Own Risk and Solvency Assessment (ORSA) Presentations to OCCA (Nov. 19, 2014) and AAIARD (Nov. 21, 2014) Jacqueline Friedland, FCIA, FCAS, FSA, MAAA Chief Actuary, RSA Canada
Presentation Outline What is ORSA? Who is involved in ORSA? How are Canadian insurers doing with ORSA? (with permission from Neil Parkinson and KPMG) 2 2
What is ORSA? International Association of Insurance Supervisors (IAIS) Insurance Core Principles (ICPs) Statements Standards Guidance material State of ORSA globally (Towers summary) Canada (OSFI Guideline E-19) 3 3
What is ORSA? International Association of Insurance Supervisors (IAIS) Insurance Core Principles (ICPs) Statements Standards Guidance material http://www.iaisweb.org/index.cfm?pageid=689&icpaction=listicps&icp_id=29 State of ORSA globally (Towers summary) Canada (OSFI Guideline E-19) 4 4
ICP 16 Enterprise Risk Management for Solvency Purposes IAIS Statement and Standards ICP 16 Enterprise Risk Management for Solvency Purposes The supervisor establishes enterprise risk management requirements for solvency purposes that require insurers to address all relevant and material risks. 16.1 The supervisor requires the insurer s enterprise risk management framework to provide for the identification and quantification of risk under a sufficiently wide range of outcomes using techniques which are appropriate to the nature, scale and complexity of the risks the insurer bears and adequate for risk and capital management and for solvency purposes. 16.2 The supervisor requires the insurer s measurement of risk to be supported by accurate documentation providing appropriately detailed descriptions and explanations of the risks covered, the measurement approaches used and the key assumptions made. 16.3 The supervisor requires the insurer to have a risk management policy which outlines how all relevant and material categories of risk are managed, both in the insurer s business strategy and its day-to-day operations. 5 5
ICP 16 Enterprise Risk Management for Solvency Purposes IAIS Standards 16.4 The supervisor requires the insurer to have a risk management policy which describes the relationship between the insurer s tolerance limits, regulatory capital requirements, economic capital and the processes and methods for monitoring risk. 16.5 The supervisor requires the insurer to have a risk management policy which includes an explicit asset-liability management (ALM) policy which clearly specifies the nature, role and extent of ALM activities and their relationship with product development, pricing functions and investment management. 16.6 The supervisor requires the insurer to have a risk management policy which is reflected in an explicit investment policy which: specifies the nature, role and extent of the insurer s investment activities and how the insurer complies with the regulatory investment requirements established by the supervisor; and establishes explicit risk management procedures within its investment policy with regard to more complex and less transparent classes of asset and investment in markets or instruments that are subject to less governance or regulation. 6 6
ICP 16 Enterprise Risk Management for Solvency Purposes IAIS Standards 16.7 The supervisor requires the insurer to have a risk management policy which includes explicit policies in relation to underwriting risk. 16.8 The supervisor requires the insurer to: establish and maintain a risk tolerance statement which sets out its overall quantitative and qualitative risk tolerance levels and defines risk tolerance limits which take into account all relevant and material categories of risk and the relationships between them; make use of risk tolerance levels in its business strategy; and embed its defined risk tolerance limits in its day-to-day operations via its risk management policies and procedures. 16.9 The supervisor requires the insurer s ERM framework to be responsive to changes in its risk profile. 7 7
ICP 16 Enterprise Risk Management for Solvency Purposes IAIS Standards 16.10 The supervisor requires the insurer s ERM framework to incorporate a feedback loop, based on appropriate and good quality information, management processes and objective assessment, which enables it to take the necessary action in a timely manner in response to changes in its risk profile. 16.11 The supervisor requires the insurer to perform its own risk and solvency assessment (ORSA) regularly to assess the adequacy of its risk management and current, and likely future, solvency position. 16.12 The supervisor requires the insurer s Board and senior management to be responsible for the ORSA. 16.13 The supervisor requires the insurer s ORSA to encompass all reasonably foreseeable and relevant material risks including, as a minimum, underwriting, credit, market, operational and liquidity risks and additional risks arising due to membership of a group. The assessment is required to identify the relationship between risk management and the level and quality of financial resources needed and available. 8 8
ICP 16 Enterprise Risk Management for Solvency Purposes IAIS Standards 16.14 The supervisor requires the insurer to: determine, as part of its ORSA, the overall financial resources it needs to manage its business given its own risk tolerance and business plans, and to demonstrate that supervisory requirements are met; base its risk management actions on consideration of its economic capital, regulatory capital requirements, and financial resources, including its ORSA; and assess the quality and adequacy of its capital resources to meet regulatory capital requirements and any additional capital needs. 16.15 The supervisor requires: the insurer, as part of its ORSA, to analyse its ability to continue in business, and the risk management and financial resources required to do so over a longer time horizon than typically used to determine regulatory capital requirements; the insurer s continuity analysis to address a combination of quantitative and qualitative elements in the medium and longer-term business strategy of the insurer and include projections of its future financial position and analysis of its ability to meet future regulatory capital requirements. 9 9
ICP 16 Enterprise Risk Management for Solvency Purposes IAIS Standards and ORSA Guidance 16.16 The supervisor undertakes reviews of an insurer's risk management processes and its financial condition, including the ORSA. Where necessary, the supervisor requires strengthening of the insurer s risk management, solvency assessment and capital management processes * * * * * * * * * ORSA requirements articulated by the IAIS: Every insurer should undertake its own risk and solvency assessment (ORSA) Documentation of the rationale, calculations, and action plans arising from ORSA Insurers to reflect risks in a robust manner ORSA supported by an effective overall ERM framework Risk management policy embedded in an insurer s operations The nature of ORSA would be appropriate to the nature, scale, and complexity of an insurer s risks 10 10
Comments about ORSA and IAIS expectations ORSA and ERM are closely linked Risk management has progressed from identification and management of risks to measurement and relating capital to risk Linkage of risk management and capital management Goal not to eliminate risk but manage it within selfimposed limits (risk appetite, risk tolerance) 11 11
IAIS Standard ERM Framework 12 12
History of ORSA Solvency II European Union Regulatory requirements for ORSA (or similar assessments) are being introduced around the world, including but not limited to: United States by the National Association of Insurance Commissioners effective 2015 South Africa by the Financial Services Board effective 2016 Bermuda by the Bermuda Monetary Authority in effect since 2011 Australia by the Australian Prudential Regulatory Authority in effect since 2013 Singapore by the Monetary Authority of Singapore in effect since 2014 13 13
Towers Expected Global Implementation Timeframes for ORSA http://www.towerswatson.com/en/insights/newsletters/global/emphasis/2013/regulators-worldwide-are-embracing-the-orsa page 21 Country ORSA regime To End 2012 2013 2014 2015 2016 2017 Solvency II Interim ORSA Solvency II EIOPA guidance Regional pilots implementation regimes Europe ORSA? - Guidance manual - Model Act Second pilot Implementation U.S. NAIC ORSA -Pilot project Australia APRA ICAAP Guidance Implementation CIRC risk-based solvency ERM First risk report submission Implementation China framework Malaysia BNM ICAAP ICAAP guidelines Implementation Japan FSA ORSA No guidance yet - Consultation - Final Implementation Singapore MAS ORSA requirements - Consultation Guidance Canada OSFI ORSA - Final Implementation Bermuda BMA CISSA Implementation South Africa FSB SAM Implementation 14 14
Canada OSFI Guidelines OSFI Guideline E-19 Own Risk and Solvency Assessment Guideline set out in six major sections: Introduction Scope ORSA and enterprise risk management Key elements Interaction of the ORSA with the supervisory review Appendix supplementary risk considerations 15 15
Canada OSFI requirements An insurer to perform ORSA on a regular basis so that it continues to provide relevant information for an insurer s management processes; An insurer to clearly and formally document its ORSA in a report to the Board at least annually and more often if circumstances warrant (e.g., when there are changes to the insurer s risk profile or risk appetite); An insurer to perform an effective assessment of its own capital needs, to determine its Internal Targets, and to assess the adequacy of its current and likely future solvency position; The Board and senior management to be responsible for the oversight of the design and implementation of the ORSA as well as regular monitoring and reporting; An insurer s ORSA to encompass all reasonably foreseeable and relevant material risks; An insurer to consider the use of an internal model in order to assess the current financial resources and the calculation of capital requirements; and All insurers to complete their first ORSA by December 31, 2014. 16 16
Canada OSFI s Key Elements of 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 17 17
ORSA at RSA Embedded as business as usual (BAU) within its operations. Evidence maintained through active risk committees and risk management processes. Risk data and risk assessments integrated into decision-making processes. Utilize a multi-line of defence system to: Inform all levels of management regarding risk appetite and risk exposures; Facilitate an effective controls and assurance environment surrounding risk and reward; Create effective top-down and bottom-up lines of communication to foster an organic risk culture; and Embed effective challenge. 18 18
ORSA is Different from an ORSA Report (slide 1 of 2) ORSA is a process for tailored and strategic analyses linking risk management, capital management, and planning. ORSA is tied to the operational and strategic plans as well as the external environment in which the insurer operates. ORSA requires a comprehensive and multi-functional approach. ORSA considers the entirety of the processes and procedures needed to identify, assess, monitor, manage, and report longterm and short-term risks of the insurer. ORSA is used to determine the capital necessary to ensure overall solvency needs are met at all times and are sufficient to meet business strategy. 19 19
ORSA is Different from an ORSA Report (slide 2 of 2) ORSA encourages an insurer to question its framework of internal systems dedicated to risk management and risk control. ORSA informs all levels of management regarding risk appetite and risk exposures; ORSA facilitates an effective controls and assurance environment surrounding risk and reward; ORSA helps create effective top-down and bottom-up lines of communication to foster an organic risk culture; and ORSA requires effective challenge. 20 20
Materiality & Proportionality Key Concepts for ORSA Materiality is defined in international accounting standards: Information is material if its omission or misstatement could influence the economic decisions of users taken on the basis of the financial statements. Materiality depends on the size of the item or error judged in the particular circumstances of its omission or misstatement. Thus, materiality provides a threshold or cut-off point rather than being a primary qualitative characteristic which information must have if it is to be useful. Proportionality addresses the extent of analysis and reporting and requires such to be commensurate with the nature, scale, and complexity of the risks assumed by the insurer. 21 21
The ORSA Report at RSA At RSA, we are using the ORSA Report to: To document ORSA for RSA s Canadian insurance operations; To provide education and training about RSA s ORSA to key stakeholders; and To meet Canadian regulatory and RSA Group reporting requirements. The ORSA Report will enable the Board to: Assess the appropriateness of RSA s ORSA including the overall results and the quality and composition of capital; and Confirm the Internal Target for each insurer. 22 22
More about ORSA at RSA (slide 1 of 3) ORSA is big it is comprehensive it hits all areas of the business. At RSA, ORSA includes: System of governance; Strategic and operational planning; Multi-line of defence model; Risk Function and Risk Committees; Risk Management System; and Canada Audit & Risk Committee. 23 23
More about ORSA at RSA (Slide 2 of 3) At RSA, ORSA includes identification and consideration of: Underwriting risk; Reserving risk; Catastrophe risk; Market risk; Operational risk; Pension risk; Emerging risk; and Strategic and reputational risk. 24 24
More about ORSA at RSA (slide 3 of 3) In relating risk to capital, our ORSA includes: Stress and scenario testing; DCAT; Financial modelling to support OSFI s Guideline A-4 Regulatory Capital and Internal Capital Targets; and Internal model. Review of the results of modeling and the decomposition of capital required by risk; and Setting an Internal Target capital. 25 25
Who is involved in ORSA? At consulting firms: Actuaries Advisory consultants Risk management consultants Auditors At insurers, include but are not limited to: Actuarial Risk Finance Legal Reinsurance 26 26
Own Risk and Solvency Assessment (ORSA) ORSA Maturity and Observations on the Canadian Experience Acumen ORSA conference September 24, 2014
Canadian Benchmarking Results
ORSA Maturity Assessment (Canadian insurers). 2014 KPMG LLP, a Canadian limited liability partnership and the Canadian member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative, a Swiss entity. 2
Maturity comments by area
ORSA summary results Management Area UK Benchmarking Findings (2013) Canadian Benchmarking Findings (2014) Roles and responsibilities In all reports firms referenced the Board playing an active role in steering the ORSA. However, there appeared to be limited evidence of the role performed by Boards in practice. More advanced reports demonstrated the challenge the Board had provided and referenced decisions taken. There was limited discussion of the role of Committees / Senior Management within the ORSA process. More advanced reports reviewed noted the key people involved in the ORSA and their role. Draft reports and project plans typically refer to planned board oversight and approvals, but the actual processes and responsibilities are not yet in operation. Limited, generalized discussion of management roles and oversight. 2014 KPMG LLP, a Canadian limited liability partnership and the Canadian member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative, a Swiss entity. 4
ORSA summary results Management Area UK Benchmarking Findings (2013) Canadian Benchmarking Findings (2014) Process The majority of reports documented the high-level components included within the ORSA process. There is clear development needed in terms of the timing, owners, detail and actual assessment undertaken. Given the ORSA may need to be run on an ad-hoc basis at short notice, the ORSA process needs to demonstrate clearly how the assessment will take place. Several reports aligned the Risk Appetite framework to the triggers for performance of an ad-hoc ORSA. This was considered to be stronger practice and an area of development for other firms. High level documentation of responsibilities and processes. Responsibilities and processes do not as yet seem to be fully thought out, as perhaps might be expected at this stage for a new process. ORSA process is generally not well defined as an operationalized process. Process and timing expectations for revising or updating an ORSA are typically not documented. The conditions that would trigger the revision or update are typically not defined. 2014 KPMG LLP, a Canadian limited liability partnership and the Canadian member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative, a Swiss entity. 5
ORSA summary results Management Area UK Benchmarking Findings (2013) Canadian Benchmarking Findings (2014) Documentation Few reports contained executive summaries which highlighted clear areas for Board discussion and comment. Given the length of reports this ought to be an area of focus for the future to ensure the core points for decision and understanding are presented. Many reports appeared to have been developed as desk-based exercises rather than as part of a broader process. As a result there was no clear story of how the Risk, Capital and Business plan aligned and sections appeared siloed. Few complete drafts exist as yet. Those that do are incomplete in many respects and do not yet show a clear overall assessment statement in the executive summary or the body of the report. Initial ORSAs do not show evidence that they are part of an operationalized process rather than a desk based exercise. Use of a multi year development roadmap is a leading practice. 2014 KPMG LLP, a Canadian limited liability partnership and the Canadian member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative, a Swiss entity. 6
ORSA summary results Risk Assessment Area UK Benchmarking Findings (2013) Canadian Benchmarking Findings (2014) Risk Strategy and Appetite Although most firms had Risk Appetite statements, there was typically less evidence of more granular limit frameworks with approved tolerances within which the business could manage risk. In several reports Risk Appetites were not clearly aligned to the material risk exposures, suggesting a lack of embedding within the business. This meant the report did not evidence a clear comparison between the Appetite and Risk Profile. Risk appetite statements are fairly rudimentary in most cases, stopping at total enterprise measures focusing on capital preservation and income volatility. RAS not usually linked to how risk profile would be expressed. RAS typically not disaggregated and linked to how risk would be managed at the business unit level, e.g. RAS at a BU level, with linkages to business limits that could be communicated to and acted on by individual managers. 2014 KPMG LLP, a Canadian limited liability partnership and the Canadian member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative, a Swiss entity. 7
ORSA summary results Risk Assessment Area UK Benchmarking Findings (2013) Canadian Benchmarking Findings (2014) Material Risk Assessment When considering the current risk profile, firms tended to focus on financial risks (core ICA risk components), which led to them overlooking other non-financial risks required under the ORSA e.g. conduct and strategic risks. In many reports the risk assessment process did not appear to align to the setting of the overall business plan. Commonly a high level focus on capital preservation and income volatility, together with some zero tolerance limits for reputational and compliance risks. Discussion of strategic risks is limited in most cases. Some distinguish strategic risks based on whether capital can be held. In many cases, it is unclear how the planned ORSA processes will be integrated with business and strategic planning. 2014 KPMG LLP, a Canadian limited liability partnership and the Canadian member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative, a Swiss entity. 8
ORSA summary results Risk Assessment Area UK Benchmarking Findings (2013) Canadian Benchmarking Findings (2014) Emerging Risk Assessment When considering emerging risks, firms tended to concentrate on upcoming regulatory changes e.g. FCA/PRA and EMIR. Reports which evidenced a process for assessing emerging risks often considered these in isolation to other risks and hence did not manage to evidence relevance to the risks faced by the firm. Few reports evidenced well developed processes for the identification and management of emerging risk. Limited treatment of emerging risks, or processes and responsibilities for identifying and monitoring emerging risks. 2014 KPMG LLP, a Canadian limited liability partnership and the Canadian member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative, a Swiss entity. 9
ORSA summary results Capital Area UK Benchmarking Findings (2013) Canadian Benchmarking Findings (2014) Stress and Scenario Testing (SST), Reverse Stress Testing (RST) Few reports demonstrated consideration of Reverse Stress Testing. In those instances where Reverse Stress Testing was considered, focus was given to the scenarios that caused the business to fail rather than the management actions to prevent it. Furthermore, the metrics and calibrations used to define business model failure from those firms that had conducted Reverse Stress Testing exercises varied significantly. Whilst several reports evidenced useful results around stress testing there was limited consideration of management actions and unclear alignment of stresses to the business plan. Common to reference enhanced use of SST in the ORSA, particularly where no EC model is in place, although nature of enhancements are often unclear. In some cases, ORSA plans include more severe stress scenarios, more rigorous use of stochastic modelling for some scenarios. Little or no use or planned use of reverse stress testing observed to date. 2014 KPMG LLP, a Canadian limited liability partnership and the Canadian member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative, a Swiss entity. 10
ORSA summary results Capital Area UK Benchmarking Findings (2013) Canadian Benchmarking Findings (2014) Projection of capital Overall Stress and Scenario Testing and Projection of Capital were noted areas of weakness for firms. Several firms referenced developments ongoing and cited a lack of production capability as the rationale. DCAT and stress testing conducted under previous regulatory requirements provide a reasonable starting point for capital projection. Existence of a working EC model is a minority (approx15-20%) practice. Currently, cycle time limits its use in a production environment. In addition, there is some partial use of EC-like models as a challenge for aspects of the standard capital model. Limited understanding of operational risk and diversification; common to use proposed OSFI QIS models as a proxy. 2014 KPMG LLP, a Canadian limited liability partnership and the Canadian member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative, a Swiss entity. 11
ORSA summary results Capital Area UK Benchmarking Findings (2013) Canadian Benchmarking Findings (2014) Capital Assessment Many firms used their current ICA (individual capital assessment) as a basis to populate the capital section of their report. A clear area of development is to utilise Solvency II numbers and broaden out risk quantification further. Firms with more mature capital sections presented a view on both the quantity and quality of own funds, including the composition and tiering of capital and debt. Few insurers expect to have an operational economic capital model for their 2014 or 2015 ORSA. Some describe their EC model as the standard model reflecting target ratios with some add-ons, but not a truly separate model. Limited discussion of quality of capital and access to new capital observed. Discussion of fungibility of capital also limited, either across legal entities or jurisdictions. 2014 KPMG LLP, a Canadian limited liability partnership and the Canadian member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative, a Swiss entity. 12
ORSA summary results Risk-based Decisions Area UK Benchmarking Findings (2013) Canadian Benchmarking Findings (2014) Risk Management System Many reports contained largely static information on the Risk Management System (RMS) explaining the processes followed and key components. Stronger reports indicated key areas of change within the RMS, whilst static information was consigned to the supporting documentation. Few reports demonstrated a review of the RMS taking place with consideration for changes needed as a result. More mature reports provided a summary of the weaknesses in the RMS which were being addressed. Commonly the description of the risk management system is narrative and static, and does not describe monitoring, current state of controls and net risks. A leading practice would be to develop monitoring and reporting processes that are at a level that is usable in ORSA process and oversight. 2014 KPMG LLP, a Canadian limited liability partnership and the Canadian member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative, a Swiss entity. 13
ORSA summary results Risk-based Decisions Area UK Benchmarking Findings (2013) Canadian Benchmarking Findings (2014) Use in Decision Making Several reports indicated how the ORSA would be used in future decision making processes. However, there was limited evidence of how the results of the Risk and Capital frameworks had been used in business decision making during the course of the year. Mature reports presented decisions for consideration by the Board and were aligned to the latest Business Plan. This demonstrated the role of the Board and key elements of the report for consideration. Embedding of ORSA in business decisions cannot yet be observed but a leading practice would be to discuss this in the ORSA description of risk management processes. 2014 KPMG LLP, a Canadian limited liability partnership and the Canadian member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative, a Swiss entity. 14
ORSA summary results Risk-based Decisions Area UK Benchmarking Findings (2013) Canadian Benchmarking Findings (2014) Alignment to Business Planning Few reports demonstrated a clear alignment to the Business Planning process. ORSAs appeared to be run in isolation, or following the Business Planning process. This limited the challenge that Boards can raise and validity of the ORSA results. Reports incorporating the anticipated changes to the business profile through implementation of the business and the projected Risk Profile associated with this were limited in number but at the stronger end of the spectrum. In many cases, it is unclear how the planned ORSA processes will be integrated with business and strategic planning. A leading practice is to clearly align the development and review of ORSA with these processes, and embed a documented risk assessment in business decisions. 2014 KPMG LLP, a Canadian limited liability partnership and the Canadian member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative, a Swiss entity. 15
Challenges for completing and developing the ORSA
Common observed weaknesses and gaps Risk appetite statements Incomplete Tend to be weak on strategic and reputational risks Lack of measurement Poor connectivity to business and strategic planning Risks and internal control assessments Too detailed, and too focused on financial reporting Lack of linkage of net risks to capital needs 2014 KPMG LLP, a Canadian limited liability partnership and the Canadian member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative, a Swiss entity. 17
Common observed weaknesses and gaps, cont d Considerable reliance on standard MCT/MCCSR model Limited modelling capabilities Need to develop challenge of MCT/MCCSR model for adequacy Operational risk poorly understood, with limited measurement Need to develop validation and verification of data and models 2014 KPMG LLP, a Canadian limited liability partnership and the Canadian member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative, a Swiss entity. 18
Internal capital alternatives maturity spectrum, in the context of ORSA Rudimentary Average Some leading practices Most sophisticated Capital measurement Use of standard MCT/MCCSR, and DCAT to meet annual requirements Standard MCT/MCCSR model + DCAT Better use of stress testing Standard model supplemented by EC and EC lite methods Stress testing Full economic capital model Continuous monitoring EC used in capital allocation Who might use? Very small and simple insurers Small to medium insurers Medium to large insurers Some larger, more complex insurers Pros and cons Simple; can t go below regulatory test anyway Is it own view? Simple; can t go below regulatory test anyway Is it own view? Support for lower Internal Target with OSFI Public disclosure plus Meet expectations of analysts, rating agencies, regulators Better management info Greater effort and cost Support for lower Internal Target with OSFI Public disclosure plus Meet expectations of analysts, rating agencies, regulators Better management info Most effort and cost 2014 KPMG LLP, a Canadian limited liability partnership and the Canadian member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative, a Swiss entity. 19
Internal capital alternatives - can you support your choice? Rudimentary Average Some leading practices Most sophisticated Capital measurement Use of standard MCT/MCCSR, and DCAT to meet annual requirements Standard MCT/MCCSR model + DCAT Better use of stress testing Standard model supplemented by EC and EC lite methods Stress testing Full economic capital model Continuous monitoring EC used in capital allocation How would you support for use in an ORSA? Acceptance of regulators should be sought in advance Internal target ratio reflects conservative judgmental assessment of the organization s risk profile Retrospective analysis of past financial results indicates no surprises or problems Qualitative analysis of whether there are indicators of higher risk or risk trending higher Acceptance of regulators should be sought in advance Internal target ratio reflects conservative judgmental assessment of the organization s risk profile Retrospective analysis of past financial results indicates no surprises or problems Qualitative analysis of whether there are indicators of higher risk or risk trending higher Some quantitative challenge of standard model for key risks EC approaches for key risks Internal target ratio reflects assessment of the organization s risks Key risk indicators are used to monitor key risks and risks trends particularly for risks where the standard model is used Model validation and governance where EC models are used Model validation and governance, such as strong internal audit Periodic independent reviews Key risk indicators are used to monitor key risks and risks trends Robust process for identifying and measuring new and emerging risks 2014 KPMG LLP, a Canadian limited liability partnership and the Canadian member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative, a Swiss entity. 20
Regulatory capital minimums and internal target ratios Supervisory Target Capital Ratios are set above the minimum regulatory capital requirement (i.e. rather than just 100%, MCCSR - Tier 1 105%, Total 150%; MCT - Total 150%) to cover the risks specified in the capital tests as well as provide a margin for other types of risks not included in the tests Insurers are expected to set Internal Target Capital Ratios in excess of the Supervisory Target, and to operate above their internal targets Stress testing Supervisory judgments Dynamic Capital Adequacy Testing (DCAT) Strategic and business planning Transparency of public disclosures Budgeting and financial projections Risk appetite decisions Economic capital modeling Rating agency assessments Supervisory Target (150%) Difference enough to cover plausible adverse conditions Internal Target (e.g. 190%) Actual capital level 2014 KPMG LLP, a Canadian limited liability partnership and the Canadian member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative, a Swiss entity. 21
Regulatory capital minimums and internal target ratios Supervisory Target Capital Ratios are set above the minimum regulatory capital requirement (i.e. rather than just 100%, MCCSR - Tier 1 105%, Total 150%; MCT - Total 150%) to cover the risks specified in the capital tests as well as provide a margin for other types of risks not included in the tests Insurers are expected to set Internal Target Capital Ratios in excess of the Supervisory Target, and to operate above their internal targets Expect ORSA to be central to these discussions in future Stress testing Supervisory judgments Dynamic Capital Adequacy Testing (DCAT) Strategic and business planning Transparency of public disclosures Budgeting and financial projections ORSA Risk appetite decisions Economic capital modeling Rating agency assessments Supervisory Target (150%) Difference enough to cover plausible adverse conditions Internal Target (e.g. 190%) Actual capital level 2014 KPMG LLP, a Canadian limited liability partnership and the Canadian member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative, a Swiss entity. 22
Common observed weaknesses and gaps, cont d Improvement in processes for emerging risks needed Insurers generally behind other financial institutions More sophisticated use of scenario and reverse stress testing Consider operational/reputational scenarios Need to develop processes to sustain ORSA - management challenge, validation and verification, and independent reviews Need to develop depth and frequency of board oversight process Most first time respondents will need a development roadmap to outline a plan for closing the gaps shorter time horizon for process and qualitative gaps, and longer (3 years +/-?) for more sophisticated quantitative methods 2014 KPMG LLP, a Canadian limited liability partnership and the Canadian member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative, a Swiss entity. 23
Neil Parkinson Partner National Insurance Sector Leader Tel +1 416-777-3906 nparkinson@kpmg.ca 2014 KPMG LLP, the Canadian member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative, a Swiss entity. The KPMG name, logo and cutting through complexity are registered trademarks or trademarks of KPMG International Cooperative (KPMG International).