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Ira Robbin, Principal P&C Actuarial Analysts, LLC.

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Presentation on theme: "Ira Robbin, Principal P&C Actuarial Analysts, LLC."— Presentation transcript:

1 Ira Robbin, Principal P&C Actuarial Analysts, LLC

2 2 CAS Antitrust Notice  The Casualty Actuarial Society is committed to adhering strictly to the letter and spirit of the antitrust laws. Seminars conducted under the auspices of the CAS are designed solely to provide a forum for the expression of various points of view on topics described in the programs or agendas for such meetings.  Under no circumstances shall CAS seminars be used as a means for competing companies or firms to reach any understanding – expressed or implied – that restricts competition or in any way impairs the ability of members to exercise independent business judgment regarding matters affecting competition.  It is the responsibility of all seminar participants to be aware of antitrust regulations, to prevent any written or verbal discussions that appear to violate these laws, and to adhere in every respect to the CAS antitrust compliance policy. 2

3 3 Disclaimers and Cautions  No statements about the views or proprietary practices of prior employers will be made or should be inferred.  No liability whatsoever is assumed for any damages, either direct or indirect, that may be attributed to use of any of the material in this presentation.  Whatever you allege I said, either I never said it, I said the opposite, I was just joking, or I was quoted out of context. 3

4 4 Agenda  Solvency II Overview  Accounting Changes  Capital Requirements  Standard Formula  Internal Model  Perspectives 4

5 Sliced Bread or Epic Fail Three Pillars Accounting Changes Technical Provisions 5 Overview

6 6 Solvency II – Best Thing Since Sliced Bread !  Institutes uniform accounting rules and solvency regulations across Euro zone  Replaces hodgepodge of outmoded regulations  Moves to principles-based, market-consistent accounting  Superior to rules-based accounting  Promotes use of internal models to determine required capital  Sophisticated models  Better at capturing real risk 6

7 7 Solvency II – Epic Fail !  Overly ambitious- grandiose  Breaks with existing P&C accounting  Requires huge IT effort  Transition/ new scorekeeping may confuse market  Less priority given to policyholder protection  Inadequate understanding of P&C risk  Push to internal models impractical  Imposes burden on regulators  Makes results non-transparent  Very costly  Repeatedly delayed 7

8 8 Three Pillars Pillar 1 Quantitative Balance sheet (including Technical Provisions Min Capital Req’ment (MCR) Solvency Capital Req’ment (SCR) Market –consistent valuation Risk-based requirements Pillar 2 Qualitative Governance, risk management and required functions ORSA Supervisory review process Business governance Internal Control processes Risk-based supervision Pillar 3 Reporting, disclosure, and market discipline SFCR and RSR Disclosure Transparency Support of supervision through market mechanisms Disclosure Transparent markets

9 SII Accounting Changes  ‘Market-based’ Valuation  Mark to model  Removal of prudential margins  Explicit discounting  Explicit risk margin  No accrual  Eliminates UEPR  Pre-up front recognition= date obligation is made  Contract boundary  different from UWY and AY  EPIFP - Expected Profits Included in Future Premiums 9

10 SII P&C Loss Provision  Technical Provisions (Liability)  TP= BE + RM  BE = Best Estimate  RM = Risk Margin  Loss Provision (TP )  Best Estimate is Discounted Mean of Scenarios  Discounted with loaded risk –free rates  Loaded with illiquidity premium  Duration matched  Risk Margin based on Cost of Capital 10

11 Risk Margin for Loss Reserves  Risk Margin = discounted Cost of Capital  r = needed additional return = 6.0%  SCR = Solvency Capital Requirement  Cost of capital for each year of runoff 11

12 Categories SCR for Unpaid Loss Standard Formula and Internal Models 12 Capital Requirement

13 Non-Life Risk Categories  Underwriting risk  Premium risk  Reserve risk  Lapse risk  A new type of P&C risk  Risk pre-up front profits not realized  CAT risk 13

14 14

15 Solvency Capital Requirement for Unpaid Loss  SCR = 99.5% Percentile excess of the mean  One-year Risk  Retrospective look at Best Estimate  Except for discounting, one-year risk would be a measure of how much projected ultimate has changed over one year.  Viewed by many as inadequate for long-tail LOBs 15

16 16 Standard Formula or Internal Model  SCR can be computed via SF or IM  IMs expected to lead to reduced SCR  IM must be approved by supervisor  Extensive documentation required  IM algorithms and parameters not specified  IM does not change conceptual calibration  99.5% excess of mean on one-year risk 16

17 Coefficients of Variation (CVs) by LOB Aggregation and Calibration 17 Standard Formula

18 18 Standard Formula – QIS5  EIOPA ~10 LOBs w Lognormal CVs  Complicated but practical  Premium and Reserve correlation  LOB Correlation matrix  Volume measures  Credit for geographic diversity  Lognormal assumption for aggregation  CAT Capital  “Factor” based - factors applied to premiums  “Scenario” based – factors applied to TIVs 18

19 SF CVs for Premium and Reserve Risk 19

20 20 LOB Reserve CV Calibration – SF  Heterogeneity within an LOB  Size of portfolio and process risk  JWG  “… volatility factors for … reserve risks are typically impacted by the size of the portfolio… the SCR will be too large for the larger portfolios and too small for the smaller ones”.  Diversification across LOBs  How real are observed correlations?  Comparison  Rating agencies used fixed factors  RBC adjusts benchmarks for company experience. 20

21 Use test Statistical quality standards Challenges and concerns 21 Internal Models

22 Internal Models under SII  SII encourages use of IM instead of SF  “Big Bang” approach  Expected to reduce capital required  Requires regulator approval  Exact form or type of model not specified.  Many companies using giant simulation models.  IM reduces transparency  Firms unlikely to disclose IM details to public 22

23 IM Documentation – Use Test  Use Test (decision making process)  “ … provide evidence … your internal model is widely used and plays an important role in your decision-making processes …” Source: G2 – FSA Solvency II Internal Model Approval Process document – Pre-application process p8 July 2010  Does anyone use such a model “widely” in P&C?  How does the SII IM relate to existing CAT, reserving, pricing, and M&A models?  The more complicated it gets, the less likely it can be used for anything other than showing SII compliance. 23

24 IM Documentation – Stat Quality Standards  Statistical quality standards  confirmation … methods are based upon current … information…  Please identify … differences in the actuarial … techniques used and the underlying assumptions...”  Why should methods (not parameters?) be based on current information? What does it mean for techniques to be different from assumptions?  Different documentation standard than ASOP 41?  “sufficient clarity…that another actuary qualified in the same practice area could make an objective appraisal…” 24

25 IM Challenges and Concerns  Cost in € and time  Firms need to hire consultants and new staff  Documentation requirements  Huge (some say excessive) effort  Changes will require justification  Management sign-offs  IM too technical for leaders to understand  IMs reduce transparency  Overwhelming regulatory burden 25

26 RBC Highlights Regulatory considerations Life vs PC Basel II - Banking NAIC Insurance Industry - Negative Comments 26 Perspectives

27 27 RBC Required P&C Capital Highlights  Specified Formula  Industry based premium and reserve risk factors  adjusted for company avg vs Industry avg  Reductions for CM and Loss Sensitive business  Square root of sum of squares for aggregating  Investment risk  detailed by asset class and instrument  Non-diversification penalties  assets and insurance risk  No CAT risk  Transparent and accessible to the public 27

28 28 Regulatory Considerations  Cost to regulator and the regulated  Ease of compliance  Equal treatment – fairness  Effectiveness – does it work?  Induced motivations and side effects  Transparency and public access  Market confidence and acceptance 28

29 29 Approaches to Regulation Constrained Free MarketPost-Modern Bureaucratic Regulatory State Gov’t intervention in response to defined need Gov’t intervention the norm Attempts to be cost-effectiveCostly Rules and detailsPrinciples, models, and process ComplianceGo beyond compliance exercise Regulator as umpireRegulator as coach Minimize opportunities to game the system Assumes cooperative relationships 29

30 30 Life vs PC Risk RiskLifePC SeverityKnownHighly variable depending on the LOB and coverage Claim countKnownHighly variable – subject to CAT, contagion, mass torts Lapse rate riskImportantDoes not exist in US GAAP, STAT Ultimate RiskLowHigh One-year riskRelatively largeRelatively small for long-tail lines 30

31 Basel II – Banking Experience With IMs  Basel II – always more cautious in use of IMs  Internally derived parameters could be approved for use in regulatory algorithm  Limited diversification benefits  Further reduced role of IMs  “Risk was not being properly captured by the models…” --Adkins FSA  Floor - Use 80% or 100% of standard approach  Implications for modeling  “ If.. sophisticated modeling means you end up with more capital, … why would banks do this?” “Bye, robot”, Risk July

32 32 Summary of US Regulator Views  No appetite for switching to SII accounting  Continue to use IMs on limited add-on basis to supplement standard approach in life  Keep focus on protecting policyholders  Support for key components of US system  liquidation approaches in STAT accounting  current US IRIS, RBC capital requirements  Proud of system performance in latest crisis  NAIC is continuing to improve - SMI 32

33 33 US Regulator Comments - Leonardi and Vaughn  CT Commissioner Leonardi Aug 2011  “… well-intended but untested European regulatory changes, known as “Solvency II” … could weaken consumer protections …”  “Solvency II is a much-needed effort to modernize an …outmoded European regulatory regime…”  NAIC CEO Vaughn Nov 2011  “ Our system is one that we're quite comfortable with… equivalence should be assessed on an outcomes basis. On that basis, we should be found equivalent.” 33

34 34 US Regulator Comments - McCarty  NAIC President McCarty Mar 2012, May 2012  “ We’re not interested in taking our system and putting it through the..analysis undertaken by… Switzerland, Bermuda and Japan”  “No disrespect to the EU but …at best, they would want to make a comparison to a system [Solvency II] that isn't in place yet... It's kind of silly to even consider that an equivalence process." 34

35 Industry Commentary – ACE Annual Report 2011 – Evan Greenberg on Solvency II  “…simply wrong-headed…overly bureaucratic, process-oriented, costly …  … I am not sure what problem we are trying to solve.  Solvency II-…would do great harm.  a framework of minimum standards ….that results in similar outcomes is far more practical and effective…” 35

36 Commentary – European Insurance Industry  Insurer groups tell EC to calm down on Solvency II or face ‘dire consequences’ Commercial Risk Europe, April 7, 2011  “At the very time that Europe is experiencing significant economic, financial and social challenges, … the draft Solvency II implementing measures…risk driving insurers out of their long- term business” Letter from PEIF, CEAA, CFO Forum. …  The group said …publication of QIS5 intensified rather than assuaged their fears …their ‘valid concerns’ have been consistently ignored. 36

37 37 Solvency II – Latest Delay  “EU may now delay Solvency II till 2015 following proposal from EU Commissioner Barnier” - Commercial Risk Europe, Sept 20, 2012  final agreement should wait until the latest study into Solvency II is completed in March  Chief executive of Hiscox, agreed. "I'd rather it be delayed and made better than have it rammed through and have to be changed later”.  October 2012: plenary vote on Omnibus 2 in the European Parliament was rescheduled from November 2012 to March

38 38 Solvency II – EIOPA Response to SII Delay  EIOPA chairman Gabriel Bernardino - WRIN TV Oct 5, 2012  “blames political maneuvering for delays…  “ ‘delay undermining EU credibility’ …”  " ‘still no clear and credible timetable…’ ” 38

39 39 Solvency II – BaFin Response to SII Delay  “BaFin considers Solvency 1.5” - Solvency II Wire Nov 15, 2012  President of BaFin Dr. Elke Konig “ Having debated something for such a long time and having had the brightest minds of the industry …means you have created a massively complex system which is probably only fully understandable for those that have created it. ” 39

40 40 Solvency II – Summary Observations  P&C concerns about SII  One-year reserve risk  Discounting with rate including illiquidity premium  CAT risk calculation  Overreliance on IMs  SII delay is being driven by concerns from Life  With exception of CAT, P&C issues not high on radar  US NAIC has staked out position against submitting to SII equivalence process  Some form of SII is probably inevitable  not as inevitable as it was last year 40

41 41 Solvency II – Closing Remarks  US actuaries should become familiar with SII  In increasingly interconnected world, need to be aware of developments in EU  Many of the accounting concepts may be adopted in some form in IFRS  Actuaries may be best able to bridge gap between modelers and insurance executives  View EU regulatory change as opportunity  What loopholes in SII can be legally exploited?  What markets will EU insurers abandon/ become more aggressive in due to SII? 41


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