Post on 06-Mar-2018
Governance of Uncertainty/Risk & US ORSADAVID SANDBERG
FSA, MAAA, CERA
September 17, 2015
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Governing The Businesses of Uncertainty
• Banking – (Uncertain Assets)• Savers money loaned away. Liability is a known
quantity. Assets are not certain• Manage risk not paid back + liquidity risk of
savers. Biggest risk = assets not there when savers want them
• Engine for growth via risk• Time horizon = daily balancing
• Insurance – (Uncertain Liabilities)• Money invested in bonds & managed so funds
sufficient to meet future promises. • Liability is uncertain, but assets are known• Ensure safety• Time horizon = quarterly to decades
• Exchanges – Price Stabilization & Speculation
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All Intersect in The Financial Market Today
Central
Bank
Markets
Net Stable Funding Ratio
Liquidity Coverage Ratio
No Domestic Credit Risk
Banking/Trading Book Option
Going-Concern Contingent Capital
Low-Trigger Contingent CapitalAdditional Capital Buffers
Counter Cyclical Premium
Matching Adjustment
No EUR Credit Risk
Equity Dampener
Lack of diversification across jurisdictions
Sovereign
Banks
Sovereign Bonds
Toxic Assets
Market influence, e.g. via prohibition of short selling, buying up of government bonds, etc.
Moral Suasion
Hold to Maturity
Approaches, IAIS ICP 14
Transfer of illiquid assets from
banks to insurers and pension funds
in exchange for liquid assets
Markets with
impaired price
finding function
Insurance regulation geared to
support banks and sovereigns
Lowered asset quality, lower reserves / technical
provisions; disincentives to sell assets with declining
market values, lower market liquidity
Taking on of banking
debt, CoCos etc.Ultimate Forward Rate
Solvency
II, etc
BSCBBasel
II/III
SIFI
Liquidity, Cash
IAIS
IASB
Expropriation of Pension Funds
Sovereign Bonds
Moral Suasion
Moral Suasion
Banking
SIFIs
Liq
uid
ity T
ran
sfo
rmati
on
s
Lo
ng
-Term
Fin
an
cin
g
Co
mp
eti
tive D
isad
van
tag
e
Liq
uid
ity T
ran
sfo
rmati
on
s
Basel II
I / S
olv
en
cy II
EM
IR, D
od
d-F
ran
k A
ct
Basel II
I
Liquidity pumps
Dir
ect
Bailo
ut
SIFI Designation
Pre
fere
nti
al
investm
en
t in
SIF
Is
Growth of SIFIs due to funding advantage and being Too
Big To Fail, Too Big to Prosecute and Too Big to Supervise
Low Interest Rate Policies
Central banks issuing and buying
sovereign bonds, Quantitative Easing,
Outright Monetary Transactions etc.
Closer link between
sovereigns and central
banks
Neglect
Conflicts of
interests
Pension
Funds
Insurers
Inefficient capital
allocation
Decline due to competitive
disadvantages and low-
interest rate environment
Lobbying power
Government Guarantee
Sovereign Bonds
Full Diversification within Conglomerates
Lo
we
r co
st o
f ca
pita
l
(~5
0 t
o 1
00
bp
)
Repo Facilities
Pension
Funds
InsurersInsurance
SIFI
Insurers
Insurance SIFI RegulationNo preferential
IAIS /
ComFrame
Inve
stm
en
t
Increasing protectionism
Enhanced supervision, resolution, higher loss absorption capacity
Offshore
Jurisdiction
De-facto control
Capital Flows
Rating
AgenciesPressure Rating Uplift
Sovereign Rating
Protectionist measures: Capital flow restrictions, trade barriers, hurdles for foreign investment, etc.
Competing
Jurisdiction
Capital Flows
Closure via
supranational
agreements
Offshore
Jurisdiction
Currency Wars
Capital Transfers to SIFI Banks: ~500bn Annually
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Pillar One & Three Pillar Two
Governing the Drivers of Insurance Value
Value of Put Option
Value of Firm
Value of Tangible Assets
Value of Liabilities
Value of Default Put
Option
Manage-ment or
Franchise Value
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Source: Babbel/Merrill, Journal of Risk & Insurance 2005
Capital as Governance Tool
• Nuance for Insurance Capital• Assets in excess of liabilities to invest or to
return to shareholders (traditional shareholder view) plus
• Required buffer for uncertainty for additional policyholder protection (regulator & policyholder view)
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Shortcomings of Capital
• Amortized Cost• Does not capture cost of the underlying
guarantees – the heart of insurance• Uses history to project future values
• Market Value• Uses todays pricing of risk to value all
future risks. • Good for assessing cost to hedge all risks,
but volatility is exaggerated
• All Reported Numbers are Approximations – Inherent Uncertainty in Liability Valuation Methods (and some assets)
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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 is sunk”.• And, are they robust or smoke and mirrors?
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Company Tools
1. Reliance on (and use of) experts (especially actuaries), with those from a profession being, perhaps, the most valuable
2. Organizational structures such as groups
3. Reinsurance, both proportional and non-proportional - to mitigate risk and to act as a form of capital
4. Hedging and asset liability management techniques
5. Enterprise Risk Management (ERM) concepts such as emerging risk identification, risk appetites, limits and controls
6. Capital focused on addressing needs in excess of regulatory balance sheet requirements
Company Tools
7. Models, including both external vendor models and internal models (e.g., catastrophe models and economic capital models)
8. Internal model control and validation procedures
9. Stress testing
10. Responsible pricing, product design and inforce management
11. Voluntary disclosures to both shareholders and policyholders
12. Traditional corporate management processes such as disaster recovery, strategic planning, compensation philosophy and market positioning.
OECD Paper on Governance
1. Identifies all the “Shoulds”
2. How to Tell the Gold from a Potemkin Village?
3. What is “Sound” Risk Management vs. Ineffective Bureaucracy?
4. How to apply so shareholders and/or regulators can tell if there is effective governance?
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Actuarial Profession Addresses Potemkin Village Issues
1. How to measure and report on Financial Risks – Book written over a decade ago
2. How to Assess Sustainability and Soundness of Processes for:
1. ERM
2. Governance of Models
3. Understanding the value, uncertainties and shortcomings of each measurement and mitigation option
4. Three Lines of Defense
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Risk Book Topics
• Wave 1 (Ready for On-Line Early Fall)• Catastrophe Risk (ICP 13)• Non-Proportional Reinsurance (ICP 13)• Professional Standards (ICP 14)• Operational Risk (ICP 13,15-17,23,25)• Actuarial Function (ICP 8)
• Wave 2 (Ready for On-Line by Mid-Fall/Winter)• Regulatory (and Management) Tools • Stress Testing (ICP 8,16-17)• Group Structure and Consequences (ICP 23 etc.)• Intra-Group reinsurance (ICP 8,9,15-17,23,25)• ORSA and ERM (ICP 16)• Financial Statements
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Future Topics
• Wave 3 (Ready for On-Line by Q1 2016?)• Overview, Executive Summary and Integration
• Governance of Models (ICP 17)
• One Year vs. Multi Year Valuation (ICP 14,16,ICS etc)
• Resolution (of insolvencies) (ICP 17, 26, FSB Key Attributes)
• ALM (ICP 15)
• Marketing/Distribution Risk
• Wave 4 (Timing Uncertain)• Use of Derivatives
• Communicating Uncertainty
• Materiality & Proportionality
• Policyholder Behavior/Management Actions
• Visualizing/Identifying Risk Interlinkages
• ???
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ERM Tools = Holistic Set
• Powerful new Tools
• Caution =
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US ORSA – Quo Vadis?
• How will recent NAIC focus on Group Capital calculations impact legal entity ORSAs?
• Will supervisory colleges make efficient or redundant use of ORSAs?
• Will ASB adopt a Standard for Actuaries involved in preparing or reviewing an ORSA?
AUDIENCE QUESTIONS
1) How many here are part of a Group Supervisory Framework?
2) How has the ORSA impacted the role of risk in your organization?A. Reduced your role with more paperwork to be done?B. No impact?C. Increased your presence at both the board and operational
levels?
3) Who owns the preparation and review (including discussion) or the ORSA?
4) What is the relationship, if any, between the ORSA and the appointed actuary discussions by the board?
The Evolution of the ORSA(Canadian Edition)
Stephen Manly, FSA, FCIA, FRM
Office of the Superintendent of Financial Institutions, Canada
September 17, 2015
Agenda
The ORSA process
ORSA – General Observations
General Feedback to Insurers
Evolution of the ORSA
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ORSA and ERM Framework
The Own Risk and Solvency Assessment is the process by which an insurer assesses its capital needs. The ORSA should be used to establish or change an insurer’s internal target
OSFI’s Corporate Governance Guideline states: “A FRFI [federally regulated financial institution] should
have a Board-approved Risk Appetite Framework that guides the risk-taking activities of the FRFI.”
ORSA is one tool used by an insurer to guide risk-taking activities. ORSA is focused on risk identification and solvency, while ERM focuses on the management of risk towards a well-defined risk appetite
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Evolution to ORSA
Dynamic Capital Adequacy Testing (DCAT) Required by OSFI since 1992 for Life insurers (1998 for P&C insurers) Driven by a recognition of the retrospective and static nature of capital
requirement rules Standards for DCAT set by CIA (Canadian Institute of Actuaries), not by OSFI
Internal Capital Target Setting OSFI Guideline A-4 for insurers effective Jun 2011 (revised Jan 2014)
Stress Testing OSFI Guideline E-18 (effective Dec 2009) Outlines OSFI’s expectations with respect to enterprise-wide stress testing
framework for all federally regulated financial institutions
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Key Elements in ORSA
Comprehensive identification and assessment of risks
Relating risk to capital
Board oversight and senior management responsibility
Monitoring and reporting
Internal controls and objective review
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Importance of the Approach to ORSA
Key point: ORSA is a process
The ORSA report and Key Metrics Report (KMR) are only outputs of the process. They document the ORSA process
Three approaches: Compliance exercise Communication or risk summary Description of process and conclusions
The approach taken can influence the usefulness of the ORSA process
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Agenda
The ORSA process
ORSA – General Observations
General Feedback to Insurers
Evolution of the ORSA
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ORSA Benchmarking
Preliminary review of more than 125 Life and P&C ORSA reports focused on characteristics: Expectations from Guideline E-19
Approaches used by insurers
Qualitative assessment
Key Metrics Report filing
Observations are broadly similar in the P&C and Life industries
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ORSA: Link to internal targets
0%
25%
50%
75%
100%
Reportidentified theinternal target
Internal targetidentified =KMR ratio
% o
f O
RSA
Rep
ort
s
ORSA reports generally identify the insurers’ internal target
However, operating level and Tier 1 internal capital target (for life insurer) usually not discussed in the report
Insurers are not using the ORSA to establish their internal target
Many insurers kept their internal target at pre-2014 levels but without explanation on how it tied to the ORSA
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ORSA: Risk identification Most insurers have not yet fully incorporated their ORSA process as part of their
ERM or strategic planning
No standard definition of risk categories Insurance risk:
In some cases catastrophe risk or reserving is a separate risk category Some definitions include reinsurance risk
Credit risk: In many cases it is strictly reinsurance counterparty credit Sometimes includes policyholder and broker counterparty credit risk Other definitions are investment based
Market risk: FX risk may be included in market risk or as a separate category
Materiality assessment determines whether a risk category is aggregated into a broader category or separated out
Implications: adding up and comparing own capital by risk categories at an industry level may not be meaningful.
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ORSA: Life risk identification
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ORSA: Life insurers own capital
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ORSA: Quantification methodology
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0%
25%
50%
75%
100%
VaR TVaR/CTE Unspecified
% o
f O
RSA
Rep
ort
s
P&C Life Total
DCATs, MCCSRs, and models (VaR, CTE) often referenced but not always explained how they integrated
Some ORSAs provide a good overview of methodologies or provide a reference of the supporting documentation
Stress testing own capital
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0%
25%
50%
75%
100%
Seve
re S
cen
ario
s
Var
yin
g Sc
enar
ios
% o
f O
RSA
Ow
n C
ap
ita
l
Proportion of own risk capital # of reports
Very few reports (~13%) include any own capital for stress testing scenarios
Some reports include a number to bring ORSA capital to the internal target level. Usually labelled a compliance amount under other or as a separate risk line.
Severity (confidence level)
15
Diversification methodology
16
ORSA: Diversification Credit
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ORSA: Risk processesReferences to various documents
The majority of the insurers:
ERM process
Policies related to risk
Risk appetite/tolerances
DCAT
Half of the insurers:
Emerging risk process
Capital fungibility
Some of the insurers:
Reverse stress testing process
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ORSA: General Observations
Examples of future planned enhancementsDevelopment/enhancement of modelMore research understanding risk profileOperational riskAggregation/diversification benefitsStress testingBetter integration with ERM and business planning
The ORSA reports at a glance: A number of reports are descriptive in nature From 4 pages to over 200 pages
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Agenda
The ORSA process
ORSA – General Observations
Feedback for Insurers
Evolution of the ORSA
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Superintendent’s remarks "I understand that many companies are interested in our feedback on the
assessments that they have shared with us. Having seen the broad range of ORSAs, we at OSFI are well positioned to provide you with recommendations for improvement, and to compare your practices with those we see as the best in the industry.”
“And while we are well positioned to do all of that, we are not going to.”
“Why not? Because our overriding goal is to keep the “Own” in ORSA. If we started making specific suggestions to individual companies, we would, inadvertently, start substituting our judgment for yours. Of course we could try to reduce the impact of our comments by noting that they are only suggestions, that you are not obliged to follow our recommendations, that your ideas might well be beter than ours, and so on. But I don’t think insurers ever forget, even for a moment, that we are the supervisor. And so comments that would be perceived as suggestions if they were made by anyone else come across as requirements if we make them.”
Source: Remarks by Superintendent Jeremy Rudin to the 2015 Property and Casualty Insurance Industry Forum, Cambridge, Ontario, June 4, 2015 (http://www.osfi-bsif.gc.ca/Eng/osfi-bsif/med/sp-ds/Pages/jr20150604.aspx
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Supervisory use
The ORSA process is the insurer’s own assessment of their capital needs. The report documents that process
Supervisors may use the information in the report or supporting documentation in understanding of the institution
The ORSA report is viewed in a manner similar to other internal management reports of the insurer. For example: risk appetite investment management report the insurer’s risk dashboard
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Supervisory feedback
Supervision may come back to the insurer if:
Clear inconsistency with Guidelines A-4 or E-19 expectations E.g. ORSA process is not used to set internal target
Inconsistency in reporting between the KMR and ORSA report E.g. Numbers do not align
No annual process to update the ORSA
An objective review plan has not been identified
Methodological concerns with the internal target setting E.g. methodologies around diversification, etc.
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General feedback to insurers The ORSA report is the documentation of an insurer’s risk
identification and own capital assessment processes. Therefore OSFI will not comment on the:
Structure of the report
Specific risks identified General content of the report
Relating risk to own capital Quantification assessments within the report are not required
(should be documented somewhere within the process) but it may be useful to a Board or Chief Agent
If the ORSA report includes a quantitative assessment, it should reconcile with the data in the KMR
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The ORSA process to set targets
The ORSA process is expected to establish the internal target
The ORSA quantification assessment should establish the internal target.
If there is a change of internal target, OSFI may be assessing the adequacy of the revised internal target and may need to review the methodology of the quantitative processes.
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Common industry questionsQ1: How does ORSA interact with Guideline A-4: Regulatory Capital and Internal Capital Targets?
Q2: Does the requirement to have the internal target greater than 150% apply before or after a stress scenario?
Q3: What are OSFI’s views with respect to having an economic capital model as a basis for setting internal capital targets?
Q4: How does OSFI intend to gain comfort in the internal capital targets derived from ORSA economic models?
Q5: How does OSFI reconcile and/or measure an internal target that is derived from ORSA economic models to a capital ratio calculated using standard MCT factors?
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Key Metrics Report The Key Metric Report is an OSFI requirement Template should not be modified.
All figures should be consistent with any figures included in the ORSA report (KMR is a summary of how the insurer has related their risks to capital).
Appropriate information, such as location in the ORSA report or supporting documents, should be given in the Methodology and References section.
Needs to be submitted within 30 days of the ORSA report being discussed with the Board (Chief Agent).
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Key Metrics Report
Top 4 Regulatory and ORSA risks in terms of capital are the same but not necessarily ranked in the same order.
Most of the KMR’s had deficiencies in their filing.
Often the amounts in the ORSA report do not reconcile to the numbers in the KMR.
The internal target identified in the report is sometimes different than the ratio on the KMR.
OSFI’s KMR template was modified or adapted by some insurers.
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Key Metrics Reports
Summary of the results of the insurer’s ORSA process for determining own capital needs and internal target(s).
Insurer is allowed to redefine the respective risk categories based on their unique risk drivers and business needs.
For aggregation/diversification credits used, reference to supporting documents is expected.
KMR must be filed annually with the Lead Supervisor.
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2015 Key Metrics Reports (KMR)
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Agenda
The ORSA process
ORSA – General Observations
Feedback for Insurers
Evolution of the ORSA
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Evolution of the ORSA
ORSA introduced in 2014
Room for continuous improvement
Elements and processes will need to mature
May take several years to achieve a mature process
Supervisory expectations will be related to size, nature and complexity of the insurer
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Questions ???
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