Risk Management for A t li Lif IAustralian Life (& General) Insurers

ICAAP & LAGICICAAP & LAGIC

2013年11月29日2013年11月29日

演講人: Fred Rowley MA FIA FIAA Hon FFA CERA演講人: Fred Rowley, MA, FIA, FIAA, Hon FFA, CERA

Appointed Actuary, TAL Life Ltd, Sydney, AustraliaPast President, Institute of Actuaries of Australia

Director, CERA Global Association

Wh me?Why me?

• In Australia, the Appointed Actuary plays several roles in a Life Insurer’s ERM processes:

• Annual Financial Condition Report (required by law) must:• Review Profitability (by product, fund and company)

• Recommend insurance risk stressesRecommend insurance risk stresses

• Calculate Capital Position (current and projected)

• Review Risk Management Framework (suitability/adequacy)

• Review and Comment on ALM matters• Review and Comment on ALM matters

• Review Reinsurance Administration (effectiveness)

• Highlight impact of any financially material compliance issues

• Product Financial Advices (required by law) must:• Consider consequences of any proposed product or

reinsurance actions/ changes/ discontinuances

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reinsurance actions/ changes/ discontinuances

Essential Backgro ndEssential Background

• In Australia, insurers report assets at fair value for accounting and regulatory purposes (with very few exceptions)

• In the P&L, policy liabilities are calculated as a ‘best estimate’ (which allows for option asymmetry) plus profit margins which will be released over the period during which policy services are to be provided, in line with

‘ i ’ ( ‘ i ’ i l i )a ‘carrier’ (e.g. ‘carrier’ = premiums or claims)

• No profit permitted on new business: acquisition expenses are deferred and amortised through P&L: as a result liabilities for viable risk (nonand amortised through P&L: as a result, liabilities for viable risk (non-investment) lines can often be negative, and vary with changes in interest rates: this approach is modified in the regulatory basis

• Losses are recognised as soon as best-estimate liabilities not adequate to recover DAC (which may be at the time of issue)

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• Profit and Loss is occasionally quite volatile ….

Australian ICAAP OverviewAustralian ICAAP Overview

ICAAPICAAP

Risk Management Capital Adequacy Framework Framework

Risk Appetite Statement Business Plan

Risk Management

Strategy

Capital (Demand)

Measurement & Reporting

ICAAP Summary

(incl. Target Capital Policy)

Capital (Supply)

Measurement & Reporting

Capital Sourcing (Strategy)

ICAAP Report

& Reporting Capital Policy) & Reporting

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Australian ICAAP OverviewAustralian ICAAP Overview

Internal Capital Adequacy Assessment Process

Includes risk measurement & management projections- Includes risk measurement & management, projections, capital planning & management (incl. sourcing), reporting, compliance, 3-yearly ‘independent’ review, etc, etc.APRA i l ki f l B d d CEO hi l ld- APRA is looking for real Board and CEO ownership, real-world ‘feel’, and demonstrable depth (e.g. Target Surplus process)

- ICAAP integrated into business decisions and planning- Capital position (PCA etc) to be published (not Sup Adj)

- Includes scenario-based stress tests -> capital sourcing- Capital usage breakdowns 3-yr projections (profit?)Capital usage breakdowns, 3 yr projections (profit?)- 3-yearly review by “operationally independent” person

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Risk AND Capital Management –in a Control Cycle

Available Risk Capital

Measure MeasureAction ActionPlan/Monitor

Available Capital

(Supply) Measurement

Capital Management/

Sourcing

Situations Addressed

Risk Control/ Management

Risk Capital Charge

(Demand) Measurement

Cycle

LPS 112

Calculation (Appointed

Actuary)

Dividend Policy/ Capital

Reductions

Current/ Historic

Positions

B i

Risk Appetite

Risk Limits

Prescribed Capital

Amount from LPS 114/5/7/8

Regulatory Adjustments

Other (P&L, admissibility, experience, growth, etc)

Business Plan

Forecast Positions

Retrocessions Policy

Prudential Adjustments

Options to Increase Capital

Positions

Stress & Scenario

Tests

Investment Policy

Credit Exposures

Validated Target Surplus

Cycle6

ICAAP (incl. Summary) (LPS110 – S13/14)

ICAAP must contain:- ADEQUATE & APPROPRIATE - risk measurement &ADEQUATE & APPROPRIATE risk measurement &

management, projections, capital planning & management, reporting, compliance, review, etc

St t f i t i i it l d ti (TS)- Strategy for maintaining capital adequacy over time (TS), addressing all risks and including capital sourcing strategy

- Stress-testing and scenario analysisg y

- Compliance processes, actions and procedures – plus (potential) breach avoidance and reporting (S55)

Sh ICAAP ( d ICAAP ti ) i ti d i i- Shows ICAAP (and ICAAP reporting) are in practice driving business decisions

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ICAAP Report (LPS110 S17/18)ICAAP Report (LPS110 – S17/18)

ICAAP Report (ANNUAL, BUT …. )

- Current and 3-yr projected capital level vsy p j pPrudential Requirements & Target Capital

- Actuals vs ICAAP Plan (amounts and actions) for last year

Ch t ICAAP- Changes to ICAAP

- “Detail and Outcomes” of stress-testing & scenarios

- Breakdown of Capital Usage over the planning horizonBreakdown of Capital Usage over the planning horizon– business activity/ geography/ risk types

- Anticipated changes in risk profile or capital processes

- Reviews of ICAAP and responses to them

- Compliance/ Capital Adequacy/ Accuracy (S18 Declaration)

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ICAAP Implementation (1)ICAAP Implementation (1)

Basic (Periodic) ICAAP Reporting- Quarterly APRA statistical reports

- updates APRA on capital position from March 2013

- ICAAP Annual Report p

- for many, Apr 2014 will be the first ‘full’ ICAAP Annual Report – but even so, they will need substantial reporting before then (i.e. already)

- most expected to treat as a continuation of Fi i l C diti R tFinancial Condition Report

- including ICAAP compliance monitoring

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ICAAP Implementation (2)ICAAP Implementation (2)

Continuous Risk & Capital Management- Boards expected to have been involved in RiskBoards expected to have been involved in Risk

Scenario workshops, and to understand implications of stress tests for Capital management & sourcing

- Capital Adequacy/ Target Capital issues will probably be escalated via CFO and/or App Actuary

Cvia Risk Committee

- Requires continuous monitoring of balance sheet( t & j t d) b t d t(current & projected) by actuary and management

- Many key components to be built

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Australian ICAAP OverviewAustralian ICAAP Overview

ICAAPICAAP

Risk Management Capital Adequacy Framework Framework

Risk Appetite Statement,

Limits & Tolerances

Business PlanRisk

Management Strategy

Capital (Demand)

Measurement & Reporting

LAGIC

ICAAP Summary

(incl. Target Capital Policy)

Capital (Supply)

Measurement & Reporting

Capital Sourcing (Strategy)

ICAAP Report

Tolerances LAGIC Measurement

Capital Policy) & Reporting

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LAGIC Measures –Statutory Capital

• Measurement of entity capital is designed to harmonise with banking and other insurers’ capital measurement:

• Capital is divided into Common Equity Tier 1, Additional Tier 1, and Tier 2 p q y , ,capital with restrictions on amounts that may be set against capital charges.

• CE Tier 1 must exceed 60% of the Prudential Capital Requirement

• Tier 1 must in total exceed 80% of the Prudential Capital Requirement

• Capital Base must exceed 100% of the Prudential Capital Requirement

• Capital Base is adjusted to be the maximum of the total termination values in any fund and the risk-free best-estimate liabiltiies (RFBEL) – which removes negative liabilities

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Risk Appetite (& Target S rpl s)Risk Appetite (& Target Surplus)

• Risk Appetite Statement(s)• Specifies risk appetites and/or tolerances in simple terms at a high level,

for the company as a whole

• Conceptually, may relate to:

• likelihood of failure to meet regulatory requirements

• likelihood of profit deviations from plan (P&L total or specific items)

• likelihood of failure to meet policyholder obligations

• Needs to be defined over a specific timeframe (& net/gross)

• Acts as basis for “cascading” risk measures to lower levels in more gconcrete terms, and in particular, supports determination of risk tolerances and risk limits at lower levels

• Examples:• Likelihood of failing to meet regulatory capital requirements over a one

year period is below X%

• Likelihood that half-yearly credit losses exceed $Ym is below Z%

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Risk Limits & Tolerances –Cascade Examples

• Insurance Risk:• Product Features and Sales Volumes

• Underwriting Limits• Underwriting Limits

• Automatic Cover Limits

• Pricing Guidelines and Price Approval Authorities

R t ti Li it (i di id l)• Retention Limits (individual)

• Retention Limits (Group)

A Ri k• Asset Risk:• Credit category exposures

• Aggregate counterparty exposures

• Inflation (mismatch) limits

• IBS – Duration (mismatch) limits

• Equity/Inflation-driven guarantees

14• Reinsurer collateralisation (vs. concentration risk)

LAGIC Risk Measures –Regulatory Capital

• Basic Methodology for Risk Charges (Over-simplified!):• Aiming to get 99.5% confidence that capital will be sufficient to meet

liabilities (or termination values) after one year – at company and sub-fund levels

• Apply insurance stresses (only) to calculate the Insurance Risk Charge. Actuarial judgement is applied to calculate most stresses.

• Apply asset stresses (only) in several different scenarios to calculate Asset Risk Charge; select the ‘plausible worst case’

• Apply diversification within each calculation

C l l t th dditi l i t f A ti (f l )• Calculate the additional impact of Aggregation (formula)

• Apply insurance and asset stresses (reduced by a formula) together, and adjust for tax effects and management actions.

C ith th l ibl t l t d b d t k th t• Compare with the plausible worst case selected above, and take the greater value; add the Operational Risk Charge, and the Asset Concentration Risk Charge (which are calculated separately)

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Risk Measures –Regulatory Capital (LAGIC)

• Insurance Risk:• Random mortality/morbidity fluctuations (relative to trend)

• Deterioration of mortality/morbidity trendsy y

• “Event” including pandemic

• Adverse lapse rate variations

• Adverse expense variationsAdverse expense variations

• Asset Risk:• Market risk (equity prices/ interest rates/ real estate/ inflation• Market risk (equity prices/ interest rates/ real estate/ inflation,

currencies, derivatives, etc.)

• Credit (spread) risk

• Credit (default) risk• Credit (default) risk

• Counterparty limits

• Reinsurer concentration limits

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Risk Measures –Regulatory Capital (LAGIC)

• Operational Risk:• Unit-pricing and other policyholder failures (~assets/ liabilities)

• Other operational breakdowns (~premiums)( )

• Rapid increase/ decrease in scale of operations (~change in premiums)

• Outcomes:Outcomes:• Total Capital charges = Prescribed Capital Amount (PCA)

• PCA (PCR) is compared with regulatory Capital Base

• Process provides $ sensitivities to various eventsProcess provides $ sensitivities to various events

• Must be integrated with pricing and financial reporting

• More sensitive to risk, so capital demand is quite volatile

• Allows for diversification => potential for optimisation• Allows for diversification => potential for optimisation

• Relates to fairly ‘real world’ scenarios (useful later!)

• Good – but volatile – basis for capital & NB planning

• No really useful P&L measures

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• No really useful P&L measures

Risk Measures Target CapitalRisk Measures – Target Capital

• Basis:• Sufficient Capital to give a 97.5% likelihood of meeting regulatory

capital requirements over a one year periodcapital requirements over a one year period

• Defined at the Company level

• Takes account of likely P&L impacts affecting Capital Base

• Takes account of likely movements in PCA• Takes account of likely movements in PCA

• Excludes ‘very unlikely’ events

• Some operational risk modelled

• ‘Real world’ scenario calculations modelling what the PCA and• Real-world scenario calculations – modelling what the PCA and Capital Base would look like after the events occur

• Set $ amount, which is reviewed periodically

• May fill any ‘gaps’ in the Prudential Capital Requirement• May fill any gaps in the Prudential Capital Requirement

• Acts as an aggregate quantified risk control (how ?)

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Reinsurance as a Risk MitigationReinsurance as a Risk Mitigation

• Retail & Group business lines:• Mitigates pricing risk and random fluctuations

• Mitigates capital impact of new businessg

• CAT Cover / Stoploss:• Mitigates extreme random fluctuationsMitigates extreme random fluctuations

• Overall:• Reduces capital demand (short position in insurance risk)• Reduces capital demand (short position in insurance risk)

• Second reference on pricing

• Some admin/underwriting support

Profit impact• Profit impact

• Can lead to counterparty risk concentrations

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Asset[/Liability] Risk –Detailed Points

• Asset Risk measures:• Allow for change in asset value – minus change in any matched

liability

• Allow increases and decreases in interest rates, inflation, and currency market prices, as well as falls in equities/ real estate/ bonds (via spreads) and various types of asset default; as well as possible increases in equity volatilityas well as possible increases in equity volatility

• What about Liquidity Risk?

• And what about New Business?

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Operational RiskOperational Risk

• Statutory Basis = Formula based approach with no discretion

• ORCR = 3%×{maximum(GP1, NL1) +

maximum(0, |GP1 – GP0| – 0.2 x GP0)}

T t C it l B i• Target Capital Basis = Simulation based on reasonable parameters

• Some instances of feedback from experience

• Overall:• Target Capital basis is much more real-world

• This overlay on the Statutory Basis is what enables the business to continue in a sound manner

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Risk ConcentrationRisk Concentration

• Reinsurance - Statutory Basis• 25% of stressed value of assets in the fund

• Must be registered insurer – else 2.5% limitg

• Mitigated by legally-enforceable collateralisation

• Other limits on deposits, and any single assetOther limits on deposits, and any single asset• See LPS 117

Fori) any other actively traded security;i) any other actively traded security;ii) a non-traded security, loan, or reinsurancearrangement with a counterparty grade of 1, 2 or 3;iii) real estate; oriv) other income producing real property asset:

The greater of:i) 5% of VAF; andii) 25% of capital base.

And half that limit for any asset not covered by any of the above categories.

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And half that limit for any asset not covered by any of the above categories.

Financial Stress/Scenario Testing

• APRA strongly recommend the use of scenario tests, stress tests, and reverse stress tests

B d h ld t k hi d b ti l d• Board should take ownership and be actively engaged

• May operate through the Board Audit / Risk Committees

• Different tools have different uses

S i b h b l f i l l i• Scenario tests may be the best tool for capital planning

• All of these integrate with the base tools for LAGIC

• Philosophy documented in the ICAAP Summary Statement

• Results and policies arising from the work will be documented in the ICAAP Annual Report.

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Capital Planning & SourcingCapital Planning & Sourcing

• Outputs from the various projections and tests are used to build a projection of capital demand and capital supply

• Board should take ownership and be actively engaged, using results from testing

• Planned uses of capital => geographic, product, etc

• Supply side may be less predictable, but equally necessary

• APRA require tracking of actual outcomes against plan

• APRA require review/update processes

• All this is necessary for business purposes regardless –but probably more complete and formal now

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Financial Risk/Capital Dashboards

• Companies have built detailed capital demand/supply projections, by product line and fund, to complement its qualitative ERM toolsqualitative ERM tools

• Used as an important live management tool, alongside budgets, and business planning

• Risk Committee will manage review/update• Risk Committee will manage review/update

• Supplemented by tests to warn of discontinuities in the basis (e.g. monitor risk concentrations)

• Supply side may be less predictable but equally necessary• Supply side may be less predictable, but equally necessary

• Board/shareholder will review actual outcomes against plan

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What is the Ind str Impact?What is the Industry Impact?

• Companies have generally been able to release some capital after LAGIC measures were introduced

G t i k iti it ll i f j d t t b d• Greater risk-sensitivity, allowing for judgement to be used

• Allowance for diversification , without excessive complexity

• Synergies between product lines

BUT S i l i h d d b fi d• BUT … Some capital instruments have needed to be refinanced

• Capital charges have been more volatile than before• Greater risk-sensitivity

• Unusually volatile experience

• For many reasons, Boards are becoming very familiar with the Risk profiles and Capital dynamics of their companies

• LAGIC/ICAAP introduction was designed to illustrate scenarios

• Real-life scenarios have arisen, too

• Process may have been “just in time” ?

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y j

Is this ERM?Is this ERM?

• Yes, provided it is ….

l t d b l ld l (i l di th T t C it l )• supplemented by real-world overlay (including the Target Capital process) and tests to warn of inadequacies or discontinuities in the regulatory bases (e.g. monitor risk concentrations)

• used as an important live management tool alongside budgets andused as an important live management tool, alongside budgets, and business planning, so that the Board/shareholder take notice and are prepared to act

• Can you suggest any other provisos?

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Thank you !

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