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EAC HARMONIZATION: Solvency and Risk Based Supervision The East African Community One People, One Destiny October 21-23, 2015 Nairobi, Kenya About the FSVC…. FSVC is a USAID government funded privatepublic partnership that channels high level volunteer technical assistance to help build sound financial systems in emerging countries. Over the past 20 years, FSVC has sent over 8500 volunteer consultants on 2500 missions in 50 countries. In Kenya, FSVC is funded by USAID-Nairobi and an implementing partner of Trade Africa. More about FSVC can be found on our website at www.fsvc.org. 2 Achieving EAC Insurance Sector Excellence INSANITY IS DOING THE SAME THING OVER AND OVER AND EXPECTING A DIFFERENT RESULT. -Albert Einstein (Emerging market insanity: insurance sector development without actuaries?) Goal: Challenge how we think about insurance regulation, in EAC countries and regionally, and the relationship between insurers, regulators and EAC economic development. 3 Perspectives on Harmonization and RBS What do you see? 4 EAC: Drivers of Regulatory Change • Global desire for consistency. • Increasing number of multi-jurisdiction players. • IAIS protocols. • The financial meltdown. • A path to harmonization. 5 Insurance Financial Regulation: Traditional Model Compliance Based Regulation: Set at a Point in Time • Application of law regardless of the material risk of the licensee. • Limited focus on individual risks. • Resource Intensive. • Does not easily incorporate non-prudential risks e.g. operational • Easy to administer. 6 How We Regulate: New Standard Risk Based Regulation: Prospective and Ongoing Regulation • Adoption of“proportionality,” i.e., size, nature, complexity. • Resource efficient BUT resource dependent: qualified actuaries, accountants, auditors supported by professional organizations. • Constant reassessment of risk by company and regulator. • Encompasses all risks including those that are operational and those not easily quantified, e.g., reputational risk. 7 Shifts in IAIS Focus • More risk-based approach to capital and solvency measurement. • Focus on risk management and governance. • Increased use of stress and scenario testing. • Group supervision. 8 Risk-Based Capital (RBC) • Method of measuring minimum capital appropriate for insurer to support overall business operations considering size and risk profile. • Can be interim step to RBS. • Typically measures asset, insurance and business risks. • Formulaic, not tailored to individual company. • Basis for regulatory action. 9 RBC Formula • Not all risks accounted for. • Each component of formula not material to all companies. • Not totally accurate for all companies but reasonably accurate for most companies. 10 RBC Components • R0 – Asset Risk Affiliated 14% • R1 – Asset Risk Fixed Income 2% • R2 – Asset Risk Equity 21% • R3 – Asset Risk Credit 7% • R4 – U/W Risk Reserve 36% • R5 – U/W Net Premiums Written 20% 11 How Does RBC Formula Apply? • Calculates minimum capital level (Authorized Control Level) compared to company’s actual capital held (Total Adjusted Capital) – – – – Company Action Level 200% ACL Regulatory Action Level 150% ACL Authorized Control Level 100% ACL Mandatory Control Level 70% of ACL • E.g., insurer with 200% RBC ratio has capital = to twice its RBC 12 Risk Based Supervision Defined A structured process aimed at identifying most critical risks facing each company and, through focused review by supervisor, assessing company management of risks and company financial vulnerability to potential adverse experience. Source: World Bank 13 Solvency: Risk, Governance and Supervision 14 ICP 7 Corporate Governance Supervisor requires insurers to establish and implement a corporate governance framework which provides for sound and prudent management and oversight of the insurer’s business and adequately recognises and protects the interests of policyholders. 15 Governance • Board and senior management responsibility. • Includes: – – – – – Underwriting risks Credit risks Market risks Operational risks Liquidity risks – Relationship between risk management and quality of financial resources needed and available. 16 ICP 17 Capital Adequacy Supervisor establishes capital adequacy requirements for solvency purposes so that insurers can absorb significant unforeseen losses and to provide for degrees of supervisory intervention. 17 ICP 16: Solvency and Risk Management Supervisor requires: insurers identify, quantify risk under wide range of outcomes. insurers document risks, measurement approaches used, assumptions made. insurers implement risk management policy outlining how risks managed. insurer describes relationship between tolerance limits, regulatory capital requirements, economic capital. insurers have asset-liability management policy and describe relationship to product development, pricing , investment management. insurers have explicit investment policy and how policy complies 18 with regulatory requirements. ICP 16 continued • insurers have underwriting risk polices. • insurers have risk tolerance statement with quantitative, qualitative risks. • tolerance levels in business strategy, day to day operations. • insures ERM framework responsive to risk profile changes. • insurer ERM framework has feedback loop. • insurer performs own risk and solvency assessment (ORSA) on adequacy of risk management, current and future solvency position. 19 ERM and ORSA ORSA is element of insurer’s Enterprise Risk Management (ERM) framework. Links insurer’s risk identification, measurement, prioritization processes with capital management and strategic planning. Each insurer’s ORSA is unique, reflecting business, strategy and approach to ERM. Regulator uses ORSA to understand insurer process. At minimum ORSA should discuss three major areas: • Insurer’s Risk Management Framework • Insurer’s Assessment of Risk Exposure • Group Risk Capital and Prospective Solvency Assessment 20 ORSA: A Tool to Improve Solvency Regulation and Company Profitability • Identify and quantify risk. • Policy outlining management of all relevant and material risks. • Relationship between tolerance limits: – capital requirements – economic capital • Methods for monitoring risk. 21 Capital Calculation: Internal Models IAIS permits superintendents to allow internal models to determine regulatory capital requirements. • Insurer must document the design, construction and governance of the model. • Including underlying rationale and assumptions. 22 Regulator: RBS Framework Solvency Framework Valuation Prudent Risk Measurement Time Horizon Risk SCR Measure Market Consistent Liabilities Legal Entity Risks Group Principles Multiyear Group Risk Consolidated Observable VaR CRTs only CRTs only Market Prices TailVaR Unobservable others 1 year Assets Quantification Scope Market Credit Amortized cost for bonds Undiscounted for P&C Mix of book value, market value Prudent discount Mark to Model MVM rate at time of sale No recognition of derivatives etc. Prudent assumptions Liabilities Assets Scope LoB Quantile (?) Mathematical Framework Legal Entity Group Insurance Standard Models Operational? Internal Models Others? Proxy Scope Type Cost of Capital Quantile? Factor Life Parallel run with standard models Others? RBC P&C Stand-alone run Scenario Health Mandatory vs facultative RI? 23 Insurer: Risk Management Framework Possible set-up of risk/capital management within insurance company: different organizational structures are possible Dividends Equity Senior Capital Hybrid Contingent Board CFO Capital Management Risk Capacity market, credit risk Risk Appetite Assets Risk and capital management, reinsurance Reserving ALM CRO CIO market, credit risk Liabilitie s Pricing Actuary insurance risk Underwriting Claims Payment Appointed Actuary credit, insurance risk Sales Reinsurance external Traditional, Finite internal Intra Group Insurance Market Premium, Future Portfolio Swaps Coinsurance,… Profit Capital Market Securitization,… 24 ASANTE! Questions Comments ? Concerns 25 This training is made possible by the generous support of the American people through the United States Agency for International Development (USAID). The contents are the responsibility of the Financial Services Volunteer Corps and do not necessarily reflect the views of USAID or the United States Government. Financial Services Volunteer Corps 10 East 53rd Street, 36th Floor New York, U.S.A. Tel. + 1 (212) 771 1412 Fax + 1 (212) 421 2162 www.fsvc.org 26