Outline the Calculation of Actuarial Liabilities under SAM
• Actuarial liabilities known as technical provisions, consist of BEL with risk margin for non-hedge able risks
• BEL is probability weighted cashflows discounted at risk-free yield curve
- where a replicating portfolio using market values exist, this can be used as technical provision.
• BEL should be gross of reinsurance with reinsurance recoverable reflected as an asset.
- Simplifications can be made due to proportionality.
• Market consistent liability can be calculated using a replicating portfolio of traded assets
• Allows for simplifications in actuarial and statistical methodology proportionate to the nature, scale and complexity of underlying risk
Outline the Calculation of BEL under SAM
Best-estimate liabilities
• Projected on a policy by policy basis, up to contract boundary.
• Boundary of contract defined:
Where insurer/reinsurer has:
o Unilateral right to terminate contract
o Unilateral right to reject premium payable under contract
o Unilateral right to amend premiums or benefits to fully reflect risks.
- BEL can be negative
- Allow for all decrements and policyholder actions including lapses
- No margins
- Allow for management actions consistent with PPFM
- Should be calculated gross of reinsurance and reinsurance recoverable should be shown as separate asset
- Options and guarantees can be valued using a market consistent stochastic model
Risk-free discount rate
• Based on government bond curve
• When matched with swap-based assets, can use a swap curve, adjusted for credit and liquidity risk
• Credit can be taken for an illiquidity premium for some business classes, to reflect extra return from holding assets to maturity
Outline the Calculation of Risk Margin under SAM
- Premium over the BEL, that would be required as compensation to take over a liability
- Calculated as the cost of providing own funds equal SCR to support obligation, only for non-hedgeable risks. Hedgeable risks are excluded
- Rate used in determining costs of own funds. Cost of capital rate is 6%, indicating a frictional cost of not being able to invest freely.
- Calculation- 6% of projected non-hedgeable SCR, for each future year, discounted at risk free rate of return.
- Approximate methods can be used subject to materiality and proportionality
- Risk margin should be calculated per line of business, allowing for diversification between lines of business.
Outline Treatment of
Participating and smoothed bonus business
under SAM
- Discretionary future benefits to be allowed for directly in TP
- No BSR is held, instead bonus rates should be determined based on how the insurer expects to distribute the with-profits pool of assets.
- Needs to reflect management actions consistent with PPFM and policyholder actions e.g. with guarantees
- Future discretionary benefits should relate to normal expected distributions only and not the estate, unless planned.
- Shareholder declarations not included. Separate disclosure.
- The BEL for guaranteed and future discretionary benefits should be calculated separately
Outline Treatment of Annuities
under SAM
• Discounted at risk-free curve, as per SAM. An illiquidity premium may be allowed for.
Outline Treatment of Unit-linked
under SAM
- Reserve= Unit + Non-Unit reserve
- Can hold a lower unit reserve, due to actuarial funding but this will increase non-unit, leading to little change liability, as need to remove the impact of actuarial funding from the non-unit reserve over time
Reasons for Holding Capital
- Protection against adverse experience/use less reinsurance
- Funding New Business Strain
- Overheads, development cost. Staff, property
- Acquiring other companies/ blocks of business
- Satisfying solvency requirements
- Support with profits and smoothing
- Working Capital
Reasons for projecting solvency
- Amount of new business strain that can be supported by available capital and any capital injections required
- Project solvency, preparing run-off for with profits fund that is closed/declining
- Estimate pattern of releases of capital to shareholders, these can be for COC calculation for EV
- Risk management- SAM/ ORSA
Economic Capital
- Amount of capital required to meet risks, liabilities and business operations, internal assessment
- Required Capital: capital required for supporting business with a certain probability of default. Economic view not regulatory
- Available Capital: Excess of Assets over liabilities on a realistic or market-consistent basis
SCR vs EC
- Different Risk measure
- Different Risks
- Different allowance for risk margin
- Stochastic modelling instead of stress testing
- Allowance of non-linearity of risks
- Differences in contract boundary
- EC may more accurately reflect risk management, allow for more complex techniques
Assets under PSR Balance Sheet
Assets • Valuation mainly follows IFRS • Goodwill valued at zero • Other intangibles at fair value • Financial Assets at fair value • Participations- Market Value, Adjusted NAV or IFRS otherwise
Calculation of basic own funds
- Market consistent balance sheet assets less liabilities + subordinated liabilities less regulatory adjustments.
- Regulatory adjustments: ineligible assets, own shares, holding company shares, cash at same conglomerate, restricted reserves, participations in financial and credit institutions and ring-fenced funds.
Describe SCR
- Should correspond/be calibrated to 99.5% VAR of basic own funds over a year period, parameters should be calibrated as such.
- Standardized formula, full or partial internal model.
- Follows a modular structure, covered in FSI 4
- Allows for diversification
The standaised formula is:
• Forward looking, risk-based measure
• Measures through stress scenarios of assets and liabilities
• proportionate i.e. allows for simplified calculations
• Allows for diversification, risk mitigation, policyholder behavior and management actions
Describe SCR Calculation
Calculation of SCR
• Within each risk module are pre-specified shock scenarios on own funds, with recalculation of assets and liabilities, as well as own fund adjustments. E.g. mortality:
o 15% relative to BE assumptions for each age policy contingent on mortality
• Individual capital requirements aggregated used pre-specified correlation matrices to allow for diversification
• First aggregated within specific risk module e.g. equity SA, global etc., then across risk modules within specific risk category e.g. market risk and finally across market, life and non-life to give BSCR
• SCR obtained by adding requirements for participations in the same sector (Included in equities if not in same sector, operational risk and adjusting for loss absorbing capacity of deferred taxes.
• Loss absorbing capacity of deferred taxes: companies can reduce deferred tax liability or even create a tax asset following a shock event.
• Should take into account change in policyholder behavior e.g. exercising options
• Risk Mitigation and management that meet certain criteria, can be used to reduce SCR
- An allowance is made for loss absorbency of technical provisions which is the insurers ability to vary premiums or bonus rates. Need to consider PRE, if industry or company specific shock.
- Adjustment is made to Market risk ADJses module to avoid to double counting
Short Comings of Standardized Formula
- Use of multiple correlation matrices is theoretically invalid and can result in inaccuracies
- May not be appropriate for new or fast-growing business
- Operational risk modelled at high level with no link to insurer actual risk management framework
- Do not allow for non-linearity of risk e.g. when two risks occur together results in a greater requirement than sum of individual.
- Complex risk management techniques e.g. dynamic hedging, reinsurance structures cannot be allowed for
- Loss absorbing capacity only adjusted in market risk module, does not allow for situations where they can be adjusted following non-market shocks
- Allowance for risk sharing between third patty and promoter cells, approximated, which may overstate SCR
Calculation of SCR using a full or partial internal model
- Effective system of governance for internal model, including model changes policy
- Demonstrate via use test that the model is embedded in risk management, decision making and system of governance
- Meet requirements for statistical quality, model calibration and validation, data quality
- Document design and operational details of the model
- Partial internal models may be used provided they are justified and well integrated with remaining standard model.
Describe MCR
- Level of solvency capita; below which policyholders will be exposed to an unacceptable level of risk
- MCR low bound for solvency capital, below which insurer cannot operate
- MCR and SCR form supervisory ladder of intervention, enabling regulator to intervene for a given degree of insolvency
- Although SCR is expected to be maintained at all times, even a buffer above SCR and regulator should be notified if even possibility of falling below SCR in short term.
- Actions: Close to new business, capital injections, reinsurance, reprice/redesign products, stop paying dividends, try to reduce SCR with risk management instrument, hedging investmet strategy with derivatives
- Conduct an analysis of change in surplus to identify change in own funds
- Analyse change in SCR components
- Analysis of profitability of new business
- Under SAM, profit margins are discounted to present due to absence of margins. Profitable new business should result in negative reserves, which increase own funds. But this may result in a decrease in capital cover due to increase in SCR.
Describe MCR calculation
- detailed in FSI 3
- calibrated at 85% VAR of own funds over a one-year period
- For life business, a simple to apply formula = to TP and capital at risk measures being multiplied by specified factors
- Upper and lower bounds linked to SCR
- Min value is R15 M or 25% of gross annualized operating expenses.
