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Risk-Based Capital Developments

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Risk-Based Capital Developments Glenn Meyers Insurance Services Office, Inc. CAS/SOA Enterprise Risk Management Symposium July 29, 2003 Introduction A current ... – PowerPoint PPT presentation

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Title: Risk-Based Capital Developments


1
Risk-Based Capital Developments
  • Glenn Meyers
  • Insurance Services Office, Inc.
  • CAS/SOA Enterprise Risk Management Symposium
  • July 29, 2003

2
Introduction
  • A current initiative of the International
    Association of Insurance Supervisors (IAIS) is to
    develop a global framework for risk-based capital
    for insurers.
  • Acting in support of the IAIS, the International
    Actuarial Association (IAA) has formed an Insurer
    Solvency Assessment Working Party (WP) to prepare
    a paper on the structure for a risk-based
    solvency assessment system for insurance.

3
Terms of Reference of the WP
  • The WP should describe the principles and methods
    involved in the quantification of the total funds
    needed to provide a chosen level of confidence to
    policyholders and shareholders that the insurers
    policyholder obligations will be met.

4
Terms of Reference of the WP
  • The paper should be specific and practical enough
    that its recommended principles and methods could
    be used as a foundation for a global risk-based
    solvency capital system for consideration by the
    IAIS.

5
Terms of Reference of the WP
  • The paper should, starting from a coherent risk
    framework, identify risk measures that explicitly
    or implicitly can be used to measure the exposure
    to loss from risk and also any risk dependencies.
    The paper should also identify measures that are
    not effective in this regard.

6
Terms of Reference of the WP
  • In balancing its focus between practical versus
    sophisticated methodologies, the working party
    will place greater weight on those methodologies
    with the greatest likelihood of practical
    implementation. However, since simple
    methodologies that can be applied to many
    insurers in a territory or across territories may
    prove insufficiently reliable or capital
    efficient, the working party should consider
    whether risk models developed internally by
    insurers can provide a useful and reliable
    approach.

7
Who is on the WP?
  • Allan Brender (Canada)
  • Peter Boller (Switzerland)
  • Henk van Broekhoven (Netherlands) -
    Vice-Chairperson
  • Tony Coleman (Australia)
  • Jan Dhaene (Belgium)
  • David Finnis (Australia)
  • Marc Goovaerts (Belgium)
  • Burt Jay (U.S.)
  • R. Kannan (India)
  • Toshihiro Kawano (Japan)
  • Sylvain Merlus (France)
  • Glenn Meyers (U.S.)
  • Teus Mourik (Netherlands)
  • Harry Panjer (Canada)
  • Dave Sandberg (U.S.)
  • Nylesh Shah (U.K.)
  • Shaun Wang (U.S.)
  • Stuart Wason (Canada) - Chairperson
  • Hans Waszink (Netherlands)
  • Bob Wolf (U.S.)

Represented are several countries, life, health,
P/Cinsurance company, consultants, regulators
and academics.
8
Contents of Report
  • Section 3 The Purpose of Capital
  • Section 4 Supplements to Capital
  • Section 5 Working Partys Approach
  • Section 6 Risks and Risk Measures
  • Section 7 Standardized Approaches
  • Section 8 Company Specific Approaches
  • Section 9 Reinsurance
  • Section 10 Total Company Requirement

9
Contents of Report
  • Appendix A Life Insurance Case Study
  • Appendix B Non-Life Insurance Case Study
  • Appendix C Health Insurance Case Study
  • Appendix D Market Risk
  • Appendix E Credit Risk
  • Appendix F Lessons from Insurer Failures
  • Appendix G Introduction to Insurance Risk
  • Appendix H Analytic Methods
  • Appendix I Copulas

10
General Insurance Case Study
  • Proposal for Standardized Approach
  • Illustrative Internal Model

11
Desirable Properties of a Standard Formula
  • Simplicity The formula can be put on a
    spreadsheet. This may allow for some complexity
    in the formulas, as long as the objective of the
    formulas is clear.
  • Input Availability The inputs needed for the
    formula are either readily available, or can be
    reasonably estimated with the help of the
    appointed actuary.
  • Conservative When there is uncertainty in the
    values of the parameters, the parameters should
    be chosen to yield a conservative estimate of the
    required capital

12
A Proposal for a Standard Formula
  • The formula is sensitive to
  • The volume of business in each line of business
  • The overall volatility of each line of insurance
  • The reinsurance provisions and
  • The correlation, or dependency structure, between
    each line of business.

13
Features of the Formula
  • Input for insurance losses
  • Expected losses for current business
  • Loss Reserves (at expected values of payout)
  • Parameters - Specified by regulator (??)
  • Claim severity distribution by line of business
  • Claim count distribution
  • Dependency model parameters (see next slide)
  • Calculates first two moments of aggregate loss
    distribution. Using lognormal approximation
  • Capital TVaR99 Expected Loss

14
Dependency Model Parameters
  • Common shock model
  • Uncertainty in trend affects all lines
    simultaneously
  • Magnitude of shock varies by line of business
  • Catastrophes treated separately
  • Capital TVaR99 Expected Loss Cat PML
  • Calculate Cat PML with a catastrophe model

15
Example on Spreadsheet
  • Big Insurer ABC Insurance Company
  • Small Insurer XYZ Insurance Company
  • ABC Volume 10 times XYZ Volume
  • Otherwise they are identical

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20
Moving Toward an Internal Model
  • Recall WP recommendations
  • That the Standard Model be deliberately
    conservative.
  • Several modifications to the Standard Model are
    possible.
  • Insurer internal model are to be subject to
    standards for risk-based capital formulas.

21
Requirements for Internal Models
  • The insurer should have an independent internal
    risk management unit, responsible for the design
    and implementation of the risk-based capital
    model.
  • The insurers Board and senior management should
    be actively involved in the risk control process,
    which should be demonstrated as a key aspect of
    business management.

22
Requirements for Internal Models
  • The model should be closely integrated with the
    day-to-day management processes of the insurer.
  • An independent review of the model should be
    carried out on a regular basis. (Amongst other
    considerations, it should be recognised that
    evolution of the modelling capabilities is to be
    encouraged)
  • Operational risks should be fully considered

23
Example of Internal Model
  • More realistic claim severity distributions
  • Richer dependency structure
  • Parameter uncertainty in claim frequency as well
    as claim severity
  • Parameter uncertainty in claim frequency applied
    across groups of lines.

24
Example of Internal Model
  • Calculates aggregate loss distribution directly
    rather than by moments
  • Catastrophe model included directly in aggregate
    loss calculation, rather than add PML.
  • Additional details to be published in Summer
    Forum
  • Aggregation and Correlation of Insurance
    Exposure Meyers, Klinker and Lalonde

25
Results
26
Next Steps
  • Complete remaining sections of report (focus on
    standardized versus advanced approaches case
    study illustrations etc.)
  • Consider input from IAA Insurance Regn Committee
    and interested supervisory bodies (e.g. IAIS, EC,
    etc.)
  • Issue discussion draft report to Insurance
    Regulation Committee for email discussion
  • Issue revised exposure draft report to
    Insurance Regulation Committee on September 30
    for Berlin meeting
  • Identify follow-on initiatives required by the
    IAA and member associations
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