Panel 5
Solvency - 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)
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
November 2009
Jason Park
Solvency - Valuation of Liabilities & Value at Risk Methodology
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IAIS: a global forum for insurance regulators
•
•
Founded in 1994
Members from more than 190 jurisdictions in
over 140 countries
Membership
classes
Members
Insurance
Supervisors
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The NAIC
Observers
International
Governmental/
Statutory bodies
Other
interested
parties
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Standard setting activities aim at global
convergence of supervisory practices
Application papers
Standards
Guidance papers
Issues papers
Insurance Core Principles
(ICPs)
Supervisory papers
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Jason Park
Supporting papers
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ICPs provide globally-accepted framework for
insurance regulation and supervision
Principles
Assessment
criteria
Essential
criteria
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Jason Park
•
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
Explanatory
notes
Advanced
criteria
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ICPs cover all insurance supervisory aspects
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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
November 2009
Jason Park
Solvency - Valuation of Liabilities & Value at Risk Methodology
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Solvency requirements are integral in the
Framework for insurance supervision
LEVEL 3
LEVEL 2
Supervisory
assessment
Supervisory assessment and intervention
Common Solvency
Structure and Standards
Regulatory
requirements
Financial
LEVEL 1
Preconditions
Governance
Market conduct
the insurance supervisory authority
Basic conditions for the
effective functioning of the insurance sector and insurance
supervision
Framework for Insurance Supervision
November 2009
Jason Park
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ISRs: a comprehensive and cohesive set of
solvency assessment documentation
International Solvency Requirements (ISRs)
STANDARDS
GUIDANCE
PAPER
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ISR 1
ISR 2
ISR 3
ISR 4
ISR 5
ISR 6
Capital
requirements
Capital
resources
Investments
(adopted in
2009)
Enterprise
risk
management
Internal
models
(adopted)
Valuation
of assets
& liabilities
(due Oct
2010)
(due Oct
2010)
(adopted)
(adopted)
ISR 1
ISR 2
ISR 3
ISR 4
ISR 5
ISR 6
Capital
requirements
Capital
resources
Investments
(adopted in
2009)
Enterprise
risk
management
Internal
models
(adopted)
Valuation
of assets
& liabilities
(due Oct
2010)
(due Oct
2010)
Solvency - Valuation of Liabilities & Value at Risk Methodology
(adopted)
(adopted)
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ICPs related to Prudential Requirements
ICP 23 Capital adequacy and solvency
• Requires insurers to comply with the
prescribed solvency regime. This regime
includes capital adequacy requirements and
requires suitable forms of capital that enable
the insurer to absorb significant unforeseen
losses.
– Capital Requirements
– Capital Resources
– Internal Models
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Jason Park
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ICPs related to Prudential Requirements
ICP 18 Risk assessment and management
•
Requires insurers to recognise the range of risks that they face
and to assess and manage them effectively.
–
Internal Models
ICP 21 Investments
•
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 22 Derivatives 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.
–
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Jason Park
Investments
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ICPs related to Prudential Requirements
ICP 20 Liabilities
• Requires insurers to comply with standards for establishing
adequate technical provisions and other liabilities, and
making allowance for reinsurance recoverable. The
supervisory authority has both the authority and the ability to
assess the adequacy of the technical provisions and to
require that these provisions be increased, if necessary.
ICP 21 Investments Essential criterion b) requires that
investments are valued according to a method prescribed by
or acceptable to the supervisory authority.
ICP 23 Capital Adequacy and Solvency Essential 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
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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
November 2009
Jason Park
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Standard & Guidance on 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
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Standard & Guidance on the Structure of Regulatory
Capital Requirements
Total balance sheet approach to recognise interdependencies
Public financial reporting
Supervisory assessment of the
financial position
capital
available
capital
capital requirement
value of assets for
supervisory purposes
risk margin
technical provisions
assets
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liabilities
liabilities
current estimate
policy obligations
liabilities and capital
requirement
financial position
Solvency - Valuation of Liabilities & Value at Risk Methodology
assets
liabilities
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Standard & Guidance on 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)
Technical
Provisions
(TP) and
Other
liabilities
Current
Estimate
(CE)
Other
Other
liabilities
liabilities
(OL)
(OL)
Insurer’s
Financial
Position
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Regulatory
Capital
Requirements
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Standard & Guidance on the Structure of
Regulatory Capital Requirements
Progressive intervention levels to ensure timely corrective
measures – an example
190%
• Prescribed capital requirement (PCR) level
• Supervisory intervention not required
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
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Jason Park
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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
November 2009
Jason Park
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Standard & Guidance on 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
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Value at Risk Methodology in IAIS document
• Guidance on the use of Internal Models
briefly comments about VaR
– The IAIS notes that some solvency regimes
which allow the use of internal models to
determine regulatory capital requirements
currently set a confidence level for regulatory
purposes, which is comparable with a
minimum investment grade level. Some
examples of modelling criteria include a 99.5%
VaR calibrated confidence level over a one
year timeframe, a 99% VaR over one year and
a 95% TVaR over the term of the policy
obligations. Different criteria apply for PCR and
MCR.
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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
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Jason Park
75%
percentile
Solvency - Valuation of Liabilities & Value at Risk Methodology
99%
percentile
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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
November 2009
Jason Park
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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
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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 reports can 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.
November 2009
Jason Park
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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
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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
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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
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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
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Asociación Internacional de Supervisores de Seguros
Muchas Gracias !
www.iaisweb.org
jason.park@bis.org
November 2009
Jason Park
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