IAIS-ASSAL Training Seminar24 November 2009, Lima Peru

Jason Park – Principal AdministratorInternational Association of Insurance Supervisors (IAIS)

PanelPanel 55Solvency - Valuation of Liabilities & Solvency - Valuation of Liabilities &

Value at Risk Methodology Value at Risk Methodology

Solvency - Valuation of Liabilities & Value at Risk Methodology 2 November 2009Jason Park

Presentation OverviewPresentation Overview

• Part I : Introduction of the IAIS

• Part II : International Solvency Requirements (ISRs) within the IAIS Framework for Supervision

• Structure of regulatory capital requirements• Use of internal models for regulatory capital

purposes• Value at Risk Methodology in IAIS document• Valuation of assets and liabilities for solvency

purposes

Solvency - Valuation of Liabilities & Value at Risk Methodology 3 November 2009Jason Park

IAIS: a global forum for insurance regulatorsIAIS: a global forum for insurance regulators

• Founded in 1994• Members from more than 190 jurisdictions in

over 140 countries

Membership classes

Members Observers

InsuranceSupervisors

The NAICInternational

Governmental/Statutory bodies

Other interested

parties

Solvency - Valuation of Liabilities & Value at Risk Methodology 4 November 2009Jason Park

Standards

Insurance Core Principles(ICPs)

Guidance papers Issues papers

Application papers

Supervisory papers Supporting papers

Standard setting activitiesStandard setting activities aim at global aim at global convergence of supervisory practicesconvergence of supervisory practices

Solvency - Valuation of Liabilities & Value at Risk Methodology 5 November 2009Jason Park

ICPs provide globally-accepted framework for ICPs provide globally-accepted framework for insurance regulation and supervisioninsurance regulation and supervision

• Benchmark for insurance supervisors

• Used to establish new regimes

• Used to improve existing regimes

• Used in evaluation of supervisory regimes – FSAPs

• Applies to all insurers and reinsurers but not intermediaries, unless indicated

Principles

Assessment criteria

Explanatory notes

Essential criteria

Advanced criteria

Solvency - Valuation of Liabilities & Value at Risk Methodology 6 November 2009Jason Park

ICPsICPs cover all insurance supervisory aspects cover all insurance supervisory aspects

Solvency - Valuation of Liabilities & Value at Risk Methodology 7 November 2009Jason Park

Presentation OverviewPresentation Overview

• Part I : Introduction of the IAIS

• Part II : International Solvency Requirements (ISRs) within the IAIS Framework for Supervision

• Structure of regulatory capital requirements• Use of internal models for regulatory capital

purposes• Value at Risk Methodology in IAIS document• Valuation of assets and liabilities for solvency

purposes

Solvency - Valuation of Liabilities & Value at Risk Methodology 8 November 2009Jason Park

Solvency requirementsSolvency requirements are integral in the are integral in the Framework for insurance supervisionFramework for insurance supervision

Preconditions

Regulatory requirements

Supervisory assessment

LEVEL 1

LEVEL 2

LEVEL 3 Supervisory assessment and intervention

Basic conditions for the effective functioning of

the insurance supervisory authority

the insurance sector and insurance supervision

Financial Governance Market conduct

Common Solvency Structure and Standards

Framework for Insurance Supervision

Solvency - Valuation of Liabilities & Value at Risk Methodology 9 November 2009Jason Park

ISRs: a comprehensive and cohesive set of ISRs: a comprehensive and cohesive set of solvency assessment documentationsolvency assessment documentation

International Solvency Requirements (ISRs)

ISR 1

Capital requirements

(adopted)

ISR 2

Capital resources

(adopted in 2009)

ISR 3

Valuation of assets

& liabilities

(due Oct 2010)

ISR 4

Investments

(due Oct 2010)

ISR 5

Enterprise risk

management

(adopted)

ISR 6

Internal models

(adopted)

ST

AN

DA

RD

S

ISR 1

Capital requirements

(adopted)

ISR 2

Capital resources

(adopted in 2009)

ISR 3

Valuation of assets

& liabilities

(due Oct 2010)

ISR 4

Investments

(due Oct 2010)

ISR 5

Enterprise risk

management

(adopted)

ISR 6

Internal models

(adopted)

GU

IDA

NC

E

PA

PE

R

Solvency - Valuation of Liabilities & Value at Risk Methodology 10 November 2009Jason Park

ICPs related to Prudential RequirementsICPs related to Prudential Requirements

ICP 23 Capital adequacy and solvency• Requires insurers to comply with the

prescribed solvency regime. This regime includes capital adequacy requirements and requires suitable forms of capital that enable the insurer to absorb significant unforeseen losses.– Capital Requirements– Capital Resources– Internal Models

Solvency - Valuation of Liabilities & Value at Risk Methodology 11 November 2009Jason Park

ICPs related to Prudential RequirementsICPs related to Prudential Requirements

ICP 18 Risk assessment and management• Requires insurers to recognise the range of risks that they face

and to assess and manage them effectively.– Internal Models

ICP 21 Investments • Requires insurers to comply with standards on investment

activities. These standards include requirements on investment policy, asset mix, valuation, diversification, asset-liability matching, and risk management.

ICP 22 Derivatives and similar commitments• Requires insurers to comply with standards on the use of

derivatives and similar commitments. These standards address restrictions in their use and disclosure requirements, as well as internal controls and monitoring of the related positions.

– Investments

Solvency - Valuation of Liabilities & Value at Risk Methodology 12 November 2009Jason Park

ICPs related to Prudential RequirementsICPs related to Prudential Requirements

ICP 20 Liabilities• Requires insurers to comply with standards for establishing

adequate technical provisions and other liabilities, and making allowance for reinsurance recoverable. The supervisory authority has both the authority and the ability to assess the adequacy of the technical provisions and to require that these provisions be increased, if necessary.

ICP 21 Investments Essential criterion b) requires that investments are valued according to a method prescribed by or acceptable to the supervisory authority.

ICP 23 Capital Adequacy and Solvency Essential criterion a) requires that the solvency regime addresses the following in a consistent manner:

• Valuation of liabilities, including technical provisions and the margins contained therein

• Quality, liquidity and valuation of assets• Matching of assets and liabilities, etc.

– Valuation of Liabilities and Assets

Solvency - Valuation of Liabilities & Value at Risk Methodology 13 November 2009Jason Park

Presentation OverviewPresentation Overview

• Part I : Introduction of the IAIS

• Part II : International Solvency Requirements (ISRs) within the IAIS Framework for Supervision

• Structure of regulatory capital requirements• Use of internal models for regulatory capital

purposes• Value at Risk Methodology in IAIS document• Valuation of assets and liabilities for solvency

purposes

Solvency - Valuation of Liabilities & Value at Risk Methodology 14 November 2009Jason Park

Standard Standard & Guidance& Guidance on the Structure of on the Structure of Regulatory Regulatory Capital RequirementsCapital Requirements

• Total balance sheet approach– Recognise interdependence between assets, liabilities, regulatory

capital requirements and capital resources – Ensure that determination of available and required capital is based

on consistent assumptions for the recognition and valuation of assets and liabilities for solvency purposes

• Establishment of a range of solvency control levels– with appropriate supervisory interventions

• Allowance of a range of approaches– standardised approaches and more advanced approaches, such as

internal models• Determination of prescribed levels of RCRs

– MCRs and PCRs– relationships between different levels

Solvency - Valuation of Liabilities & Value at Risk Methodology 15 November 2009Jason Park

Public financial reporting

capital

liabilities

assets liabilities

Supervisory assessment of the financial position

value of assets for supervisory purposes

current estimate

policy obligations

risk margin

capital requirement

liabilities

available

capital

assets liabilities and capital requirement

financial position

technical provisions

Standard Standard & Guidance& Guidance on the Structure of on the Structure of Regulatory Regulatory Capital RequirementsCapital Requirements

Total balance sheet approach to recognise interdependencies

Solvency - Valuation of Liabilities & Value at Risk Methodology 16 November 2009Jason Park

16

Standard Standard & Guidance& Guidance on the Structure of on the Structure of Regulatory Capital RequirementsRegulatory Capital Requirements

Solvency Control Levels and Regulatory Capital Requirements

Minimum Capital Requirement

(MCR)

TechnicalProvisions(TP) and

Other liabilities

Capital Resources

(CR)

Required Capital

Risk Margin (RM)

Current Estimate

(CE)

RegulatoryCapital

Requirements

Insurer’s FinancialPosition

Prescribed Capital

Requirement (PCR)

Other liabilitie

s(OL)

Other liabilities

(OL)

Solvency - Valuation of Liabilities & Value at Risk Methodology 17 November 2009Jason Park

Standard Standard & Guidance& Guidance on the Structure of on the Structure of Regulatory Capital RequirementsRegulatory Capital Requirements

• Prescribed capital requirement (PCR) level

• Supervisory intervention not required

Capital Adequacy Ratio

= Capital Available

Capital Required

190%

160%

100%

130%

• Submission of business plan to improve capital buffers

• Increased on-site supervision

• Additional stress and scenario testing

• Limit shareholder dividends

• Restrict new business acquisition

• Delay approval of new products

• Minimum capital requirement (MCR) level

• Winding-up of operation

Progressive intervention levels to ensure timely corrective measures – an example

Solvency - Valuation of Liabilities & Value at Risk Methodology 18 November 2009Jason Park

Presentation OverviewPresentation Overview

• Part I : Introduction of the IAIS

• Part II : International Solvency Requirements (ISRs) within the IAIS Framework for Supervision

• Structure of regulatory capital requirements• Use of internal models for regulatory capital

purposes• Value at Risk Methodology in IAIS document• Valuation of assets and liabilities for solvency

purposes

Solvency - Valuation of Liabilities & Value at Risk Methodology 19 November 2009Jason Park

Standard Standard & Guidance& Guidance on the Use of on the Use of Internal ModelsInternal Models for for Regulatory CapiRegulatory Capital tal PurposesPurposes

• What are internal models?– A risk management system developed by an insurer to

analyse and quantify its risk position and to determine the commensurate economic capital

• The internal model approach is suitable only if certain preconditions are met– Level of sophistication of insurers / markets– Corporate governance structures– Competent / accountable insurance professionals and

management– Supervisory resources and expertise

• Standards and guidance paper applies only in jurisdictions where internal models are recognised for regulatory capital purposes

Solvency - Valuation of Liabilities & Value at Risk Methodology 20 November 2009Jason Park

Value at Risk MethodologyValue at Risk Methodology in IAIS document in IAIS document

• Guidance on the use of Internal Models briefly comments about VaR – The IAIS notes that some solvency regimes

which allow the use of internal models to determine regulatory capital requirements currently set a confidence level for regulatory purposes, which is comparable with a minimum investment grade level. Some examples of modelling criteria include a 99.5% VaR calibrated confidence level over a one year timeframe, a 99% VaR over one year and a 95% TVaR over the term of the policy obligations. Different criteria apply for PCR and MCR.

Solvency - Valuation of Liabilities & Value at Risk Methodology 21 November 2009Jason Park

A sample target criteria – VaR at 99% A sample target criteria – VaR at 99% confidence level, 1 year time horizonconfidence level, 1 year time horizon

Probability

Losses

Current estimate

75% percentile

99% percentile

Technical provision Capital requirement

1 in 100 years event

Solvency - Valuation of Liabilities & Value at Risk Methodology 22 November 2009Jason Park

Presentation OverviewPresentation Overview

• Part I : Introduction of the IAIS

• Part II : International Solvency Requirements (ISRs) within the IAIS Framework for Supervision

• Structure of regulatory capital requirements• Use of internal models for regulatory capital

purposes• Value at Risk Methodology in IAIS document• Valuation of assets and liabilities for solvency

purposes

Solvency - Valuation of Liabilities & Value at Risk Methodology 23 November 2009Jason Park

• Ongoing works of “Joint Valuation Working Group” (by the Solvency and Insurance Contracts Subcommittees) – Summary of Requirements / Guidance on

the Valuation of Assets and Liabilities, including Technical Provisions for Solvency purposes

– Appropriate valuation of assets and liabilities for solvency purposes is a fundamental part of a solvency regime and contributes to the consistent assessment of insurer strength

– Characteristics of technical provisions are similar to those being considered by IASB

Standard & Guidance on the Valuation of Assets and Liabilities for Solvency Purposes

Solvency - Valuation of Liabilities & Value at Risk Methodology 24 November 2009Jason Park

Standard on the Valuation of Assets and Liabilities for Solvency Purposes

Key Principle

The IAIS believes that it is most desirable that the methodologies for calculating items in general purpose financial reports can be used for, or are substantially consistent with, the methodologies used for regulatory reporting purposes, with as few changes as possible to satisfy regulatory requirements.

The IAIS believes that it is most desirable that the methodologies for calculating items in general purpose financial reports can be used for, or are substantially consistent with, the methodologies used for regulatory reporting purposes, with as few changes as possible to satisfy regulatory requirements.

Solvency - Valuation of Liabilities & Value at Risk Methodology 25 November 2009Jason Park

Standard on the Valuation of Assets and Liabilities for Solvency Purposes

General valuation requirements for assets & liabilities• The valuation for solvency purposes of assets and

liabilities should be undertaken on consistent basis• Assets and liabilities should be valued in a reliable and

transparent manner• The valuation for solvency purposes of assets and

liabilities should be an economic valuation• An economic valuation of assets and liabilities should

reflect the risk adjusted present values of their CFs

Key requirements – provisional

Solvency - Valuation of Liabilities & Value at Risk Methodology 26 November 2009Jason Park

Standard on the Valuation of Assets and Liabilities for Solvency Purposes

Valuation of technical provisions• The solvency regime should require the valuation of

technical provisions to exceed the current estimate of the cost of meeting the insurance obligations (Current Estimate) by a margin to reflect the inherent uncertainty of those obligations (Margin over the Current Estimate or MOCE)

• The Current Estimate should reflect the expected present value of all relevant future cash flows that arise in fulfilling insurance obligations using unbiased current assumptions

Key requirements – provisional (continued)

Solvency - Valuation of Liabilities & Value at Risk Methodology 27 November 2009Jason Park

Standard on the Valuation of Assets and Liabilities for Solvency Purposes

Valuation of technical provisions• The MOCE should reflect the inherent uncertainty related

to all relevant future cash flows that arise in fulfilling insurance contract over the full time horizon thereof

• The valuation of technical provisions should allow for the time value of money. The solvency regime should establish criteria for the determination of appropriate interest rates to be used in the discounting of technical provisions

Key requirements – provisional (continued)

Solvency - Valuation of Liabilities & Value at Risk Methodology 28 November 2009Jason Park

Standard on the Valuation of Assets and Liabilities for Solvency Purposes

Valuation of technical provisions• The value of technical provisions should not reflect the

insurer’s own credit standing• The solvency regime should require the valuation of

technical provisions to make appropriate allowance for embedded options and guarantees

Key requirements – provisional (continued)

Solvency - Valuation of Liabilities & Value at Risk Methodology 29 November 2009Jason Park

www.iaisweb.org

Asociación Internacional de Supervisores de SegurosAsociación Internacional de Supervisores de Seguros

Muchas Gracias !

jason.park@bis.org