Title: Risk-Based Capital Developments
1Risk-Based Capital Developments
- Glenn Meyers
- Insurance Services Office, Inc.
- CAS/SOA Enterprise Risk Management Symposium
- July 29, 2003
2Introduction
- 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.
3Terms 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.
4Terms 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.
5Terms 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.
6Terms 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.
7Who 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.
8Contents 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
9Contents 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
10General Insurance Case Study
- Proposal for Standardized Approach
- Illustrative Internal Model
11Desirable 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
12A 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.
13Features 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
14Dependency 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
15Example 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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20Moving 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.
21Requirements 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.
22Requirements 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
23Example 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.
24Example 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
25Results
26Next 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