Session 3
Solvency Capital Requirements
Regional Training Seminar IAIS-ASSAL
San Salvador, El Salvador, 22-25 November 2010
Takao Miyamoto, IAIS Secretariat
Agenda
Assessment of
financial solvency
Available capital resources
– Broadly given as excess
of assets over liabilities
– Subject to fungibility &
transferability aspects
– Subject to quality criteria
Required regulatory capital
– Reflects potential adverse
change of excess of
assets over liabilities over
time
Valuation of assets & liabilities
for solvency purposes
1
Total Balance Sheet Approach
• Solvency is assessment of overall financial position
– Consistent measurement of assets & liabilities
– Explicit identification & consistent measurement of risks
– Potential impact of risks on all components of balance
sheet
• Recognise interdependence – cannot be considered
in isolation
–
–
–
–
Assets
Liabilities
Regulatory capital requirements
Capital resources
2
Assets & Liabilities – Quick Look
• Assets
– Security
– Liquidity
– Diversification
• Liabilities
– Technical provisions: Amount required to fulfill insurance
obligations & settle all commitments to policyholders
– Other liabilities
• Asset-liability management (ALM)
– Manage risk & business under coordinated decisions
3
Agenda
Assessment of
financial solvency
Available capital resources
– Broadly given as excess
of assets over liabilities
– Subject to fungibility &
transferability aspects
– Subject to quality criteria
Required regulatory capital
– Reflects potential adverse
change of excess of
assets over liabilities over
time
Valuation of assets & liabilities
for solvency purposes
4
Role of Capital
• Serve as safety cushion against adverse
environment & financial fluctuation
– Reduce probability of insolvency
– Reduce losses to policyholders in event of insolvency
• Enhance safety & soundness of insurance (& other
financial) sector
– Macroprudential perspective
• Meet strategic & operational needs of capital
– Start-up, growth (into new products, market segments etc.)
– Allocation of capital for decision & performance review
5
Stakeholders
• Policyholders
↑ Prefer sufficient capital to protect their interests
• Shareholders
↓ Care about rate of return
↓ Existing shareholders want to maintain control
↑ Avoid worst scenario (insolvency & wipe-off all shares)
• Supervisors
↑ More focus on policyholder protection & financial stability
↑ Insolvency may put job & reputation at risk
• Board & senior management
↓ Under pressure from market for return
↓ Salary dependent on share prices or rate of return
↑ Insolvency may put job & reputation at risk
↑ Care about ratings agency
↑ Attract more customers by providing sense of safety
6
Different Perspectives
• Going concern
– Carry on business as going concern and continue to take
on new business
• Run-off
– Stop new business and manage only existing business until
they are settled or expired
• Winding (Break)-up:
– Stop new business and settle or transfer existing business
as soon as possible
7
Quality & Suitability of Capital Resources
Subordination
– Extent to which and in what circumstances capital element is
subordinated to policyholders rights in insolvency or winding-up
Availability
– Extent to which capital element is fully paid & available to
absorb losses
Permanence
– Period for which capital element is available
Encumbrance
– Extent to which capital element is free from mandatory
payments or encumbrances
8
Quality & Suitability of Capital Resources
Quality of capital
Loss absorbency
Loss absorbency
under going concern
Loss absorbency
under winding-up
Subordination
Availability
Permanence
Absence of
encumbrance
9
Adjustment for Solvency Purpose
• Broadly regarded as assets over liabilities
– Based on recognition & valuation for solvency purpose
• Certain types of liabilities (+)
– e.g. subordinated debt
– Act buffer to reduce loss to policyholders
• Contingent assets (+)
– e.g. letters of credit, members’ calls by mutual, unpaid
element of partly paid capital
• Certain types of assets (–)
– e.g. intangible assets, deferred tax assets
– Realisable value under winding-up may be significantly
lower than economic value under going concern
– Adjustment through deduction of capital resources or
addition to capital requirements
10
Group Issues
• Multiple (Double) gearing
– Insurer invests in capital instrument of subsidiary
• Intra-group creation of capital
– Insurer holds shares in or makes loans to another entity,
which holds capital instrument of insurer
Holding company (P)
Assets
2,400
Debt to A 1,000
Equity
Own 75%
of shares
Loan
1,000
1,400 (500 owned by B)
Own 100%
of shares
General insurance subsidiary (B)
Life insurance subsidiary (A)
Assets
22,700 Life fund
Assets
20,000
Debt to B 700
Equity
Own 500
shares
2,000
Loan
700
3,500
Insurance
liability
1,800
Debt
800
11
Equity
900
Agenda
Assessment of
financial solvency
Available capital resources
– Broadly given as excess
of assets over liabilities
– Subject to fungibility &
transferability aspects
– Subject to quality criteria
Required regulatory capital
– Reflects potential adverse
change of excess of
assets over liabilities over
time
Valuation of assets & liabilities
for solvency purposes
12
Approaches
• Range of approaches allowed
– Reflect nature, scale & complexity of risk & business
• Standard formula
– Feasible for small & medium sized insurers
– Should be designed to reasonably reflect overall risks
• Internal models (partial or full)
– More tailored to individual insurers
– Subject to prior approval & ongoing validation by
supervisors
– Criteria: statistical quality test, calibration test, use test,
documentation
13
Process
Identify all material
risk sources
Underwriting, credit, market, operational,
liquidity etc,
Assess &
characterise
distributions
Aggregate risks
Correlation
Dependency
Measure capital
requirements
Redistribute & use
for management
14
Required Capital and Technical Provision
Technical provision
(current estimate &
risk margin)
Required
capital
Probability
Solvency level
(e.g. VaR (1 year, 99%)
15
Loss
Quantify or Not
• Some risks may be less readily quantifiable
– Due to its nature, lack of data, lack of well developed model
– e.g. strategic, reputational, liquidity, operational risks
• Alternative treatment
–
–
–
–
Simple proxies
Stress & scenario testing
Exposure limits
Qualitative requirements (e.g. systems, controls)
16
Diversification Effect
• Diversification effect exists
–
–
–
–
–
Horizontal (within risks)
Vertical (between different risks)
Business lines
Geographical
Across entities
• Whether & to what extent should it be allowed?
–
–
–
–
Dependencies increase in times of stress
Limited availability of data, especially stressed situation
Lack of fungibility of capital & transferability of assets
Robustness and reliability for supervisory actions
17
Example
(Source) Joint Forum “Developments in Modelling Risk Aggregation”
18
Example
(Source) Joint Forum “Developments in Modelling Risk Aggregation”
19
Agenda
Assessment of
financial solvency
Available capital resources
– Broadly given as excess
of assets over liabilities
– Subject to fungibility &
transferability aspects
– Subject to quality criteria
Required regulatory capital
– Reflects potential adverse
change of excess of
assets over liabilities over
time
Valuation of assets & liabilities
for solvency purposes
20
Demand vs. Supply
• Supervisory assessment of financial position
– Could be different from public financial reporting due to
prudential filter
Available
capital
Capital
requirement
Assets
Risk margin
Current
estimate
Technical
provision
Liabilities
Other
liabilities
21
Solvency Control Levels
• Prescribed Capital Requirement (PCR)
– Above PCR, supervisor would not intervene on capital
adequacy grounds
• Minimum Capital Requirement (MCR)
– If breached, supervisor would invoke strongest actions, in
absence of corrective actions
• Additional control levels
– Range of different intervention actions between PCR &
MCR
22
ComFrame Update
Common Framework for the Supervision of
Internationally Active Insurance Groups
(“ComFrame”)
23
Background
Current state of play
• IAIS solvency regime (ICPs, standards & guidance)
remains high-level, not so concrete
• Various approaches exist in different jurisdictions &
regions
Challenges
• Difficult to implement and assess
• Difficult for cross-border cooperation
• Difficult for efficient global management
24
Five Modules
25
Timeline
1 July 2010
We are here – ComFrame is off to a good start!
26
¡Muchas gracias!
www.iaisweb.org
[email protected]
27