Solvency Regulation: A Perspective from the US

Transcription

1 Solvency Regulation: A Perspective from the US Rob Hoyt Gen Re Client Symposium

2 The Georgia RMI Program #2 RMI Program nationally in the U.S. News Rankings Largest RMI Program in the U.S. Risk Management Magazine 129 graduates last year Risk management and insurance emphasis in the MBA program Significant Ph.D. program

3 Agenda Solvency II An Overview The US Insurance Market Financial Solvency The US Experience Important Results from Prior Research in the US Increasing Importance of Risk Management Enterprise risk management (ERM) Conclusions

4 Solvency II An Overview

5 Why is Solvency Monitoring Important? Nature of the contractual promise Scarce regulatory resources Externalities consumers insurance industry contagion effect insurance industry via guarantee funds

6 Three Pillars Solvency II 1: quantitative capital requirements 2: supervisory review of the internal controls and risk management function 3: supervisory reporting and public disclosure requirements Deadline for compliance, January 1, 2013

7 Solvency II Issues Poses potential hurdle for small/niche insurers due to increased cost and regulations The insurance industry could follow what happened in banking with regards to consolidation Germany (and the US) are home to a large number of insurers ranging from small to very large Cost of compliance could be high Data and systems needs will increase

8 Internal v. Standard Models Internal models More complex, but higher predictive power More costly Harder to assess and to compare Model arbitrage Standard models Less costly, but lower predictive power Comparable across insurers Possible systematic risk

9 Solvency II and Captives (A.M. Best, 2011) Higher costs Increased capital requirements 3 to 4 times increase in minimum capital due to: Small size Lack of diversification of risks High counterparty exposures Tightened enterprise risk management standards

10 Importance of Capital Sources Equity (shareholders) Not an option for mutual insurers Contingent capital Reinsurance Catastrophe bonds Surplus notes Change operations to alter the regulatory capital requirement Can have unintended consequences

11 Annual Catastrophe Bond Transactions Volume Q $1 billion v. $650 million in Q Risk Capital Issued Number of Issuances Risk Capital Issues ($ Mill) $8,000 $7,000 $6,000 $5,000 $4,000 $3,000 $2,000 $1,000 Catastrophe bond issuance soared in the wake of Hurricanes Katrina and the hurricane seasons of 2004/2005, but retrenched during the financial crisis of 2008 $846.1 $984.8$1,139.0 $1,219.5 $966.9 $633.0 $1,729.8 $1,142.8 $1,991.1 $4,693.4 $7,329.6 $2,700.0 $3,400.0 $4, Number of Issuances $ Source: MMC Securities Guy Carpenter, A.M. Best; Insurance Information Institute.

12 The US Insurance Market

13 Industry Size (L-H v. P-C) 2,343 Life Insurers in 1988 Insurers Premiums ($billion) Assets ($trillion) Life-Health Property-Liability 0% 20% 40% 60% 80% 100% Source: III Insurance Fact Book 2010, Data for 2009.

14 Evolving Regulatory Issues in the US Concern over systemic risk Do insurers represent systemic risks? One regulator v. multiple regulators Federal Insurance Office (FIO) Director appointed recently (former Ins. Comm. of Illinois) Advisory Committee being created now (to include academics) Role of government in addressing risk exposures Examples: NFIP and possible expansion TRIA Health Care reform

15 Current Solvency System in the US Regulatory authority rests in the individual states (but the system has become increasingly uniform and coordinated) Uniform risk-based capital system (since early 90s) Standard model Uniform accounting and financial reporting New Form F requires reporting of enterprise risks NAIC serves a coordinating and supporting role Centralized database of financial information allows host states to monitor insurers

16 Financial Solvency - The US Experience

17 P/C Insurer Impairments 70 The number of impairments varies significantly over the p/c insurance cycle, with peaks occurring well into hard markets Source: A.M. Best; Insurance Information Institute

18 Underwriting Gain (Loss) $ Billions Insurers earned a record underwriting profit of $31.7 billion in 2006, the largest ever but only the second since Cumulative underwriting deficit from 1975 through 2009 is $446 billion Source: A.M. Best, ISO; Insurance Information Institute * Includes mortgage & finl. guarantee insurers

19 Reasons for P/C Insurer Impairments ( ) Deficient Loss Reserves and Inadequate Pricing Are the Leading Cause of Insurer Impairments. Investment and Catastrophe Losses Play a Much Smaller Role Sig. Change in Business Investment Problems 7.0% Misc. 9.1% 3.7% 4.2% Reinsurance Failure 38.1% Deficient Loss Reserves/ Inadequate Pricing Affiliate Impairment 7.9% 7.6% Catastrophe Losses 8.1% Alleged Fraud 14.3% Rapid Growth Reason in 54.5% of insolvencies in 2010 Source: A.M. Best: Impairment Review, Special Report, Apr. 6, 2008

20 Number of Impaired L/H Insurers Average number of impairments, : The Number of Impairments Spiked in , with Smaller Spikes in 1983 and But in the Financial Crisis, When Hundreds of Banks Failed, Virtually No Life Insurers Failed. Source: A.M. Best Special Report Impairment Review ; Insurance Information Institute.

21 $Billions L/H Industry Net Income Source: NAIC Annual Statements, p.4, line 35, from National Underwriter HighlineData, Insurance Information Institute.

22 Reasons for L-H Insurer Impairments ( ) Leading Causes of Impairment ---Business Management (Rapid Growth, Investment Problems, Affiliate Problems) ---Deficient Loss Reserves/ Inadequate Pricing Source: A.M. Best, Impairment Review, Special Report

23 Important Results from Prior Research in the US

24 Managerial Discretion and the Impact of Risk-Based Capital Requirements on Property-Liability Insurer Reserving Practices Hoyt and McCullough (2010) To assess whether P-L insurers have altered their reserving practices in response to RBC requirements RBC alters the costs of regulatory scrutiny and implements a single threshold Insurers have significant discretion in setting their reserves The loss reserve charge is a significant portion of the RBC formula

25 Results Insurers under regulatory scrutiny did reduced incurred but not reported (IBNR) loss reserve levels in the post-rbc period No evidence of a similar drop in IBNR by insurers not facing regulatory scrutiny Important public policy implications for regulators tasked with creating regulatory capital requirements designed to accurately measure the financial strength of insurers Highlights the limitations associated with regulatory methods that define explicit requirements or capitalization levels Regulated firms may tend to manage their reported financial results to surpass these explicit objectives Important as the NAIC undertakes a review of the RBC formula as part of the Solvency Modernization Initiative

26 Evaluating the Risk of Life Insurer Insolvency (Carson and Hoyt, 2000) Important solvency-related variables identified: inadequate pricing/surplus; rapid growth; affiliate problems; overstated assets; size; age Temporal nature of variables (e.g., real estate) Variables may be sample-dependent Minimum C&S requirements vs. risk-based capital

27 Economic and Market Predictors of Life and Non-Life Insolvencies Browne and Hoyt (1995) Economic and insurance market variables are important predictors of non-life insurer failure rates Insolvency rate is positively related to the industry combined ratio and the number of insurers Browne, Carson and Hoyt (1999) Economic and market variables are important predictors of life-health insurer failure rates Insolvency rate increases in long-term interest rates, personal income, unemployment, the stock market, and to the number of insurers, and is negatively related to real estate returns

28 The Value of Group-Level Financial Information Pottier and Sommer (2011): group-level financial information substantially improves the predictive power of an insolvency prediction model relative to a model that uses only the analogous company-level variables group-level variables are found to often be substantially more powerful than company-level variables in predicting individual insurer insolvencies insolvency analysis should include group-level information

29 Dynamic Financial Models of Life Insurers Browne, Carson and Hoyt (2001) Over 99% of insurers do not fail and remain going-concerns Many financial/economic factors from insolvency studies are equally relevant in assessing going-concern financial performance The results provide guidance to actuaries and others in selecting relevant factors for the performance of DFA

30 Lessons for Future Solvency Regulation Solvency standards will affect insurer behavior (quality of accounting information is critical) Market and economic factors are important as well as firm-specific variables Important to consider group and affiliate effects More than 99% of insurers remain solvent must be cautious that solvency regulation doesn t damage the insurance market in an effort to prevent a few minor problems

31 Increasing Importance of Risk Management

32 Risk Management Risk Management Number of hits in Google 2006 & 2007: 3.2 million 2008 & 2009: 27.2 million 2010: 63.3 million Much greater appreciation by consumers and industry for the importance of managing risk

33 Interest in Enterprise-Wide View Google Search Strategic risk management 93,700 hits Chief risk officer 252,000 hits Integrated risk management 135,000 hits Enterprise risk management 568,000 hits Audit committee members rank risk management as top worry, KPMG Survey of Corporate Directors

34 New View of Risk Management (ERM) Centralized management of risk Efforts to take advantage of portfolio effects Use of RM to create competitive advantage Integration of risk into plans/budgets Monitor more risks, but focus on fewer Link RM to corporate objectives

35 One US Non-Life Insurer Example Capital modeling is being driven by our interest in understanding risk Our interest in maintaining a favorable rating with AM Best has influenced our focus on modeling Board has gotten much more engaged in the process of monitoring risk levels and capital implications

36 ERM in Financial Institutions (Deloitte, 2009) 85% of firms with ERM in place said the benefits outweighed the costs Highest value improved understanding of risk improved perception by the regulator (in these highly regulated industries) ability to escalate critical issues to senior management

37 ERM Adoption by German Insurers Altuntas, Berry-Stoelzle and Hoyt (2011) Examine the implementation of the ERM components by insurers Surveyed all German non-life insurers with premiums written in excess of 40 million Euros 113 such insurers, 95 participated in survey, 84% response rate

38 Risk Evaluation Aggregate single risks to an overall corporate risk model In 1999, only one company had implemented models calculating the overall corporate risk By 2007, 86% of the companies aggregated risks to an overall risk model

39 Risk Capital Allocation Allocate risk capital (risk types, departments, divisions) Prior to 2002, no companies allocated risk capital By 2004, increased to 21% By 2007, increased to 74% Almost all companies consider diversification effects when allocating

40 ERM Summary High level of attention on the importance of risk management by all stakeholders Broadened view of risk management (ERM) is here to stay One-size doesn t fit all

41 Other Lessons Lesson of Japanese Earthquake dangers of slavish devotion to models GenRe s CEO describes this as Model Mania Capital standards are coming Pressure for uniformity and comparability globally is present Solvency II model, for good or for bad, seems to have the lead For most insurers (over 99%), any capital standards are likely to be non-binding Focus on modeling that improves the business Compliance will readily follow

42 Conclusions Broader attention on Risk Management will continue Overall, the soundness and the importance of insurers has been highlighted by recent developments Consideration of tail risks or Black Swans will become increasingly important Managing in a highly regulated environment will be the norm for the foreseeable future

43 Contact Information for the Risk Management and Insurance Program at the University of Georgia Department Head, Rob Hoyt Brooks Hall 206 Our web site