David LightfootGuy Carpenter - Instrat
Solvency II – The March Solvency II – The March Towards Economic Capital Towards Economic Capital ModelsModels
CAS Spring Meeting – June 19, 2007CAS Spring Meeting – June 19, 2007
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Discussion
What is an Internal or Economic Capital Model (ECM)?
Why are EU Regulators and Companies Supporting Use of ECMs?
ECM Results as Full or Partial Replacement of the SCR Standard Formula
– How to Use– Regulatory Approval
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Economic Capital ModelingDefinition of Economic Capital
Estimate of capital needed to support the enterprise given the possibility of decreasing assets, increasing liabilities or unexpected net losses resulting from the risks undertaken or inherent in the business
Assets
Liabilities
Capital
Assets
Liabilities
Capital Net Losses
Net Losses
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Review of ECM Components
Capital Need forNon-Life Insurance
Company
Insurance Hazard Financial (Asset)Operational &
Strategic
Underwriting
Accumulation / Cat
Reserving
Credit
Market
Liquidity
People / Processes / Systems
External Events
Business Strategy
Quantitative Methods
• Factor / Scenario Based
• Simulation Based
Quantitative Challenges
• Data Availability / Resolution
• Correlation
• Treatment of Uncertainty
• Non-modeled Perils
• Operational Risk
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Why Growing Support for this Development?
Regulators– Principal regulatory objectives
Better risk management Encouragement of innovation in risk management methodology Improved risk sensitivity in capital requirements
– Other stated benefits Higher competitiveness through lower cost of capital Better modeling of non-standard contracts Better, more informed and more consistent discussion with
regulators and rating agencies
Companies– Integral to ERM virtuous circle of risk identification, measurement,
and management– Organizational, reputation and operational benefits
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ECM Results as Full or Partial Replacement of the SCR Standard Formula How to Use
Full Internal Model (long term goal)– Model and simulate all important aspects of the business – Take correlation between risks into account– Calculate Net Operating Income for each simulation– SCR = 1 in 200 year negative result
Partial Internal Model (valuable starting point)– Model and measure risk using Partial Internal Models– Clearly identify which componets of the SCR standard formula are
affected by the use of the ECM– Aggregate capital requirements to total capital requirement
Correlation needs to be considered
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ECM Results as Full or Partial Replacement of the SCR Standard Formula Regulatory Approval
Actuarial Model
Internal Risk Management
Regulatory Capital Requirement
Test 1:
Statistical Quality
Test 2:
Use
Test 3:
Calibration
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Key Message
The movement is well under way in Europe for better, transparent risk management supported by a clearer measurement of risk and ultimately how risk relates to capital