George M. Levine, FCAS, MAAA Senior Manager, KPMG LLP September 24, 2002 Arlington, Virginia
© 2002 KPMG NINTH ANNUAL CONFERENCE OF INTERNATIONAL ASSOCIATION OF INSURANCE SUPERVISORS 11...
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© 2002 KPMG NINTH ANNUAL CONFERENCE OF INTERNATIONAL ASSOCIATION OF INSURANCE SUPERVISORS 11 October 2002 FINANCIAL SERVICES
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Transcript of © 2002 KPMG NINTH ANNUAL CONFERENCE OF INTERNATIONAL ASSOCIATION OF INSURANCE SUPERVISORS 11...
© 2002 KPMG
NINTH ANNUAL CONFERENCE OF
INTERNATIONAL ASSOCIATION OF INSURANCE SUPERVISORS
11 October 2002
FINANCIAL SERVICES
© 2002 KPMG
Joachim Kölschbach
The case for change
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© 2002 KPMG
The case for change
Why change ? The role of capital What are the alternatives ?
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© 2002 KPMG
The case for change - Europe
The European solvency system has worked well- Prudent asset and liability valuation rules have offered a
cushion to absorb unexpected losses But there are inconsistencies in implementation of
directives- Super-equivalent rules- Inconsistent accounting rules- Implicit capital requirements
Change in business and market dynamics (lower interest rates, equity returns, guarantees, operational risks)
Future accounting developments
All highlighting the pressing need for reform
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© 2002 KPMG
The case for change - International
Need for level playing field globally and across the financial sector
Capital markets pressure to optimize use of capital US terrorist attacks have created solvency concerns for a
number of insurers Developments in the banking industry Other regulatory authorities move towards more advanced
approaches
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© 2002 KPMG
Business case for change
. . . but computer power now exists to develop complex and better models
Manage risks and capital effectively
Transparency
Rating agency pressure
Understanding risks and risk interaction
Competitive pressure
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© 2002 KPMG
The role of capital
Provides buffer against- Risks - Expected and unexpected
future losses- Deterioration in provisions
Capital definition – how much capital is required?
Regulatory capital vs risk capital – should there be a difference?
Relationship between provisions, assets and reserves – does it matter?
Source: KPMG, Study for the European Commission, May 2002
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© 2002 KPMG
Overview: Assets and liabilities in the solvency system
Liabilities
Investments
Reinsurers’ share of technical
provisions
Other assets
Actual margin
of solvenc
y
Relationship with
liabilities
Prudent valuatio
n method
s
Prudent valuatio
n method
s
Market risk
Creditrisk
Operational risk
Asset / liability
mismatch risk
Insurance risk
Required margin of solvency
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© 2002 KPMG
What are the alternatives ?
Benefits in simplicity of European fixed ratio approach
The US RBC approach aims to incorporate more risks
Canadian & Australian supervisors are encouraging the development of internal risk models
Apparent benefits in more sophisticated approaches may be undermined by practicalities of implementation
Fixed ratio
Risk based capital
More advanced approache
s
Source: KPMG, Study for the European Commission, May 2002
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© 2002 KPMG
EU fixed ratio approach
Advantages Disadvantages
Simple No clear capital definition
Little subjectivity Inadequate recognition of risks
No significant data issues Weak predictive power
Low compliance costInconsistent valuation of assets and liabilities
Easy to standardiseLittle effect on internal risk management
Source: KPMG, Study for the European Commission, May 2002
“…to calculate a solvency margin requirement based on fixed proportion of a proxy for exposure to risk.”
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© 2002 KPMG
Risk based capital approaches
Advantages Disadvantages
Relatively simple No clear capital definition
Little subjectivityNot enough scope for risk-interaction, diversification and size effects
No significant data issuesOperational and reinsurance risks not adequately dealt with
Low compliance cost Not dynamic
Easy to standardiseLittle effect on internal risk management
Source: KPMG, Study for the European Commission, May 2002
“…to calculate capital requirements which reflect the size and overall risk exposures of an insurer”
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© 2002 KPMG
Fixed Ratio RBC Scenario basedProbabilistic
approach
Extent of risks Poor Good Good Excellent
Risk interaction Poor Fair Good Excellent
Predictive power Poor Fair Good Excellent
Dynamic Poor Fair Good Excellent
Data Minimal Moderate Considerable Demanding
Subjectivity None None Considerable Considerable
Cost Low Low Medium High
Standardisation Easy Easy Possible Difficult
Assessment of different approaches
Source: KPMG, Study for the European Commission, May 2002
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© 2002 KPMG
Key challenges for a future system
Greater recognition of risks
Company specific risk profiles
Size and diversification effects
Broad risk categorization
Operational and asset/liability mismatch risk
Explicit and transparent system
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© 2002 KPMG
Overview of KPMG study
Chapters- Risks & risk models- Technical liabilities- Asset valuation- Reinsurance- Alternative risk transfer
arrangements and advanced risk reduction techniques
- Impact of future accounting changes
- Use of rating agencies and market mechanisms
- Comparative analysis of solvency margin methodologies
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Conclusion
Use of riskmodels
Enhanced riskmanagement
Need for flexibility in supervisory
approach
Broad workable framework
Risk based Cost effective
Banking regulatory developments
Accounting changes
Consistency and transparency of
capital requirements
Greater recognition of risks
© 2002 KPMG LLP. KPMG LLP, a UK limited liability partnership and the UK member firm of KPMG International, a Swiss nonoperating association. All rights reserved. Printed in Belgium.
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© 2002 KPMG
NINTH ANNUAL CONFERENCE OF
INTERNATIONAL ASSOCIATION OF INSURANCE SUPERVISORS
11 October 2002
FINANCIAL SERVICES
