Stress Beyond DCAT September 20, 2012 CIA Appointed Actuary Seminar Chris Townsend, FCIA Managing Director P&C Actuarial Division
Agenda Stress OSFI Guideline E-18 Definition Purposes Two types & two dimensions DCAT in the context of E-18 Capital Management A-4 Purpose and process The report Single vs. multiple risks DCAT vs. A-4 Comparison What is next? Page 2 of 13
Stress - Definition A risk management technique Evaluates the potential effects on financial condition Corresponds to exceptional but plausible events Should be embedded in enterprise wide risk management Entity Wide Consistently Business View Comprehensively Product Line Page 3 of 13
A Stress Program Should 1. Aid risk identification and control 2. Provide a complementary risk perspective to other risk management tools 3. Support capital management 4. Improve liquidity management OSFI expects to see evidences that stress testing is integrated into institutions internal risk management process. Page 4 of 13
Stress two types Sensitivity Involves an incremental change in a risk factor (or a limited number of risk factors) Over a short time horizon Scenario A hypothetical future state of the world Changes in a number of risk factors Includes ripple effects, management and regulatory actions Over the time horizon appropriate for the business and risks being tested Page 5 of 13
Stress two dimensions Page 6 of 13
DCAT is between Sensitivity and Scenario Sensitivity Involves an incremental change in a risk factor (or a limited number of risk factors) Over a short time horizon Scenario A hypothetical future state of the world Changes in a number of risk factors Includes ripple effects, management and regulatory actions Over the time horizon appropriate for the business and risks being tested Sensitivity DCAT SEVERITY/COMPLEXITY Scenario Page 7 of 13
DCAT should be complementary to capital planning process Capital Planning Process Other forwardlooking scenarios Dynamic capital adequacy testing (DCAT) Reverseengineered scenarios Page 8 of 13
Capital Planning Process Internal Target (A-4) Based on company s own risk and capital adequacy assessment process Internal Target > 150% Supervisory Target : 150% Absorbs unexpected losses from the risks specified in the capital tests Covers other risks of the insurer as well Provides adequate time for management to resolve financial problems Page 9 of 13
A good Internal Target Report should Include Sufficient Information about - the process - underlying principles - methodologies - key assumptions - overall results Integrate with - risk appetite - strategic and operational plans - capital management framework of the company Enable the board to make an assessment on - the overall result - appropriateness of the internal target Page 10 of 13
A scenario combining risks is often more severe than a single risk scenario 99th 90th Risk A 100 55 Risk B 90 50 Risk A & B 105 Bad things come in threes! Page 11 of 13
DCAT vs. A-4 Level of Event DCAT A-4 Plausible Adverse Scenarios [95-99 percentile] Exceptional but Plausible [likely and higher loss] Type of Scenario Single or Integrated Single or Multiple Ripple effect Yes Maybe Ownership Appointed Actuary The company Recommendations Good Practice Integrated with discussion Opinion Yes No Review Peer Review (E15) Actuarial Function Page 12 of 13
Stay tuned. DCAT will evolve to ORSA Stress Own Risk and Solvency Assessment (ORSA) Capital management A4 DCAT Page 13 of 13