Enhancing Transparency and
Monitoring of Insurance Markets
North Dakota Commissioner Adam Hamm
© 2013 National Association of Insurance Commissioners
Outline
 Insolvency predictors of insurance companies
 Analytical tools in monitoring the insurance sector
 Stress testing
© 2013 National Association of Insurance Commissioners
Insolvency predictors
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Deficient Reserves
Inadequate Pricing
Rapid Growth
Fraud
Catastrophic Losses (P/C only)
Problems With Affiliates
Investment Problems
Business Change
Reinsurer Failure
Confidential - For Regulator Use Only
The major causes of insolvencies will
be discussed in the units in this
course.
© 2013 National Association of Insurance Commissioners
Analytical tools in monitoring the
insurance sector
 FAST
 Financial Analysis Handbook
Review
 Scoring / IRIS RATIOs
 Financial Profile
 Other I-Site tools
© 2012 National Association of Insurance Commissioners
tools
Early Warning Signs
Categorization of characteristics of early warning
solvency concerns can be grouped within the
following:
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Capitalization
Profitability
Leverage
Assets Quality and Liquidity
Confidential - For Regulator Use Only
© 2013 National Association of Insurance Commissioners
Early Warning Signs
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Capitalization
RBC/RBC Trend Test
Change in Surplus
Surplus Notes
Unassigned Funds
Dividends
Change in unrealized gain/loss
Confidential - For Regulator Use Only
© 2013 National Association of Insurance Commissioners
Early Warning Signs
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Profitability
Net Income Trend
Combined Ratio
Loss Ratio by LOB
Return on Revenue
Return on Assets
Return on Equity
Investment Yield
Confidential - For Regulator Use Only
© 2013 National Association of Insurance Commissioners
Early Warning Signs
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Leverage
Writing Leverage
Loss Reserve Leverage
Claims Unpaid to Incurred Claims Expense
Reinsurance Recoverable
Surplus Aid
Confidential - For Regulator Use Only
© 2013 National Association of Insurance Commissioners
Early Warning Signs
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Asset Quality/ Liquidity
Liquidity
Invested and Non-Invested Assets
Schedule BA Assets or Write-ins
Mortgage Loans and Real Estate
Surrenders and Withdrawals
Investment Turnover
Cash Flow Impact
Confidential - For Regulator Use Only
© 2013 National Association of Insurance Commissioners
Monitoring Interest Rate Risk
10
Regulatory Tools
• Annual Statement
• Risk Based Capital
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Interest Rate Risk
Market Risk
• Asset Adequacy Testing
 NY 7 Stress Tests
 Stochastic Stress Tests
• Own Risk Solvency Assessment (ORSA)
11
NAIC – Annual Statement Data (713 Life Companies)
Year
Total Reserve
Net Portfolio
Yield
Guaranteed
Credited Rate
Spread
Spread
Revenue
ALM Reserve
2006
$ 1.98 Trillion
5.94%
4.22%
1.72%
34,056,000,000
2,193,430,055
2007
$ 2.10 Trillion
6.00%
4.20%
1.80%
37,800,000,000
2,857,022,208
2008
$ 2.30 Trillion
5.64%
4.11%
1.53%
35,190,000,000
10,322,556,476
2009
$ 2.46 Trillion
5.29%
4.14%
1.15%
28,290,000,000
4,749,522,666
2010
$ 2.57 Trillion
5.45%
4.09%
1.36%
34,952,000,000
5,822,638,743
2011
$ 2.74 Trillion
5.31%
3.92%
1.39%
38,086,000,000
6,761,438,743
2012
$ 2.78 Trillion
5.09%
3.99%
1.10%
30,580,000,000
9,731,732,695
Ave
$ 2.42 Trillion
- 0.85
- 0.23
- 0.62
- 15 Billion
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NAIC – Annual Statement Data
Net Spread Over Guaranteed Interest Rate
1.72%
1.80%
6.00%
1.53%
1.36%
5.50%
2.00%
Scenario – Low Interest Rates
1.80%
Actual impact on Life Insurance Industry
Investment Margin 2006-2012.
713 Companies, $ 2.42 Trillion Ave Reserves.
1.60%
1.39%
1.40%
1.15%
1.10%
5.00%
1.20%
1.00%
0.80%
4.50%
0.60%
0.40%
4.00%
0.20%
3.50%
0.00%
2006
Net Spread
2007
2008
2009
Net Portfolio Yield
2010
2011
2012
Net Spread
Portfolio Yield/Guaranteed Rate
6.50%
Take-Away
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Net portfolio Yield declines 85 basis points
Guaranteed Rate declines 23 basis points
Margin declines 62 basis points
Annual Earnings Impact $15.0 Billion
2012 ALM Reserve $9.7 Billion
Guaranteed Interest Rate
Tail Risks of Low Interest Rate Environment
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Scheduled Maturities Lower Investment Margin due to lower reinvestment rate.
Renewal Premiums Lower Investment Margin due to lower reinvestment rate.
Large Spikes in Interest Rates Increase Investment Margin due to higher reinvestment rate but may cause
spike in surrenders causing assets to be sold at a loss which Lowers Investment Margin
Areas to Monitor
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Compile Industry data on Interest Rate Stress Scenarios such as the New York 7 documented in AOMR.
Compile Industry profile of asset rollover rate focusing on scheduled maturities.
Compile Industry profile of renewal premium income
Determine scenarios causing solvency break points.
13
Life Risk Based Capital
2012
2011
2010
2009
2008
2007
2006
761
786
804
814
847
874
926
Company Action Level Trend Test
1
3
3
2
4
2
1
Company Action Level
1
2
2
4
6
4
4
Regulatory Action Level
0
1
1
2
5
3
4
Authorized Control Level
1
0
1
2
3
2
2
Mandatory Control Level
4
6
7
8
7
2
2
7
12
14
18
25
13
13
Total Adjusted Capital (Billions)
455.9
429.9
415.8
384.9
337.9
382.6
363.5
Authorized Control Level (Billions)
49.0
47.1
46.3
46.1
44.6
47.7
44.8
Aggregate RBC Ratio
930%
912%
898%
835%
758%
802%
811%
Median RBC Ratio
1,032%
1,050%
1,047%
989%
910%
1,009%
996%
Asset Risk
63.81%
64.91%
64.04%
62.75%
63.00%
65.92%
62.65%
Insurance Risk
17.89%
17.79%
18.29%
18.55%
19.97%
17.76%
18.93%
Interest Rate Risk
10.44%
10.08%
9.49%
9.72%
9.94%
9.37%
11.23%
Market Risk
2.32%
1.56%
2.49%
3.03%
1.05%
1.98%
1.85%
Business Risk
5.54%
5.66%
5.69%
5.95%
6.04%
4.97%
5.34%
Number of Companies
Total
14
Asset Adequacy Testing
• NY 7 Stress Tests (Parallel Yield Curve Shifts)
1. Level
2. Uniformly Increasing over 10 years at 0.5% per year then level
3. Uniformly Increasing over 5 years at 1% per year then decreasing at 1%
per year to original level
4. Immediate Increase of 3% then level
5. Uniformly Decreasing over 10 years at 0.5% per year then level
6. Uniformly Decreasing over 5 years at 1% per year then increasing at 1%
per year to original level
7. Immediate Decrease of 3% then level
• Stochastic Stress Tests
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Economic Scenario Generator
Randomly Generated Stochastic Interest Rates
Example: 1,000 scenarios of 30 years of annual interest rates
15
Asset Adequacy Testing
• Requires a Company Financial Model
• Projects asset cash flows
• Projects liability cash flows
• Projects surplus = asset cash flow minus liability cash flow
• Run Financial Model using:
1.
2.
NY 7 stress tests
Stochastic stress tests
• Metrics:
1.
2.
Market Value of Ending Surplus
Lowest Market Value of Surplus over time horizon
16
Asset Adequacy Testing Example
Ending MV
Surplus
(millions)
Lowest MV
Surplus
(millions)
Year
480
460
2
(100)
(100)
30
Increasing over 5 Years at 1% per year then decreasing at 1%
per year to original level
50
(130)
7
Immediate Increase of 3% then level
150
(75)
14
Decreasing over 10 years at 0.5% per year then level
500
415
1
Decreasing over 5 years at 1% per year then increasing at 1%
per year to original level
300
290
25
Immediate Decrease of 3% then level
450
450
30
Interest Rate Scenario
Level
Increasing over 10 Years at 0.5% per year then level
17
Own Risk Solvency Assessment
• Company to identify major risk exposures
• Company determines capital needs to cover major risks under:
1.
2.
Normal
Stressed Scenarios
• Company incorporates business plan (3-5 years)
• Company projects capital needs incorporating business plan
under:
1.
2.
Normal
Stressed Scenarios
18