Solvency Assessment and Management: Pillar II - Sub Committee Stress Testing Task Group Discussion Document 88 (v 4) Macro-Prudential Stress Testing

Transcription

1 Solvency Assessment and Management: Pillar II - Sub Committee Stress Testing Task Group Discussion Document 88 (v 4) Macro-Prudential Stress Testing EXECUTIVE SUMMARY 1. INTRODUCTION AND PURPOSE The purpose of the document is to advise and recommend, based on research conducted on other jurisdictions (insurance supervisory authorities) to the Registrar the types of stresstesting and stress-testing governance that should be implemented in South Africa as part of a macro-prudential stress testing programme. In designing and formulating these recommendations the stress testing task group has been asked to consider the key objectives of the Financial Services Board (FSB) and specifically the main purposes of prudential supervision. In essence, stress testing is seen as one of the supervisory tools that assist the Registrar in facilitating pro-active supervision and also addresses the objectives of having sound financial institutions and ensuring systematic stability within the financial sector. In order to address the above objective, the following was considered in formulating the recommendations contained in section 7 below: Stress tests should be focused on both a micro-prudential (insurer and insurance group perspective) and a macro-prudential (system-wide) perspective; Insurer-designed stress tests; and Supervisory prescribed stress tests. The approach taken by the task group to inform the recommendations was to identify a number of international supervisory regimes and establish their respective approaches to stress testing. A summary of the research by jurisdiction is shown in section 5. Section 6 sets out some specific aspects of the South African insurance environment that was considered in formulating the final set of recommendations outlined in section 7. It is important to note that this discussion document is intended to provide the FSB with guidance and recommendations on a stress testing framework. A separate document will be prepared by this task group intended as guidance to smaller insurers on how to conduct stress testing. 2. INTERNATIONAL STANDARDS: IAIS ICPs Over the last number of years the International Association of Insurance Supervisors (IAIS) was involved in a process of refining and modernising its insurance core principles (ICP). The IAIS issued on 1 October 2011 all its ICPs in a single document.

2 Solvency Assessment and Management: Pillar II - Sub Committee Stress Testing Task Group Discussion Document 88 (v 4) Macro-Prudential Stress Testing Under paragraph of this document the stress and scenario testing concept was introduced and highlights the following: The risk management function should establish, implement and maintain appropriate mechanisms and activities to conduct regular stress testing and scenario analyses as defined in ICP 16 Enterprise Risk Management for Solvency Purposes. Paragraph of ICP 16 states that risk limits of an insurer should be set after careful consideration of corporate objectives and circumstances and, where appropriate, should take into account the projected outcomes of scenarios run using a range of plausible future business assumptions which reflect sufficiently adverse scenarios. Paragraph states that the level of risk borne by the insurer should be assessed regularly using appropriate forward-looking quantitative techniques such as risk modelling, stress testing, including reverse stress testing, and scenario analysis. Paragraph Stress testing measures the financial impact of stressing one or relatively few factors affecting the insurer. Scenario analysis considers the impact of a combination of circumstances which may reflect extreme historical scenarios which are analysed in the light of current conditions. Scenario analysis may be conducted deterministically using a range of specified scenarios or stochastically, using models to simulate many possible scenarios, to derive statistical distributions of the results. Reverse stress testing, which identifies scenarios that are most likely to cause an insurer to fail, may also be used to enhance risk management. While some risk of failure is always present, such an approach may help to ensure adequate focus on the management actions that are appropriate to avoid undue risk of business failure. The focus of such reverse stress testing is on appropriate risk management actions rather than the assessment of financial adequacy and so may be largely qualitative in nature although broad assessment of associated financial impacts may help in deciding the appropriate action to take. Paragraph 16.2 states that 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. Paragraph 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. Paragraph 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. Paragraph states for complex investment strategies, aspects to consider include liquidity and responsiveness to sudden market movements. Stress testing, as well as contingency planning for stressed situations, is essential. Supervisors should require the results of the most material risk modelling, stress testing and scenario analysis and the key assumptions underlying them to be reported to them, as appropriate to the nature, scale and complexity of the risks, and have access to all other results if requested. Where a supervisor considers that the calculations conducted by an insurer should be supplemented with additional calculations, it should be able to require the insurer to carry out those additional calculations. Where the supervisor considers that the insurer s response to the results of its risk modelling, stress testing and scenario testing are Page 2 of 19

3 Solvency Assessment and Management: Pillar II - Sub Committee Stress Testing Task Group Discussion Document 88 (v 4) Macro-Prudential Stress Testing insufficient it should be able to direct the insurer to develop a more appropriate response. Supervisors should also consider available reverse stress tests performed by insurers where they wish to satisfy themselves that appropriate action is being taken to manage the risk of business. While insurers should carry out stress testing and scenario analysis and risk modelling that are most appropriate for their businesses, supervisors may also develop prescribed or standard tests and require insurers to perform them when circumstances are appropriate. One purpose of such testing may be to improve consistency of testing among a group of similar insurers. Another purpose may be to assess the financial stability of the insurance sector to economic or market stresses or other stresses that apply to a number of insurers simultaneously, such as pandemics, or major catastrophes. Such tests may be directed at selected insurers or all insurers. The criteria for scenarios used for standard tests should be developed as appropriate to the risk environment of insurers in each jurisdiction. Forward-looking stress testing, scenario analysis and risk modelling of future capital positions and cash flows whether provided by the insurer s own continuity analysis or in response to supervisory requirements is a valuable tool for supervisors in assessing the financial condition of insurers, Such testing informs the discussion between supervisors and insurers on appropriate planning, comparing risk assessments against stress test outcomes, risk management and management actions and enables supervisors to consider the dynamic position of insurers and form a high-level assessment of whether the insurer is adequately capitalised to withstand a range of standardised and bespoke stresses. 3. EU DIRECTIVE ON SOLVENCY II: PRINCIPLES (LEVEL 1) The EU directive does not cover stress testing specifically, beyond providing the regulator with the ability to require stress testing results from an insurer. Based on the task group recommendations, the current draft of the new insurance bill will allow the regulator the ability to require insurers to perform stress testing from time to time. 4. MAPPING ANY PRINCIPLE (LEVEL 1) DIFFERENCES BETWEEN IAIS ICP & EU DIRECTIVE Not applicable. 5. INTERNATIONAL SUPERVISORY APPROACH TO STRESS TESTING The task group identified the following jurisdictions to be considered before formulating recommendations to the FSB: United Kingdom Hong Kong Australia Canada Bermuda Switzerland Page 3 of 19

4 Solvency Assessment and Management: Pillar II - Sub Committee Stress Testing Task Group Discussion Document 88 (v 4) Macro-Prudential Stress Testing As each jurisdictions approach was expected to be different a specific set of questions was formulated to allow more focused research. In particular the following questions were addressed in each case: 1 What the regulator does with this information and whether the stress testing forms part of the capital calculation or not. 2 Number of scenarios to be modelled. 3 Whether stress testing levels are prescribed or left to the company s discretion? If prescribed what is the required levels? 4 Before and after management actions allowable? 5 Whether reverse stress testing is required or not? 6 Frequency of reporting? 7 Point in time stress testing at reporting date only or projected solvency position? 8 Governance around the individual stress testing? 9 Format of stress testing? 10 Group-wide stress testing used? 11 The definition of financial soundness? The approach did not specifically focus on macro-prudential stress tests but incorporated the regulatory approach to micro-prudential stress testing as well. Please see Annexure A for a comparison of the various jurisdictions. 6. ASSESSMENT OF AVAILABLE APPROACHES GIVEN THE SOUTH AFRICAN CONTEXT 6.1 Discussion of inherent advantages and disadvantages of each approach The research indicated that there are broadly 4 approaches taken by regulators. These are: Prescribed scenarios only Prescribed scenarios plus additional scenarios identified by the company (usually the actuary s responsibility) Principle based with no prescribed scenarios and very little guidance. Principle based with no prescribed scenarios and detailed guidance on approach expected. The advantages and disadvantages of each of the approaches are outlined in more detail below. Prescribed scenarios only Page 4 of 19

5 Solvency Assessment and Management: Pillar II - Sub Committee Stress Testing Task Group Discussion Document 88 (v 4) Macro-Prudential Stress Testing Advantages Disadvantages Easy to perform industry wide comparison between companies. Once established by companies, should be easy and quick to perform from period to period. This also implies a lower cost of compliance which will be welcomed by smaller firms. Prescribed scenarios plus additional identified by company May not reflect inherent risk exposure of individual companies. Will only really apply to the average company, or the company profile to which the scenarios were calibrated. New scenarios developing due to market changes or changes in products may not be identified this will be contradictive to riskbased regulation. Advantages Disadvantages Easy to perform industry wide comparison between companies. Once established by companies, should be easy and quick to perform from period to period. Provides additional information on company specific risks. May still not reflect inherent risk exposure of individual companies. Will only really apply to the average company, or the company profile to which the scenarios were calibrated. Will require additional time and resources from the FSB to analyse additional scenarios. The prescribed scenarios will become the basic standard and very little additional scenarios (if any) will be added voluntarily. Principle based with no prescribed scenarios and very little guidance Advantages Disadvantages Consistent with intention of SAM to be principle based. Should be a more appropriate reflection of the risk faced by an individual insurer. As it is principle based, the lack of rules often implies a lack of loopholes. It will inform the regulator of the whole universe of possible risk scenarios. One insurer may identify an important risk scenario that was not identified by its competitors. This will improve the overall coverage of risk scenarios considered by all insurers over time. Will be difficult to compare companies across the industry as they may all select a different set of scenarios. [Potential solution is to request specific scenarios from selected insurers as part of industry stress testing] Will place a strain on the resources and time of the FSB as each submission will require detailed analysis by the FSB. Smaller companies may not have the resources and expertise to define and establish appropriate scenarios. [Potential solution is to issue separate more detailed guidance for smaller insurers] There is very limited guidance which could result in a broad range of potential scenarios from the industry. Principle based with no prescribed scenarios and detailed guidance on approach expected Advantages Disadvantages Consistent with intention of SAM to be Will be difficult to compare companies across Page 5 of 19

6 Solvency Assessment and Management: Pillar II - Sub Committee Stress Testing Task Group Discussion Document 88 (v 4) Macro-Prudential Stress Testing principle based. Should be a more appropriate reflection of the risk faced by an individual insurer. As it is principle based, the lack of rules often implies a lack of loopholes. It will inform the regulator of the whole universe of possible risk scenarios. One insurer may identify an important risk scenario that was not identified by its competitors. This will improve the overall coverage of risk scenarios considered by all insurers over time. Level of consistency achieved by issuing detailed guidance on the principles. the industry as they may all select a different set of scenarios. [Potential solution is to request specific scenarios from selected insurers as part of industry stress testing] Will place a strain on the resources and time of the FSB as each submission will require detailed analysis by the FSB. Smaller companies may not have the resources and expertise to define and establish appropriate scenarios.. [Potential solution is to issue separate more detailed guidance for smaller insurers] A few key features that seems to apply to most of the regulatory approaches are: Management actions are taken into account, however, the results have to be report before and after allowing for management actions. Documentations of scenarios selected and the process of selecting scenarios is required and report to the regulator. In addition to the position at the reporting date, the stress testing is a forward looking exercise over a 3 to 5 year period. 6.2 Impact of the approaches on EU 3 rd country equivalence None of the approaches identified would impact on EU 3 rd country equivalence. 6.3 Comparison of the approaches with the prevailing legislative framework The current legislation allows the FSB to request stress and scenario testing, but is silent on how the FSB should go about it. Currently the FSB requires that large insurers submit results of economic stress tests twice a year, and that all long- and short-term insurers submit results of economic and non-economic stress tests once a year. These stress tests are fully prescribed by the FSB. Any new approach would therefore be in addition to the current legislation. 6.4 Conclusions on preferred approach Based on the research preformed the task group recommends the following approaches be adopted by the FSB in respect of stress and scenario testing: Macro-prudential (system-wide) stress testing It will be difficult to pre-define industry wide stress testing to be performed by the FSB that will be valid for an extended period of time. The systemic and industry wide risks that would interest the FSB would change over time and be informed, amongst other things, by the following: Information provided by individual companies as part of the ORSA submissions; The current state and future outlook of the local and global economy; and, Developments in the insurance industry. Page 6 of 19

7 Solvency Assessment and Management: Pillar II - Sub Committee Stress Testing Task Group Discussion Document 88 (v 4) Macro-Prudential Stress Testing The proposal is that the FSB task an internal committee (or similar task group as this one) to collate the information from the above sources to develop specific stress testing requirements from time to time. These requirements would include: Specific level and types of stresses to be performed. Information requirements to allow the stress testing to be performed. As the industry stress testing will allow the FSB to be proactive, it is important that a person (or department) within the FSB be given responsibility to monitor the information on a regular basis and initiate the development of updated stress testing requirements when new risks are identified. Micro-prudential stress testing The task group recommends that a principle based approach be followed with no prescribed scenarios. This is consistent with the requirement to conduct an ORSA, which includes requirements pertaining to stress testing. Detailed principles and guidance on these principles may be provided to the industry to inform companies as to how to go about performing stress and scenario testing. Way forward In terms of micro-prudential stress testing, the stress-testing Task Group will continue developing guidance for insurers as to how to conduct stress tests as part of their ORSA processes. In terms of macro-prudential stress testing, the FSB will need to develop an internal process pertaining to system-wide stress tests to be conducted. This should take cognisance of the stress-tested nature of the SCR, and avoid repetition of these calculations. Page 7 of 19

8 Annexure A: Stress Testing across Jurisdictions questions posed by the ST Task Group 1. What the regulator does with this information and whether the stress testing forms part of the capital calculation or not. (EIOPA = EIOPA stress testing, SST = Swiss Solvency Test) In carrying out the stress tests and scenario analyses, the firm must estimate the financial resources that it would need in order to continue to meet the overall financial adequacy rule (i.e. a firm must at all times maintain overall financial resources, including capital resources and liquidity resources) and the CRR (i.e. SCR) in the adverse circumstances being considered. Stress and scenario testing does not form part of the standard capital calculation. An annual solvency testing investigation must be performed and the results submitted in writing to the Insurer s Board of Directors. The stress testing investigations is set out in an Actuarial Guidance Note issued by the Actuarial Society of Hong Kong and it s unclear whether the results are submitted to the regulator. The stress testing is not part of the capital calculation. Does not form part of the capital calculation - but rather used to assess the capital calculation Regulator makes use of Risk Registers (through stress testing) as a compare and contrast function to confidently identify areas in which the institution they supervise is an outlier. The Office of the Superintendent of Financial Institutions (OSFI) uses the results of the stress testing programs as important information and integrates the results into its assessment of the inherent risks and risk controls and oversight of institutions business activities. Stress testing is used to support capital management, where rigorous, forwardlooking stress testing can identify severe events including a series of compounding events or changes in market conditions that could adversely affect the institution. The risk-based capital model (standard or internal) of an insurer should be supplemented by the stress and scenario testing in order to assess their potential vulnerability to defined extreme events. Where the results of scenario and stresstesting indicated potential capital vulnerability, the Bermuda Monetary Authority (BMA) would be able to require a higher solvency cushion. EIOPA: Not part of Capital calculation. Aim is to receive information on the current vulnerability of the EU insurance sector to adverse developments. SST: Forms part of the risk based solvency capital requirement calculation

9 2. Number of scenarios to be modelled. No minimum number of scenarios is specified. However, a firm must carry out stress tests and scenario analyses for the major sources of risk identified in accordance with GENPRU R. Basically, this means that the following should be considered: A firm must at all times maintain overall financial resources to ensure that there is no significant risk that its liabilities cannot be met as they fall due. credit risk; market risk; liquidity risk; operational risk; insurance risk; concentration risk; residual risk; securitisation risk; business risk; interest rate risk; pension obligation risk ; and group risk Base scenario plus 6 prescribed scenarios plus any further plausible scenarios identified by the actuary. The actuary should also consider integrated scenarios (combining different scenarios) and ripple effects of stressing one assumption on other assumptions and potential responses by the regulator, the policyholder and the insurer The Australian Prudential Regulation Authority (APRA) does not prescribe the number of scenarios to be modelled. Some of the areas that have been subject to stress testing by APRA: declining equity and asset prices widening credit spreads increased market volatility on the capital position Pandemics Catastrophe stresses OSFI does not prescribe the number of scenarios to model. The insurers are expected to have a base scenario that is consistent with the insurer s business plan and a number of plausible adverse scenarios. These should include non-historical scenarios. These adverse scenarios should cover: Basic risks Select those that are relevant for the company. For example, P&C claim frequency and severity risks, premium risks. Life mortality, morbidity and reinsurance risk. Test ripple effects Impact on other base assumptions. Integrated scenarios Combination of risk, usually if the probability of an adverse scenario is high. The following categories of scenarios were prescribed: Economic Scenarios (3 scenarios) Underwriting Loss Scenarios (6 scenarios where applicable) (Re)insurer Specific Scenario (1 qualitative scenario) Worst-Case Annual Aggregate Loss Scenario (1 scenario) Catastrophe Loss Event Analysis (1 scenario) Terrorism (1 scenario) Three Other Scenarios (where none or only some of the Underwriting Loss Scenarios apply to the (re)insurer) EIOPA: 3 main scenarios (baseline stress, adverse stress, inflation stress) SST: The paper gives 14 adverse scenarios are prescribed and that the appointed actuary should define scenarios that reflect the insurer s specific exposures

10 3. Whether stress testing levels are prescribed or left to the company s discretion? If prescribed what is the required levels? Stress testing levels are not prescribed. However, in carrying out the stress tests and scenario analyses, a firm must identify an appropriate range of adverse circumstances of varying nature, severity and duration relevant to its business and risk profile and consider the exposure of the firm to those circumstances, including: circumstances and events occurring over a protracted period of time; sudden and severe events, such as market shocks or other similar events; and some combination of the circumstances and events described in (a) and (b), which may include a sudden and severe market event followed by an economic recession. 6 prescribed scenarios: 15% increase in mortality rates for life, morbidity rates and incidence rates for disability, accident and sickness; 15% decrease in mortality rates for annuities 5% absolute addition or subtraction from lapse rates determined in such a way as to achieve adverse result at product level Interest rates down 15% relative; equity and property drop of 25% over 3 year period Interest rates up 30% relative; equity and property drop of 25% over 3 year period High growth in new business volumes of min(30%; 150% of base assumption) Low growth with year 1 sales 80% of current year, followed by 20% drop for each of the next 2 years. No expense savings can be assumed APRA already expects insurers to have in place a process to assess their capital needs and manage their capital levels. ICAAP (Individual Capital Adequacy Assessment Process) formalises those requirements. In particular, they want insurers to assess their own risk profile and the capital needed to support the risks they undertake, and to carry out appropriate capital projections and stress testing On occasions in the past, APRA has requested insurers to conduct stress tests on their business, based on parameters specified by APRA. Stress testing levels are not prescribed. Companies are required to test a range of severities, including events capable of generating the most damage, whether through size of loss or through loss of reputation. Prescribed. See the document 2010 STRESS/SCENARIO TESTS CLASS 4 AND CLASS 3B (RE)INSURERS issued by the BMA. EIOPA: Levels prescribed (see Annex 2 below) SST: Financial distress scenario: equity drop by 30%, downgrade to sub investment grade (if company is rated), new business -75%, lapse = 25%. Reserve scenario: 10% increase in claims provisions

11 4. Before and after management actions allowable? The regulations do not explicitly state whether the stress testing is before or after management actions. However, since it is stated that the firm must estimate the financial resources that it would need in order to continue to meet the overall financial adequacy rule and the CRR in the adverse circumstances being considered, it is implied that one has to take into account management actions. The actuary may make allowance for the Insurer s expected response to adversity if the Insurer can prove practicality and credibility of such responses. The actuary needs to include details of such responses in the report. Not addressed by APRA Yes, management action is allowed. However, there is a specific requirement to take into account constraints on management action due to the stressed scenario. As such undue reliance should not be place on the timeliness of mitigating actions. Not specified. EIOPA: Management actions generally not allowed. Where used, report both before and after positions. SST: Not mentioned

12 5. Whether reverse stress testing is required or not? UK HONG KONG AUS CANADA BERMUDA SWITZERLAND Reverse stress testing is required but does not form part of the standard capital calculation. Reverse stress testing should be performed at least annually. Also, a firm must update its reverse stress test more frequently if it is appropriate to do so in the light of substantial changes in the market or in macroeconomic conditions. The design and results of a firm's reverse stress test must be documented and reviewed and approved by the firm's senior management or governing body. The regulator may request a firm to quantify the level of financial resources which, in the firm's view, would place it in a situation of business failure should the identified adverse circumstances crystallise. Where reverse stress testing reveals that a firm's risk of business failure is unacceptably high, the firm should devise realistic measures to prevent or mitigate the risk of business failure. Reverse stress testing is recommended as a tool to determine material risk and sensitivity to different assumptions. Yes Yes, reverse stress testing is required. These are defined as scenarios that could challenge the viability of the institution. Not Specified. EIOPA: Not required SST: Not mentioned In the light of the results of a firm's reverse stress tests, the FSA may require the firm to implement specific measures to prevent or mitigate the risk of business failure where that risk is not sufficiently mitigated by the measures adopted by the firm in accordance with SYSC R, and the firm's potential failure poses an unacceptable risk to the FSA's statutory objectives. No minimum number of scenarios is specified nor is the format of the reverse stress testing prescribed. However, a firm should at least take into account each of the sources of risk identified in accordance with GENPRU (see previous section for the requirements of GENPRU ). A reverse stress test is by definition a stress that tests the business plan to failure. To that end, the firm must identify a range of adverse circumstances which would cause its business plan to become unviable and assess the likelihood that such events could crystallise. ) Business plan failure in the context of reverse stress testing should be understood as the point at which the market loses confidence in a firm and this results in the firm no longer being able to carry out its business activities. Where tests reveal a risk of business failure that is unacceptably high when considered against the firm's risk appetite or tolerance, the firm must adopt effective arrangements, processes, systems or other measures to prevent or mitigate that risk.

13 6. Frequency of reporting? Stress tests and scenario analyses should be carried out at least annually. Annually; interim investigations must be performed if there is a material adverse change in the Insurer s circumstances. No concrete information can be obtained but it is implied that stress testing be undertaken on an annual basis. Annual reports need to be submitted to the regulator. The annual DCAT (Dynamic Capital Adequacy Testing) should be submitted to OSFI within 30 days of its presentation to the board. Initially the DCAT was required within 6 months of the year-end, however, this requirement was changed to say that the DCAT should be integrated with the business planning process. The DCAT is equivalent to the ORSA requirement contained in SAM. Annual. EIOPA: Once off for now (this is precursor of regulations to follow) SST: The stated stress were only for a field test

14 7. Point in time stress testing at reporting date only or projected solvency position? Extends to both point in time and projected solvency. A firm must identify an appropriate range of adverse circumstances of varying nature, severity and duration relevant to its business and risk profile and consider the exposure of the firm to those circumstances, including: Projected solvency position over period of 3 years; 5 years if there are reasonable indications that a solvency problem will occur after 3 years. Mention is made of a three year forecast period. Requires both point in time and forward looking stress testing. Forecast period is 5 years for Life insurers and usually 3 years for General insurers (minimum requirement of 2 years). At reporting date. EIOPA: Point in time SST: Point in time circumstances and events occurring over a protracted period of time; sudden and severe events, such as market shocks or other similar events; and some combination of the circumstances and events described in (1) and (2), which may include a sudden and severe market event followed by an economic recession.

15 8. Governance around the individual stress testing? A firm must make a written record of the stress and scenario testing records. The solvency tests are performed by the Actuary/Actuarial department; followed by discussions of the results with senior management before submission. The report must be submitted within six months of financial year-end. The report must include an opinion on the financial condition of the Insurer signed by the Actuary No Formal Guidance can be found The following principles should be adhered to: Have written policies and procedures governing the stress testing program. Program should be appropriately documented. Infrastructure should be sufficiently robust and flexible to accommodate different and possibly changing stress test at an appropriate level of granularity. Regularly maintain and update stress testing framework. This should involve regular and independent assessments of the effectiveness of the stress testing program and the robustness of individual components. This assessment should be both qualitative as well as quantitative. TBC EIOPA: Not mentioned SST: Not mentioned It is expected that both risk management and internal audit play a key role in the review of the stress testing framework. It is accepted that internal audit would be in a position to perform an independent review of the adequacy of the design and effectiveness of the operations of the stress testing program.

16 9. Format of stress testing? Not specified. The report to Board of Directors is recommended to be interpretative rather than statistical. The report must include recommended actions for dealing with threats to solvency identified. APRA already expects insurers to have in place a process to assess their capital needs and manage their capital levels. ICAAP formalises those requirements. In particular, they want insurers to assess their own risk profile and the capital needed to support the risks they undertake, and to carry out appropriate capital projections and stress testing Part of the DCAT report. Not aware of additional stress testing required by OSFI, but still need to investigate this further. Stress testing to be done on one of three vendor models to assist the BMA with comparability. However, the (re)insurer should inform the BMA if stress testing was performed using own internal model. EIOPA: Excel template completed SST: Excel template completed Have not been able to find a specific document from APRA setting out guidelines for stress testing for Life and General Insurers.

17 10. Group-wide stress testing used? Yes Not specified No reference to stress testing, only capital adequacy and risk management. GPS 111 Capital Adequacy: Level 2 Insurance Groups GPS 221 Risk Management: Level 2 Insurance Groups (effective until 30 June 2012) GPS 221 Risk Management: Level 2 Insurance Groups (effective from 1 July 2012) Applied on a group wide basis. Not specified EIOPA: The market coverage (ie who must participate) was calculated based on gross written premiums by solo undertakings. However, there was not necessarily a need for each undertaking identified by the national supervisors to carry out a separate stress test. The stress test was conducted on the highest level of insurance consolidation within the European Union or EEA. This means that for the purpose of this exercise, solo undertakings part of groups which are participating in the stress test exercise, did not have to submit individual stress test results (but the group had to). GPS 311 Audit and Actuarial Reporting and Valuation: Level 2 Insurance Groups SST: The SST has to be done both on a legal-entity level and on a group-level. Thus scenario testing is done at group level as well.

18 11. The definition of financial soundness? GENPRU : A firm must at all times maintain overall financial resources, including capital resources and liquidity resources, which are adequate, both as to amount and quality, to ensure that there is no significant risk that its liabilities cannot be met as they fall due. That the assets exceed the liabilities and that the minimum regulatory capital requirement is met. By APRA: The primary responsibility for financial safety and soundness within an institution rests with its board of directors and senior management. APRA s approach is to ensure that boards and managers understand these responsibilities. Financial soundness and stability of the authorized deposit taking institution is ensured by providing continued assurance that it will honour its obligations to depositors and creditors. By RBA: The Reserve Bank of Australia has a general and longstanding responsibility for safeguarding the stability of the Australian financial system. In broad terms, financial system stability equates to smoothly functioning financial markets and the absence of financial disturbances that may threaten the health of the economy more broadly. The RBA can use its balance sheet to support a sound financial institution facing liquidity difficulties, should system stability be at risk. Capital Targets Adequacy Actuarial standard for satisfactory opinion: Meet minimum regulatory capital requirement under the base scenario Meet all future obligations under the base scenario and all plausible adverse scenarios Regulatory capital requirement: P&C companies are required, at a minimum, to maintain an MCT ratio of 100% Regulator expects each institution to establish a target capital level, and maintain ongoing capital, at no less than the supervisory target of 150% Regulator encourages active discussions amongst the actuary, board and management of any scenarios where minimum capital is not met As per the Minimum Solvency Margins as set out in the Insurance Returns and Solvency Regulations 1980 (amended). EIOPA: Financial Soundness is defined in terms of level of own funds (i.e. available capital) before and after the stress test compared with the Minimum Capital Requirement (MCR) in Solvency II. The Solvency II MCR was used as a benchmark which is consistent with the aim of the stress test as it is deemed to be the ultimate intervention threshold for regulatory purposes whereas a breach of the SCR allows for a more flexible approach. Swiss groups were assessed based on Swiss Solvency Test requirements. Swiss insurance groups calculated their equivalent of the MCR (e.g. Threshold 3 in Circular 2008/44 SST). The direct output of the stress test was the reduction in available own funds after stress test shocks (scenarios), i.e. own funds as of end-2010 minus the change in own funds after the scenario. This was compared to the MCR. Participants could recalculate the MCR level after the shock in each scenario, as this would have represented their solvency position more appropriately. However, for simplicity reasons, the pre-stress MCR was the default numerator (i.e. in line with the best effort basis participants could opt for leaving the MCR unchanged post stress). SST: Insurers must calculate two capital numbers: Minimum solvency (statutory) is based on the statutory balance sheet. It is easy to calculate but does not reflect directly the insurer s specific risk exposures. Target capital (market-consistent), conversely, is risk-based and grounded in a market-consistent assessment. Target capital is considered as an early warning signal. While it is risk specific, it is also model dependent. If target capital conditions are not met, the company is not insolvent but gradual regulatory measures are initiated.

19 Solvency Assessment and Management: Pillar II - Sub Committee Stress Testing Task Group Discussion Document 88 (v 4) Macro-Prudential Stress Testing Page 19 of 19