CEIOPS Seminar on Solvency II. Using Internal Models to determine the SCR

Similar documents
Risk Based Capital Solvency 2

SOLVENCY II Level 2 Implementing Measures

An Introduction to Solvency II

Solvency II Interpreting the key principles

The Society of Actuaries in Ireland

Solvency Assessment and Management: Pillar 2 - Sub Committee ORSA and Use Test Task Group Discussion Document 35 (v 3) Use Test

Solvency II. Insurance and Pensions Unit, European Commission

Actuaries and the Regulatory Environment. Role of the Actuary in the Solvency II framework

Solvency II Insights for North American Insurers. CAS Centennial Meeting Damon Paisley Bill VonSeggern November 10, 2014

29th India Fellowship Seminar

Webinar. The Gibraltar Financial Services Commission. Solvency II Implications for Non-Executive Directors (NEDs) 28 th May 2015

Karel VAN HULLE. Head of Unit, Insurance and Pensions, DG Markt, European Commission

The Solvency II project and the work of CEIOPS

Solvency II Detailed guidance notes for dry run process. March 2010

Defining the Internal Model for Risk & Capital Management under the Solvency II Directive

THE INSURANCE BUSINESS (SOLVENCY) RULES 2015

The valuation of insurance liabilities under Solvency 2

CEA proposed amendments, April 2008

Final input from the Groupe Consultatif in regard to the development of Level 3 guidance on the Own Risk and Solvency Assessment (ORSA)

Current status of Solvency II and challenges down the line. Matthew Edwards 11 October 2011

Vice President and Chief Actuary CLHIA

Solvency II, messages and findings from QIS 5. Carlos Montalvo Rebuelta Executive Director Brussels, 7 March 2011

Solvency Assessment and Management: Steering Committee Position Paper (v 4) Life SCR - Retrenchment Risk

It is our understanding that an intercompany loan should be treated as a financial instrument and subject to market stresses as appropriate.

Statement of Guidance for Licensees seeking approval to use an Internal Capital Model ( ICM ) to calculate the Prescribed Capital Requirement ( PCR )

1. INTRODUCTION AND PURPOSE

Guideline. Own Risk and Solvency Assessment. Category: Sound Business and Financial Practices. No: E-19 Date: November 2015

Actuarial Roles under the Solvency II Framework Dr. Huijuan Liu

ALM in a Solvency II World. Craig McCulloch

INSURANCE CORE PRINCIPLES, STANDARDS, GUIDANCE AND ASSESSMENT METHODOLOGY

Society of Actuaries in Ireland Solvency II for Beginners. Mike Frazer. 19 May 2011

Lloyd s Minimum Standards MS13 Modelling, Design and Implementation

INTERNATIONAL ASSOCIATION OF INSURANCE SUPERVISORS

Solvency Assessment and Management: Steering Committee Position Paper (v 3) Loss-absorbing capacity of deferred taxes

[ALL FACTORS USED IN THIS DOCUMENT ARE ILLUSTRATIVE AND DO NOT PRE-EMPT A SEPARATE DISCUSSION ON CALIBRATION]

Guidance paper on the use of internal models for risk and capital management purposes by insurers

INTERNAL CAPITAL ADEQUACY ASSESSMENT PROCESS GUIDELINE. Nepal Rastra Bank Bank Supervision Department. August 2012 (updated July 2013)

Solvency II. New Rules in Europe for the Insurance Industry. Lecture at UConn Law, January 28, 2013

EIOPA Proposal for Guidelines on the preparation for Solvency II. October Milliman Solvency II Update

Solvency II implementation measures CEIOPS advice Third set November AMICE core messages

Solvency Monitoring and

Solvency II: Implementation Challenges & Experiences Learned

INTERNATIONAL ASSOCIATION OF INSURANCE SUPERVISORS

CEIOPS-DOC-61/10 January Former Consultation Paper 65

Life under Solvency II Be prepared!

Discussion Document 105 (v 3) was approved as a Position Paper by Steering Committee on 12 September

IAIS: Enterprise Risk Management for Capital Adequacy & Solvency Purposes. George Brady. IAIS Deputy Secretary General

2.1 Pursuant to article 18D of the Act, an authorised undertaking shall, except where otherwise provided for, value:

Solvency II. Building an internal model in the Solvency II context. Montreal September 2010

Hot Topic: Understanding the implications of QIS5

Position Paper. The Role of the Actuary in Solvency II: Managing Financial Risks

CEIOPS-DOC January 2010

Solvency II overview

Challenges in developing internal models for Solvency II

RESERVE BANK OF MALAWI

Solvency Assessment and Management: Stress Testing Task Group Discussion Document 96 (v 3) General Stress Testing Guidance for Insurance Companies

Solvency II Standard Formula: Consideration of non-life reinsurance

Solvency Assessment and Management (SAM)

BERMUDA MONETARY AUTHORITY INSURANCE DEPARTMENT GUIDANCE NOTE #14 INSURANCE ACTIVITY

Guideline. Capital Adequacy Requirements (CAR) Chapter 8 Operational Risk. Effective Date: November 2016 / January

Guidance Note: Internal Capital Adequacy Assessment Process (ICAAP) Credit Unions with Total Assets Greater than $1 Billion.

Practical Uses of Local Reporting in Taiwan. Kitty Ching 金肖雲 VP, Actuarial Risk Management

Results of the QIS5 Report Short Version

Solvency and financial condition report 2017

Solvency II Update. Latest developments and industry challenges (Session 10) Réjean Besner

FRBSF ECONOMIC LETTER

SOLVENCY ASSESSMENT AND MANAGEMENT (SAM) FRAMEWORK

'SOLVENCY II': Frequently Asked Questions (FAQs)

Feedback on Solvency II Draft Directive

January CNB opinion on Commission consultation document on Solvency II implementing measures

CAPTIVE BEST PRACTICE GUIDELINES

PRA Solvency II update James Orr. 29 April 2015

GUIDELINES FOR THE INTERNAL CAPITAL ADEQUACY ASSESSMENT PROCESS FOR LICENSEES

BERMUDA MONETARY AUTHORITY DISCUSSION PAPER ON THE OWN RISK AND SOLVENCY ASSESSMENT PROCESS

Capital Adequacy and Supervisory Assessment of Solvency Position

ORSA An International Development

Tools for testing the Solvency Capital Requirement for life insurance. Mariarosaria Coppola 1, Valeria D Amato 2

WHITE PAPER. Solvency II Compliance and beyond: Title The essential steps for insurance firms

Agile Capital Modelling. Contents

Lessons from the ICAS regime for UK insurers

Final Report. Guidelines on the management of interest rate risk arising from non-trading book activities EBA/GL/2018/02.

ENTERPRISE RISK MANAGEMENT, INTERNAL MODELS AND OPERATIONAL RISK FOR LIFE INSURERS DISCUSSION PAPER DP14-09

Framework for a New Standard Approach to Setting Capital Requirements. Joint Committee of OSFI, AMF, and Assuris

Solvency Assessment and Management: Steering Committee Position Paper 34 1 (v 5) Own Risk and Solvency Assessment

The Challenges of Solvency II

We referred to ICP 20 which deals with public disclosures and is therefore directly comparable to the SFCR.

Assessing the Appropriateness of the Standard Formula Survey Results August 2015

GUIDELINE ON ENTERPRISE RISK MANAGEMENT

Guidance on the Actuarial Function MARCH 2018

Prudential Standard GOI 3 Risk Management and Internal Controls for Insurers

Hong Kong RBC First Quantitative Impact Study

Solvency II dragging Australia into Europe once again

NAIC OWN RISK AND SOLVENCY ASSESSMENT (ORSA) GUIDANCE MANUAL

Consultation Paper CP20/16 Solvency II: consolidation of Directors letters

PREMIER UNDERWRITING HOLDINGS (GIBRALTAR) LIMITED PREMIER INSURANCE COMPANY LIMITED

The fourth quantitative impact study of new regulation in the insurance sector 1 Peter Paluš, Andrea Gondová

A (personal) view. Philip Whittingham, European Chief Enterprise Risk Officer. 22 March 2010

Swiss Re Portfolio Partners S.A. Solvency and Financial Condition Report

Solvency Assessment and Management (SAM) Roadmap

Link between Pillar 1 and Pillar 2

Transcription:

Seminar on Solvency II Using Internal Models to determine the SCR Paul Sharma Internal Models Expert Group Chair Bucharest, 13 June 2008 1

Outline Background Solvency Capital Requirement (SCR) principles Standard formula Internal models What is an internal model? What is the purpose of an internal model? What are the expected benefits? Approval process: the regulatory perspective Calibration using a third party vendor model Lessons from the CRD/Basel II Conclusions Questions Page 2

Adequacy of Financial Resources Free assets SCR Assets covering technical provisions, MCR and SCR assets MCR Risk margin Best estimate for non-hedgeable - risk components Technical provisions Market consistent valuation for hedgeable risk components Page 3

Solvency Capital Requirement (SCR) (Cfa 10.2) The SCR should deliver a level of capital that enables an insurance undertaking to absorb significant unforeseen losses over a specified time horizon and gives reasonable assurance to policyholders that payments will be made as they fall due Page 4

SCR: proposed principles Derived using either an approved internal model or a standard formula Partial internal model Full internal model Standard formula 99.5% confidence level over 1 year As a minimum to cover insurance, market, credit and operational risks Part of supervisory review process (SRP) Page 5

Pillar 1 SCR (std. formula) SCR BSCR SCRop SCRnl SCRmkt SCRdef SCRhealth SCRlife NLpr MKTeq LIFElapse LIFEmort NLcat MKTsp MKTconc LIFEexp LIFElong MKTint LIFEdis LIFEcat MKTprop MKTfx Health LT = Health ST Health WC = adjustment for the risk -mitigating effect of future profit sharing Page 6

What is an internal model? What is the purpose of an internal model? What is an internal model? A risk management system developed by an insurer to analyse the overall risk position, to quantify risks and to determine the economic capital required to meet those risks Solvency II Glossary (CEA/GC) What is the purpose of an internal model? To fully integrate processes of risk and capital management within the insurer Page 7

Internal Models Framework use test internal model (in the wider risk management sense) actions / steering internal risk control functions reporting / monitoring SCR (regulatory capital) Pillar-2 adjustment actuarial model (in the narrow sense) risk exposure data forecasts for P&L distributions SCR estimate adjusted SCR statistical quality test risk driver data myth1: main use is regulatory -> internal use more important myth2: main goal is computation of SCR -> SCR/EC = airbag : just one aspect of car safety myth3: one risk measure -> distributions & several risk measures/metrics for reporting calibration test Page 8

What are the expected benefits? Improved risk sensitivity of SCR related to the insurer s specific profile leading to a more adequate modelling of non-standard, especially non-linear, contracts, Better alignment of regulatory capital requirements with economic capital Encouragement of innovation in risk management methodology leading to higher competitiveness through better risk management and hence lower costs of capital, Page 9

What are the expected benefits? More effective pillar 2 discussion and familiarity of the supervisor with more detailed exposure data than is generally available in accounting records, Cost efficiencies through re-use of risk modelling infrastructure for discussion with supervisors, rating agencies, analysts and shareholders. Page 10

Approval process Formal application Documentary evidence that requirements are met (art. 118.3) The administrative or management bodies have overall responsibility for application role of internal committees (art.114.1) Systems must be in place to ensure internal model operates properly on a continuous basis (art 114.2) Supervisors have six month to grant approval (art. 118.4) reason for rejection must be provided (art. 118.6) Requirement to run standard approach in parallel for two years (art. 118.7) Page 11

Full Internal models Insurers must satisfy: Use test Statistical quality standards Calibration standards Validation standards Profit and Loss Attribution Documentation standards Use of external vendor models does not exempt insurers from any of the standards Page 12

Use test requirements (art. 118) Use test: process by which the internal model is assessed by the insurer in terms of its application within the undertaking s risk management processes Internal model must be central to: risk management and decision-making economic and solvency capital assessment system of governance Must be fully embedded in the operational and organisational structure of the insurer Demonstrate that the model remains useful and is applied consistently over time Board take full responsibility for model's use and validation Page 13

Statistical quality test requirements (art. 119) Probability distribution forecast: based on sound actuarial/ statistical techniques current, credible info/ realistic assumptions broadly consistent with approach to technical provisions assumptions justified by firms data appropriate and accurate No particular method, provided IM meets criteria of use test All material risks to be covered, including all those addressed in Standard Formula Page 14

Statistical quality test requirements Diversification approach to be sound and implemented with integrity Allowance for risk mitigation permitted provided counterparty credit risk and other risks arising reflected in internal model Financial guarantees or options to be modelled where material Management actions can be modelled provided firm reasonably expect to carry out in specific circumstances allowance for time to carry out management actions and obligations to policyholders (with regard to policyholder s reasonable expectations) Page 15

Calibration test requirements (art. 120) Where feasible, use VaR at 99.5% over 1 year confidence level Different risk measure/ time horizon permitted provided policyholders protection equivalent to Standard Formula i.e. 99.5% over 1 year, VaR Approximations permitted where firm demonstrates approach provides equivalent protection Supervisors may compare an insurer s internal model with industry benchmarks to verify specification meets market practice Page 16

Validation The undertaking has a primary responsibility for validation Validation is an iterative process There is no single validation method Validation should encompass both quantitative and qualitative elements Validation should be subject to independent review Page 17

Validation standards (art. 122) Regular cycle of model validation shall include: Monitoring the performance of the model Reviewing the ongoing appropriateness of its specification Testing its results against experience Analysis of stability of the model Testing the sensitivity of the results to changes in key underlying assumptions Assessment of the accuracy, completeness and appropriateness of data used by the internal model Page 18

Profit & Loss Attribution (art. 121) Analysis of profit and loss by cause/source for each major business unit, at least annually Demonstrate how categorisation of risk chosen explains the causes/sources of P&L Page 19

Documentation (art. 123) It must be thorough, detailed and complete enough to allow third parties to replicate the internal model It shall provide a detailed outline of: The theory Assumptions Mathematical and empirical basis underlying the model It is a crucial tool for the firm to demonstrate the supervisor that the undertaking really understands and has mastered the internal model it is using It shall indicate any circumstances under which the internal model does not work effectively (weaknesses) It must be revisited and, if necessary, updated in line with the complexity and stability of the risk profile of the insurer Page 20

Partial internal models Insurance and reinsurance undertakings may use them for the calculation of one or more: risk modules or sub-modules of the SCR operational risk adj. for the loss-absorbing capacity of TPs and deferred taxes In addition to: the whole business of insurance and reinsurance undertakings, or only one or major business unites Approval subject to the same requirements as full IM, plus additional conditions: Reason for the limited scope of application IM SCR reflects more appropriately the risk profile of the undertaking Page 21

Calibration using a third party vendor model (art. 124) Supervisors do not approve the model per se, but the use of the model!!!! Firms must be able to document and explain the role of vendor products and the extent to which they are used within their internal processes Firms must be able to demonstrate a thorough understanding of vendor products used in their internal processes Vendor products should be appropriate to the nature, scale and complexity of the risks incorporated within the firm s risk strategy and business objectives Firms must have clearly articulated strategies for regularly reviewing the performance of vendor model results and the integrity of external data used in their risk quantification process Page 22

Lessons from the CRD/Basel II Banks typically took longer than three years to implement the CRD/Basel II The length of Insurance liabilities can be much greater and data collection may take many years Data collection should be started as soon as possible so that embedded models are ready when Solvency II is implemented due to back testing, calibration and user test requirements Most of the CRD/Basel II expenditure was around the IT systems to capture the data Page 23

Lessons from the CRD/Basel II Banks were used to building models. However their models: were typically used for management purposes and not for capital purposes had not always been reviewed or subject to independent challenge Documentation issues Governance issues and commitment of Senior Management Competitive pressures Pricing Institutional investors and rating agencies Page 24

Summary Internal models are not only for large and sophisticated firms. However, the CRD/Basel II experience has shown that to develop and maintain an internal model four main conditions need to be satisfied: Good understanding of the business Commitment of senior management Knowledge, expertise to create and maintain model Good, deep and rich data sets Page 25

Questions?? Page 26