Governance of Uncertainty/Risk & US ORSA

Transcription

1 Governance of Uncertainty/Risk & US ORSA DAVID SANDBERG FSA, MAAA, CERA September 17, 2015

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3 Governing The Businesses of Uncertainty Banking (Uncertain Assets) Savers money loaned away. Liability is a known quantity. Assets are not certain Manage risk not paid back + liquidity risk of savers. Biggest risk = assets not there when savers want them Engine for growth via risk Time horizon = daily balancing Insurance (Uncertain Liabilities) Money invested in bonds & managed so funds sufficient to meet future promises. Liability is uncertain, but assets are known Ensure safety Time horizon = quarterly to decades Exchanges Price Stabilization & Speculation 3

4 All Intersect in The Financial Market Today Direct Bailout Competitive Disadvantage Long-Term Financing Basel III Liquidity Transformations Basel III / Solvency II Liquidity Transformations EMIR, Dodd-Frank Act Investment Preferential investment in SIFIs Lower cost of capital (~50 to 100 bp) Capital Transfers to SIFI Banks: ~500bn Annually Sovereign Rating Pressure Moral Suasion Moral Suasion Rating Agencies IAIS IASB Rating Uplift Hold to Maturity Approaches, IAIS ICP 14 Growth of SIFIs due to funding advantage and being Too Big To Fail, Too Big to Prosecute and Too Big to Supervise Transfer of illiquid assets from banks to insurers and pension funds in exchange for liquid assets Lobbying power Offshore Jurisdiction Net Stable Funding Ratio Liquidity Coverage Ratio No Domestic Credit Risk Low-Trigger Contingent Capital Banking/Trading Book Option Government Moral Guarantee Suasion BSCB SIFI Basel II/III SIFI Designation Going-Concern Contingent Capital Additional Capital Buffers Full Diversification within Conglomerates Sovereign Bonds Repo Facilities Banking SIFIs Banks Capital Flows Increasing protectionism De-facto control Closure via supranational agreements Competing Jurisdiction Offshore Jurisdiction Currency Wars Capital Flows Sovereign Closer link between sovereigns and central banks Conflicts of interests Solvency II, etc Insurance regulation geared to support banks and sovereigns IAIS / ComFrame Central Bank Expropriation of Pension Funds Toxic Assets Sovereign Liquidity, Bonds Cash Low Interest Rate Policies Neglect Central banks issuing and buying sovereign bonds, Quantitative Easing, Outright Monetary Transactions etc. Sovereign Bonds Counter Cyclical Premium Lowered asset quality, lower reserves / technical Matching Adjustment provisions; disincentives to sell assets with declining No EUR Credit Risk market values, lower market liquidity Equity Dampener Lack of diversification across jurisdictions Ultimate Forward Rate Enhanced supervision, resolution, higher loss absorption capacity Insurance SIFI Regulation Pension Funds Insurers Insurers Insurance Insurers SIFI Market influence, e.g. via prohibition of short selling, buying up of government bonds, etc. No preferential Markets Liquidity pumps Markets with impaired price finding function Inefficient capital allocation Taking on of banking debt, CoCos etc. Decline due to competitive disadvantages and lowinterest rate environment Protectionist measures: Capital flow restrictions, trade barriers, hurdles for foreign investment, etc. 4

5 Governing the Drivers of Insurance Value Value of Put Option Pillar One & Three Pillar Two Value of Firm Value of Tangible Assets Value of Liabilities Value of Default Put Option Management or Franchise Value Source: Babbel/Merrill, Journal of Risk & Insurance

6 Capital as Governance Tool Nuance for Insurance Capital Assets in excess of liabilities to invest or to return to shareholders (traditional shareholder view) plus Required buffer for uncertainty for additional policyholder protection (regulator & policyholder view) 6

7 Shortcomings of Capital Amortized Cost Does not capture cost of the underlying guarantees the heart of insurance Uses history to project future values Market Value Uses todays pricing of risk to value all future risks. Good for assessing cost to hedge all risks, but volatility is exaggerated All Reported Numbers are Approximations Inherent Uncertainty in Liability Valuation Methods (and some assets) 7

8 What is the Important Problem? What Pillar 2 (ERM) processes and tools can be used to sustain the Balance Sheet before Pillar 1 indicates the ship is sunk. And, are they robust or smoke and mirrors? 8

9 Company Tools 1. Reliance on (and use of) experts (especially actuaries), with those from a profession being, perhaps, the most valuable 2. Organizational structures such as groups 3. Reinsurance, both proportional and nonproportional - to mitigate risk and to act as a form of capital 4. Hedging and asset liability management techniques 5. Enterprise Risk Management (ERM) concepts such as emerging risk identification, risk appetites, limits and controls 6. Capital focused on addressing needs in excess of regulatory balance sheet requirements

10 Company Tools 7. Models, including both external vendor models and internal models (e.g., catastrophe models and economic capital models) 8. Internal model control and validation procedures 9. Stress testing 10. Responsible pricing, product design and inforce management 11. Voluntary disclosures to both shareholders and policyholders 12. Traditional corporate management processes such as disaster recovery, strategic planning, compensation philosophy and market positioning.

11 OECD Paper on Governance 1. Identifies all the Shoulds 2. How to Tell the Gold from a Potemkin Village? 3. What is Sound Risk Management vs. Ineffective Bureaucracy? 4. How to apply so shareholders and/or regulators can tell if there is effective governance? 11

12 Actuarial Profession Addresses Potemkin Village Issues 1. How to measure and report on Financial Risks Book written over a decade ago 2. How to Assess Sustainability and Soundness of Processes for: 1. ERM 2. Governance of Models 3. Understanding the value, uncertainties and shortcomings of each measurement and mitigation option 4. Three Lines of Defense 12

13 Risk Book Topics Wave 1 (Ready for On-Line Early Fall) Catastrophe Risk (ICP 13) Non-Proportional Reinsurance (ICP 13) Professional Standards (ICP 14) Operational Risk (ICP 13,15-17,23,25) Actuarial Function (ICP 8) Wave 2 (Ready for On-Line by Mid-Fall/Winter) Regulatory (and Management) Tools Stress Testing (ICP 8,16-17) Group Structure and Consequences (ICP 23 etc.) Intra-Group reinsurance (ICP 8,9,15-17,23,25) ORSA and ERM (ICP 16) Financial Statements 13

14 Future Topics Wave 3 (Ready for On-Line by Q1 2016?) Overview, Executive Summary and Integration Governance of Models (ICP 17) One Year vs. Multi Year Valuation (ICP 14,16,ICS etc) Resolution (of insolvencies) (ICP 17, 26, FSB Key Attributes) ALM (ICP 15) Marketing/Distribution Risk Wave 4 (Timing Uncertain) Use of Derivatives Communicating Uncertainty Materiality & Proportionality Policyholder Behavior/Management Actions Visualizing/Identifying Risk Interlinkages??? 14

15 ERM Tools = Holistic Set Powerful new Tools Caution = 15

16 US ORSA Quo Vadis? How will recent NAIC focus on Group Capital calculations impact legal entity ORSAs? Will supervisory colleges make efficient or redundant use of ORSAs? Will ASB adopt a Standard for Actuaries involved in preparing or reviewing an ORSA?

17 AUDIENCE QUESTIONS 1) How many here are part of a Group Supervisory Framework? 2) How has the ORSA impacted the role of risk in your organization? A. Reduced your role with more paperwork to be done? B. No impact? C. Increased your presence at both the board and operational levels? 3) Who owns the preparation and review (including discussion) or the ORSA? 4) What is the relationship, if any, between the ORSA and the appointed actuary discussions by the board?

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19 The Evolution of the ORSA (Canadian Edition) Stephen Manly, FSA, FCIA, FRM Office of the Superintendent of Financial Institutions, Canada September 17, 2015

20 Agenda The ORSA process ORSA General Observations General Feedback to Insurers Evolution of the ORSA 2

21 ORSA and ERM Framework The Own Risk and Solvency Assessment is the process by which an insurer assesses its capital needs. The ORSA should be used to establish or change an insurer s internal target OSFI s Corporate Governance Guideline states: A FRFI [federally regulated financial institution] should have a Board-approved Risk Appetite Framework that guides the risk-taking activities of the FRFI. ORSA is one tool used by an insurer to guide risk-taking activities. ORSA is focused on risk identification and solvency, while ERM focuses on the management of risk towards a well-defined risk appetite 3

22 Evolution to ORSA Dynamic Capital Adequacy Testing (DCAT) Required by OSFI since 1992 for Life insurers (1998 for P&C insurers) Driven by a recognition of the retrospective and static nature of capital requirement rules Standards for DCAT set by CIA (Canadian Institute of Actuaries), not by OSFI Internal Capital Target Setting OSFI Guideline A-4 for insurers effective Jun 2011 (revised Jan 2014) Stress Testing OSFI Guideline E-18 (effective Dec 2009) Outlines OSFI s expectations with respect to enterprise-wide stress testing framework for all federally regulated financial institutions 4

23 Key Elements in ORSA Comprehensive identification and assessment of risks Relating risk to capital Board oversight and senior management responsibility Monitoring and reporting Internal controls and objective review 5

24 Importance of the Approach to ORSA Key point: ORSA is a process The ORSA report and Key Metrics Report (KMR) are only outputs of the process. They document the ORSA process Three approaches: Compliance exercise Communication or risk summary Description of process and conclusions The approach taken can influence the usefulness of the ORSA process 6

25 Agenda The ORSA process ORSA General Observations General Feedback to Insurers Evolution of the ORSA 7

26 ORSA Benchmarking Preliminary review of more than 125 Life and P&C ORSA reports focused on characteristics: Expectations from Guideline E-19 Approaches used by insurers Qualitative assessment Key Metrics Report filing Observations are broadly similar in the P&C and Life industries 8

27 % of ORSA Reports ORSA: Link to internal targets 100% ORSA reports generally identify the insurers internal target 75% 50% 25% However, operating level and Tier 1 internal capital target (for life insurer) usually not discussed in the report Insurers are not using the ORSA to establish their internal target 0% Report identified the internal target Internal target identified = KMR ratio Many insurers kept their internal target at pre-2014 levels but without explanation on how it tied to the ORSA 9

28 ORSA: Risk identification Most insurers have not yet fully incorporated their ORSA process as part of their ERM or strategic planning No standard definition of risk categories Insurance risk: In some cases catastrophe risk or reserving is a separate risk category Some definitions include reinsurance risk Credit risk: In many cases it is strictly reinsurance counterparty credit Sometimes includes policyholder and broker counterparty credit risk Other definitions are investment based Market risk: FX risk may be included in market risk or as a separate category Materiality assessment determines whether a risk category is aggregated into a broader category or separated out Implications: adding up and comparing own capital by risk categories at an industry level may not be meaningful. 10

29 ORSA: Life risk identification 11

30 ORSA: Life insurers own capital 12

31 % of ORSA Reports ORSA: Quantification methodology 100% 75% P&C Life Total DCATs, MCCSRs, and models (VaR, CTE) often referenced but not always explained how they integrated 50% 25% Some ORSAs provide a good overview of methodologies or provide a reference of the supporting documentation 0% VaR TVaR/CTE Unspecified 13

32 Severe Scenarios Varying Scenarios % of ORSA Own Capital Stress testing own capital 100% Proportion of own risk capital # of reports 75% Very few reports (~13%) include any own capital for stress testing scenarios Some reports include a number to bring ORSA capital to the internal target level. Usually labelled a compliance amount under other or as a separate risk line. 50% 25% 0% 14

33 Severity (confidence level) 15

34 Diversification methodology 16

35 ORSA: Diversification Credit 17

36 ORSA: Risk processes References to various documents The majority of the insurers: ERM process Policies related to risk Risk appetite/tolerances DCAT Half of the insurers: Emerging risk process Capital fungibility Some of the insurers: Reverse stress testing process 18

37 ORSA: General Observations Examples of future planned enhancements Development/enhancement of model More research understanding risk profile Operational risk Aggregation/diversification benefits Stress testing Better integration with ERM and business planning The ORSA reports at a glance: A number of reports are descriptive in nature From 4 pages to over 200 pages 19

38 Agenda The ORSA process ORSA General Observations Feedback for Insurers Evolution of the ORSA 20

39 Superintendent s remarks "I understand that many companies are interested in our feedback on the assessments that they have shared with us. Having seen the broad range of ORSAs, we at OSFI are well positioned to provide you with recommendations for improvement, and to compare your practices with those we see as the best in the industry. And while we are well positioned to do all of that, we are not going to. Why not? Because our overriding goal is to keep the Own in ORSA. If we started making specific suggestions to individual companies, we would, inadvertently, start substituting our judgment for yours. Of course we could try to reduce the impact of our comments by noting that they are only suggestions, that you are not obliged to follow our recommendations, that your ideas might well be beter than ours, and so on. But I don t think insurers ever forget, even for a moment, that we are the supervisor. And so comments that would be perceived as suggestions if they were made by anyone else come across as requirements if we make them. Source: Remarks by Superintendent Jeremy Rudin to the 2015 Property and Casualty Insurance Industry Forum, Cambridge, Ontario, June 4, 2015 ( 21

40 Supervisory use The ORSA process is the insurer s own assessment of their capital needs. The report documents that process Supervisors may use the information in the report or supporting documentation in understanding of the institution The ORSA report is viewed in a manner similar to other internal management reports of the insurer. For example: risk appetite investment management report the insurer s risk dashboard 22

41 Supervisory feedback Supervision may come back to the insurer if: Clear inconsistency with Guidelines A-4 or E-19 expectations E.g. ORSA process is not used to set internal target Inconsistency in reporting between the KMR and ORSA report E.g. Numbers do not align No annual process to update the ORSA An objective review plan has not been identified Methodological concerns with the internal target setting E.g. methodologies around diversification, etc. 23

42 General feedback to insurers The ORSA report is the documentation of an insurer s risk identification and own capital assessment processes. Therefore OSFI will not comment on the: Structure of the report Specific risks identified General content of the report Relating risk to own capital Quantification assessments within the report are not required (should be documented somewhere within the process) but it may be useful to a Board or Chief Agent If the ORSA report includes a quantitative assessment, it should reconcile with the data in the KMR 24

43 The ORSA process to set targets The ORSA process is expected to establish the internal target The ORSA quantification assessment should establish the internal target. If there is a change of internal target, OSFI may be assessing the adequacy of the revised internal target and may need to review the methodology of the quantitative processes. 25

44 Common industry questions Q1: How does ORSA interact with Guideline A-4: Regulatory Capital and Internal Capital Targets? Q2: Does the requirement to have the internal target greater than 150% apply before or after a stress scenario? Q3: What are OSFI s views with respect to having an economic capital model as a basis for setting internal capital targets? Q4: How does OSFI intend to gain comfort in the internal capital targets derived from ORSA economic models? Q5: How does OSFI reconcile and/or measure an internal target that is derived from ORSA economic models to a capital ratio calculated using standard MCT factors? 26

45 Key Metrics Report The Key Metric Report is an OSFI requirement Template should not be modified. All figures should be consistent with any figures included in the ORSA report (KMR is a summary of how the insurer has related their risks to capital). Appropriate information, such as location in the ORSA report or supporting documents, should be given in the Methodology and References section. Needs to be submitted within 30 days of the ORSA report being discussed with the Board (Chief Agent). 27

46 Key Metrics Report Top 4 Regulatory and ORSA risks in terms of capital are the same but not necessarily ranked in the same order. Most of the KMR s had deficiencies in their filing. Often the amounts in the ORSA report do not reconcile to the numbers in the KMR. The internal target identified in the report is sometimes different than the ratio on the KMR. OSFI s KMR template was modified or adapted by some insurers. 28

47 Key Metrics Reports Summary of the results of the insurer s ORSA process for determining own capital needs and internal target(s). Insurer is allowed to redefine the respective risk categories based on their unique risk drivers and business needs. For aggregation/diversification credits used, reference to supporting documents is expected. KMR must be filed annually with the Lead Supervisor. 29

48 2015 Key Metrics Reports (KMR) 30

49 Agenda The ORSA process ORSA General Observations Feedback for Insurers Evolution of the ORSA 31

50 Evolution of the ORSA ORSA introduced in 2014 Room for continuous improvement Elements and processes will need to mature May take several years to achieve a mature process Supervisory expectations will be related to size, nature and complexity of the insurer 32

51 Questions??? 33