Individual Capital Assessment David King 8 th September 2004

1. !@ # Individual Capital AssessmentDavid King8th September 2004

2. Contents • Regulatory Requirements: Pillar 1 vs Pillar 2 • ICA: Implementation Progress • ICA: Assumptions • ICA: Implications

3. Regulatory Requirements: Pillar 1 vs Pillar 2

4. Pillar 1 vs Pillar 2 Capital Requirements Pillar 2 Surplus Market Value Assets Realistic Value Assets Realistic Surplus Admissible assets Regulatory Surplus ICA Risk Capital Margin WPICC Long-term Insurance Capital Requirement Realistic Value Liabilities Market (Fair) Value Liabilities Resilience Capital Requirement Mathematical reserves Regulatory Peak Realistic Peak Pillar 1 Pillar 2 • WPICC is set so that regulatory surplus equals realistic surplus if the former is higher; zero otherwise • If realistic assets equal admissible assets, WPICC is the amount of capital to bring the regulatory peak up to the realistic level

5. Risks Covered: Peak 1 vs Peak 2 vs ICA Market Risk Market Risk Market Risk Credit Risk Credit Risk Credit Risk Insurance Risk Mortality Persistency Expenses Insurance Risk Mortality Persistency Expenses Insurance Risk Mortality Persistency Expenses Operational Risk Operational Risk Operational Risk Liquidity Risk Liquidity Risk Liquidity Risk Group Risk Group Risk Group Risk Peak 1 (LTICR + RCR + WPICC) Peak 2 (RCM) ICA

6. Capital Requirement Rules: Peak 1 Resilience CapitalRequirement Long-Term InsuranceCapital Requirement

7. Capital Requirement Rules: Peak 2 Risk Capital Margin

8. Calculation of Capital Resource Requirements (CRR) • PRU 2.1.35 defines a firm’s CRR to be: • Resilience Capital Requirement • + Long-Term Insurance Capital Requirement • + With-Profit Insurance Capital Component • FSA will issue Individual Capital Guidance (FSA’s view of appropriate capital resources for a firm), based on the firm’s ICA • To compare ICA with CRR, adjustment is needed for any differences in valuing assets and liabilities under Pillar 2. Possible approach: • Adjusted ICA = ICA – Max (0, Realistic Value Reserves – Market Value Liabilities) • – (Market Value Assets – Realistic Value Assets) • Additional capital required as a result of ICA is • Max (0, Adjusted ICA – CRR)

9. ICA: Implementation Progress

10. Typical ICA Methodologies: end 2004

11. Methodology enhancements for 2005?

12. Current Implementation Issues

13. ICA: Assumptions

14. Typical ICA Stress Tests vs RCM * Based on 10-year gilts

15. Typical Correlation Assumptions • Typically, companies are reporting diversification benefits of around 25-30%

16. ICA: Implications

17. Shareholder Value Implications of ICA

18. Top Ten Management Actions From ICA • Ensure the firm’s ICA calculation is consistent with its risk policies • Collect and analyse company/market data to justify volatilities and correlations • Build management information systems to understand risk exposures • Understand key drivers of ICA and develop mitigations to reduce capital requirements • Develop analysis of change in ICA over the period • Take ownership of calibration of the ESG • External review of ICA to negotiate Pillar 1 waivers • Develop management information to ensure ICA known at all times • Price new business to reflect ICA capital costs • Manage business on the basis of risk based capital