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1 A Review of the Capital Requirements for Life Insurers in India By Jim Thompson, Raju S, Richard Holloway Presented at the 5th Global Conference of Actuaries.

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Presentation on theme: "1 A Review of the Capital Requirements for Life Insurers in India By Jim Thompson, Raju S, Richard Holloway Presented at the 5th Global Conference of Actuaries."— Presentation transcript:

1 1 A Review of the Capital Requirements for Life Insurers in India By Jim Thompson, Raju S, Richard Holloway Presented at the 5th Global Conference of Actuaries - Delhi, February 2003

2 2 Content Background Background The current situation in India The current situation in India Developments in other markets Developments in other markets Conclusions and recommendations for India Conclusions and recommendations for India

3 3 Why Capital/Solvency Margin? To give the regulator and the policyholder the peace of mind that he will be paid what he has been promised To give the regulator and the policyholder the peace of mind that he will be paid what he has been promised

4 4 Major risk areas of a life insurance company Investment risk Market risk Operational riskExpense risk New business risk Liquidity risk Credit risk Insurance risk Mismatch risk Currency risk Correlation between risks Group riskCredit risk Life insurance company risk universe Regulatory riskOther risks

5 5 Internal and external risks – Examples Internal External High level of guaranteed investment returns and mismatching as a result of falling investment returns Other guarantees Annuity options Surrender values Benefits on investment-linked contacts Bonus structure and policyholders’ expectation of a smoothed return has meant that the fall in investment markets cannot be fully passed on Regulatory issues Increase compliance costs Compensation costs from mis-selling (USD20 billion) Government imposed product pricing (UK) Increasing solvency requirements (Phase 2) Distributor pressure Rising costs Competition from cheaper channels Merger and acquisition activity (Declining value in acquisitions) Falling investment markets

6 6 Common risks that the Indian insurer faces…. Asset default Asset default Mortality and Morbidity understated Mortality and Morbidity understated Interest Margin Pricing Interest Margin Pricing Interest Movements Interest Movements Guarantees given Guarantees given Business Risks Business Risks

7 7 Traditional approaches to determining capital requirements Fixed factors Absolute amount with fixed factors Dynamic solvency testing Absolute amount Rs. 50 crores 6% reserve % sum at risk MAX[6% reserve % sum at risk. Rs. 50 crore] Solvency testing under prescribed scenarios

8 8 What is Risk Based Capital A realistic assessment of the capital requirements for the risks being run Varies from company to company Tends to focus on the key measurable and quantifiable risks Introduced in many of the more developed markets Risk Based Capital

9 9 Content Background Background The current situation in India The current situation in India Developments in other markets Developments in other markets Conclusions and recommendations for India Conclusions and recommendations for India

10 10 India – Overview of solvency requirements Typical formula approach Typical formula approach Simplistic and easy to administer Simplistic and easy to administer Working solvency margin is 150% of the formula Working solvency margin is 150% of the formula Minimum solvency requirement of Rs 50 Cr Minimum solvency requirement of Rs 50 Cr Solvency margin can be met by Surplus from Policyholder fund and Shareholder fund Solvency margin can be met by Surplus from Policyholder fund and Shareholder fund

11 11 Valuation of assets and liabilities Assets are largely valued as a mixture of book value and market value Assets are largely valued as a mixture of book value and market value No explicit charge for Asset Risk No explicit charge for Asset Risk Certain assets are inadmissible for solvency purposes Certain assets are inadmissible for solvency purposes Gross premium method for policy reserves with allowance for future bonuses Gross premium method for policy reserves with allowance for future bonuses The policy reserves include some “solvency margins” via the Margins for Adverse Deviations The policy reserves include some “solvency margins” via the Margins for Adverse Deviations

12 12 Solvency requirement Non-linked business: Non-linked business: 4% Reserves + 0.3% Sum at risk 4% Reserves + 0.3% Sum at risk Linked Business: Linked Business: with guarantees: 2% Reserves + 0.2% Sum at risk with guarantees: 2% Reserves + 0.2% Sum at risk without guarantees: 1% Reserves + 0.3% Sum at risk without guarantees: 1% Reserves + 0.3% Sum at risk Group Business: Group Business: premiums guaranteed for not more than one year: premiums guaranteed for not more than one year: 1% Reserves + 0.2% Sum at risk premiums guaranteed for more than one year: premiums guaranteed for more than one year: 3% Reserves + 0.3% Sum at risk

13 13 Solvency requirement for rider policies Similar treatment for base policies and riders Simplistic example Premium = 1.5 ‰ Reserves = 0.75 ‰ Required solvency margin (RSM) = 3.03 ‰ 150% of RSM = 4.55 ‰

14 14 Limitations of current framework Formula approach for solvency does not vary between companies Formula approach for solvency does not vary between companies Does not differentiate between different mix of business e.g. par and non-par business Does not differentiate between different mix of business e.g. par and non-par business Little differentiation between insurers with good and bad investments Little differentiation between insurers with good and bad investments No reflection of the specific risks that each company is exposed to. No reflection of the specific risks that each company is exposed to. No allowance for the mismatching No allowance for the mismatching

15 15 Anomalies Penalizes companies holding stronger reserves by imposing higher solvency requirements Penalizes companies holding stronger reserves by imposing higher solvency requirements Onerous requirement for pure risk policies e.g. Riders and Group Term policies Onerous requirement for pure risk policies e.g. Riders and Group Term policies Lighter requirement for health insurance (e.g. 4% reserves), which is known to be a riskier business Lighter requirement for health insurance (e.g. 4% reserves), which is known to be a riskier business

16 16 Content Background Background The current situation in India The current situation in India Developments in other markets Developments in other markets Conclusions and recommendations for India Conclusions and recommendations for India

17 17 UK – Valuation of liabilities Net Premium method with appropriate margins Net Premium method with appropriate margins PRE to provide for appropriate level of RB to emerge, but provision of TB not required PRE to provide for appropriate level of RB to emerge, but provision of TB not required Mortality/Morbidity rates determined by Appointed Actuary Mortality/Morbidity rates determined by Appointed Actuary Valuation interest rate reflects yield on existing assets less 2.5% Valuation interest rate reflects yield on existing assets less 2.5% Resilience Reserves determined on various scenarios Resilience Reserves determined on various scenarios Sufficient to cover prescribed scenarios Sufficient to cover prescribed scenarios Different scenarios for par (3 scenarios) and non-par business (1 scenario) Different scenarios for par (3 scenarios) and non-par business (1 scenario)

18 18 Capital requirement Single tier capital requirement – Solvency margin Single tier capital requirement – Solvency margin Solvency margin defined as % of SAR and policy reserves Solvency margin defined as % of SAR and policy reserves Minimum solvency margin is 800,000 ECU Minimum solvency margin is 800,000 ECU Assets held at market value/net realisable value Assets held at market value/net realisable value Certain assets are inadmissible for solvency purposes Certain assets are inadmissible for solvency purposes

19 19 USA – Valuation of liabilities Net Premium method with a prescribed minimum basis Net Premium method with a prescribed minimum basis Mortality – 1980 CSO Mortality – 1980 CSO Prescribed dynamic maximum valuation interest rate Prescribed dynamic maximum valuation interest rate Additional cash-flow testing requirement Additional cash-flow testing requirement Asset adequacy using cash-flow testing Asset adequacy using cash-flow testing Project asset and liability cash flows (excluding new business) under various scenarios Project asset and liability cash flows (excluding new business) under various scenarios

20 20 Capital requirement Risk based capital requirement Risk based capital requirement Minimum capital specified based on company’s size and risk profile Minimum capital specified based on company’s size and risk profile RBC identifies major risk factors with an adjustment for correlation between the various risks: Risk CategoryRBC Regulatory Trigger RBC identifies major risk factors with an adjustment for correlation between the various risks: Risk CategoryRBC Regulatory Trigger Affiliates Risk (C0) >199% No action required Affiliates Risk (C0) >199% No action required Asset Risk (C1) 150% – 199% Company action Asset Risk (C1) 150% – 199% Company action Insurance Risk (C2) 100% – 149% Regulatory action Insurance Risk (C2) 100% – 149% Regulatory action Interest Rate Risk (C3)70% – 99% Authorised action Interest Rate Risk (C3)70% – 99% Authorised action Business Risk (C4) <70% Mandatory control Business Risk (C4) <70% Mandatory control RBC = f (C0,C1,C2,C3,C4) RBC = f (C0,C1,C2,C3,C4)

21 21 Canada – Valuation of liabilities Gross premium valuation with margins for adverse deviation Gross premium valuation with margins for adverse deviation Margins represent limited and reasonable level of mis- estimation and deterioration from expected experience scenario assumptions Margins represent limited and reasonable level of mis- estimation and deterioration from expected experience scenario assumptions Due regard to PRE (provision for all future bonuses) Due regard to PRE (provision for all future bonuses) Discount rate dependent on existing asset yields Discount rate dependent on existing asset yields No resilience reserve requirement No resilience reserve requirement All assets are admissible All assets are admissible

22 22 Capital requirement Risk based capital requirement-Minimum Continuing Capital and Surplus Requirement (MCCSR) Risk based capital requirement-Minimum Continuing Capital and Surplus Requirement (MCCSR) MCCSR determined by applying factors to each of four risk components and adding the results MCCSR determined by applying factors to each of four risk components and adding the results Risk components of MCCSR and composition of total capital requirement (at year end 1998) were Risk components of MCCSR and composition of total capital requirement (at year end 1998) were Asset default risk 50% Asset default risk 50% Mortality/morbidity/ lapse risk31% Mortality/morbidity/ lapse risk31% Interest margin pricing risk 4% Interest margin pricing risk 4% Changes in Interest Rate Environment Risk15% Changes in Interest Rate Environment Risk15% Target MCCSR ratio is 150% (however may vary according to individual company risk profile) Target MCCSR ratio is 150% (however may vary according to individual company risk profile)

23 23 Australian – Capital Adequacy Standards 1. Margin on Services Valuation – Gross Premium Basis 2. Statutory Valuation = BEL + Profit Margin 3. All assumptions are based on the latest best estimates at the time of valuation – pro active basis

24 24 Two Tiered level of Capital Adequacy 1. Solvency Standard 1. Intended to ensure Solvency of the company 2. Disclosed in the Financial Statements 2. Capital Adequate Standard 2. Intended to ensure financial soundness of the company as and ongoing concern. 3. Not disclosed in the financial statements

25 25 Requirements Solvency Solvency Requirement Solvency Requirement Other Liabilities Other Liabilities Resilience Reserve Resilience Reserve Inadmissable Assets Reserve Inadmissable Assets Reserve Expense Reserves Expense Reserves Capital Adequacy Capital Adequacy Requirement Other Liabilities Resilience Reserves Inadmissable Asset Reserve New Business Reserve

26 26 Margins Min.Max. 110%Best Est110%140% 120%Best Est120%150% 130%Best Est 130%160% 0.25%0.5%2.5% InvestmentLinked CriticalIllness Disability Mortality Capital Adequacy Solvency

27 27 Investment Assumptions Solvency Capital Adequacy Minimum Maximum Minimum Maximum Gross Redemption BE – 0.4% BE – 3.0% Yield of a 10 year Govt Security

28 28 Resilience Reserves The amount that needs to be held before the happening of a prescribed set of changes in the economic environment such that after the changes the company is able to meet the liabilities of the fund

29 29 Equity Resilience assumptions SolvencyCapital Adequacy 1.25% 0.5%+(0.4xYield) 1.25% 2.5% 1.75% 1.0%+(0.2xYield) 0.6%1.0% 10%15% Currency IndexedBonds Property InterestBearing

30 30 Singapore – Valuation of liabilities Looking to move to a gross premium basis - basis selected by actuary, having regard to professional guidance (a change from net premium valuation) Looking to move to a gross premium basis - basis selected by actuary, having regard to professional guidance (a change from net premium valuation) A PAD is added to the best estimate liabilities. A PAD is added to the best estimate liabilities. Propose risk free rates are used for non- participating business (based on government bonds). Propose risk free rates are used for non- participating business (based on government bonds). Can significantly increase liability Can significantly increase liability

31 31 Singapore – Capital requirements Regulators are proposing a change to the current traditional framework (3% reserves per mille of sum at risk) that is more in line with banking sector, is risk based, flexible and transparent. Regulators are proposing a change to the current traditional framework (3% reserves per mille of sum at risk) that is more in line with banking sector, is risk based, flexible and transparent. New framework will have a fund solvency requirement (for each fund) (‘FSR’), and an overall capital adequacy requirement (‘CAR’). New framework will have a fund solvency requirement (for each fund) (‘FSR’), and an overall capital adequacy requirement (‘CAR’).

32 32 Singapore – Capital requirements FSR takes in to account liabilities and risks in the form of three components: FSR takes in to account liabilities and risks in the form of three components: LC1 - Liability component (as per valuation with margins) LC1 - Liability component (as per valuation with margins) LC2 - Market, Credit and Mismatching Risk LC2 - Market, Credit and Mismatching Risk LC3 - Inadmissible asset risk component LC3 - Inadmissible asset risk component FSR = LC1+LC2+LC3 - Value of liabilities FSR = LC1+LC2+LC3 - Value of liabilities Capital adequacy such that: Capital adequacy such that: Available capital/Required Capital > Specified minimum Available capital/Required Capital > Specified minimum

33 33 Policy Liability LC1 LC2 LC3 Fund Solvency Requirement Surplus Fair Value of Assets Liability Component Market, Credit & Mismatching Risk Component Inadmissible Asset Singapore – Fund Solvency Requirement

34 34 South Africa Capital Adequacy Requirements Gross Premium Valuation Basis Gross Premium Valuation Basis One level of Capital Adequacy One level of Capital Adequacy RBC Approach RBC Approach

35 35 OCAR OCAR = IOCAR grossed up for the effect of the assumed fall in fair value of the assets backing it OCAR =IOCAR/0.7 if assets in equities assumed to fall 30% OCAR =IOCAR if assets in cash

36 36 IOCAR IOCAR = Intermediary Ordinary Capital Requirements before taking into account the effect of the assumed falls in fair value of the assets covering it – Resilience scenario

37 37 Elements of Capital Adequacy IOCAR = a 2 + b 2 + c i 2 + c ii 2 + c iii 2 + d 2 + e 2 + f 2 + g 2 + h 2 + i 2 + j a= Lapse risk b= Surrender risk c i = Mortality Fluctuation c ii = Morbidity Fluctuation c iii = Medical Fluctuation d= Annuitant Mortality e= Mortality, Morbidity Medical Assumptions - Capital Adequacy Requirements; (Mortality 5%, Morbidity 10%, Medical 15%) Requirements; (Mortality 5%, Morbidity 10%, Medical 15%) f= Expense Fluctuation (10% last year’s renewal expenses) g= Expense Assumption (policies not valued on a discounted cash flow basis) h= Investment Capital Adequacy Requirement i= Foreign Exchange Risk – 20% Movements j= Any understatement of Liabilities

38 38 Investment Capital Adequacy Requirements Greater of: 1. Resilience Capital Adequacy Requirement – volatile market conditions 2. Worse Investment Return – Investments returns 2% lower than assumed in valuation

39 39 Resilience Capital Adequacy Asset Fall in fair value Property15% Fixed interest Fall equivalent to a 3% increase in yields Cash0% Equities Dividend Yield <= 4% Dividend Yield <= 4%30% Dividend Yield >= 5% Dividend Yield >= 5%20% Other OtherInterpolate

40 40 Country Comparison CountryValuationSolvency India Gross Premium Formula UK Net Premium Formula but under review USA Net Premium RBC Australia Gross Premium RBC South Africa Gross Premium RBC Canada RBC Singapore (Proposed) Gross Premium RBC

41 41 Capital Requirements Internationally 1. Move to a Gross Premium valuation and Risk Based Capital Approach. 2. Margins are generally specified and part of the solvency calculation. 3. Methodology is based on projections. 4. Resilience Reserves focus on both assets and liabilities. 5. Resilience Reserves are related to the level of markets.

42 42 Content Background Background The current situation in India The current situation in India Developments in other markets Developments in other markets Conclusions and recommendations for India Conclusions and recommendations for India

43 43 Conclusions Solvency is not a big issue for new companies at the moment, but this will change as companies get bigger. Solvency is not a big issue for new companies at the moment, but this will change as companies get bigger. Globally move to Gross Premium Valuation and RBC Solvency Globally move to Gross Premium Valuation and RBC Solvency Ensures greater consistency to other financial sectors Ensures greater consistency to other financial sectors Valuation of assets and liabilities consistent Valuation of assets and liabilities consistent Focuses attention on risk management Focuses attention on risk management Can vary by company. Can vary by company. India has Gross Premium Valuation move to RBC logical India has Gross Premium Valuation move to RBC logical

44 44 Implementation Issues to consider Technology Technology How do we get the know how How do we get the know how Phasing in to existing levels of capital Phasing in to existing levels of capital Setting of the risk charges/parameters Setting of the risk charges/parameters Impact on Business Impact on Business Big workload on the Regulator and Industry Big workload on the Regulator and Industry

45 45 Recommendation IRDA start giving consideration to adopting a RBC approach to solvency in 3 – 5 years IRDA start giving consideration to adopting a RBC approach to solvency in 3 – 5 years The Regulator should involve the Industry and work together to discuss the implications of moving to an appropriate RBC regime for India The Regulator should involve the Industry and work together to discuss the implications of moving to an appropriate RBC regime for India

46 46 Acknowledgements We take this opportunity to thank all those actuaries and Appointed Actuaries in India who provided us with valuable inputs for this paper. We take this opportunity to thank all those actuaries and Appointed Actuaries in India who provided us with valuable inputs for this paper. All the views expressed in this paper are the views of the authors and are not necessarily the views of our employers All the views expressed in this paper are the views of the authors and are not necessarily the views of our employers


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