The Actuarial Society of Hong Kong Implementing ERM, Solvency II and Capital

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1 The Actuarial Society of Hong Kong Implementing ERM, Solvency II and Capital Eberhard Mueller, Chief Risk Officer 6 th May, 2013

2 Overview Risk and governance the pillar II requirements Organisational requirements Basic documents / Strategic framework Communication and enforcement Capital requirements Internal Model vs. Standard Formula Global Reinsurer vs. Life Insurer Impact of reinsurance 2

3 Solvency II - More than "just" new capital requirements Solvency II - The three pillars Capital and Resources Risk and Control Reporting and Transparency Solvency / minimum capital requirement (SCR/MCR) Available financial resources Standard and internal model Internal controls and risk management Internal risk assessment Supervisory activities Supervisory reporting Public disclosure Market discipline 3

4 Risk Management requirements (MaRisk) Solvency II Supervisory Framework (effective 2016/7?) Insurance Supervision Act (VAG) Qualitative Requirements based on Pillar II (Risk Reporting and sound management) (effective since / transition period until ) Minimum requirements on risk management (MaRisk) Overarching set of qualitative requirements based on VAG (effective from 3/2009) Strategic principles Enterprise Risk Management Risk Management Framework 4

5 German MaRisk (VA): Separation of tasks required German "advanced" Pillar II introduction: MaRisk1) Minimum requirements for the risk management of insurance undertakings Valid from 2009 Principle based requirements Strategic Framework Organisational Framework Internal Steering and Control System: ISCS2) Organisational Framework: Clear separation required between: Units responsible for "creating and reporting profits and losses" Underwriting Accounting Independent risk controlling function Quantitative Risk Management Qualitative Risk Management Process independent internal auditing 5

6 General structure Board Overall responsibility of the board Supported by steering Unit Risk Committee supported by Controlling et.al. Businesssegment RISK CRO (Risk Mgmt.) et.al.. "controls" Steering / P&L responsibility (incl. controls within processes) "monitors" Risk monitoring (independent risk control function within processes) Process independent control (on behalf of board) Auditing 6

7 Centralized Group Risk Management CEO (Chair) CFO COO Life COO Non-Life CRO Chief Controller Chief Auditor (guest) Executive Board Group Risk Committee RC Risk hierarchy 1. Reserving risk 2. Exposure risk 3. Mispricing risk 4. Asset risk 5. Operational risks Group Risk Management headed by Chief Risk Officer Quantitative risk management (DFA-Model) Qualitative risk management (Risk Cockpit) Group Auditing Internal control system 7

8 The "Blue" and the "Yellow"... Segregation of Tasks (MaRisk) compatible with "Lines of Defence" Board Risktaker First line of defence Second line of defence Independent Risk-Controlling Function (IRCF) Third line of defence Internal Audit 8

9 Functions according to Solvency II Framework Guideline... Actuarial Function in both "lines of defence" Board Risktaker e.g. Pricing Actuarial Function e.g. Reserving Independent Risk-Controlling Function (URCF) Internal Audit 9

10 Level 2 Implementing Measures (Draft): 4 Functions!!!... Risk Management, Actuarial, Compliance and Audit Function 10

11 BUT: Segregation of 4 functions!... Risk Management, Actuarial, Compliance and Audit Function 11

12 Segregation according to Implementing Measures More colours occur... Board Risktaker Independent Risk-Controlling Function (IRCF) Actuarial Function Compliance Function Internal Audit 12

13 Compliance Evolution it s getting sharky U/W Actuarial Function Risk Management Function Audit Function Compliance? Function 13

14 Risk Management requirements (MaRisk) Solvency II Supervisory Framework (effective 2016/7?) Insurance Supervision Act (VAG) Qualitative Requirements based on Pillar II (Risk Reporting and sound management) (effective since / transition period until ) Minimum requirements on risk management (MaRisk) Overarching set of qualitative requirements based on VAG (effective from 3/2009) Strategic principles Enterprise Risk Management Risk Management Framework 14

15 Strategic principles 15

16 Strategic principles Corporate Strategy Strategic objectives (already addressing risk management) Risk Strategy Overriding Objective Ten Principles Risk Management Framework Guideline Overarching rules for group wide risk management Principle oriented framework with room for local fitting System of Limits and Thresholds Warning and escalating ladder Risk categories according to Risk Register 16

17 All starts with the Corporate Strategy... Basis for Value Creation Our mission: "Growing Hannover Re profitably" We seek to strengthen and further expand our position as a leading, globally operating reinsurance group, delivering profitability that is above the average of the sector. We are passionate about reinsurance and chart our own course. We are quick, flexible and independent; striving for excellence in our actions. We aspire to be the best option for our business partners when it comes to choosing a reinsurance provider. 17

18 A corporate strategy with 10 strategic principles 1. Our business model 2. We have ambitious profit and growth targets 3. We manage risks actively 4. We are a preferred business partner 5. We aim for successful employees 6. We maintain an adequate level of capitalisation 7. We strive for a stable investment income 8. We ensure a lean organisation 9. We are committed to sustained compliance 10. We strive for performance excellence 18

19 Active Risk Management is 3 rd strategic commandment In order to accomplish our business objectives, we enter into a broad range of risks which while offering opportunities for profit can also have adverse implications for the company. Risk management in both quantitative and qualitative terms is therefore of vital importance. The foundation of our risk management strategy is our Economic Capital Model. Based on this model we manage our risk exposure to achieve a positive IFRS net income with a probability of XX%. We also ensure that the probability of a complete loss of our economic as well as IFRS shareholders' equity does not exceed 0.0Y% p.a.. On this basis, our shareholders' equity is allocated to the individual areas of our business activity with the aim of maximizing the risk-adjusted profits. The details of our risk management approach are set out in the Risk Strategy which is approved and regularly reviewed by the Executive Board. In this regard special importance is given to the initiative of the Chief Risk Officer. 19

20 The risk strategy reflects the segregation of tasks 20

21 Our overriding objective Our overriding objective The overriding objective of our risk management is to adhere to the strategically defined risk positions of the Hannover Re Group: The expected return on equity after tax shall be at least ZZZ basis points above the risk-free interest rate. Occurrence of a net loss under IFRS (return on equity less than or equal to 0) with a recurrence period of maximum once in AA years. Complete loss of IFRS shareholders' equity with a probability of less than 0.0Y % p.a. In this context a capitalisation that ensures the 3 following conditions is absolutely indispensable: The target rating (Example: "AA-" from Standard & Poor's, "A+" from A.M. Best) Regulatory Solvency Ratio: Solvency Ratio >100% Probability of economic ruin < 0.0Y% p.a. 21

22 Our risk conception Overriding Objective Adhere to risk positions Risk Conception Holistic 22

23 Risk management framework guideline 23

24 Risk management framework guideline 24

25 Risk communication throughout the entire organisation Explain rationale for ERM External requirements (supervisors, rating agencies) Internal motivation (contribution to value creation) Necessary organisational platform (segregation of tasks) Explain basic documents and their strategic embedding Point of departure: corporate strategy Risk strategy Risk management framework guideline (incl. tasks and responsibilities) System of limits and thresholds (Overview) Specific guidelines (e. g. BCM, IS, DQM) Compare group situation with local situation Supervisory environment Business risk environment Agree on to do s Local vs. central ERM responsibility (local CRO? Local Risk Committee?) Reporting lines, reporting formats (incl. ad hoc reporting) 25

26 Challenge for HR: covering presence in all 5 continents Content 26

27 Hannover Re s Risk Management Roll-Out HR Roll out of risk management system in local offices (Life and Non-Life) from June 2010 through August 2011: 10 subsidiaries: Ireland (2), UK (2), Bermuda (2), South Africa (2), USA (1), Australia (1) 7 branches: Australia, Canada, China, France, Korea, Malaysia, Sweden Roll out at smaller entities in May-June 2012: Hong Kong, Bogota, HR Bahrain (+ branch), Implementation of organisational features at subsidiary level: Position of a Chief Risk Officer or of a risk monitoring responsible Reporting dotted line to Group CRO Implementation of a risk committee CRO or head of central RM unit is usually guest or member of local risk committees 27

28 Solvency II - More than "just" new capital requirements... but of course they are there, too... Solvency II - The three pillars Capital and Resources Risk and Control Reporting and Transparency Solvency / minimum capital requirement (SCR/MCR) Available financial resources Standard and internal model Internal controls and risk management Internal risk assessment Supervisory activities Supervisory reporting Public disclosure Market discipline 28

29 From standard to individual company implementation Capital requirements and treatment of reinsurance Standard model with simplifications Standard model Standard model and undertaking specific parameters Standard model and partial internal model Full internal model Standard risk profile Inadequate recognition of reinsurance Increasing complexity and risk-sensitivity Individual risk profile Appropriate recognition of reinsurance 29

30 Hannover Re will apply for internal model approval Convergence of internal and external requirements? Standard Model Internal Model Value-at-Risk at 99.5% confidence level Scenario based approach Predefined risk categories - not tailored to the company's individual risk profile Calibration of risk factors based on "average company" "Average company" correlation structure Adequate for small companies without complex or highly unique risks Limited resource requirements Limited suitability for risk management and business decision purposes (just external reporting) Full distribution of capital requirements Stochastic modelling Quantitative modelling of all material risk categories for Hannover Re Calibration of risk factors by company-specific data Company-specific dependency structure reflecting (worldwide) diversification effects adequately (e.g. catastrophe risk) Adequate for a Global Reinsurer and large multinational insurers Gives important additional information for capital management and business decision purposes (internal and external reporting) Adequate integration into decision processes and risk management of the HR Group 30

31 Internal model approval on track Hannover Re has engaged in 2008 with the German regulator to prepare Solvency II pre-application for internal model approval Since then we have explained our approach to capital modelling in over 100 meetings to the regulator Coverage of all major areas of the model Coverage of all aspects of Pillar II Coverage of almost all EEA entities and one non-eea entities early engagement with local regulators All areas where gaps had been identified in the review process have been addressed in the past years. Currently, we are in the process of fine-tuning our systems and processes, e.g. in the areas Own risk and solvency assessment (ORSA) Model validation Profit and loss attribution Legal entity reporting (in contrast to group reporting) 31

32 Hannover Re Group very well capitalised Internal model results Available capital and required risk capital* in EUR million Underwriting risks in non-life reinsurance 3.340, ,3 Underwriting risks in life and health reinsurance 1.973, ,1 Market risks 2.943, ,2 Credit risks 671,8 569,4 Operational risks 404,0 408,6 Diversification effect (3.364,6) (2.562,9) Total required capital 5.967, ,7 Available economic capital , ,7 Capitalisation ratio 173,9% 159,7% 32

33 Risk profiles Market risk dominates life insurers risk profile 33

34 Risk profiles Different levels of diversification 34

35 The (double) impact of risk mitigation Moderate decrease due to dominance of market risk Substantial increase of own funds due to lower risk margin*** Substantial decrease due to reinsurance Moderate increase due to reinsurance 35

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