standard & Guidanceon the Structure of Regulatory Capital Requirements Progressive intervention levels to ensure timely corrective measures – an example • Prescribed capital requirement (PCR) level • Supervisory intervention not required 190% 160% • Submission of business plan to improve capital buffers • Increased on-site supervision • Additional stress and scenario testing Capital Adequacy Ratio = Capital Available Capital Required 130% • Limit shareholder dividends • Restrict new business acquisition • Delay approval of new products 100% • Minimum capital requirement (MCR) level • Winding-up of operation Solvency - Valuation of Liabilities& Value at Risk Methodology

18. Presentation Overview • Part I : Introduction of the IAIS • Part II : International Solvency Requirements (ISRs) within the IAIS Framework for Supervision • Structure of regulatory capital requirements • Use of internal models for regulatory capital purposes • Value at Risk Methodology in IAIS document • Valuation of assets and liabilities for solvency purposes Solvency - Valuation of Liabilities& Value at Risk Methodology

19. Standard & Guidanceon the Use of Internal Models for Regulatory Capital Purposes • What are internal models? • A risk management system developed by an insurer to analyse and quantify its risk position and to determine the commensurate economic capital • The internal model approach is suitable only if certain preconditions are met • Level of sophistication of insurers / markets • Corporate governance structures • Competent / accountable insurance professionals and management • Supervisory resources and expertise • Standards and guidance paper applies only in jurisdictions where internal models are recognised for regulatory capital purposes Solvency - Valuation of Liabilities& Value at Risk Methodology

20. Value at Risk Methodology in IAIS document • Guidance on the use of Internal Modelsbriefly comments about VaR • The IAIS notes that some solvency regimes whichallow the use of internal models to determine regulatory capital requirements currently set aconfidence level for regulatory purposes, which is comparable with a minimum investmentgrade level. Some examples of modelling criteria include a 99.5% VaR calibrated confidence level over a one year timeframe, a 99% VaRover one year and a 95%TVaR over the term of the policy obligations. Different criteria apply for PCR and MCR. Solvency - Valuation of Liabilities& Value at Risk Methodology

21. A sample target criteria – VaR at 99% confidence level, 1 year time horizon Probability Technical provision Capital requirement 1 in 100 years event Losses Current estimate 75% percentile 99% percentile Solvency - Valuation of Liabilities& Value at Risk Methodology

22. Presentation Overview • Part I : Introduction of the IAIS • Part II : International Solvency Requirements (ISRs) within the IAIS Framework for Supervision • Structure of regulatory capital requirements • Use of internal models for regulatory capital purposes • Value at Risk Methodology in IAIS document • Valuation of assets and liabilities for solvency purposes Solvency - Valuation of Liabilities& Value at Risk Methodology

23. Standard & Guidance on the Valuation of Assets and Liabilities for Solvency Purposes • Ongoing works of “Joint Valuation Working Group”(by the Solvency and Insurance Contracts Subcommittees) • Summary of Requirements/ Guidance on the Valuation of Assets and Liabilities, including Technical Provisions for Solvency purposes • Appropriate valuation of assets and liabilities for solvency purposes is a fundamental part of a solvency regime and contributes to the consistent assessment of insurer strength • Characteristics of technical provisions are similar to those being considered by IASB Solvency - Valuation of Liabilities& Value at Risk Methodology

24. Standard on the Valuation of Assets and Liabilities for Solvency Purposes Key Principle The IAIS believes that it is most desirable that the methodologies for calculating items in general purpose financial reportscan be used for, or are substantially consistent with, the methodologies used for regulatory reporting purposes, with as few changes as possible to satisfy regulatory requirements. Solvency - Valuation of Liabilities& Value at Risk Methodology

25. Standard on the Valuation of Assets and Liabilities for Solvency Purposes Key requirements – provisional General valuation requirements for assets & liabilities • The valuation for solvency purposes of assets and liabilities should be undertaken on consistent basis • Assets and liabilities should be valued in a reliable and transparent manner • The valuation for solvency purposes of assets and liabilities should be an economic valuation • An economic valuation of assets and liabilities should reflect the risk adjusted present values of their CFs Solvency - Valuation of Liabilities& Value at Risk Methodology

26. Standard on the Valuation of Assets and Liabilities for Solvency Purposes Key requirements – provisional (continued) Valuation of technical provisions • The solvency regime should require the valuation of technical provisions to exceed the current estimate of the cost of meeting the insurance obligations (Current Estimate) by a margin to reflect the inherent uncertainty of those obligations (Margin over the Current Estimate or MOCE) • The Current Estimate should reflect the expected present value of all relevant future cash flows that arise in fulfilling insurance obligations using unbiased current assumptions Solvency - Valuation of Liabilities& Value at Risk Methodology

27. Standard on the Valuation of Assets and Liabilities for Solvency Purposes Key requirements – provisional (continued) Valuation of technical provisions • The MOCE should reflect the inherent uncertainty related to all relevant future cash flows that arise in fulfilling insurance contract over the full time horizon thereof • The valuation of technical provisions should allow for the time value of money. The solvency regime should establish criteria for the determination of appropriate interest rates to be used in the discounting of technical provisions Solvency - Valuation of Liabilities& Value at Risk Methodology

28. Standard on the Valuation of Assets and Liabilities for Solvency Purposes Key requirements – provisional (continued) Valuation of technical provisions • The value of technical provisions should not reflect the insurer’s own credit standing • The solvency regime should require the valuation of technical provisions to make appropriate allowance for embedded options and guarantees Solvency - Valuation of Liabilities& Value at Risk Methodology

29. www.iaisweb.org Asociación Internacional de Supervisores de Seguros Muchas Gracias ! jason.park@bis.org Solvency - Valuation of Liabilities& Value at Risk Methodology