CIA Annual Meeting Session 5709

1. CIA Annual MeetingSession 5709 LOOKING BACK…focused on the future

2. Use this cover page for external presentations Insurer Solvency AssessmentGlobal developments Client logo should go no higher than this guide Client logo should be aligned bottom with this guide Date shouldbe aligned topwith this guide Title shouldbe aligned topwith this guide May 27, 2005 Stuart Wason Chair, IAA Solvency Sub-Committee

3. Key topics for this session • IAA Solvency Sub-Committee • Its role • Rome agenda • Insurer solvency stakeholders • Stakeholder initiatives • IAIS Cornerstones document • Comparison of solvency frameworks

4. Role of IAA SSC • IAA formed a Solvency Sub-Committee (SSC) in 2004 following the publishing in 2004 of the IAA book “A Global Framework for Insurer Solvency Assessment” (i.e. to set forth principles and methods for a global risk-based solvency framework starting from a coherent risk framework) • Role of IAA SSC • To continue work of IAA in area of insurer solvency and risk assessment • To be point of contact for IAIS on these issues • To coordinate related projects with various actuarial associations interested in this area

5. Current work of IAA SSC • Continue work of IAA • Practical demonstrations of Working Party report • Further gathering of educational material & best practices for selected solvency topics (e.g. standardized and advanced approaches; risk aggregation; liquidity; operational risk etc) • Point of contact for IAIS • On-going contact with Solvency Sub-Committee • Speaking slots at IAIS meetings • Coordinate related projects with actuarial associations • Solvency II development with European actuarial profession via Groupe Consultatif

6. IAA Solvency Sub-CommitteeRome agenda – selected topics • Life and non-life risks – Identify and debate key issues • Asset risks – Identify and debate key issues • Internal models – Draft standard of practice • Best (current) estimates – Review latest IAA draft standard • Liquidity & operational risk – Discuss their role in solvency capital framework • Risk aggregation – Discuss evolving practice

7. Insurer solvency frameworksStakeholder developments • Insurance supervisors • International Association of Insurance Supervisors (IAIS) • Insurance Core Principles & Methodology (2003) • Principles on Capital Adequacy and Solvency (2002) • European Committee of Insurance and Occupational Pension Supervisors (CEIOPS) • Report on Prudential Supervision of Insurance Undertakings (2002) • Solvency II • Local supervisors (e.g. OSFI & AMF in Canada use a “risk-based” supervisory framework including a scoring of the insurer’s risk management)

8. Insurer solvency frameworksStakeholder developments • IAIS Insurance Core Principles & Methodology (2003) • ICP #18 Risk Assessment and Management • The supervisory authority requires insurers to recognize the range of risks that they face and to assess and manage them effectively • Risk management should be appropriate to the size and complexity of insurer • Insurer to use risk tolerance limits to determine risk exposure • Assess risk as early as possible • Supervisors to review and monitor insurer controls • Ultimate risk management responsibility rests with Board

9. Insurer solvency frameworksStakeholder developments • IAIS Insurance Core Principles & Methodology (2003) • ICP #23 Capital Adequacy and Solvency • Insurers must comply with the prescribed solvency regime which includes capital adequacy requirements and suitable forms of capital to enable the insurer to absorb significant unforeseen losses. • The solvency regime addresses 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 • suitable forms of capital • capital adequacy requirements. • Any allowance for risk mitigation or transfer considers both its effectiveness and the security of any counterparty. • Suitable forms of capital are defined. • Capital adequacy requirements are sensitive to the size, complexity and risks of an insurer.

10. Insurer solvency frameworksStakeholder developments • Financial sector supervisors • Bank for International Settlements and its Basel Committee on Banking Supervision (BCBS) have been responsible for the widespread introduction of the solvency framework for banks called Basel II • Jaime Caruana, Chair of the BCBS spoke in HK on Feb 7 about Basel II and the importance of risk management • “It is my hope that…Basel II framework would be portrayed (as developing)…rules that align capital requirements more closely to the actual degree of economic risk a bank faces…an important step forward in continuing to replace static rules with rules that offer incentives for firms to improve constantly their internal governance and management of risk.” • “Financial stability is a key precondition for sustained growth. It is crucial...to find reliable ways of identifying risks to financial stability and…to try to manage these risks in the most effective way.”

11. Insurer solvency frameworksStakeholder developments • Financial sector supervisors • Joint Forum (BIS, IAIS, IOSCO) recent papers • Liquidity risk (under development) • Credit risk transfer (March 2005) • Outsourcing in financial services (Feb 2005) • Financial disclosure (May 2004) • Trends in risk integration and aggregation (Aug 2003) • Operational risk transfer across financial sectors (Aug 2003) • Risk management practices & regulatory capital cross-sectoral comparison (Nov 2001)

12. Insurer solvency frameworksStakeholder developments • Supranational organizations • World Bank & IMF Financial Sector Assessment Program (FSAP) introduced in May 1999 to promote the soundness of financial systems in member countries • Determine strengths and vulnerabilities • Determine how key sources of risk are being managed • Ascertain developmental and tech assistance needs • Assess risks to macroeconomic stability • OECD • Report (2003) “Assessing the Solvency of Insurance Companies” – comparative study of solvency frameworks and key risks faced by insurers

13. IAIS common solvency structure and standards within the framework for insurance supervision# Common Solvency Structure and Standards # IAIS Cornerstones Paper, February 2005 draft

14. IAIS Cornerstones • Cornerstone I: the solvency regime addresses the robustness of the insurer to meet its liabilities both short term and over a longer time span. • Cornerstone II: the solvency regime is sensitive to risk, and is explicit as to which risks, individually and in combination, lead to a regulatory financial requirement and how they are reflected in the requirement. • Cornerstone III: the solvency regime is explicit on how, for each of the risks that attract a financial requirement, individually and in combination, prudence is reflected in these requirements. • Cornerstone IV: the solvency regime requires a valuation methodology which makes optimal use of and is consistent with information provided by the financial markets and generally available data on insurance technical risks.

15. IAIS Cornerstones • Cornerstone V: the solvency regime includes the definition of technical provisions. Technical provisions have to be prudent, reliable, and objective and allow comparison across insurers. The regime should require as a minimum that sufficient assets are available to cover the technical provisions and other liabilities. • Cornerstone VI: the solvency regime requires the determination of a ´best estimate´ of the costs of meeting the obligations arising from the insurance portfolio, taking into account the time value of money. The discount rate for this calculation is determined by reference to the relevant risk free interest rates on the financial markets. • Cornerstone VII: the solvency regime establishes a range of solvency control levels and the supervisory instruments associated with each of the control levels. • Cornerstone VIII: the solvency regime allows a set of standardised and more advanced approaches to determine the solvency requirements, and includes the use of internal models if appropriate.

16. Comparison of solvency frameworks • A recent CEA and Mercer Oliver Wyman report compared a number of solvency frameworks from around the world • The survey identifies several key features of these frameworks and provides comparisons from country to country • The survey focuses on the current state of the frameworks and provides much useful information

17. Comparison of solvency frameworksSome of the elements reviewed in the CEA/MOW report • Split between static and dynamic based models • Risks covered • Total balance sheet approach • Valuation basis of liabilities • Use of deterministic, stress-test, stochastic scenarios etc • Type of risk measure used • Confidence level and time horizon used • Types of diversification considered • Types of risk mitigation assumed

18. Future solvency frameworksKey principles & current debate • Multi-pillar approach to supervision • IAIS is developing a common structure and standards for the assessment of insurer solvency • IAIS takes a broader view than the Basel II framework (for banking supervision) while still maintaining compatibility with supervision in other financial sectors and thus facilitating communication across sectors • All types of risks to be included • General agreement that all risks to be captured somewhere within the overall framework • Little disagreement with inclusion of market, credit & underwriting within Pillar I capital requirements • Debate on-going regarding the placement of risk assessment for liquidity and operational risks (for example)

19. Future solvency frameworksKey principles & current debate • Principles-based approach preferred to rules-based approach • Lively debates in some jurisdictions on this topic • PB approach winning converts but RB approach still has some strong support • Total balance sheet approach • Merits of TBS approach seem to be winning converts (e.g. UK, Netherlands, Switzerland) • TBS is economic-based using consistent values for assets and liabilities • Use appropriate risk measures • General theoretical agreement on use of appropriate risk measures such as Tail VaR rather than VaR • Much discussion remains on risk measure design at practical implementation stage

20. Future solvency frameworksKey principles & current debate • Select an appropriate time horizon & degree of protection • Convergence towards use of 1 yr horizon and 99% • Allow for risk management • General agreement on the need to recognize, risk management, risk mitigation (e.g. reinsurance), risk dependencies, risk concentration etc. • Practical implementation issues remain and creative solutions are needed • Standardized approaches proposed • Different jurisdictions are using a variety of standardized approaches – much work remains on developing the most effective techniques • Much can be learned from advanced models and from other countries • Practical application by small and mid-size insurers is a necessity

21. Future solvency frameworksKey principles & current debate • Advanced or company specific approaches proposed • Supervisory willingness to explore use of internal models is greater than expected • Companies underestimate the effort to build acceptable models

22. Canada and the USCurrent activity • Canada • Agreement in principle among key stakeholders to move to a TBS approach according to IAA approach by 2010 • Will likely use combination of internal model and standardized approaches • Already in place are TBS concept; Appointed Actuary; peer review; best estimate plus margin assumptions; future financial condition reports; full stochastic modeling and TVaR risk measure for segregated fund guarantees etc • US • Through the SVL II project the US is considering a principles based approach drawing on global experiences as well as US specific considerations

23. Use this cover page for external presentations Insurer Solvency AssessmentGlobal developments Client logo should go no higher than this guide Client logo should be aligned bottom with this guide Date shouldbe aligned topwith this guide Title shouldbe aligned topwith this guide Thank you! You can contact me at swason@compcorp.ca IAA Solvency Sub-Committee