Session 119 PD, Evolving Regulatory Landscape Around Capital and Risk Management Moderator: Patricia E. Matson, FSA, MAAA

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1 Session 119 PD, Evolving Regulatory Landscape Around Capital and Risk Management Moderator: Patricia E. Matson, FSA, MAAA Presenters: Richard H. Daillak, FSA, MAAA Gaetano Geretto, FSA, CERA, FCIA Patricia E. Matson, FSA, MAAA

2 Evolving regulatory landscape around capital and risk management US ORSA and Other Developments September 25, 2014 Patricia E. Matson, FSA, MAAA

3 Overview of ORSA Section I Section II Section III Description of the Insurer s Risk Management Framework Insurer s Assessment of Risk Exposure Group Assessment of Risk Capital and Prospective Solvency Assessment ORSA provides a management view of risks and capital, which helps to challenge what is covered under traditional approaches to reserves and capital ORSA aggregates risks across all the activities of the insurance company to enable a comparison of required capital to available capital ORSA is not solely a quantitative representation of the risks but also requires a systematic identification, assessment and management of the risks A thorough evaluation of risk requires that an insurance company not only evaluates its current exposure to risk but also its future potential risk, in light of strategic objectives ORSA plays a key role in the communication between an insurance company and regulator Risk & Regulatory Consulting LLC Not to be Duplicated Without Prior Consent 2

4 ORSA Model Act Adopted September 2012 Responds to IAIS s Insurance Core Principle 16, Enterprise Risk Management ORSA defined confidential internal assessment, appropriate to the nature, scale and complexity of an insurer or insurance group of the material and relevant risks associated with the insurer and the sufficiency of capital resources to support those risks Confidential report(s) to be filed at most 1x/year w/lead state Exemption <$500M legal entity premium <$1B group premium Effective January 1, 2015 However regulator can decide, based on specific circumstances, to request anyway Risk & Regulatory Consulting LLC Not to be Duplicated Without Prior Consent 3

5 ORSA Guidance Manual First issued in 2012; latest revision July 2014 Provides further guidance on ORSA in support of Model Act ORSA Report should include: Section 1: Description of Risk Management Framework Section 2: Assessment of Risk Exposure Section 3: Group Assessment of Risk Capital and Prospective Solvency Should identify accounting basis, time period, legal entities covered Signed by CRO or similar Further details for each of the 3 sections on what to include Clear focus on OWN Risk & Regulatory Consulting LLC Not to be Duplicated Without Prior Consent 4

6 Draft NAIC Guidance for Regulators Risk Focused Surveillance Working Group released detailed guidance on use of ORSA in financial analysis and exams in March, 2014; since that time, three exposure periods have been completed States that principle goals of ORSA, upon which regulatory guidance will be established, are: To foster an effective level of ERM at all insurers To provide a group level perspective on risk and capital, as a supplement to the existing legal entity view. To allow the regulator to obtain a high level understanding of the insurer s ORSA, and to assist the commissioner in determining the scope, depth and minimum timing of risk focused analysis and examination procedures Summarizes the guidance as well as the RIMS ERM maturity model to provide education to the user on what to expect from good ERM Failure to demonstrate sufficient ERM is likely to result in increased supervision, up to and including a hazardous financial condition determination ERM assessed on a 1 5 scale Risk & Regulatory Consulting LLC Not to be Duplicated Without Prior Consent 5

7 Draft NAIC Guidance for Regulators RIMS risk maturity as described in the guidance. Additional details are provided for each section and subsection of the ORSA report Non Existent No identification, monitoring, or management Ad Hoc No developed or documented standard processes; relies on individual efforts Initial Processes in place, but not operating consistently and effectively. Certain risks defined and managed in silos Repeatable Processes in place; designed and operated in a timely, consistent, sustained way. Actions taken to address issues for high priority risks Managed Activities coordinated across business areas; tools and processes activities used. Enterprisewide identification, monitoring, management, and reporting in place Leading Tools embedded in strategic planning, capital allocation, etc and used in daily decision making. Limits in place to identify breaches and require corrective action by Board and management Risk & Regulatory Consulting LLC Not to be Duplicated Without Prior Consent 6

8 ERM Framework Link to business strategy Capital Management Stress and Scenario testing Risk appetite and limits Risk Culture and Governance Monitoring and reporting Identify and assess risks Risk measure manage - ment Source: North American CRO Council ERM involves a control cycle, in which: The foundation is the risk culture and governance of the company An appetite for risk is established, linked to company strategy Risk limits are set Risks are identified, quantified, and prioritized Risks are monitored relative to limits, and risk mitigation actions are taken Risk capital is determined and allocated to business initiatives Risk analysis is communicated to leaders Results of risk analysis impact strategic objectives Section I Section II Section III Risk & Regulatory Consulting LLC Not to be Duplicated Without Prior Consent 7

9 Risk Management Framework Section I Risk culture and governance Risk identification and prioritization Risk appetite, tolerance, and limits Risk management and controls Risk reporting and communication This section may include descriptions of items such as: Board and committee structure, roles and responsibilities Key risk exposures and limits; mitigations in place Company culture regarding risk, organization of risk function, risk charters/policies Strategy and associated risk appetite; risk appetite results Summary of risk reports and sample recent results Risk & Regulatory Consulting LLC Not to be Duplicated Without Prior Consent 8

10 Assessing Enterprise Risks Section II Considering Outside Forces Tolerance for Risk Risks to be Taken Enterprise Top Risks Top Risks Aggregation Process Risk Assessments Business Units Corporate Functions Strategic Partners Appetite for Risk Stress Testing Exposures Section 2 will cover the identification, quantification, prioritization, and mitigation of top risks The process for determining top risks typically involves both a top down and a bottom up approach Top risks should be considered in light of the organization s strategy, risk appetite, and risk tolerance Identification of risks should come from those in the business and corporate functions, with support from and aggregation by ERM Consideration should be given to emerging risks and the impact of external factors such as regulatory change and competitor actions Risk & Regulatory Consulting LLC Not to be Duplicated Without Prior Consent 9

11 Assessing Solvency Section III Assessment of group solvency should describe approach used, methods, assumptions. Examples provided in the ORSA Guidance Manual: Considerations Description of Methods/Assumptions Examples Definition of Solvency How solvency is defined (capital and liquidity) Cash flow basis, balance sheet basis Accounting/Valuation Regime Underlying accounting/valuation basis GAAP, Stat, market consistent, IFRS, rating agency Business Included Subset of business included in capital analysis Inforce as of a specific date, new business included Time Horizon Horizon over which risks are modeled 1 year, multi year, lifetime, runoff Risks Modeled Which risks included, are all relevant and material ones in? Credit, market, insurance, liquidity, operational Quantification Method How risk exposure is quantified Stresses, stochastic, factor based Risk Capital Metric Defined Security Standard Aggregation/ Diversification Measurement metric for determining needed capital Std used to determine risk capital, incl link to strategy Method of aggregation and group diversification benefits considered/calculated VaR, TVaR, P(ruin), P(ruin) given capital available AA solvency, %ile confidence, % of RBC Correlation matrix, dependency structure, full/part/no diversification Risk & Regulatory Consulting LLC Not to be Duplicated Without Prior Consent 10

12 Economic Capital Section III There is fairly wide variation in use of, and definition of, economic capital in the US insurance industry. A summary of practices currently in place is as follows: Component Typical Practices Comments Underlying balance sheet Risk metric Time horizon Confidence level Company defined market based Market consistent Statutory GAAP Absolute surplus loss Loss based on defined external criteria (ratings, RBC ratio) Ranges from 1 year to runoff of business Ranges from 99% to 99.99% Company defined market based most common for US companies, though smaller and P/C often use Statutory Market consistent, based on Solvency II definition, more comment globally Most typically defined as the absolute loss in surplus based on the balance sheet definition above 1 year most common for market based balance sheet, and runoff most common for statutory balance sheet 99.5% common for global companies since it is the basis for Solvency II. Many align this with AA/AAA rating and therefore use 99.9x% Risk & Regulatory Consulting LLC Not to be Duplicated Without Prior Consent 11

13 Internal Models Section III A variety of internal models may be used for various components of ERM. Key considerations include link to strategy and risk appetite, data source, reconciliations, and use of results in strategic decision making Strategic Objectives, Risk Appetite, Risk Tolerance Data Sources Asset data Policy data Market data Data load Approach & Assumptions Data Capture and Staging Data storage Transformation Model Governance Framework Stress Testing Financial planning Pricing Risk Modeling ERM-Owned Models Risk Appetite Other Corporate Models Cash flow testing Line of Business Models Reserving Economic Capital ALM Risk assessment Risk Monitoring & Management Risk reporting Risk mitigation Strategic decisions Risk & Regulatory Consulting LLC Not to be Duplicated Without Prior Consent 12

14 Model Validation Section III Core Principle* Build for intended purpose Model validation is independent Establish model validation owner Appropriate model governance Consider proportionality Validate model components Address validation limitations Document the validation Considerations While the idea of a single model is nice in theory, it often fails in practice Many ERM models are designed for full enterprise use, and therefore may be less granular than other company models A separate functional area charged with validation Creates accountability Should have authority to communicate and remediate Defined policies that cover roles, responsibilities, and minimum requirements Critical for validation to provide sufficient benefits for the cost Data, methods, assumptions, calculations, and outputs Including plans to address in the future Can be used to improve and focus future validations *8 core principles identified in the North American CRO Council s paper Model Validation Principles Applied to Risk and Capital Models in the Insurance Industry Risk & Regulatory Consulting LLC Not to be Duplicated Without Prior Consent 13

15 US ORSA Pilots Two pilots completed, third in early stages First pilot: 13 reports submitted 8 complete: 3 full data; 5 redacted data 2 included framework but otherwise incomplete 3 more incomplete relative to others Submissions ranged from pages Second pilot: 22 reports submitted None redacted; only 3 need material improvements Risk & Regulatory Consulting LLC Not to be Duplicated Without Prior Consent 14

16 US ORSA Pilots Key Observations Report on ACTUAL ERM, not just a regulatory exercise Glossary of terms and acronyms used Significant risk limit details Risks include rankings (heatmaps preferred), mitigations, owners Changes in limits, appetite, tolerance Include ERM/Control flowchart Compensation/incentives to risk decisions/risks taken Attach or summarize referenced documents Include prospective/emerging risks (sections 2 and 3) Explanation of tables/graphs Comparison of multiple capital model approaches and results Combined stress scenarios, in addition to single scenarios Describe the capital model and its validation Provide liquidity stress test results Risk & Regulatory Consulting LLC Not to be Duplicated Without Prior Consent 15

17 Other US Regulatory Developments Corporate Governance Annual Disclosure Model Act and Model Regulation Annual summary of the Corporate Governance structure Describe Board and committees, duties of each Senior management oversight Business strategy and risk oversight Insurance Holding Company Act Transactions within a holding company Group supervision FIO Annual Report SIFI designations Terrorism insurance (TRIA expiration) and Nat l Flood Ins Program International supervision Risk & Regulatory Consulting LLC Not to be Duplicated Without Prior Consent 16

18 Appendix Sample ORSA Contents Risk & Regulatory Consulting LLC Not to be Duplicated Without Prior Consent 17

19 Risk Culture and Governance Section I Involvement of Senior Management and the Board Structure and independence of risk management function Reporting and escalation procedures Consideration of risk in performance measurement and compensation Tone at the Top Risk awareness policies, procedures, and training Roles and responsibilities of risk management functions Consideration of enterprise risk in decision making Risk & Regulatory Consulting LLC Not to be Duplicated Without Prior Consent 18

20 Risk Policies & Procedures Section I Good ERM should include policies and procedures for key risk-taking and control activities, including activity descriptions, roles and responsibilities, limits, approvals, escalation procedures, and change controls. Examples of such policies include: Key function and committee charters Asset-liability management policy Underwriting policy/manuals Liquidity policy, including contingent funding plan Privacy and security policies Derivatives use plan Risk mitigation policies (ie reinsurance, hedging, etc) Data management policies Model governance framework Risk & Regulatory Consulting LLC Not to be Duplicated Without Prior Consent 19

21 Establishing a Risk Appetite Section I Tolerance Enterprise Strategy Tolerance 1 Tolerance 2 Tolerance 4 Limit Risk Appetite Early Warning Tolerance % 10% 12% 3 etc 4 5 Current Exposure Risk appetite* is the total exposed amount that an organization wishes to undertake on the basis of risk-return trade-offs for one or more desired and expected outcomes. Risk tolerance* is the amount of uncertainty an organization is prepared to accept in total or more narrowly within a certain business unit, a particular risk category or for a specific initiative. Risk limit** is a threshold used to monitor the actual risk exposure of a specific risk or activity unit of the organization to ensure that the level of actual risk remains within the risk tolerance. Source: *RIMS and **American Academy of Actuaries Risk & Regulatory Consulting LLC Not to be Duplicated Without Prior Consent 20

22 Risk Appetite Example Section I Strategy Setting and Business Planning Strategic objective: stay financially strong and provide value to shareholders 3-year financial plan for 8% growth target Risk Appetite and Tolerance Definition Financial strength component of risk appetite defined based on RBC ratio Risk tolerance is a minimum 300% RBC ratio Scenario Definition and Limit Setting Limit: maintain RBC ratio of at least 300% (325% early warning signal) 3 stress scenarios defined Analyze, Communicate, and Manage Scenario RBC Ratio Year 1 RBC Ratio Year 3 Baseline 400% 400% Severe recession 345% 315% Reputational Event 385% 395% Sharp rise in rates 345% 360% Based on breach of early warning, mitigation plans involve curtailing growth in capital intensive business Risk & Regulatory Consulting LLC Not to be Duplicated Without Prior Consent 21

23 Risk Quantification Section II ERM should provide specific criteria for assessing the likelihood, severity, and velocity of risks. In addition, the Sample Likelihood Scale Somewhat Highly time period of the Unlikely Likely Likely Likely assessment should be defined 0 15% 15 30% 30% 50% >50% (ie 1 year, 2 years, Sample Severity Scale etc) Immaterial Moderate Threatening Severe Capital <550M M 500M 1B >1B Impact On: Earnings <10% drop 10 20% drop 20 40% drop >40% drop Liquidity <20% outflow increase 20 40% outflow increase 40 60% outflow increase >60% outflow increase Risk & Regulatory Consulting LLC Not to be Duplicated Without Prior Consent 22

24 Risk Assessment Results Section II Heatmaps often used to show prioritization by frequency, severity, and speed of onset (velocity) Risk & Regulatory Consulting LLC Not to be Duplicated Without Prior Consent 23

25 Stress and Scenario Testing Section II Examples of stress/scenario tests currently being evaluated as part of ORSA include: Business Scenario Definition Use of Results P&C Health Health Life Cat Risk: Hurricane Regulatory Change Risk: ACA Regulatory Change Risk: ACA Market Risk: Low Interest Rates Specific level of hurricane occurs in multiple cities in the same time period (e.g. 1 year) Antiselection under new ACA requirements increases morbidity/claims by 10% 30% increase and decrease in membership driven by ACA requirements Interest rates drop 50% and stay at that level for 10 years before a gradual recovery Assess impact on capital, liquidity, and ratings to determine whether still within defined risk tolerance (and if not, determine necessary immediate mitigating actions) Understand level of exposure over time to influence strategic decisions on business mix, growth plans, and potential mitigation strategies Risk & Regulatory Consulting LLC Not to be Duplicated Without Prior Consent 24

26 Section 3 Assessing Solvency Section III Below is a sample of the type of information that may be included in Section 3 of the ORSA, assuming the insurer has a prospective view on economic solvency 500 Current and 2 Year Prospective Solvency Regulatory Economic Regulatory Economic Regulatory Economic Required risk capital: Operational Expense Behavior Morbidity Longevity Mortality Currency Market Credit Sample Commentary: International operations sold in late 2014, eliminating currency risk Planning entry into disability income in 2015, which will create exposure to morbidity risk but also drive diversification benefits Available regulatory capital Available economic capital Risk & Regulatory Consulting LLC Not to be Duplicated Without Prior Consent 25

27 OSFI update PD 119 Evolving regulatory landscape around capital and risk management Presentation to the SOA Annual Meeting Orlando, FL, USA October 28, 2014 Gaetano Geretto Senior Director Insurance Risk Management and Strategy

28 Possible topics of interest ORSA progress Assessing the actuarial function Advisory on new directors Cyber-risk self assessments OSFI P&C Capital Updates OSFI Life Insurance Regulatory Framework 2

29 ORSA Objective Insurers perform self-assessments to determine if their capital position is adequate and is likely to remain so in the future; Benefits Promotes better understanding of the interrelationships between the risk profile and capital needs of an insurer; Links with other processes (e.g. enterprise-wide risk management) builds consistency; and Potential to enhance existing balance between business development and risk management practices 3

30 ORSA The ORSA Report or Document Narrative without standard format or structure Minimum content and expectations Filing / reporting / review Standard filing template: Key Metrics Report ORSA is not a box-checking exercise and the exercise should better position the insurer to ask questions of itself regarding what can be done better or more consistently 4

31 Assessing the Actuarial Function Actuarial Function was added to OSFI s revised Supervisory Framework (2010) There are 7 oversight functions that may exist in a FRFI, including Compliance The organization of the Actuarial Function varies considerably across the industry and is a function of the insurer s nature, size, and complexity. 5

32 Advisory on New Directors International regulatory movement toward increased involvement in due diligence on new Board and senior management members (though some go much further) OSFI Advisory not intended to supersede independent decisions by FIs, but rather formalize existing process for OSFI to express any specific concerns regarding the appropriateness of a candidate 6

33 Cyber Risk Self-Assessments Set out OSFI s expectations in 6 areas of selfassessment with detailed criteria Deliver a standard assessment tool to the sector Assist a financial institution to carry out a point-intime self-assessment of maturity of its cyber security function and capabilities Encourage a financial institution s management to develop an action plan setting out initiatives or work needed to achieve a rating of "Fully Implemented 7

34 OSFI P&C Capital Updates New MCT Standard Approach More risk sensitive capital requirements Final guideline & returns publication Fall 2014 Implementation effective January 1, 2015 MCT Internal Models Approach Criteria and guidance under development Insurance risk Target completion 2016 Non-insurance risks Target 2016/18 8

35 OSFI Life Insurance Regulatory Framework New MCCSR Standard Approach QIS6 Publication October 2014 / responses due January 2015 QIS6 Additional tests Final guideline & reporting forms 2016 Implementation target of January 2018 Internal Models Approach Work on hold until new standard approach finalized 9

36 Insurance Capital Frameworks Major areas of change Definition of available capital Interest rate risk Credit for Diversification Credit for Par Policies (Life only) Mortality (Life only) Segregated Funds Guarantees (Life only) 10

37 Questions? 11

38 International Insurance Capital Developments SOA Annual Meeting, 28 October 2014, Session 119 PD Richard Daillak

39 G20 member states, working through their Financial Stability Board, have sought to strengthen global financial resilience Members: Argentina, Australia, Brazil, Canada, China, France, Germany, India, Indonesia, Italy, Japan, Republic of Korea, Mexico, Russia, Saudi Arabia, South Africa, Turkey, United Kingdom, United States and the European Union. 2

40 The FSB has directed sectoral standard-setters to enhance solvency standards and to help it identify globally important financial institutions G-SIBs Basel III G-SIIs BCR/HLA ICS 3

41 Insurance solvency modernization is also happening locally around the globe Europe: Solvency II legislation 2016 China: C-ROSS project 2015 C-ROSS II ahead? Canada: Japan: QIS in preparation of the economic risk based solvency regime United States: SMI, USGCS? Mexico: LISF 2015 Switzerland: SST legislation in place since 2008, revision in 2015 to adapt to SII Singapore/ Malaysia: RBC 2 (currently postponed) Chile: Australia: PCR in place Indonesia: Starts to work on ICPs with IAIS South Africa: SAM as part of Twin peaks In addition to the global standards developed by the IAIS, local solvency standards are being strengthened in many insurance markets 4

42 IAIS: Supervision, Capital and Risk Management 5

43 IAIS Projects ICPs Insurance Core Principles For all insurers Standards for supervision Requirements for the insurer Requirements for the supervisor Used by World Bank/IMF to assess national regimes (FSAP) ComFrame Project in Progress For Internationally Active Insurance Groups (IAIGs) Common framework for supervision Consistent with the ICPs but elaborated and extended Modules: Scope, IAIG (including capital requirements), Supervisor Targeted completion: end 2018 For G-SIIs Globally Systemically Important Insurers At FSB direction, IAIS created a project to identify globally systemically important insurers (G-SIIs) and to devise additional policy measures to apply to them 6

44 Initial outcomes of the G-SII project Initial list of G-SIIs designated by FSB July 2013 Allianz AIG Assicurazioni Generali Aviva Axa MetLife Ping An Insurance (Group) Prudential Financial (US) Prudential plc (UK) GSII list redetermined annually by FSB Policy Measures, designed by IAIS Enhanced supervision Effective recovery and resolution Higher loss absorbency (HLA) First: BCR- a straightforward, "basic capital requirement" to serve as foundation for HLA Apply to all group activities Balance simplicity and risk sensitivity Provide more comparable foundation than local capital requirements Then: HLA- which will focus on systemic risks and nontraditional, noninsurance activities 7

45 Work begins on new capital standards BCR, HLA and ICS All Insurers All IAIGs ICPs ComFrame Identify FSB designates All G-SIIs BCR HLA Enhanced Supervision Effective Recovery & Resolution 8

46 ICS bridges between the G-SII and ComFrame efforts The IAIS has committed to develop a risk-based insurance capital standard (ICS) for all IAIGs, including all G-SIIs. FSB supports the development of the ICS. Intended to be more risk-sensitive than the BCR, and therefore expected to be more complex than BCR. For G-SIIs, the ICS is expected to replace the BCR as the foundation for HLA. For IAIGs generally, the ICS will replace ComFrame Module 2, Element 5, Capital Adequacy Assessment, a long-debated component of ComFrame. Expected timeline for Insurance Capital Standard First ICS test Second ICS test ICS reporting to supervisors Dec: Consultation on design of ICS (all IAIGs) ICS reporting to supervisors + public disclosure ICS full implementation (?) Adoption of ComFrame by IAIS including ICS 9

47 Current focus of the IAIS is to complete the BCR for G-SIIs in order to achieve comparability and apply HLA Basic Capital Requirements (BCR) (BCR) for for G-SIIs G-SIIs BCR to apply to all group activities (including noninsurance) of G-SIIs BCR as initial foundation for HLA requirements for G-SIIs BCR to be finalized by November 2014 and reported, to supervisors only, from 2015 IAIS using a factor based approach for the BCR Higher Loss Absorption Capacity (HLA) (HLA) for for G-SIIs G-SIIs HLA implementation details by end of 2015; will apply to then designated G-SIIs starting from January 2019 HLA requirements to be met by the highest quality capital fully available to cover losses at all times Location of HLA undecided Insurance Capital Standard (ICS) for for G-SIIs+IAIGs & IAIGs Global standard to apply to all IAIGs including G-SIIs Framework completed in 2016; public disclosure from beginning of 2018; enforcement expected 1 January 2019 Development of BCR will inform the ICS BCR to be reassessed once ICS is developed HLA to be redetermined on ICS, once available Insurance Capital Standard, for IAIG Planned outcome HLA ICS BCR Higher Loss Absorbency, for G-SII Basic Capital Requirements, for G-SII ICS replaces BCR as the foundation for HLA 10

48 Status of ICS Development On 28 May the IAIS published a memorandum on the ICS, including an overview of the approach the IAIS plans to apply for the ICS ICS will define a consolidated, group-wide, globally comparable risk-based measure of capital adequacy addressing all material risks and financial activities The valuations of assets and liabilities must respond to stresses over a specified time horizon The amount of qualifying capital resources is to be compared to the capital requirement to determine the ICS ratio IAIS states that the ICS will enhance supervisory cooperation and coordination groupwide, support financial stability, enable policyholder protection, facilitate cross-border insurance activities and contribute to a level playing field. On 12 September, IAIS also issued principles for ICS development. See appendix. Thus far, work on ICS has taken a back seat to work on BCR. 11

49 NAIC response to ICS While NAIC has strongly questioned the need for a global ICS, it remains engaged at IAIS to help influence the standard. NAIC has just begun work toward a U.S. group capital standard (USGCS). NAIC ICS Forum, August 2014, Louisville; follow-up meeting, September USGCS likely would apply to U.S.-parented insurance groups. Intended to complement but not replace U.S. RBC. Fills a clear gap left by the legal entity approach taken by RBC. Once USGCS is developed, NAIC says it plans to argue that the U.S. solvency regime is at least as robust as that provided by the ICS. The possibility of making such an argument is suggested by paragraph 30 of IAIS's May 2014 consultation. 30. Within the ICS, the IAIS will consider what other risk-based methods of implementation jurisdictions may introduce to address additional risk coverage and/or maintain higher prudential targets than the standard, as long as these methods produce outcomes at least as robust as the ICS standard method. NAIC appears open to separate USGCS approaches or models for P&C and Life. 12

50 Industry response to ICS Many are engaged. For example, non-iaigs are active because they believe that ICS would ultimately affect them, through competition and consumer pressure to report. Industry has been divided. Some argue the U.S. should "just say no." Others, believe ICS is coming and industry needs to help make it work. Groups with significant life and annuity spread business are concerned if a marketconsistent economic approach is pursued. Many of the same issues are raised as were raised in European Solvency II. Volatility Disincentives to long-term business Some U.S. companies are exploring what they describe as a valuation-agnostic approach based on projection of asset and liability cash flows under stressed scenarios. Scenarios might be prescribed by the supervisors, for comparability, rather than determined from internal models. Being addressed: Translating pass-fail results to a solvency ratio that can be reported. Determining how to create the scenario set, and how to combine results from scenarios for distinct types of business. A cash flow projection approach to P&C has been opposed by a number of companies. 13

51 Appendix Additional details on BCR, HLA, ICS 14

52 Key features of BCR according to the IAIS 3 substantive principles 3 constructive principles Major risk categories considered Comparability of outcomes across jurisdictions Resilience of BCR to stress Simple design and presentation Internal consistency Optimise transparency and use of public data Balance Sheet valuations Operational and Liquidity risk Liabilities: Current estimates (best estimate) as proxy Assets: Local GAAP with adjustments Operational risk and liquidity risk not included in BCR Group balance sheet Consolidated group balance sheet as starting point BCR Adequacy Ratio = Qualifying Capital Resources / Required Capital Required Capital = Σ (Liability factors x Liability measures) + Σ (Asset factors x Asset measures) + Σ (NI factors x NI measures) Qualifying Capital Resources = Capital Resources +/ Adjustments 15

53 BCR update, based on July consultation The IAIS issued its second and final consultation on BCR in July 2014 The IAIS consultation has clarified certain elements of the BCR: calculation on a consolidated group level three basic risk components (insurance/banking/non-insurance) and 15 factors applied to specific segments simple and comparable basis as foundation for HLA diversification and ALM not explicitly factored However open items remain: overall calibration has not yet been fixed treatment of margin over current estimate, MOCE (cost of holding capital) segmentation of assets and liabilities determination of current estimates (i.e. best estimates) for certain products treatment of non-qualifying reinsurance calibration of risk factors tiering of available capital The FSB is expected to review and approve the BCR proposal in October 2014 in order for the G20 to endorse it in November

54 BCR required capital - Formula 17

55 IAIS principles for HLA development Comparability Outcomes should be comparable across jurisdictions G-SII risks HLA should reflect the drivers of the assessment of G-SII status Internalise costs HLA should internalise some of the costs that the G-SII's failure or distress would cause the financial system and economy Resilient HLA should work and remain valid in a wide variety of economic conditions Going concern HLA should assume G-SIIs are"going concerns" 18

56 IAIS principles for HLA development (continued) Quality of Capital HLA capital requirement is to be met by the highest quality capital Pragmatic Design needs to be pragmatic and practical, with an appropriate balance between granularity and simplicity Consistent Structure should be consistent and applicable over the range of insurance and non-insurance entities it will need to cover Transparent Level of transparency, esp. with regard to results and use of public data, should be optimized Refinement HLA will be refined over time in the course of field testing 19

57 IAIS principles for ICS development Consolidated group-wide standard; globally comparable risk measure Consistent valuation principles for assets and liabilities, definition of qualifying capital resources, and a risk based capital requirement Main objectives: protect policyholders; contribute to financial stability ICS becomes the foundation for HLA Replacing BCR as that foundation Reflects all material risks to which an IAIG is exposed Taking into account- assets, liabilities, non-insurance risks, off-balance sheet activities Aims at comparability of outcomes across jurisdictions, enhances supervisor understanding and cross-border analysis Can contribute to a level playing field and reduce capital arbitrage 20

58 IAIS principles for ICS development (continued) Promotes sound risk management By IAIGs and G-SIIs Promotes prudentially sound behavior while minimising inappropriate pro-cyclical behavior by supervisors and IAIGs Does not encourage the IAIG to take actions that exacerbate a stress event Balances risk-sensitivity and simplicity appropriately Sufficient granularity and complexity, but sensitive to tradeoff in benefit Transparent Particularly with regard to the disclosure of the final results Requirement based on appropriate target criteria underlying the calibration Reflects the level of solvency protection deemed appropriate by the IAIS 21

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