Capital Base Expectations and Solvency

Transcription

1 Capital Base Expectations and Solvency Presented by: Kevin Wick, FCAS, MAAA Two Distinct Business Models Have Emerged Risk Risk Surplus Cash Call Surplus Surplus 1

2 Pools are at Different Stages Have not recognized business model has changed Minimal effort in assessing capital needs Same measurement tools that were used 25 years ago It has worked so why change? resistant to change attitude Recognized change but are struggling to upgrade financial measures Common pitfall is using the wrong measure 90% confidence level is not conservative Universal set of financial benchmark ratios does not exist Risk based capital is not a target Understands capital requirements and pool operation is consistent with goals Defined appropriate surplus targets Leverage off recent advances in capital measures Consider impact on surplus needs of key financial decisions. Common Pool Solvency Measures The Confidence Level Incomplete measurement of program risk - Unpaid claims only Misleading - Percentage scale - Generally misunderstood by stakeholders Not used in broader insurance marketplace Made sense in the context of pooling when use started 2

3 Common Pool Solvency Measures Benchmark Financial Ratios Dependent on benchmark values Are pools comparable to the insurance industry? Value of comparing to mostly unregulated and unrated industry? Individual pools are unique Examples Reserve to Surplus Premium to Surplus Net Retention to Surplus A one size fits all set of pool financial ratios to determine optimal capital targets does not and cannot exist Common Pool Solvency Measures Risk Based Capital formula RBC is a Regulatory Tool Developed for a specific context Having sufficient resources left in a troubled company to rehabilitate or liquidate Not capital you should hold based on your risk will not compute the precise amount of capital an insurer needs to maintain in a competitive, dynamic and uncertain marketplace. 3

4 Are Pools Different than Insurance Companies? Goal is not to make money for investors Oversight is done by Board of Directors made up of members Members have voting privileges Policies and business practices are focused on serving the members Lower cost structure How different is the underlying business model and need for capital? Determining Capital Targets using Capital Modeling Risk Measurement Capital Requirements Financial Goals (Risk Appetite) 4

5 Financial Risk Categories Reserving Actual unpaid claims may be higher than current estimates Underwriting Next year s losses may come in higher than projected Asset/Credit Interest rates may go up which results in bond holdings decreasing in value Excess carrier may default Operational Next year s administrative budget may be exceeded due to an unforeseen event Risk Measurement (Capital Modeling) Process Step 2: The individual risks are aggregated into four broad categories considering interdependencies. Total Funding Need Step 3: In a similar manner, the total funding need is determined through a risk aggregation process. Underwriting Reserving Asset & Credit Operational AL APD PR GL AL APD PR GL Int. rate Equity Counter -party People External System WC WC Step 1: The uncertainty associated with each of this risk elements is measured. Slide 10 5

6 Example of Modeling Output Determining Capital Targets Risk Measurement Capital Requirements Financial Goals (Risk Appetite) 6

7 Context for Determining Risk Appetite/Financial Goals Pooling versus Insurance Differences Perspective from Other Pool s Insurance Industry Standards Pool Financial Goals Other Financial Demands of Members Example of Outcome/Financial Targets In this example, the minimum target funding level is a 1-in-100 year event. The board felt members are expecting at a minimum that level of protection. The board consensus was that funding which exceeded what is necessary to cover a 1-in-500 year event is excessive. The current funding level is below the target. 7

8 Modeling also Provides Understanding on the Source of the Capital Needs The current funding level is below the target. Modeling showed a large source of risk and thus capital need was from the long bond duration. Reducing the bond duration reduced risk and thus fund need. Decision Framework Representative common pooling measures 8

9 Observations from Studies Completed Common solvency measures being used by pools provide a false sense of security Comparing to insurance industry problematic smaller, concentrated exposure, higher retentions Pool structures and risk profiles are unique Clarity on funding adequacy is valuable to the stakeholders Greater risk awareness leads to better financial decisions Key Milestones Transition from a cash call to a risk transfer business model Recognition Understand Capital Requirements Financial Goals Defined Ongoing Financial Discipline Business model has matured Surplus is important Common pool solvency measures developed in a cash call context Consideration of all financial risks Extreme enough events measured Members/owners make this decision Context provided by management and consultants Understanding of how financial decisions impact risk and funding adequacy Surplus is used efficiently proper financial controls and framework 9

10 Recap of Session Objectives 1. Provide clarity on the appropriate pool surplus question 2. Critique the common measures used by many pools to evaluate funding adequacy 3. Present at a high level an alternative approach to develop target surplus levels 4. Relate how the results of a capital modeling study can be used to answer common pool financial questions 5. Outline key milestones for making the transition from a cash call to a risk transfer business model Questions and Comments For further discussion regarding pool solvency measures and framework, please contact: Kevin L. Wick, FCAS, MAAA Hyeji Kang, FCAS, MAAA Craig J. Scukas, FCAS, MAAA Managing Director Director Director +1 (206) (312) (206) Kevin.L.Wick@us.pwc.com Hyeji.Kang@us.pwc.com Craig.J.Scukas@us.pwc.com 10