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Global Life Actuarial INTERNAL USE ONLY ASSAL-IAIS Training Seminar: Risk Margin in the Swiss...
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Transcript of Global Life Actuarial INTERNAL USE ONLY ASSAL-IAIS Training Seminar: Risk Margin in the Swiss...
Global Life Actuarial
INTERNAL USE ONLY
ASSAL-IAIS Training Seminar: Risk Margin in the Swiss Solvency Test
22nd November 2012Alex Summers
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Important note
The views expressed in this presentation are the presenter’s own and do not necessarily represent the views of either Zurich Insurance Group (Zurich), or FINMA
I am very grateful to colleagues within Zurich and at FINMA for their assistance in preparation
Further information from FINMA on the Swiss Solvency Test can be found on FINMA’s website at http://www.finma.ch
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Agenda
Purpose and relevance of the SST risk margin
Key principles and conceptual framework
Calculation including simplifications
Comparison against alternative approaches
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The risk margin helps SST protect policyholders by giving a high probability of orderly run-off of the business
SST identifies insurers* at risk of being unable to honour their existing obligations
A ladder of intervention allows appropriate actions to be taken when insurers run into difficulties
SST sets capital requirements so that there is high probability after one year of
1. Still being solvent (Expected shortfall SCR)2. Having enough capital to fund future SCRs
over the life time of the business (Risk margin)
Risk margin should thus give just enough capital to allow orderly run-off of the business, whether internally or via transfer of liabilities to a third party if necessary
Both fulfilment and transfer value concepts are relevant for risk margin in the SST
Risk Total required 0 margin capital
SST ladder of intervention
Based on FINMA SST technical document p8
*: The term “Insurers” has been used throughout to indicate both insurance and reinsurance undertakings
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Overview of risk margin in the SST
Risk margin is the extra amount needed above best estimate of liabilities to cover the cost of supporting risks the liabilities bring
Non-hedgeable risks only
Present value of opportunity cost of regulatory capital needed to support risks over the lifetime of the liabilities
Simplifications are needed in practice
SST risk margin is similar in nature to Solvency II risk marginDetails differ slightly
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Relevance of SST risk margin can vary significantly across insurers
Source: FINMA Report on the Swiss Insurance Market, SST 2012Charts show % total Market Value of Liabilities + required capital (BEL + ES SCR + Risk Margin)
“MVM” (Market Value Margin) is another name for risk margin in SST
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Even though risk margin is small relative to total liabilities, it can have a very significant effect on SST solvency ratio…
Source: FINMA Report on the Swiss Insurance Market, SST 2012Charts shows weighted averages for Swiss Industry, expressed as % total Market Value of Assets
Risk margin is particularly important in stressed marketsNevertheless risk margin is small enough to be a rounding error in BEL
Accurate assessment of BEL is important, considering materiality of impact on target capital
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…as can be seen from consideration of different components of SST target capital
Source: FINMA Report on the Swiss Insurance Market, SST 2012Charts shows weighted averages for Swiss Industry, expressed as % total required capital (Expected Shortfall SCR + Risk Margin)
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Agenda
Purpose and relevance of the SST risk margin
Key principles and conceptual framework
Calculation including simplifications
Comparison against alternative approaches
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The SST risk margin is the expected amount of capital needed today to be able to support regulatory capital requirements over the lifetime of the business
1
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ttcapital Requiredttcapital of Costtfactor Discountmargin Risk
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ttcapital Requiredtfactor Discountmargin Risk
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SST risk margin is based on projected regulatory SCR, allowing for own diversification
For SST the principles defining how risk margin is calculated are based on both transfer and fulfillment value considerations
Inputs mix regulatory and company specific aspectsSolvency II is more strictly motivated by transfer value concept
Benefits of allowing consideration of company specific aspects include
Consistency of balance sheetImproved incentives for good risk management, including diversification
Aspects supplied by
FINMA
Undertaking-specific aspects
Consistent with both transfer value and fulfilment concepts
Consistent with fulfilment concept
Risk measure for regulatory capital6% cost of capital rate
Non-hedgeable risk exposuresDiversification
Assumptions consistent with
best estimateCompany policy
for going concern management
actions
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Only non-hedgeable risks need to be considered in SST risk margin
Practical policyholder protection
Theoretical robustness
Relevance of risk margin increases in a stressed solvency position
Considering non-hedgeable risks only is consistent with possible outcomes under ladder of intervention
Good value safeguarding industry competitiveness: minimum needed for policyholder protection
In market consistent framework, only compensated for risks that can’t be hedged or diversified
Consistent with view of total market value of liabilities as corresponding to value of an optimal replicating portfolio
No double counting
No penalty for market risk associated with free surplus
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SST risk margin is consistent with other elements of the balance sheet, and required capital
Same assumptions should be used for valuing risk margin and best estimate discounted liabilities
In particular there should be a consistency of assumptions pertaining to
Own business policiesSettling own portfolioDiversificationOwn expense riskClient behaviour
This prevents distortions from artificial shortening of run-off period through inconsistencies in lapse assumptions, or assumption of aggressive run-off rather than treatment as a going concern
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6% Cost of Capital rate corresponds to BBB credit rating
Derived considering opportunity cost of capital in excess of risk-freeSteady “through the cycle” assumption
BBB credit rating consistent with 99% Expected Shortfall risk measureHigher credit rating would give lower CoC rate, offsetting higher SCR
Using the same 6% rate for all insurers is consistent with a transfer value concept
Disproportionate effort for each company to calibrate a specific rate
Using same rate for all improves transparency
Other rates can be used e.g. lower rates used for MCEV Cost of Residual Non-Hedgeable Risks
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Company-specific diversification is a key advantage of SST risk margin
Allowing for company-specific diversification recognises that diversification is at the heart of good risk management practice for insurance
So it’s not a disadvantage that company-specific diversification leads to a different “market” value of liabilities for different insurers
Consistent with fulfilment value conceptHopefully this should be more often relevant than transfer value!
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Agenda
Purpose and relevance of the SST risk margin
Key principles and conceptual framework
Calculation including simplifications
Comparison against alternative approaches
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Calculating SST risk margin is generally relatively simple in practice…
Brute force multi-year stochastic-on-stochastic-on-stochastic approach to projecting the required capital is not generally feasible
A simplification can be used:The contribution to the ES SCR for each risk driver is assumed to follow an appropriate run-off pattern, starting from the initial ES SCR e.g. sum at risk for mortalityA simple aggregation method can then be used to give the overall projected ES SCR for each time period
Expert judgment as to choice of run-off pattern needs careful consideration
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… although distinguishing non-hedgeable component of market risks can be a challenge
Non-hedgeable risks relate to components of the liabilities for which there is no liquid market
Expert judgment is needed in determining an optimal replicating portfolio
Good documentation needed
Non-market risks are often not hedgeable at low cost
However if replicating portfolios used for Internal Models, these can also be set up to consider only candidate assets for which there is a liquid market
Comparison with full “theoretical candidate asset” replicating portfolio across many real world scenarios can then inform estimate of non-hedgeable proportion of market risk
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Agenda
Purpose and relevance of the SST risk margin
Key principles and conceptual framework
Calculation including simplifications
Comparison against alternative approaches
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Risk Margins for Solvency II and SST are similar in concept but differ in some details
“Story“ Transfer to empty shell company
Both transfer value and fulfilment value concepts are relevant
Approach Cost of Capital Cost of Capital
Cost of capital rate
6% 6%
Risks covered Insurance risk, operational risk, counterparty risk and non-hedgeable market risks excluding interest rate risk
All non-hedgeable risks, including interest rate riskOperation risk excluded
Diversification Legal entity but not between life and non-life
Whole company specific
Tax Post-tax, but no loss absorbency of deferred taxes
Pre-tax
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IFRS Phase 2 approach to risk adjustment will probably give some flexibility
Cost of capital, VaR, tail VaR and replicating portfolio approaches all potentially acceptable
Accounting purpose is differentBut synergies from allowing a consistency of approach would save effort
Less allowance for diversification
Risk margin vs. residual margin: to split or not to split?
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Overview of risk margin in the SST
Risk margin is the extra amount needed above best estimate of liabilities to cover the risks the liabilities bring
Non-hedgeable risks only
Present value of opportunity cost of regulatory capital needed to support risks over the lifetime of the liabilities
Relevant for both transfer and fulfilment value concepts
Simplifications are needed in practice
SST risk margin is similar in nature to Solvency II risk marginDetails differ slightly