1. Implications of Realistic Reporting
- The Lure of Mathematics
Mike Urmston
Chief Actuary
Norwich Union
Presentation title Slide /03/2017
© Aviva plc

2. Implications for Risk Management Implications for Policyholders
Agenda
1. Realistic Reporting
State of Play
Implications for Risk Management
Implications for Policyholders
- Implications for Intermediaries
2. Individual Capital Assessments
- State of play
- Implications of early results
- Implications for Risk Management
3. Role of the Board
Presentation title Slide /03/2017

3. 1.1 Realistic Reporting - State of Play
Different stages of model development
semi-stochastic, non-dynamic, dynamic
Model sophistication use of different ESGs
- degree of management action
- degree of policyholder action
Power - hardware and software development
- number of model points
Linkage to PPFM - definition and discretion/practice tightening
Audit standard - phased progress to “undefined” level
Speed versus Accuracy - Penrose accounting
Presentation title Slide /03/2017

4. 1.2 Realistic Reporting - Implications for Risk Management
Much improved discipline for the management of risk
- actuarial judgement now subject to vigorous challenge
Much more than a valuation method
- a methodology that is all intrusive on the future management
of risk
- a methodology that has a major impact on our customers
Risk management strategies need to be clearly defined
Available capital limits level of risk borne by funds
- policyholder and shareholder capital
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5. 1.2 Realistic Reporting - Implications for Risk Management (continued)
Key guarantees - need very careful attention
- minimum maturity values
- no MVR points and options
- guaranteed annuity options, S32 annuities
Key principles - very influential on approach
- degree of real asset exposure
- degree of smoothing of returns
- amount of risk sharing
Presentation title Slide /03/2017

6. 1.2 Realistic Reporting - Implications for Risk Management (continued)
Other changes to “balance the books”
- reduce annual bonuses (future guarantee costs)
- payouts much more tightly aligned to asset shares
- future smoothing policy
- charges to pay for guarantees
- more regular reviews of surrender or transfer values
- all subject to PPFM and treating customers fairly
Presentation title Slide /03/2017

7. 1.2 Realistic Reporting - Implications for Risk Management (continued)
Investment policy - changes in place or under development
- swaptions to hedge GAOs
- reductions in Equity Backing Ratios
- differential investment/credit risk strategy for estate
- differential investment for different groups of policyholders
(subject to PPFM)
- duration matching of fixed interest
- level of credit risk and duration
Presentation title Slide /03/2017

8. 1.2 Realistic Reporting - Implications for Risk Management (continued)
Formulate plans to deal with future shocks
- volatility spikes
- market crash
- credit crunch
Use of derivative and dynamic hedging strategies to protect
funds in extreme conditions
Possibility that all occur at once?
- mathematics doesn’t always work
- LTCM!
Presentation title Slide /03/2017

9. Merton Miller, Nobel Laureate
“ In a strict sense, there wasn’t any risk - if the world had behaved as it did in the past ”
“ The question….is whether the LTCM disaster was merely a unique and isolated event, a bad drawing from nature’s arms; or whether such disasters are the inevitable consequence of the Black-Scholes formula itself and the illusion it may give that all market participants can hedge away all their risk at the same time ”
Merton Miller, Nobel Laureate
Presentation title Slide /03/2017

10. 1.3 Realistic Reporting - Implications for Policyholders
Did anyone ask them?
Shareholders/Mutuals likely to be risk averse
- nature of regulatory pressure
Lower risk means less volatility in returns
- BUT less rewards, inconsistent with expectations
Pooling approach to the sharing of risk across generations has been lost
FSA implementation retrospective and rushed - Equitable “panic”
With profits would never have started on this basis, and old concept unlikely to survive for future new business for any but the strongest
Smoothed managed funds may have some future
Presentation title Slide /03/2017

11. 1.3 Realistic Reporting - Implications for Intermediaries
Customers will see lower guaranteed bonuses, falling
payouts, active MVRs
Low EBRs mean more certainty but little upside potential
Policyholders “trapped” in poor performing funds
Dangers of misselling and growth of complaints
Intermediaries looking to switch/offer alternative investment vehicles
Need for help as to what to advise customers
Presentation title Slide /03/2017

12. 2.1 Individual Capital Assessment - State of Play
Stress and scenario tests generally used
Consistency with 99.5% probability of solvency within one year
- economic generators used for market risks
- credit risk needs careful approach
- more difficult to define for other types of risk
e.g. annuitant mortality, persistency, expenses
Presentation title Slide /03/2017

13. 2.1 Individual Capital Assessment - State of Play (contd)
Risk based capital models can be run to provide support to some of the tests being used
- run off approach or test solvency yearly?
Correlation matrix key to diversification benefits
- degree of independence of risk, more research needed
Difficult areas include operational risk and pension scheme deficits
Presentation title Slide /03/2017

14. 2.2 Individual Capital Assessments - Implications of early results
Current non-profit statutory valuations look very strong.
Capital requirements likely to be lower for protection business
and unit-linked savings
Guarantees will require more capital. Annuities likely to see higher capital requirements in view of risks involved
Arguments for realistic reporting for non profit business - future FSA agenda. Possible waivers?
Capital utilisation and Returns on Capital likely to be impacted by new assessment regime.
Presentation title Slide /03/2017

15. 2.3 Individual Capital Assessments - Implications for Risk Management
Development of strategies to manage non-market risks less advanced
Level of exposure and risk appetite need more definition
Use of reinsurance and capital markets to reduce risk
e.g. catastrophe risk, annuitant mortality risk?
Systems and controls to manage operational risk
No natural markets developed yet. Can we envisage mortality or persistency swaps between insurers and reinsurers?
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16. 3. Role of the Board
Board has responsibility that there is no significant risk that the firm is not able to meet its liabilities
Board needs to understand its risks far more and the likelihood - probability distribution - of these risks
Board needs to be satisfied on the techniques used and the assumptions made
Board must ensure that management actions are consistent with what with profit policyholders are expecting and published practice
Such complex issues require far more training. Directors and non executive directors need to understand far more detail about the risks involved - is this reasonable
Understanding mathematics is at the heart of the Board’s agenda
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17. “ Markets can remain irrational longer than you can remain solvent ”
John Maynard Keynes
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18. Presentation title Slide 18 28/03/2017

19. Thank you
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