IAA Risk Book - Amazon S3 · 2016-03-29 · About the IAA Risk Book (1 of 5) Background IRC published Blue Book on Insurer Solvency Assessment in 2004 Blue Book explored the then

IAA Risk BookGovernance, Management and Regulation

of Insurance Operations

Presented by Tom Herget, FSA, MAAA, CERA

Chicago Actuarial Association Workshops

March 23, 2016

Foreword

� The goal of this presentation is two fold:

� Provide overview of the IAA Risk Book rather than teach the concepts

� Encourage audience engagement via further reading, feedback and

critiques of this project

� Chapters are summarized in 2 – 4 slides

� A bit much on these slides as they serve as reference

2

About the IAAWho

� Worldwide organization of actuarial associations (about 70)

� Represents 63,000 actuaries in 110 countries

Mission� To represent the actuarial profession and promote its role, reputation and

recognition in the international domain; and

� To promote professionalism, develop education standards and encourage research, with the active involvement of its Member Associations and Sections, in order to address changing needs.

Operations� Staff of ten based in Ottawa, Canada

� Committees meet twice a year

3

About the IRC

Insurance Regulation Committee (IRC)� One of many IAA committees; comprises 40 members from around the world

� Purpose:

� To promote the role of actuaries in the regulation and supervision of insurers so that the public interest is served

� To support the creation of international principles and frameworks for regulation and supervision of insurers in order to reflect actuarial principles where appropriate

� To maintain and to strengthen the relationships with key international organisations dealing with the regulation and supervision of the insurance and reinsurance industry (e.g. IAIS)

4

About the IAA Risk Book (1 of 5)

Background

� IRC published Blue Book on Insurer Solvency Assessment in 2004

� Blue Book explored the then current “best practice” elements needed for a

risk based capital determination for insurers

� This Risk Book has been a two+ year project to update our prior work to

reflect current perspectives on risk

� No single risk measure provides the full “video” picture of risk. The Risk

Book reviews the multiple tools available to a company and to a supervisor

to manage risk in a sustainable manner

5


Contributors

� Risk Book steering committee includes regulators, current practitioners and

retirees

� Individual authors – from around the world

� Many more contributing to review

� Objective = write each chapter in 20 pages or less

� Geared more to practice than theory

6


How it works (on the website), how it gets updated and how to access

� Chapters being submitted as they are completed (10 out of 21 @ Mar 2016)

� Located at IAA website under PUBLICATIONS, pull down to RISK BOOK

� Or

http://www.actuaries.org/index.cfm?lang=EN&DSP=PUBLICATIONS&ACT=RI

SKBOOK

� Will accept and respond to comments

� Intend to update chapters as needed

7


Table of contents

1. Introduction

2. Actuarial Function

3. Professional Standards

4. Operational Risk

5. Catastrophe Risk

6. Non-Proportional Reinsurance

7. Intra-Group Reinsurance

8. Addressing the Consequences of

Insurance Groups

9. Distribution Risk

10. ORSA

8


Chapters under construction� Resolution of Insolvencies

� Role of Capital

� ALM

� Derivatives

� Financial Statements

� Governance of Models

� Communicating Uncertainty

� Materiality & Proportionality

� One year vs. Multi-year Valuation

� Policyholder Behaviour & Management Actions

� Stress Testing

9

10

Chapter 1 Introduction (1 of 2)

Key messages include:

� Managing and Communicating Uncertainty – Our Professional

Opportunity & Responsibility

� ERM Is the Core Franchise Value of Insurance

What is the Important Problem?

� What Pillar 2 (ERM) processes and tools can be used to sustain

the Balance Sheet before Pillar 1 indicates the “ship has sunk”.

� And, are they robust or smoke and mirrors?

11

Chapter 1 Introduction (2 of 2)

What are the Important Solutions?

� To manage and communicate uncertainty, processes are essential

� Can the Actuarial Function step into and/or assist these roles more directly?

� ORSA

� Model governance

� Stress testing

� ERM

� Recovery and resolution planning oversight

� Micro (firm specific) vs macro (sector specific) implications

12

Chapter 2 Actuarial Function (AF)(1 of 3)

Key messages:

� Insurance supervisors are focusing on oversight role of AF as

part of second of the traditional “three lines of defence” in

ERM.

� Lines of defence are functions that:

1. Own, manage, and report on risks (e.g., operational

management);

2. Oversee risks (e.g., AF, risk management, compliance, risk

committees, and sign-off requirements); and

3. Provide independent assurance (e.g., internal and/or

external audit).

13

Chapter 2 Actuarial Function (2 of 3)

Key messages (continued):

� Actuaries are not restricted to providing the oversight of risk

(i.e., second line of defence), but are active in some or all of the

three lines of defence within an insurer.

� Independent risk oversight by AF is important to boards, senior

management, and supervisors because of unique actuarial

perspective on insurer’s risks. Effective AF oversight can

facilitate less intrusive supervision.

14

Chapter 2 Actuarial Function (3 of 3)


� AF frequently expected to make material contributions to ERM

� AF must be organized & operate within insurer/insurance group in clear, effective & transparent manner

� Insurance supervisors develop & maintain confidence in work of AF through:

� Validation of important aspects of work of AF

� Presence of strong professionalism

� Presence of effective feedback loops between the supervisor, profession, standard setters, and the disciplinary process.

15

Chapter 3 Professional Standards (1 of 2)

Key messages:

� Actuarial standards:

� assure the public that actuaries are professionally accountable

� gives the users of actuarial work confidence that the work has been performed appropriately

� provide practicing actuaries with a basis for assuring their work will conform to appropriate practice.

� can be of significant value to regulators

� Members of Full Member associations (FMAs) must comply with applicable actuarial standards.

16

Chapter 3 Professional Standards (2 of 2)


� The scope of actuarial standards includes the process of setting assumptions, selecting methodologies, and disclosure.

� Actuarial standards and regulations complement each other.

� Actuarial standards guide actuarial work:

� usually principle-based, rather than prescriptive

� permit departures from the standard’s guidance if justified.

� Regulations are usually prescriptive and mandatory.

� Model actuarial standards are adopted in a particular jurisdiction by the entity entitled to enact standards.

17

Chapter 4 Operational Risk (1 of 3)

Key messages:

� Quality & maturity of risk management process are key

indicators that can impact potential losses arising from

operational risk (OR) events.

� OR is closely linked to the risk culture of an insurer; qualitative

issues (such as strength of governance processes and oversight

functions) play large role in management of OR.

� Reliability of any OR modelling exercise is strictly connected

with actual quality of the overall data (internal or external data)

- generally an unknown.

18



� Appropriate model calibration in the data-poor environment of

operational risk is one of the most significant and persistent

challenges for insurers.

� Typically a capital charge or other mitigation method acts to

reduce risk exposure, but adding an operational risk charge

based on past losses (or the lack thereof) can be pro-cyclical.

19



� Operational risk events for high-frequency/low-severity events

can be captured & modelled; tail events that are low

frequency/high severity are where a qualitative scaling

assessment can be most effective.

� Credible approach for OR should include a blend of qualitative

and quantitative assessments to evaluate the effectiveness of

management processes to address OR exposures to both low

and high-severity events.

20

Chapter 5 Catastrophe Risk (1 of 3)

Key messages:

� Catastrophes result in a sudden and mass destruction of

property, lives, environment, and/or the economy.

� Catastrophes can be natural or man-made (e.g., terrorism).

� The frequency and severity of catastrophe losses have been

increasing over past several decades primarily due to increasing

concentrations of population and property in geographical

areas prone to disasters.

21



� Catastrophes impact society first, and insurers only to the

extent that the damages are insured.

� Due to their infrequent nature, analysis of past losses can’t

sufficiently measure catastrophe risk, so many insurers use

catastrophe models to estimate potential losses.

� Catastrophe models are based on four primary components –

event catalogs, intensity formulas, damage functions and a

financial module.

22



� Model uncertainty is unavoidable and is impacted by both data

issues (related to quality and availability) and political issues

(influencing how events will unfold in times of stress). This is in

addition to the uncertainty related to random events.

� Model development and usage is evolving, including a trend

towards open models (as opposed to closed proprietary

models) and their use for scenario analysis.

� Catastrophe models are part of the risk management process

both in terms of pricing/underwriting and in terms of

solvency/capital management.

23

Chapter 6 Non-Proportional Reinsurance (1 of

2)

Key messages:

� Non-proportional reinsurance (NPR) is a very powerful tool in

spreading risk, diversifying risk and managing the “dangerous”

tail of loss distributions.

� NPR is used extensively in P&C reinsurance , but is less common

for life and health insurance where proportional reinsurance

continues to dominate.

� In addition to risk and capital considerations, NPR is used

extensively to reduce the potential volatility of a company's

quarterly or yearly earnings.

24

Chapter 6 Non-Proportional Reinsurance (2 of

2)


� The risk assessment and the pricing of NPR products are reliant

upon having good meaningful data.

� As regulatory capital regimes become more risk-based it is likely

that NPR solutions will become more common across all lines of

business.

� NPR structures, and reinsurance in general, carry a risk in

respect of a failure of the reinsurer which needs to be reflected

in the capital requirements.

25

Chapter 7 Intra-Group Reinsurance (1 of 3)

Key messages:

� Rationale for IGR transactions is similar to normal reinsurance

transactions, but the relationship between the two related

transacting companies gives rise to special considerations. The

presence of third party, the Group (parent), requires that good

process and governance is in place.

� IGR transactions are useful within a group for managing risk and

capital across the entire organization; IGRs are often used as an

alternative to increasing the capital within a subsidiary company

as they can transfer risk to another subsidiary company where

there is surplus capital.

26



� The IGR structure depends upon the intended outcome. Aiming

to reduce the overall capital requirement of a ceding legal entity

will be different to seeking to reduce P&L volatility.

� These transactions need to be executed as if they are between

independent parties; each legal entity takes responsibility that

the transaction is beneficial from its own perspective.

27



� Conflicts of interest will arise. Individual participants need to

recognize potential conflicts and know to whom are they

advising or for whom are they taking a decision.

� Active negotiation needs to take place and be evident.

Transaction pricing should be in the range of what is observable

within the market that each company operates.

� Where IGR transactions involve the use of Special Purpose

Vehicles (SPVs) or other similar vehicles then additional

considerations may apply.

28

Chapter 8 Addressing the Consequences of Insurance Groups (1 of 3)

Key messages:

� There is a need for a group level ERM function supported by

local risk functions.

� Identification of all the material linkages between members of

the insurance group and their associated risks, including

concentration or accumulation of risk exposures (both direct

and indirect) is very important for the risk and capital

management of the group as well as its prudential supervision.

� Members of the insurance group and its head need to

understand the roles, expectations and requirements of their

respective involved supervisors.

29



� Head of the insurance group has ultimate responsibility within

the group for meeting expectations and requirements of group-

wide supervisor.

� Group-wide supervisor, in cooperation and coordination with

involved supervisors, plays a lead role in effective group-wide

supervision, including addressing any resolvability issues.

� The cooperation and co-ordination of all involved supervisors in

carrying out their roles as local supervisors and as members of

the supervisory college is important to the effective supervision

of the group.

30



� Actuaries involved in risk management generally, and control

functions specifically have appropriate regard not only to their

entity specific responsibilities/risks but also for the wider group

context/risks within which their work is conducted.

� Head of insurance group should have adequate access to

actuarial expertise; internationally active insurance groups

(IAIG’s) may be required to establish an actuarial function at the

group level.

31

Chapter 9 Distribution Risk (1 of 3)

Key Messages:

� Distribution system and marketing practice risks can lead to

significant financial and reputational harm from lack of new

business or poor quality of business, which in turn can

adversely affect the insurer’s income, brand value and value as

a going concern

� Distribution risks can result in risks to a distribution channel, to

the insurer’s business and ultimately to its financial

sustainability

32


Key Messages:

� Some types of distribution risks are similar to operational risks,

which are unpredictable in nature but can represent significant

reputation and financial risks to the insurer

� Perceived concerns regarding sustainability or brand

impairment of an insurer can result in a rapid deterioration of

the size and effectiveness of the insurer’s distribution system

33


Key Messages:

� Insurance market conduct supervisors are charges with ensuring

that sales and service of insurance policies are made in a a

manner that delivers acceptable value to the consumer.

Actuaries may need to sign off on the accuracy of illustrations of

new sales / inforce insurance policies that clearly explain the

mechanics of complex or long-term products and provide

advice on the suitability of sales to customers.

� Because of the importance of this risk, actuaries are involved in

assessing the quality of sales, estimating policy performance in

pricing insurance products and helping to identify, measure and

manage the risks of the distribution and conduct of business as

part of the assessment of overall ERM

34

Chapter 10 ORSA (1 of 2)

Key Messages:

� Own Risk and Solvency Assessment

� ORSA is an ongoing part of risk and capital management

practices and has merit beyond any regulatory requirement

� ORSA is not a “one size fits all” process; significant variations

occur from company to company and even within different

organizational units of large groups

� Both quantitative and qualitative analyses support ORSA

processes

35

Chapter 10 ORSA (2 of 2)

Key Messages:

� ORSA processes are most effective when integrated within

other business processes, particularly strategic and business

planning capital management and, as appropriate, product

pricing and underwriting

� Promoting ORSA disciplines has value at both a macro (ie

industry-wide) and at a micro (ie company- or group-specific)

level

� Actuaries are highly experience in assessing complex topics and

have the skills, professional processes and perspective needed

to create valuable risk analysis frameworks for management,

boards and regulators

36

Chapter 11 Resolution of Insolvencies (1 of 5)

Recover vs Resolution:

� Recover – actions trying to prevent failure

� Resolution – mitigates the impact of an actual failure

Insurers vs. Banks: Insurer features

� Longer time horizon for business decisions & Resolution needs

� Illiquidity

� Uncertain liabilities

� Asset values readily available

� Run unlikely

� Lower risk of contagion

37


Insurers vs. Banks: Bank features

� Value of assets (loans) uncertain & difficult to quantify

� Liabilities easy to quantify

� Liabilities are extremely liquid – business model assumes

depositors will not all ask for their money at the same time

Susceptible to “run” – could pay first depositors requesting, but

not later

� Nothing fundamental needs to be wrong with bank for a run to

occur

� Resolutions typically happen over a weekend

38


Recovery – key elements

a. The identification of two to four principal scenarios, including

idiosyncratic and sector-wide or market-wide stress situations

which create significant capital or liquidity shortfalls

b. Detailed quantitative & qualitative description of the scenarios

c. A description of principal recovery options that are likely to

have a material impact on the firm in at least one scenario

considered, including an assessment of each option in detail

d. Valuation and impact analysis (capital, liquidity, franchise)

e. Speed and timing of actions

f. Suitability & feasibility in each recovery scenario

39


Recovery – key elements (continued)

g. Operational aspects and responsibilities, including

dependencies on outside suppliers

h. Impediments and constraints

i. Internal and external risks and issues

j. Credibility and necessary preparations

k. Maintenance of the recovery plan, including the process by

which the recovery plan is refreshed and aligned to the

changing shape of the business

40


Resolution of Insolvencies – key insurer/regulator options

� Capital raising (equity and/or debt)

� De-risking the investment portfolio

� Enhanced use of reinsurance

� Reduce the volume of new business

written/transition into run-off

� Proactive run-off by actively commuting policies

� Disposal of subsidiaries or blocks of business

� Scheme of arrangement – use existing statute or regulation to

agree to a compromise that binds all parties

41

Chapter 12 Role of Capital (1 of 4)

Reading the Tea Leaves of Capital

1. What is its purpose? (Will vary by stakeholder - investor,

policyholder, supervisor, rating agency, shareholder, etc.)

2. What level is needed for each Stakeholder?

3. What method(s) should be used to calculate needed capital?

4. What actions will follow if needed capital is not there?

5. Role & Meaning of capital will vary based on the set of

mitigation tools and processes used to ensure the sustainability

of the business model (such as reserves and the quality of

processes used to monitor risk (ORSA)).

42


Various Stakeholder Interests

1. Financial strength indicator (Assets less Liabilities)

2. Solvency buffer (Required Capital)

3. Earnings/liquidity buffer (Margin Over Current Estimate)

4. Source of funds for future growth, acquisition or investment

5. Source of future shareholder & policyholder dividends

6. Legal trigger to constrain management or to transfer authority

to supervisor

43


Fine Tuning: will need to consider:

1. Solvency measurement should reflect real economic risks.

2. Required capital insolvency is not cash insolvency.

3. Addressing the Uncertainty of Any Capital Estimate.

4. Risk based Capital Charges should lead to better risk

management practices.

5. Group vs. Legal Entity Capital

a. Fungibility

b. Diversification

c. Too Big to Fail

44


6. Business Model

7. Pro-cyclicality of market based capital requirements

8. Role of Insurer Liabilities

9. Impact of Insurer Franchise Value due to ERM/ORSA process

Chapter on Financial Statements (1 of 2)

• Purposes

– Investor (performance)

– Policyholder (solvency)

– Management (economic)

– Tax authority (revenue)

• Discusses

– Balance Sheet

– Income Statement

– Disclosures

– How used for solvency testing

Chapter on Financial Statements (2 of 2)

• Insurer-Unique Issues

– Use and significance of estimates

– Long-term nature of life business

– Significant use of counterparties

– Development of assumptions

– Similar assumptions needed for multiple uses

– Is an observed event a one-off item or the start of a trend

– Many more

Chapter on Asset Liability Matching (1 of 1)

• Focuses on importance of ALM since insurance is primarily

liability-driven and assets acquired to match

• Interest rate risk exposure with long duration contracts

• Effective governance

• Influence of regulatory regimes

• Aggregation level for ALM

• Sources of risk (interest rate, credit (aka default), liquidity,

market

• Risk identification, tolerance and measurement

• Assets associated with surplus

• Strategies and their execution

• Definitions

Thank you

www.actuaries.org

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IAA Risk Book - Amazon S3 · 2016-03-29 · About the IAA Risk Book (1 of 5) Background IRC published Blue Book on Insurer Solvency Assessment in 2004 Blue Book explored the then

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