Risk & Capital Management
A Regulator’s Perspective
Stuart Wason
Senior Director
Actuarial Division, OSFI
June 16, 2008
Topics
•
•
•
•
Global trends
Implications for regulators
Canadian developments
Risk & capital management issues
2
Global trends
• International standards setters
– International Accounting Standards Board (IASB)
– International Association of Insurance
Supervisors (IAIS)
– International Actuarial Association (IAA)
• ERM
– Widespread growth in practices and
development of the art/science
– Risk management as a profession
– CRO Forum influence
– Internal risk model development
3
Implications for regulators
1. Move to total balance sheet approach
for risk assessment and capital
requirements
– Switch from old “liability” plus “capital
requirement add-on” approach
– Allows independence from accounting definition
of liabilities
– Consistent with ERM, economic capital and
internal risk model developments
– TBS now endorsed/adopted by IAA, IAIS,
Solvency II, OSFI etc.
– Regulators need to develop new processes,
expertise, disclosures etc.
4
Total Asset Requirement
Required capital to be determined indirectly:
Required
Capital
=
Total Asset Requirement
Assets
GAAP Policy
Liabilities
Liabilities
& Capital
free
assets
solvency
buffer
total asset
requirement
expected
asset
requirement
required capital
margins
best
estimate
policy
liability
GAAP policy
liabilities
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Implications for regulators
2. Shift to reliance and principles based
supervision
– IASB insurance contract liability likely to be best
estimate + risk margin
– Capital requirements will increasingly rely on full
internal (or partial) models to better capture risks
– Internal and external reviews will be needed to
give assurance on integrity of work
– Regulators need to design appropriate
approvals processes (use test; governance test;
sufficiency test) and retain staff with appropriate
expertise
6
Implications for regulators
3. Assessing risks over the risk horizon
– Lifetime?
– Shorter shock period (e.g. one year) at high
confidence level frequently used for capital and
solvency assessment purposes
– How should provision be made for remaining
risks after one year (a.k.a. terminal provision)
– Need for longer term risk management horizon
(say 3-5 years) as part of supervisory review
(e.g. own risk solvency assessment [ORSA] and
dynamic capital adequacy [DCAT])
7
Implications for regulators
4. Consider differences between insurer
and bank capital requirements
–
–
–
–
–
Credit risk
Market risk
Insurance risk
Operational risk
Risk diversification
8
Canadian developments
• Emergence of IASB standards for
insurance accounting means that CICA
will cease to be an accounting standards
setter for insurers by 2011
• Introduction of IFRS by Canadian
insurers will necessitate a change in the
methods used to determine their capital
requirements
9
Canadian IFRS developments
• OSFI has identified 17 standards that
have key differences between IFRS and
Canadian GAAP impacting financial
institutions
• IFRS 4 will redefine what is an insurance
versus investment contract
• Insurance contracts standard will define
how these contracts are to be valued
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Other IFRS to watch for
•
•
•
•
•
•
•
Fair Value Measurements
Revenue Recognition
Derecognition/Consolidation
Financial Statement Presentation
Conceptual Framework
Liabilities & Equity
Improvements to Financial Instruments
11
Canadian capital
developments
• Advanced probabilistic models,
– Now used by larger insurers for internal risk & capital
management
– Allowed and encouraged in Solvency II
– Existing Canadian solvency framework is generally not
capable of reflecting advanced products and risk
mitigation
– Internal models are allowed by Basel II
• Current standard approach
– Originally designed and calibrated many years ago
before market values used
– Market risk component uses simple factor
– No allowance for diversification or concentration
– Increasingly includes fairly complex to calculate
elements (i.e. no longer a “standard” approach?)
– Not suitable for IASB insurance liabilities
12
Canadian timeline
2008
- Work on non-life (P&C) issues commences
- Finalize market & credit risk advanced approach
- Finalize framework for risk aggregation for advanced
approach
- Draft life insurer standard approach ready for QIS
2009
- Further QIS on revised life insurer standard approach
- Life insurer standard approach finalized
2010
- Implementation measures necessary for new standard
approach put in place
201?
- New standard approach takes effect January 1, 201?
- Approval of new advanced approach for large insurers?
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Canadian vision concepts
Future solvency financial requirements should:
– take into account all credit, market, underwriting &
operational risks
– recognize all cash flows from all of the assets and liabilities
– value the cash flows consistently and realistically
– reflect the risk mitigation strategies used by the insurer
– consider the dependencies within risks and between risks
and recognize when appropriate and measurable
– ensure that insurer assets are sufficient, with high degree of
confidence, to withstand adversity emerging over a defined
regulatory control time horizon (e.g. might be one year)
– ensure that there are sufficient assets at the end of the
defined time horizon to provide for the:
• transfer of the remaining obligations to another insurer
or
• run-off of the remaining obligations
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Canadian Vision
Minimum
Asset
Requirement
Regulatory control
level
Determined using
“standard” approach
(e.g. 66% of “standard”)
Target Asset
Requirement
Threshold investment grade
security level – regulator
going concern level
Determined using “advanced”
or “standard” approach
Target 1 year CTE(99) sufficiency
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Canadian Vision
Advanced Approach
•
•
•
•
•
•
•
Uses company models
Sophisticated scenario modeling
integrated with ERM
Measures all risks & risk
mitigation
Risk dependencies modeled
Requires regulatory approval
Encouraged for large insurers,
technically able insurers & those
with complex risks
Selection of advanced approach
separate for credit, market,
insurance and operational risk
Standard Approach
•
•
•
•
Industry formulaic, factor
based or stress scenario
Not as advanced but
developed to be
consistent & reflect key
risks & mitigation of
advanced approach
Risk dependencies
partially recognized
Designed to produce an
appropriate requirement
across the industry
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Canadian design issues
 Risk horizon: One year (working hypothesis)
 Risk measure: CTE (working hypothesis: CTE99)
 Hedgeable risks valued after one year at post-stress
market consistent valuations
 Non-hedgeable risks valued after one year at poststress BEL + post-stress risk margin (working
hypothesis: CTE based)
 How will standard approach differ from advanced
(internal model) approach?
CTE = Conditional Tail Expectation or Tail VaR
BEL = Best Estimate Liability
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Framework Comparison
Solvency II
Canada
Cover All Risks
P
P
Company Risk Profile
P
P
Two Tiers
 SCR and MCR
 TAR and MAR
Standard vs Advanced
P
P
Use of Approximations
Significant implementing
assumptions and approximations
being contemplated
Extent of approximations
unclear
Total Asset
Requirement
Defines both technical provisions
and capital required
Defines total asset requirement
directly
Risk Horizon
P
P
Risk Measure
 VAR 99.5%
 CTE99%
Risk Margins
 Implicit in MV if Hedgeable,
with ability criteria only
 CoC MVM if Non-Hedgeable
 Does NOT reflect post-stress
distribution
 Implicit in MV if Hedgeable;
with ability and intent criteria
 RW CTE if Non-Hedgeable
 Reflects post-stress risk
distribution
 Frameworks align
 Frameworks differ
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Risk & capital management
issues
• Guidance is needed to narrow the range of
practice w.r.t. the IASB insurance accounting
standard and insurer capital models
• Decisions will be needed regarding the tradeoffs to
be made in the new Canadian insurer capital
framework in consideration of Solvency II and
Basel II (e.g. diversification)
• New IFRS and capital frameworks will likely alter
stakeholder views of insurer profitability, earnings
volatility and soundness
• Need to define the resources for the industry and
regulator to implement these changes in sufficient
time (as early as 2011 for some aspects)
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Risk & Capital
Management
A Regulator’s Perspective
Stuart Wason
Senior Director
Actuarial Division, OSFI
June 16, 2008
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