ORSA Implementation Challenges

ORSA Implementation Challenges

Christopher Crombie, FSA, FCIA

AVP ERM & Financial Risk Management

Standard Life Assurance Company of Canada To CIA Annual Meeting

Context

Our Own Risk and Solvency Assessment (ORSA) is being

introduced in order to:

 Meet Solvency II requirements for European Business Units;

 Prepare our Group level ORSA;

 Adopt best practices being introduced in many jurisdictions

including OSFI’s required ORSA, expected in 2014.

Background on Solvency II (S2)



S2 proposes:

– A market consistent balance sheet approach.

– Regulatory capital requirements closely aligned with the risks

firms are running.

– Risk models genuinely used to help decision making and run

the business.



_{Affects all insurers operating within Europe.}

– Other jurisdictions also affected through group solvency

assessment.



_{Development ongoing since 2010 in Canada.}

Significant Deliveries for S2



Standard Formula Basis under a new Balance Sheet. Ability to

calculate regulatory capital requirements using a “one size fits all”

basis.



Internal Model Basis. Development of an internal model to calculate

regulatory capital requirements.



Economic Capital. Internal basis for assessing our capital needs and is

based on an adjusted Solvency 2 internal model basis.



Internal Model Approval Process (IMAP). A submission to the

regulatory body must be made to seek approval to use an Internal

Model.



Own Risk Self Assessment (ORSA). A draft ORSA report was prepared

Significant Deliveries for S2



Other considerations



Building up the reporting framework to provide all required

information for consolidation at Group level within the needed

timeframe.



Finalizing the methodology and assumptions for the internal model.



Enhance our oversight and governance processes over the internal

model.



Documentation



Significant requirements on the documentation aspects of the

methodology and on the data standards.

ERM Framework and

Own Risk and Solvency Assessment

ORSA ERM Framework ORSA Internal Model

System of Governance

ORSA Process

The ORSA Process comprises all the processes that exist within the ERM Framework for identifying, assessing, controlling and monitoring risks. The key processes are:

 The Strategy, Capital and Business Planning Process  The Emerging Risk Process

 The Validation Activity and Validation Reporting Process  The Risk and Profitability Reporting Process

 The Risk Appetite Setting and Monitoring Process  Stress and Scenario Testing Programme

 Extreme Scenario Analysis

 The Liquidity Risk Management Process  The Operational Risk Assessment Process  The Identification of Risk Modules for the

Internal Model

 Monthly MI Reporting and Monitoring Process

 Policy Compliance Process  Control Self Assessment

These processes run concurrently and often operate continuously throughout the year. All of these processes exist within the ERM Framework to identify, assess, monitor, manage and report risks.

IDENTIFY

Consider:-• current business environment & future strategy.

• new products/projects. • emerging risks. • validation activity. List risks and causes on risk registers.

ASSESS

Assess significance of risk.

Assess probability of risk occurring. Determine capital requirement. MONITOR Collect data. Analyse.

Ensure response process followed when controls breached.

CONTROL

Establish ownership. Identify method of control. Set up risk indicators e.g. Key Risk Metrics Define principles of risk management (via the Group Policy Framework). Determine procedures e.g. Control Self Assessment.

Risks included in the Internal Model



The Internal Model must reflect the risk profile of the company and cover

all material risks.



A risk should be considered “material” if its exclusion leads to a decision

choice that would be considered inappropriate had the risk been included.



Available historic data is used to assess materiality. Significant judgement

is required for certain risks.



For certain risk modules or factors, qualitative techniques and expert

judgement will be used.

Management actions

Management actions mitigate the effect of extreme events on the company’s capital

Modelled management actions:

 The level of smoothing

Risk distributions

Key assumptions

 Choice of distribution, parameterisation

 Chosen and calibrated with reference to historical data and expert judgement.

 Distributions are a simplified model of the real world, and the available data rarely suggests a particular distribution. Expert judgement is used to match the characteristics of a

distribution to a risk.

Dependencies

Key assumptions

 Choice of copula, parameterisation

 The strength of correlation between variables is a key driver of diversification benefit, and is an important area of expert judgement. Modelled using a mathematical function called a copula.

 Although the strength of relationships can change under stress the choice of copula is less important than the choice of

correlation strength, and more complicated copulas would significantly reduce the transparency of the model.

Key Assumptions

45.0% Loss Functions and Interactions

Key assumptions

 Loss function structure, parameterisation

 Chosen and calibrated based on the behaviour of assets/liabilities as risk events change.

 The loss function structure can be a straight line, a curve or even stepped to reflect the impact of hedges.

-800 -600 -400 -200 0 200 400 600 800 -1 .0 -0 .9 -0 .8-0.7-0.6-0.5.4-0-0.3-0.2-0.10.010.0.20.30.40.50.60.70.80.91.0 Risk factor 1 -1000 -500 0 500 1000 1500 -1-0.9-0.8-0.7-0.6-0.5-0.4.3-0-0.2-0.100.10.20.30.4 0. 50.60.70.80.91 Risk factor 2

 Changes to investment mix  Changes to deductions for

Key benefits of an Internal Model



Capital requirements are driven by the “real” risks



Decisions which are beneficial from a risk perspective can reduce

regulatory capital requirements (e.g. using reinsurance or hedging)



A Standard Formula will not necessarily reflect the risk profile of the

company.



Risk and capital management is at the heart of decision-making



Outputs from the Internal Model play an integral role in operational

decision-making.



Reputation



Seen as an indicator of the strength of a firm’s risk management

capability under Solvency 2.

Control: Self assessment tests

1. Use Test

 Internal model adequately reflects the nature and scale of the business  Management can demonstrate understanding of the internal model

 Outputs from the Internal Model play an integral role in key strategic and operational decision making

 Internal model integrated with risk management 2. Statistical quality / 3. Calibration standards

 Model based on appropriate actuarial/statistical techniques

 Model results are transparent, stable and reflect the company’s risk profile  Model assumptions are documented, credible and transparent

 Data complete, accurate and appropriate

 Cover all material risks and provide ability to judge and prioritise risks  Appropriate allowance for diversification/management actions

Control: Self assessment tests

4. Profit and loss attribution

 Perform an analysis to allocate actual profit and loss arising to major business units and risk categories

 Validates that the model covers all material risks observed  Supports validation that risk exposures are correctly calibrated  Informs on updates to the model

5. Validation standards

 Validation must be independent from development and operation of model  Some validation tools are specified including stress and scenario analysis and

reverse stress testing

Control: Self assessment tests

6. Documentation standards

 Results in principle reproducible using inputs/documentation  Documentation held in an inventory

 Documentation appropriately structured and detailed  Documentation complete and up to date

 Proper change control

Monitor: The ORSA report

The ORSA Report is a key requirement of the Solvency 2 Regulations Purpose of the ORSA Report is to document:

 The current risks to the business;

 Our assessment of our current solvency and own funds; and,

 A forward-looking assessment of the risks and solvency needs in light of the business strategy.

The report enhances an ERM Framework, bringing information on the framework and risk exposures into a single document.

The report is presented to senior management and the Board, allowing a holistic view to be taken and sets out the relationship between risk and capital.

Monitor: The ORSA report

The full ORSA report has been set out in 4 primary sections as follows:

Section A sets out the purpose of the report and provides a summary of the Canadian business.

Section B provides a comprehensive description of our System of Governance and ERM Framework.

Section C provides an overview of the key risk exposures, setting out the nature and sources of these risks in an accessible and understandable manner.

 Development of an ORSA is an iterative process

 Most insurers have an established ERM framework which includes modelling risks and capital.

 You should build on what you have unless completely inadequate (long process).

 Complexity of the modelling should not be underestimated.

 Documentation is one of the biggest elements

 Need to justify and provide evidence for all assumptions and methodology.

 Need to document all of the ERM Framework

 Need to have 2nd _{line validation and proper control environment.}

 Not just a calculation or reporting exercise

 Expected that the results be used to manage the business.

 Training is a key element.

 Regulations have still to be finalised

 Solvency 2 has not yet been adopted.

 OSFI’s guidelines are still in draft form.