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Use test
Izabela Sabała
Insurance and Pension Inspection Department
KNF Office
TAIEX Workshop on Solvency II Requirements
Baku, December 17‒18, 2013
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Disclaimer
Any views and opinions expressed in this presentation or
any material provided with it wholly express only the
personal views of the author and not necessarily exactly
reflect the common position of the speaker’s employer,
namely the KNF (Polish Financial Supervision Authority)
Office (Urząd Komisji Nadzoru Finansowego).
The information, views, opinions or any other material are
provided without any warranty, including but not limited
to, warranties of correctness, of completeness or of
validity.
TAIEX Workshop on Solvency II Requirements
Baku, December 17‒18, 2013
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General framework
Art. 120 of SII Directive
IM use
• IM is widely used in and plays an important role in the
system of governance, in particular in the risk
management system and ORSA
Frequency of
calculation
• frequency of calculation of SCR consistent with the
frequency with which it is used for the other purposes
• at least annually
Responsibility of
the administrative,
management and
supervisory body
• ensuring the ongoing appropriateness of the design
and operations of IM
• ensuring that IM continues to appropriately reflect the
risk profile
TAIEX Workshop on Solvency II Requirements
Baku, December 17‒18, 2013
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TAIEX Workshop on Solvency II Requirements
Baku, December 17‒18, 2013
Understanding of IM
Integration with RM
IM should be used in a way
that creates incentives to
improve its quality.
Support for decision-making
If an undertaking does not
trust its IM sufficiently to use
it, why should the supervisor?
Fit to the business
Use test philosophy
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Fit to the business
 The modelling approaches reflect the nature, scale and
complexity of the risks inherent in the business of the
undertaking which are within the scope of IM.
 The outputs of IM and the content of the internal and external
reporting of the undertaking are consistent.
 IM is capable of producing outputs that are sufficiently
granular to play an important role in the relevant
management decisions of the undertaking
– as a minimum, the outputs of IM shall differentiate between
material lines of business, between risk categories and between
major business units.
 The policy for changing IM foresees that IM is adjusted for
changes in the scope or nature of the business of the
undertaking.
TAIEX Workshop on Solvency II Requirements
Baku, December 17‒18, 2013
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Support
for decision-making
 IM shall be used to support the relevant decisionmaking processes in the insurance or reinsurance
undertaking, including the setting of the business
strategy.
 IM shall be used to assess the impact of potential,
material decisions including the impact on expected
profit or loss and the variability of the profit or loss
resulting from those decisions.
 IM and its results shall be regularly discussed and
reviewed in the administrative, management or
supervisory body of the insurance or reinsurance
undertaking.
TAIEX Workshop on Solvency II Requirements
Baku, December 17‒18, 2013
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Integration
with risk management
 All material quantifiable risks identified by the risk
management system are covered by IM.
 The outputs of IM, including the measurement of
diversification effects, are taken into account in formulating
risk strategies, including the development of risk tolerance
limits and risk mitigation strategies.
 The relevant outputs of IM are covered by the internal
reporting procedures of the risk management system.
 The quantifications of risks and the risk ranking produced by
IM trigger risk management actions where relevant.
 The policy for changing IM foresees that IM model is changed,
where relevant, to reflect changes in the risk management
system.
TAIEX Workshop on Solvency II Requirements
Baku, December 17‒18, 2013
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Understanding of IM
 The administrative, management or supervisory
body of the insurance or reinsurance undertaking
and the other persons who effectively run the undertaking
shall be able to demonstrate an overall understanding of IM:
– the structure of IM and the way the model fits to the business and
is integrated in the risk-management system of the insurance or
reinsurance undertaking;
– the scope and purposes of IM and the risks covered by IM, as well
as those not covered;
– the general methodology applied in IM calculations;
– the limitations of IM;
– the diversification effects taken into account in IM.
 The persons who effectively run the undertaking shall be able
to demonstrate a sufficiently detailed understanding of the
parts of IM used in the area for which they are responsible.
TAIEX Workshop on Solvency II Requirements
Baku, December 17‒18, 2013
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Use test assessmnet
 Indication on the areas where IM should be used,
 Concrete examples of decisions where IM has been used supported by
analysis made for this purpose ,
 Description of the decision-making process with defining the roles of
persons involved,
 Indication on variables analysed on a regular and ad hoc basis,
 Report (and reporting templates) with IM outputs and explanation
why the elements covered by the report are analyzed,
 Documents indicating on an active use of IM in risk analysis (risk
management policy, ORSA),
 Indication when IM is run and assessment if it is consistent with the
period when main (including strategic ones) decisions are made,
 Catalogue of trainings on IM, including participants or target
audience,
 Minutes from meetings of the board and relevant committees.
TAIEX Workshop on Solvency II Requirements
Baku, December 17‒18, 2013
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Examples of IM use
Strategic
management
• Performance
measurement
• Economic Value
Added (EVA)
• MCEV
• RoRAC
• Limit systems
• Risk bearing
capacity
• Risk tolerance
• Risk limits
Strategic asset
allocation and
investment decisions
Product development
and pricing
• Analysis of ALM
positions
• ALM position (CF
models)
• Implications of
various SAA options
• Cost of capital
Reinsurance
optimization
• Analysis of various
re-insurance
structures
• Setting investment
related limits
TAIEX Workshop on Solvency II Requirements
Baku, December 17‒18, 2013
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Example 1: risk surplus determination (1/4)
To ensure that sufficient eligible own funds are hold in order to
cover the solvency need from its risk position equaling SCR.
•
SCR increasing to an extent that own funds available do no
longer cover the Solvency needs from its risk position
•
Own funds decreasing by an extent that existing SCR can no
longer be covered.
TAIEX Workshop on Solvency II Requirements
Baku, December 17‒18, 2013
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Example 1: risk surplus determination
(2/4)
Determination of the starting position for
the risk appetite as the amount of the eligible
own funds
Definition of an initial risk appetite based on
the volatility of SCR
Definition of an intial risk tolerance based on
the defined solvency buffer
Calculation of the available surplus
TAIEX Workshop on Solvency II Requirements
Baku, December 17‒18, 2013
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Initial risk tolerance
SCR
SCR
volatility
Initial risk appetite
Solvency
buffer
TAIEX Workshop on Solvency II Requirements
Baku, December 17‒18, 2013
Risk appetite
Surplus
the amount of the eligible own funds
Example 1: risk surplus determination (3/4)
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Surplus
SCR
SCR
volatility
Initial risk appetite
Add-on
Initial risk tolerance
Solvency
buffer
TAIEX Workshop on Solvency II Requirements
Baku, December 17‒18, 2013
Risk appetite
The amount of add-on allocated
individually per risk category.
the amount of the eligible own funds
Example 1: risk surplus determination (4/4)
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Example 2: Performance measures
 Risk-adjusted Return on Capital – the relative performance of
business segments that have different levels of risk, which are
reflected in the denominator
 Return on Controllable Assets - the performance of business in
relation to the capital hold
 Economic Value Added – the amount of earning generated above
and beyond the cost of capital employed to generate those earnings
(stakeholders must earn return that compensates for the risk taken)
TAIEX Workshop on Solvency II Requirements
Baku, December 17‒18, 2013
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Example 3: Market Consistent
Embedded Value (MCEV)
 Net Asset Value (NAV)=
+
Required capital (RC)
+
Free Surplus (FS)
RC
FS
PVFP
-
Time value of financial options and
guarantees (TVFOG)
-
Cost for non-hedgeable risk (CNHR)
-
Frictional cost of required capital for
the in-force business (FCRC)
CNHR
Present value of future after tax
profits (PVFP)
FRCR
+
TVFOG
 Value of in-force portfolio of life
policies (ViF) =
VIF
NAV
MCEV
TAIEX Workshop on Solvency II Requirements
Baku, December 17‒18, 2013
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Example 4: Investment Management
GOAL:
To create an asset mix that will provide the optimal balance
between expected risk and return for a long term investment
horizon
Limit framework
The target weights
for the asset classes
consistent with the
limits
Verified at the levels
on which limits are
applicable
TAIEX Workshop on Solvency II Requirements
Baku, December 17‒18, 2013
Duration of the fixed
income portfolio
ALM
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TAIEX Workshop on Solvency II Requirements
Baku, December 17‒18, 2013
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Thank you!
Izabela Sabała
+48 (22) 262 53 42
[email protected]
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