ING Insurance
Economic Capital Framework
Thomas C. Wilson
Chief Insurance Risk Officer
Kent University, September 5, 2007
www.ing.com
Objectives of this session
• ING has been using economic capital internally over many years to
support management decisions within an Enterprise Risk
Management framework
• The framework which ING has developed is unique in many respects,
being based on
• An economic or market value balance sheet
• Using replicating portfolios in order to model the financial component of
liabilities
• In this session, we would like to accomplish two important objectives:
• First, demonstrate how economic capital integrally supports risk and value
management within ING
• Second, describe our economic capital framework and provide some
insights
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Contents
• Role of economic capital at ING Insurance
• ING’s economic capital framework
• ING’s risk profile
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How concretely does Insurance Risk
Management support ING strategy?
IRM Mission Statement: Together with the business, build a sustainable
competitive advantage by fully integrating risk management in our daily
business activities and strategy and ensure that:
Risk
Disclosure
Our risks and strategy are transparent to internal and
external stakeholders to support an appropriate
evaluation
Risk
Strategy
Delegated authorities are consistent with the overall
Group strategy for profitable growth and the Group’s
risk appetite
Risk
Controlling
Risk
Underwriting
Our risk profile is transparent, e.g. “no surprises”, and
consistent with delegated authorities
Our products and portfolios are structured,
underwritten, priced, approved and managed
appropriately
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How does Economic Capital support Insurance
Risk Management’s mandate?
Examples
Risk
Disclosure
Risk
Strategy
Risk
Controlling
Risk
Underwriting
Role of Economic Capital
• Risk disclosures
• Embedded value reporting
• Investor disclosures
• IFRS 7 Risk Paragraph
• Basis for Solvency II
• Risk appetite / “hotspots”
• Strategic planning & targets
• Defines economic solvency
• Calibrates capital for traditional
value metrics
• Basis for market value metrics
• Economic capital & limits
• Value metrics, e.g. vROEC
• Capital management & planning
• Risk Dashboard
• Limits
• Core element of risk
measurement and limit
framework
• Standards of Practice/Guidelines • Incorporated in PARP
• Value metrics / targets – IRR,
• Calibrates traditional value
market consistent
metrics
• Product Approval Process (PARP) • Basis for market value metrics
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What is Insurance Risk Management?
Group CRO
Koos Timmermans
Audit & Risk
Committee
Group CIRO
Thomas C. Wilson
Finance & Risk
Committee
CIRO Canada
CIRO Rest of
Europe
CIRO US
CIRO Division
Intermediaries
CIRO Asia Pacific
Asset/Liability
Committees
• Group
• Regional
• Local
Model
Parameter
Committee
CIRO Latin America
• Global network of 725+ combined risk / actuarial professionals in
30+ countries
• Internationally recognized:
• One of only three insurers globally with S&P Excellent ERM rating
• 2006 Insurer of the Year, Risk Magazine
• 2007 Insurance CRO of the Year, Life & Pensions Magazine
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Contents
• Role of economic capital at ING Insurance
• ING’s economic capital framework
• ING’s risk profile
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Overview of ING Economic Capital Framework
Definition: ING Insurance economic capital defined as maximum loss to ING
Insurance’s Market Value Surplus (MVS) within a 99.95% confidence interval based
on shocks which could occur over a one year horizon
Market
Value
Assets
One year
MVS
Scenarios
Market Value
Liabilities
Expected value
EC
MVS
Based on total Market Value Surplus
• Current balance sheet value, no
future business
• Market Value of Liabilities, including
options and guarantees, not best
estimate liabilities
• Includes free surplus; no assumption
about “duration of equity” or surplus
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99.95% worst case
99.95% confidence interval
• Consistent with AA rating
• More conservative than minimum Solvency II
Consistency with Solvency II
• Maximum loss / “VaR” not tail risk
• One year horizon, not run-off
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Market Value of Liabilities
•
Definition: The market value of each of ING’s insurance liabilities is defined as the current cash
value which would be required by an independent, professional, well diversified and financially
secure insurance company or investor in order for them to assume the liability in an orderly manner.
•
Comments
• Exit or transfer value
• Each individual liability (and asset) is valued on a stand alone basis
• Liabilities divided into two components: Financial Component of Liabilities (FCL) and Market
Value Margin (MVM)
Liabilities Which Do Not Depend on
Financial Markets, eg Term Life, Non-Life
Liabilities Which-Do Depend on
Financial Markets, eg SPVA, etc
Value of
options/guarantees/
profit sharing
Liability
cashflow
Liability
cashflow
+
=
Fixed
Fixed
payouts
payouts
Financial
component
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Non - financial
component
=
Guaran
Guaran teed
teed
liabilities
liabilities
Financial
9
+
Non - financial
component
(MVM)
Risks which impact Market Value Surplus
Financial risk
Credit & transfer Insurance risk
risk
Operational risk
Business risk
Changes in
financial markets
which would
impact the market
value of assets
and liabilities
(including options
in assets and
liabilities) from:
Changes in the
credit quality of
assets,
reinsurance
receivables and
counterparties,
including default.
Unexpected
events such as
processing
errors, fraud,
systems failures,
litigation,
regulatory or
compliance
breaches, etc.
Deviations from
best estimates on
business
expenses, lapses
/ persistency and
future premium
re-rating
•
•
•
•
•
•
Interest rates
Equity prices
Real estate
Credit spreads
Implied vols
Currency rates
The recovery risk
in case of default
or loss of value
due to migration.
The inability to
repatriate or
transfer
shareholder
value due to
transfer
restrictions.
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Deviations from
best estimate
claims
development,
including size,
frequency and
timing of both
level and long
term trend,
covering:
•
•
•
•
•
•
Mortality
Morbidity
Longevity risk
Property
Casualty
NATCAT
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Best Practice Models Within and Across Risks
Across risk classes
• Best-in-class aggregation model
• Conservative correlation assumptions
Risk Aggregation
(“Gaussian Copula” based on conservative correlations)
Financial risk
Credit &
transfer risk
Insurance risk Operational
risk
Monte Carlo
simulation
MKMV portfolio
manager,
meeting BIS II
advanced
Actuarial
models for
each risk, inhouse and
external
Internal/
Internal models
external data /
model, meeting
BIS II
advanced
Historical vol &
correlations, 5
yr weekly data
MKMV
correlations
Management
correlation
assumptions
Management
correlation
assumptions
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Business risk
Management
correlation
assumptions
For each risk
• Best-in-class
models
• Best estimate
correlations
Summary of Challenges of current EC process
Source
Data
Cash flow
Systems
Actuarial
Analysis
System
Spreadsheets
Regional
Office
Spreadsheets
BU 1
BU 2
Consolidated
Reporting
Spreadsheets
CIRM
Current Data
Interface = EC /
Shocks
• Efficiency: Complex processes & system environment implying need to
automate interfaces, optimize hardware / software, balance precision &
effort, leverage development
• Control & Audit: Confidence in numbers & consistency, implying need for
clear standards, improved systems, documentation, controls & procedures
• Functionality: Improved methods and greater analysis needs, implying
need for changing data interface and new techniques
• In 40+ different units + 8 Regional Offices + CIRM globally!
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Overview of ECAPS Project Approach
Source
Data
Cash flow
Systems
Actuarial Analysis
System
Spreadsheets
Consolidated
Reporting
Spreadsheets
BU 1
Improved
interface,
pushing
boundary
ECAPS
Tool
Web-Based
Access to Input
Improved analysis at BU,
Region, and CIRM
And Results at BU
• Available on the desktop of BU CIROs and risk
professionals
• Significantly reducing the number of
downstream spreadsheets
• Improved Analytics: based on industry market
risk platform well known within ING (e.g.
Algorithmics)
• Facilitating timely reporting
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Improved
methods
Replicating portfolio approach – insurance
contract as bundle of financial products
Insurance contract financial component
Standard capital market equivalents
• Best estimate claims, expenses, etc.
• Zero coupon cash flows
• Minimum accumulation guarantees, ratchets,
etc.
• Put option on underlying asset returns,
ratchet options, etc.
• Option to annuitize at predetermined rate
• Interest rate swaption
• Crediting rate influenced by current long term
investment conditions
• Constant maturity swap pay-out
• Increased lapses driven by increasing rates,
persistency driven by decreasing rates
• American style put option on underlying
insurance contract
ING Replicating Portfolio Approach
What portfolio of standardized capital market instruments best represents the cash flow
uncertainty of the insurance contract under a wide range of economic scenarios?
Assessment criteria: R-Squared (goodness of fit measure), sensitivities (“Greeks”, duration,
convexity, tail behavior, etc.)
• Accurate representation of value and risk profile
• Supports optimal hedge decisions
• Reinforce financial engineering during product design and pricing
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ECAPS Overview
ECAPS
Tool
Via
Intranet
Scenario
Generator
Economic
Capital (EC)
Calculation
Replicating
Portfolio
(X/Y)
Reporting
Business Unit (BU)
• Focus on providing asset/ liability data and non-market risk EC
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Where do these scenarios come from?
• Automated process via ING’s Global Market Database
• Scenarios generated quarterly for EC calculations
• Market data from real data as much as possible
• Incomplete Market data and Non-market data linked to
known market data as much as possible
• Few remaining items based on expert judgment
Get Market Data
Bloomberg
Reuters
Develop Correlations/
Volatilities
ALGO Scenario
Generator
ING’s
ECAPS
GMDB
Lehman Bros
CIRM
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ING replicating portfolio approach – Comparing
target with replicating portfolio
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ING replicating portfolio approach –
Understanding portfolio characteristics
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Additional information useful for interpreting the
numbers
• Corporate line is defined by a set of internal transactions representing
• Group funding transactions and associated hedges
• Virtual transfer of free surplus from US, NN, and Taiwan
• This is not fully consistent with the corporate line presented for P/L
• Recognition of risk diversification
• ING EC model assumes full ability to move capital if necessary to cover a
loss in a specific legal entity
• Diversification benefits across businesses are fully allocated to business
units on a proportional basis relative to undiversified EC
• Economic capital is based on instantaneous quarterly shocks, scaled to
annual value impact with recognition given for explicitly recognized
dynamic hedging programs
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Contents
• Role of economic capital at ING Insurance
• ING’s economic capital framework
• ING’s risk profile
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ING Insurance Economic Capital Profile 12.06
Risk breakdown
Geographic Breakdown
4%
4%
25%
15%
14%
14%
62%
6%
32%
Americas
Corp Line
24%
Europe
Not Modelled
Asia Pacific
Financial
Non-financial
ING Economic Capital
• Balanced across regions
• Dominated by financial risks
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Credit
Not Modelled
Insurance
ING Insurance solvency position
As of 12.06
Economic Solvency
Statutory Solvency
Euro billion
Euro billion
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Economic
Capital
Available
Financial
Resources
Deferred Tax
Liability
Market Value
Adjustments
Tier 1 Sub
Debt
Shareholders
equity
0
22
0
Book Equity
EU Solvency
(100%, 150%)
ING Insurance benefits from geographic and
risk diversification
Euro billions, 12.31.06
Geographic
Risk
36%
31%
0
0
Undiversified EC
Financial risk
Insurance risk
Diversified EC
Undiversified EC
Diversified EC
Credit risk
Non-financial risk
Americas
Asia Pacific
Diversified EC
Europe
Corporate Line
Diversified EC
ING enjoys strong benefits from diversification with total diversification = XX%
• Diversification across risk categories = 31%
• Diversification across regions = 36%
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Certain of the statements contained herein are statements of future
expectations and other forward-looking statements. These
expectations are based on management's current views and
assumptions and involve known and unknown risks and
uncertainties. Actual results, performance or events may differ
materially from those in such statements due to, among other things,
(i) general economic conditions, in particular economic conditions in
ING’s core markets, (ii) performance of financial markets, including
emerging markets, (iii) the frequency and severity of insured loss
events, (iv) mortality and morbidity levels and trends, (v) persistency
levels, (vi) interest rate levels, (vii) currency exchange rates (viii)
general competitive factors, (ix) changes in laws and regulations, (x)
changes in the policies of governments and/or regulatory authorities.
ING assumes no obligation to update any forward-looking
information contained in this document.
www.ing.com
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