Capital Management in Changing Regulatory Environment

Transcription

1 The Actuarial Society of Hong Kong Capital Management in Changing Regulatory Environment Gaston Nossiter RGA - Global Financial Solutions 7 May 2013

2 Content Regulatory Capital: Past, Present & Future Economic Capital: Adam Smith s view on insurance Case Studies: Hong Kong and Singapore ALM issues Capital Management via Reinsurance 2

3 Development of International Solvency Requirments EU Solvency EC Solvency I 1979 (Life Directive) 2004 EC Solvency II 201X Rule Base Principle Base US NAIC RBC 1992 RBC in Asia 200X 201X RBC2 Solvency II in Asia 201X 202X 3

4 Today s Journey Regulatory Capital Regimes Trends Principals based Economic / market consistent More risk adjusted (and complex) Increase in quality and amount of capital Japan: RBC Korea: RBC Taiwan: RBC Europe: Solvency II Hong Kong: Solvency I China: Solvency I Singapore: RBC US: RBC Canada: RBC Australia: RBC 4

5 Conflicts in Measurement Basis We have heard a lot from CFO, CRO, CA and ALM practitioners. My assets are not moving in line with my liabilities. Various statutory measurement basis across Asia Assets Mark to Markets Book Value (uncommon) Liabilities NPV with a book yield NPV with some blended yields GPV with regulatory yields GPV with actual asset yields GPV with risk free yields Fundamental issue is the valuation of liabilities 5

6 Economic Basis The Actuarial Society of Hong Kong

7 Adam Smith (1776) View on Insurance In order to make insurance, either from fire or sea-risk, a trade at all, the common premium must be sufficient to compensate the common losses, expense of management, and afford such a profit as might have been drawn from an equal capital employed in any common trade. => Premium = Claims + Expense + Cost of Capital The person who pays no more than this, evidently pays no more than the real value of the risk, or the lowest price at which he can reasonably expect to insure it. => Risk Based Approach 7

8 Economic Basis Aim to reflect The Real Value of the Risk Real World vs. Market Consistent Economic Capital - various definitions North American Economic Capital vs. European Economic Capital Run-off vs. 1-year VaR Economic Capital Allocation Efficient Resource Allocation 8

9 Solvency II Concept Aim to use economic basis Allow insurers to become more efficient in balancing risks and returns Source: EIOPA 2012 technical specification 9

10 The Actuarial Society of Hong Kong Case Studies: Hong Kong and Singapore ALM issues

11 Interest Rate Scenarios 11

12 Hong Kong Regulator requires insurers to reserve on a prudent basis No lapse assumption Net Premium Valuation Prudent valuation interest rate Dollar duration problem: Economic Basis HK Statutory Basis 1 HK Statutory Basis 2 Future RBC Regime 15 years 25 Years 20 Years 18 years Question: How do you formulate strategic asset allocation for duration? 12

13 ALM Duration Matching No perfect solution as any duration strategy would create some issues. Economic Basis Create significant volatility under statutory basis May not survive regulatory solvency requirements if rates fall further In Between Economic and Statutory Basis Volatility (albeit smaller) under all measurement basis Is this a easier justification politically under all rates scenario? Statutory Basis Change in regulatory basis lead to change in duration strategy Not efficient i.e. economic reality will catch up sooner or later 13

14 Singapore Long term guaranteed liabilities discounted by Long Term Risk Free Discount Rate A slow moving average yield Minimum dollar duration for statutory liabilities During recent rates fall, financial resources (available capital) has increased A contrast to economic reality Sudden rates up could be a nightmare MAS allows insurers to hedge interest rate risks and discount long term liabilities by market rates (by applying MAS319) to solve the matching issue Question: Is it optimal to solve a liability measurement problem with an asset solution? 14

15 Capital Management via Reinsurance The Actuarial Society of Hong Kong

16 Recharacterise Liabilities Liabilities dimension reduction Conflict in ALM is often due to multiple liabilities measurement bases Use Coinsurance with Funds Withheld (Co-FWH) reinsurance to reduce multiple bases into one basis Economic Basis 15 years HK Statutory Basis 1 HK Statutory Basis 2 25 Years 20 Years Co-FWH Funds Withheld Basis Future RBC Regime 18 years 16

17 Coinsurance Funds Withheld Statutory reserve coinsured to Reinsurer. That is, Insurer would pay the statutory reserves to Reinsurer on day one. Reinsurer would pay to Insurer two amounts: Funds Withheld (FWH) reserve equal to insurers economic reserves (or any other reasonable basis agreed with the reinsurer); plus An initial ceding commission equal to the difference between the statutory reserves and the FWH reserves is paid to Insurer Statutory Reserves INSURER FWH = Economic Reserves Initial Ceding Commission Reinsurer 17

18 Balance Sheet Post Reinsurance Insurer Reinsurer Assets Investment Assets as before Liabilities FWH liability to Reinsurer Assets FWH assets (deposit with insurer) Liabilities Reinsured liability (policyholders claims) Ceding company now manage ALM on a FWH basis No longer constrained by statutory reserving basis No longer need to worry about changes in statutory basis Minimize volatility and release redundant reserves and capital Reinsurer will need to ensure FWH assets sufficient to pay claims on an economic basis 18

19 Regulation of Capital Motivated Reinsurance Most countries do not have separate regulations for Financial Reinsurance e.g. Australia, Singapore, UK, US, Taiwan, Canada, Hong Kong. In these countries, the insurer can only take reserve credit for reinsurance, if the reinsurance contract meets the definition of an insurance contract under the local regulation/accounting standard In principles based (or GPV) reserving basis the reinsurance is reflected in the cash flow projections (so automatically reflects the degree of risk transferred) e.g. Canada, Singapore In most of these countries a reinsurance contract (no matter what type) is defined as a contract that passes risk transfer usually on an IFRS4 basis Some of the countries may impose additional conditions on contracts that are for capital motivated purposes e.g. Requiring cash commissions (e.g. UK) or not allowing claim payments to be withheld (e.g. Singapore) 19

20 Reinsurance in Asia Regulation Country Fin Re YRT Coinsurance China CIRC approval, prefer cash Hong Kong Indonesia Japan Korea Malaysia Singapore Require approval Untested Require approval Prefer cash Taiwan Require approval Approval for reserve credit Thailand Require approval, untested Approval recently not given Vietnam No credit No credit 20

21 Concluding Thoughts Regulatory capital requirements will keep changing However, there is only one economic truth Reinsurance can be used to remove regulatory constraints and allow insurers to optimize its capital position 21