FINANCIAL CONDITION REPORTING

1. FINANCIAL CONDITION REPORTING Ioana Abrahams 13 November 2009

2. AGENDA • Current methodology • Background • FCR • FCR to date • FCR Graphical Overview • Model options under FCR • Prescribed Model • Internal Model • Partial Model • Conclusion • Way forward

3. CURRENT METHODOLOGY • Current methodology • Insurance liabilities: • Outstanding claims reserves (OCR) • Incurred but not reported reserve (IBNR) • Unearned premium provision (UPP) • Unexpired risk reserve (URR) • Contingency reserve: 10% of NWP • Capital requirement: • Additional amount: 15% of net written premium (NWP) • Minimum of R3 million (shortly to be increased to R5 million then 10 million under FCR)

4. BACKGROUND • Current methodology doesn’t allow for: • Underlying risks • Size of insurer • Diversification / concentration • Risk management • FSB is implementing risk-based supervision • IAIS requirements must be met • Act changes made during 2008 to facilitate FCR • World-wide trend to move to different techniques

5. FCR TO DATE • The FCR process was started in 2002 • Various working groups formed • The first calibration done during 2005 • First issues paper released for comment in December 2006 • Comments received were taken into account and this resulted in a recalibration exercise • Recalibration exercise started in 2007; now nearly complete

6. FCR GRAPHICAL OVERVIEW

7. MODEL OPTIONS UNDER FCR • Prescribed Method • Industry structure • Industry Parameters • Internal Models • Company structure • Company parameters • Peer review (application) • Annual certification by an actuary • Partial Models • A combination of above two options • Revised issues paper

8. PRESCRIBED MODEL • Based on aggregate industry data – “average” view • Formulae for reserves and margins • Capital requirement allows for proportional reinsurance and expenses • Some shortcomings of initial model: • Non-proportional reinsurance • Data not always reliable • Cell business • Reinsurance companies

9. PRESCRIBED MODEL • Capital requirement • Consists of: • Asset Capital Charge • Very small part of total capital charge • Protection against loss in market value of the assets backing the liabilities and other capital elements • Insurance Capital Charge • Major part of total capital charge • Calculation tool in ST return

10. PRESCRIBED MODEL • Assets • Use current Act & Directives • Insurance liabilities • Claim liabilities • OCR – best estimate (should be the same) • IBNR – six-year run-off per business class • Premium liabilities • UPP – as before, seen as 75% sufficient • URR – as before • Prescribed margins take liabilities to 75% sufficiency

11. PRESCRIBED MODEL: REVISED • Small working group was formed in 2007 • Considered comments on how previous method could be improved • Terms of reference for recalibration • Deloitte was appointed for the recalibration exercise • Three years of data added (FY 2005 - 2007) • Aims: • Simplify previous method • More appropriate method for typical insurers

12. PRESCRIBED MODEL: REVISED • The following changes were made to the previous prescribed model: • Simplify diversification and correlation • Discounted IBNR • Credit Risk: Reinsurance • Credit Risk: Assets • Non-proportional reinsurance (MER) • Remove expense and investment return adjustment • Minimum CAR – will include an allowance for operating expenses and operational risk

13. PRELIMINARY RECALIBRATION RESULTS

14. EFFECT OF UPDATES

15. INTERNAL MODEL • This is (in our opinion) what an insurer should develop – However: • Determining regulatory capital should not be the primary reason • Appropriateness with respect to complexity of risks • Detailed data required • Guidance will be updated, taking international practices into account

16. INTERNAL MODELS • Qualitative standards • IM based on sound risk management principles and structure • Integral part of day-to-day management • Independent review • Audit trail • Analysis of change

17. INTERNAL MODEL • Specification of risk factors • Must consider all risks • Rank most important risks • Suitable method chosen – not necessarily stochastic • Allow for correlations between risks (method not prescribed) • Stress testing • Specific tests not prescribed • Test model sensitivity to assumptions

18. INTERNAL MODEL • Sign-off and review • Board assumes ultimate responsibility • Statutory actuary sign-off of calculations • Actuary to follow professional guidance • IAA guidance on internal models • SA guidance for reserving completed • External review required for approval (at this stage)

19. INTERNAL MODEL • Proposed model approval process • Approval for calculating regulatory capital • External providers’ models not approved automatically • Application form • On-site visits • Use test, calibration test, statistical quality test • Model used at least one year prior to implementation • Progress from prescribed  partial  internal model • Can’t regress without approval • Application subject to a fee

20. PARTIAL MODEL • This is a combination of own company specific factors and industry factors • Same approval process proposed as for the full internal model route

21. CONCLUSION • The FCR model is specific to the short-term environment • The proposed FCR approach fits in with international developments • Risk-based capital requirements • A better model to run an insurance business

22. WAY FORWARD • New Solvency Assessment and Management (SAM) project • Based on Solvency II • Will encompass both life and short-term insurance • Work done to date on FCR will be the first draft for discussion for short-term insurance • First Steering Committee meeting end November 2009 • Full implementation 1 January 2014; however, standardised model for short-term insurance to be implemented on 1 January 2012

23. THANK YOU Ioana Abrahams Actuarial Analyst: Insurance Tel: 012 428 804 Email: ioanaa@fsb.co.za