COMPARISON OF REGULATION IN AUSTRALIA, CANADA, AND THE U.K. – San Diego

1. COMPARISON OF REGULATION IN AUSTRALIA, CANADA, AND THE U.K.– San Diego Glen Barnett David J. Oakden Ming Roest 12 September 2007

2. Agenda Introduction Canada Australia Europe and UK Comparison Conclusions

3. Australia (main focus on liability side) • Brief History - before late ‘90s, supervision under Insurance & Superannuation Commission - Replaced by Australian Prudential Regulation Authority (APRA - www.apra.gov.au) - responsible for supervision of financial institutions: Banking (& other deposit-takers), Insurance, Superannuation. Fully operational in 1999. - Drafted new standards, which were under public comment and review, when…

4. - 2001 failure of HIH (large failure!). • Review process halted, new standards put in place (some changes from late rounds undone - a number of identified problems with the wording remained) - Royal Commission: primary cause of failure -- under-reserving

5. 2002 liability valuation basics: - outstanding claims; premiums liability • account for many sources of uncertainty: process variability, parameter uncertainty, & many other sources of risk • reflect the future liability process and its uncertainty (predictive distribution) • discount at market rates

6. median mean +/2 75th percentile (upper quartile) 2002 liability valuation Minimum liability: • max(75th %ile, mean+½std.dev.) Predictive distribution of liability – must hold at least upper end of one-tailed PI (not a CI for the mean)

7. 2002 liability valuation: • Not required to use probabilistic models in estimating the relevant aspects of that distribution – but easier to justify the probability-distribution calculations with a probabilistic model • Some improvements were made to GPS210, e.g. in 2004

8. Current situation: Recent (2006) major update: GPS310 2006-07 phase-in Outlines roles & responsibilities of: • Approved Auditor • Approved Actuary

9. GPS310 •Approved Auditor - audits yearly statutory accounts and annual review of other aspects of the operations. Provides a certificate and a report on these to the Board. May also be required to do other things (e.g. special purpose review) • Approved Actuary - assess overall financial condition - advise on the valuation of insurance liabilities - Financial Condition Report (FCR) - Insurance Liability Valuation Report (ILVR) … annually to the Board (then on to APRA) - Actuarial peer review of ILVRs

10. GPS310 • Basic rule • unchanged minimum: max(75th%ile, µ+½) • but focus is more on modeling, looking to the particular circumstances of the individual insurer, (- information in FCR&ILVR) • Requirement to follow the “relevant professional standard” (PS300 for liabilities) where no conflict - so wording of that also important. (Where there is overlap, generally very similar)

11. GPS310 • Discounting: - observable, market-based rates (sovereign risk securities matching liabilities currency and term profile) • rates derived from a yield curve either directly, or as a suitable average rate

12. Financial Condition Report • business overview; • summary of key results of ILVR • Assess: - recent experience & profitability, - adequacy of past estimates - asset & liability management, investment strategy - current & future capital adequacy, approach to capital management; - pricing, premium adequacy; - reinsurance arrangements (suitability, adequacy) - risk management framework

13. Financial Condition Report - value liabilities on prospective basis, both net and gross of reinsurance and recoveries. - value with regard to individual circumstances, but must be at least greater of: - 75% sufficiency for liabilities - mean + ½ std. deviation of liabilities (incl. uncert.) - overall and by class of business, but diversification benefit applies to calculations by class (generally provisions are higher than minimum) [Valn of liabilities also needed for Minimum Capital Requirements]

14. Insurance Liability Valuation Report For each class of business - value of insurance liabilities - assumptions used; extent experience-based - availability & appropriateness of data - significant aspects of recent experience; - methodologies used to model mean - indication of the uncertainty; standard deviation

15. Insurance Liability Valuation Report - sensitivity analyses; - description of probability distributions and parameters, (or how uncertainty estimated otherwise) • risk margins that relate to the inherent uncertainty Describe assumptions and methods so another actuary can understand valuation process, results, limitations & key risks

16. Capital Adequacy (GPS110) - Either Internal Model (with approval) or Prescribed Method • Prescribed analysis of 3 main risk types - insurance risk (risk GPS310 value is inadequate) – generates a capital charge (liabilities x factor for class of business 9-15% for direct-insurance outstanding; more for premium liability, and for inward reinsurance) - investment risk – also a capital charge (value x factor 1.2% for cash… 100% for loans to directors) - concentration risk (related to Maximum Event Retention)

17. Capital Adequacy (GPS110) • Internal Model - covers at least those risks + more (operational risk, etc) - determine capital to reduce probability of default within 1year to < ½% (lots about valuing capital and justifying model that I won’t cover here) Two tiers of capital (divided and then subdivided by quality) - specified minimum proportions in higher subtiers, maximum amounts in lower subtiers

18. Risk Management (GPS220) • Must submit annual Risk Management Stratregy • Systems for identifying, assessing, mitigating and monitoring risks that may affect its ability to meet obligations to policyholders. • Have dedicated risk management function • 3 year business plan • Annual Risk Management Declaration • Financial Information declaration

19. Summary • model based for assets and liabilities (if approval), but underlying minimum prescriptive - assets and liabilities discounted at market rates - implicit margins replaced with explicit risk margins - recognition that insurer is subject to risk of the actual liability process, not just its mean (process variation major component of liability risk) - regulator expects, & insurers do: · use model based approaches; · be more conservative than the prescriptive minimums (e.g. holding more reserves and capital)

20. Conclusions • possible in practice to determine appropriate reserves incorporating process variability, parameter risk, etc etc • possible in practice to determine appropriate reserves incorporating discounting at market rates - avoidance of implicit margins → better understanding of risk