Session 119 PD, Evolving Regulatory Landscape Around Capital and Risk Management Moderator: Patricia E. Matson, FSA, MAAA

Session 119 PD, Evolving Regulatory Landscape Around Capital and Risk Management

Moderator:

Patricia E. Matson, FSA, MAAA Presenters:

Richard H. Daillak, FSA, MAAA Gaetano Geretto, FSA, CERA, FCIA

Evolving regulatory landscape around 

capital and risk management 

US ORSA and Other Developments

September 25, 2014

Overview of ORSA

• ORSA provides a management view of risks and  capital, which helps to “challenge” what is covered  under traditional approaches to reserves and capital • ORSA aggregates risks across all the activities of the  insurance company to enable a comparison of  required capital to available capital • ORSA is not solely a quantitative representation of the  risks but also requires a systematic identification,  assessment and management of the risks • A thorough evaluation of risk requires that an  insurance company not only evaluates its current  exposure to risk but also its future potential risk, in  light of strategic objectives • ORSA plays a key role in the communication between  an insurance company and regulator Description of the  Insurer’s Risk  Management  Framework Section    I Insurer’s  Assessment of Risk  Exposure Section  II Group Assessment of  Risk Capital and  Prospective Solvency  Assessment Section  III

ORSA Model Act

•

Adopted September 2012

•

Responds to IAIS’s Insurance Core Principle 16, Enterprise Risk 

Management

•

ORSA defined 

– “confidential internal assessment, appropriate to the nature, scale and  complexity of an insurer or insurance group” – “of the material and relevant risks associated with the insurer” – “and the sufficiency of capital resources to support those risks”

•

Confidential report(s) to be filed at most 1x/year w/lead state

•

Exemption

– <$500M legal entity premium – <$1B group premium

•

Effective January 1, 2015

However regulator can decide,  based on specific   circumstances, to request  anyway

ORSA Guidance Manual

•

First issued in 2012; latest revision July 2014

•

Provides further guidance on ORSA in support of Model Act

•

ORSA Report should include:

– Section 1: Description of Risk Management Framework – Section 2: Assessment of Risk Exposure – Section 3: Group Assessment of Risk Capital and Prospective Solvency

•

Should identify accounting basis, time period, legal entities 

covered

•

Signed by CRO or similar

•

Further details for each of the 3 sections on what to include

•

Clear focus on OWN

Draft NAIC Guidance for Regulators

• Risk‐Focused Surveillance Working Group released detailed guidance on use of ORSA in  financial analysis and exams in March, 2014; since that time, three exposure periods have  been completed • States that principle goals of ORSA, upon which regulatory guidance will be established,  are: – To foster an effective level of ERM at all insurers – To provide a group‐level perspective on risk and capital, as a supplement to the  existing legal entity view. – To allow the regulator to obtain a high level understanding of the insurer’s ORSA,  and to assist the commissioner in determining the scope, depth and minimum  timing of risk‐focused analysis and examination procedures • Summarizes the guidance as well as the RIMS ERM maturity model to provide education  to the user on what to expect from “good ERM” • Failure to demonstrate sufficient ERM is likely to result in increased supervision, “up to  and including a hazardous financial condition determination” • ERM assessed on a 1‐5 scale

Ad‐Hoc No developed or  documented  standard  processes; relies  on individual  efforts Initial Processes in  place, but  not  operating  consistently  and  effectively.   Certain risks  defined and  managed in  silos Managed Activities  coordinated  across  business  areas; tools  and processes  activities  used.   Enterprise‐ wide  identification,  monitoring,  management,  and reporting  in place

Draft NAIC Guidance for Regulators

Non‐Existent No identification,  monitoring, or  management Repeatable Processes in  place;  designed and  operated in a  timely,  consistent,  sustained  way.  Actions  taken to  address issues  for high  priority risks Leading Tools  embedded in  strategic  planning,  capital  allocation, etc   and used in  daily decision  making.   Limits  in place to  identify  breaches and  require  corrective  action by Board  and  management

RIMS risk maturity as described in the guidance. Additional details are provided for each section and subsection of the ORSA report

ERM Framework

ERM involves a control cycle, in which:

• The foundation is the risk culture  and  governance of the company • An appetite for risk is established, linked  to company strategy • Risk limits are set • Risks are identified, quantified, and  prioritized • Risks are monitored relative to limits, and  risk mitigation actions are taken • Risk capital is determined and allocated  to business initiatives • Risk analysis is communicated to leaders • Results of risk analysis impact strategic  objectives

Source: North American CRO Council

Section  II Section  III Section  I Risk Culture and Governance Risk appetite and limits Identify and assess risks Risk measure -ment Monitoring and reporting Stress and Scenario testing Capital Manage -ment Link to business strategy Risk Culture and Governance Risk appetite and limits Identify and assess risks Risk manage -ment Monitoring and reporting Stress and Scenario testing Capital Manage -ment Link to business strategy

Risk Management Framework

Section I

Risk culture and governance

This section may include descriptions of 

items such as:

• Board and committee structure, roles and  responsibilities • Key risk exposures and limits; mitigations in  place • Company culture regarding risk, organization of  risk function, risk charters/policies • Strategy and associated risk appetite; risk  appetite results • Summary of risk reports and sample recent  results Risk identification and prioritization Risk appetite, tolerance, and limits

Risk management and controls

Risk reporting and communication

Assessing Enterprise Risks

Tolerance for Risk Appetite for Risk Risks to be Taken Risk Assessments Business Units Corporate Functions Strategic Partners

Enterprise Top Risks

Top Risks Aggregation

Process

Considering Outside Forces

• Section 2 will cover the identification,

quantification, prioritization, and mitigation of top risks

• The process for determining top risks typically involves both a top down and a bottom up approach

• Top risks should be considered in light of the organization’s strategy, risk appetite, and risk tolerance

• Identification of risks should come from those in the business and corporate functions, with support from and aggregation by ERM

• Consideration should be given to emerging risks and the impact of external factors such as regulatory change and competitor actions

Section  II

Stress T

Assessing Solvency

Considerations Description of Methods/Assumptions Examples

Definition of Solvency How solvency is defined (capital and liquidity) Cash flow basis, balance sheet basis Accounting/Valuation 

Regime

Underlying accounting/valuation basis GAAP, Stat, market consistent, IFRS,  rating agency

Business Included Subset of business included in capital analysis Inforce as of a specific date, new  business included

Time Horizon Horizon over which risks are modeled 1 year, multi year, lifetime, runoff Risks Modeled Which risks included, are all relevant and 

material ones in?

Credit, market, insurance, liquidity,  operational

Quantification Method How risk exposure is quantified Stresses, stochastic, factor‐based Risk Capital Metric Measurement metric for determining needed 

capital VaR, TVaR, P(ruin), P(ruin) given  capital available Defined Security  Standard Std used to determine risk capital, incl link to  strategy AA solvency, %ile confidence, % of  RBC Aggregation/  Diversification Method of aggregation and group  diversification benefits considered/calculated Correlation matrix, dependency  structure, full/part/no diversification Section  III

Assessment of group solvency should describe approach used, methods, assumptions. Examples provided in the ORSA Guidance Manual:

Economic Capital

Component Typical Practices Comments

Underlying  balance  sheet • Company‐defined market‐based • Market‐consistent • Statutory • GAAP Company defined market based most common  for US companies, though smaller and P/C often  use Statutory Market‐consistent, based on Solvency II  definition, more comment globally

Risk metric • Absolute surplus loss

• Loss based on defined external  criteria (ratings, RBC ratio) Most typically defined as the absolute loss in  surplus based on the balance sheet definition  above Time  horizon • Ranges from 1 year to runoff of  business 1 year most common for market‐based balance  sheet, and runoff most common for statutory  balance sheet Confidence  level • Ranges from 99% to 99.99% 99.5% common for global companies since it is  the basis for Solvency II.  Many align this with  AA/AAA rating and therefore use 99.9x%

There is fairly wide variation in use of, and definition of, economic capital in the US insurance industry. A summary of practices currently in place is as follows:

Section  III

Internal Models

Data  Sources Asset  data Policy  data Market  data Data Capture and  Staging Risk Modeling Data load T ransformation

Line of Business Models

Reserving Pricing

Other Corporate Models

Cash flow testing ALM ERM-Owned Models Risk Appetite Data storage Model  Gov ernance  Fr amew ork Economic Capital Stress Testing Financial planning Risk  Monitoring &  Management  Risk  reporting Risk  mitigation Risk assessment Approach &  Assumptions Strategic Objectives, Risk Appetite, Risk Tolerance

A variety of internal models may be used for various components of ERM. Key considerations include link to strategy and risk appetite, data source,

reconciliations, and use of results in strategic decision making

Strategic  decisions

Section  III

Model Validation

Core Principle* Considerations Build for intended purpose While the idea of a “single model” is nice in theory, it often  fails in practice Many ERM models are designed for full enterprise use, and  therefore may be less granular than other company models Model validation is independent A separate functional area charged with validation

Establish model validation owner Creates accountability

Should have authority to communicate and remediate Appropriate model governance Defined policies that cover roles, responsibilities, and

minimum requirements

Consider proportionality Critical for validation to provide sufficient benefits for the cost

Validate model components Data, methods, assumptions, calculations, and outputs

Address validation limitations Including plans to address in the future

Document the validation Can be used to improve and focus future validations

*8 core principles identified in the North American CRO Council’s paper “Model Validation Principles Applied to Risk and Capital Models in the Insurance Industry

Section  III

US ORSA Pilots

Two pilots completed, third in early stages

•

First pilot: 13 reports submitted

•

8 complete: 3 full data; 5 redacted data

•

2 included framework but otherwise incomplete

•

3 more incomplete relative to others

•

Submissions ranged from 10‐100 pages

•

Second pilot: 22 reports submitted

•

None redacted; only 3 need material improvements

US ORSA Pilots – Key Observations

•

Report on ACTUAL ERM, not just a regulatory exercise

•

Glossary of terms and acronyms used

•

Significant risk limit details

•

Risks include rankings (heatmaps preferred), mitigations, owners

•

Changes in limits, appetite, tolerance

•

Include ERM/Control flowchart 

•

Compensation/incentives to risk decisions/risks taken

•

Attach or summarize referenced documents

•

Include prospective/emerging risks (sections 2 and 3)

•

Explanation of tables/graphs

•

Comparison of multiple capital model approaches and results

•

Combined stress scenarios, in addition to single scenarios

•

Describe the capital model and its validation

•

Provide liquidity stress test results

Other US Regulatory Developments

•

Corporate Governance Annual Disclosure Model Act and 

Model Regulation

Annual summary of the Corporate Governance structure Describe Board and committees, duties of each Senior management oversight Business strategy and risk oversight

•

Insurance Holding Company Act

Transactions within a holding company Group supervision

•

FIO Annual Report

SIFI designations Terrorism insurance (TRIA expiration) and Nat’l Flood Ins Program International supervision

Appendix

Risk Culture and Governance 

• Involvement of Senior Management and the Board

• Structure and independence of risk management function

• Reporting and escalation procedures

• Consideration of risk in performance measurement and

compensation

• Tone at the Top

• Risk awareness policies, procedures, and training

• Roles and responsibilities of risk management functions

• Consideration of enterprise risk in decision making

Section  I

Risk Policies & Procedures

• Good ERM should include policies and procedures for key risk-taking and control activities, including activity descriptions, roles and

responsibilities, limits, approvals, escalation procedures, and change controls.

• Examples of such policies include:

• Key function and committee charters • Asset-liability management policy • Underwriting policy/manuals

• Liquidity policy, including contingent funding plan • Privacy and security policies

• Derivatives use plan

• Risk mitigation policies (ie reinsurance, hedging, etc) • Data management policies

• Model governance framework

Section  I

Establishing a Risk Appetite

• Risk appetite* is the total exposed amount that an organization wishes to undertake on the

basis of risk-return trade-offs for one or more desired and expected outcomes.

• Risk tolerance* is the amount of uncertainty an organization is prepared to accept in total or

more narrowly within a certain business unit, a particular risk category or for a specific initiative. • Risk limit** is a threshold used to monitor the

actual risk exposure of a specific risk or activity unit of the organization to ensure that the level of actual risk remains within the risk tolerance.

Source: *RIMS and **American Academy of Actuaries

Enterprise Strategy Tolerance 1 Tolerance 2 Tolerance 4 Tolerance 3 Risk Appetite Toler‐ ance Limit Early  Warning Current  Exposure 1 100 110 175 2 15% 10% 12% 3 etc 4 5 Section  I

Risk Appetite Example

Section  I Strategy Setting and  Business Planning Risk Appetite and Tolerance  Definition Scenario Definition and  Limit Setting Analyze, Communicate, and Manage

• Strategic objective: stay financially strong and provide value to

shareholders

• 3-year financial plan for 8% growth target

• Financial strength

component of risk appetite defined based on RBC ratio • Risk tolerance is a minimum

300% RBC ratio

• Limit: maintain RBC ratio of at least 300% (325% early warning signal)

• 3 stress scenarios defined

Scenario RBC Ratio Year 1 RBC Ratio Year 3

Baseline 400% 400% Severe recession 345% 315% Reputational Event 385% 395% Sharp rise in rates 345% 360% Based on breach of early warning, mitigation plans involve curtailing growth in capital intensive business

Risk Quantification

ERM should provide specific criteria for assessing the likelihood, severity, and velocity of risks.

Unlikely Somewhat  Likely Likely Highly  Likely 0‐15% 15‐30% 30%‐50% >50%

Immaterial Moderate Threatening Severe

Capital <550M 250‐500M 500M‐1B >1B

Earnings <10% drop 10‐20% drop 20‐40% drop >40% drop

Liquidity <20% outflow  increase 20‐40%  outflow  increase 40‐60%  outflow  increase >60%  outflow  increase

Sample Severity Scale Sample Likelihood Scale

In addition, the time period of the assessment

should be defined (ie 1 year, 2 years, etc)

Impact On:

Section  II

Risk Assessment Results

Heatmaps often used to show prioritization by frequency, severity, and

speed of onset (velocity)

Section  II

Stress and Scenario Testing

Business Scenario Definition Use of Results

P&C Cat Risk:  Hurricane Specific level of hurricane  occurs in multiple cities in the  same time period (e.g. 1 year) •Assess impact on capital,  liquidity, and ratings to  determine whether still  within defined risk tolerance  (and if not, determine  necessary immediate  mitigating actions) •Understand level of  exposure over time to  influence strategic decisions  on business mix, growth  plans, and potential  mitigation strategies Health Regulatory  Change Risk:  ACA Antiselection under new ACA  requirements increases  morbidity/claims by 10% Health Regulatory  Change Risk: ACA 30% increase and decrease in  membership driven by ACA  requirements

Life Market Risk:  Low Interest  Rates

Interest rates drop 50% and  stay at that level for 10 years  before a gradual recovery

Examples of stress/scenario tests currently being evaluated as part of ORSA include:

Section  II

Section 3 – Assessing Solvency

0 50 100 150 200 250 300 350 400 450 500

Regulatory Economic Regulatory Economic Regulatory Economic

2014 2015 2016 Operational Expense Behavior Morbidity Longevity Mortality Currency Market Credit Sample Commentary: • International operations sold in late 2014,

eliminating currency risk • Planning entry into

disability income in 2015, which will create exposure to morbidity risk but also drive diversification benefits

Current and 2 Year Prospective Solvency

Required risk capital:

Available regulatory capital Available economic capital

Below is a sample of the type of information that may be included in Section 3 of the ORSA, assuming the insurer has a prospective view on economic solvency

Section  III

OSFI update

Gaetano Geretto Senior Director

Insurance Risk Management and Strategy

PD 119 “Evolving regulatory landscape around capital and risk management” Presentation to the SOA Annual Meeting Orlando, FL, USA

Possible topics of interest

• ORSA progress

• Assessing the actuarial function

• Advisory on new directors

• Cyber-risk self assessments

• OSFI P&C Capital Updates

ORSA

• Objective

– Insurers perform self-assessments to determine if their capital position is adequate and is likely to remain so in the future;

• Benefits

– Promotes better understanding of the

interrelationships between the risk profile and capital needs of an insurer;

– Links with other processes (e.g. enterprise-wide risk management) builds consistency; and

– Potential to enhance existing balance between business development and risk management practices

ORSA

• The ORSA “Report” or “Document”

– Narrative without standard format or

structure

– Minimum content and expectations

– Filing / reporting / review

– Standard filing template: “Key Metrics

Report”

ORSA is not a box-checking exercise and the

exercise should better position the insurer to

ask questions of itself regarding what can be

done better or more consistently

Assessing the Actuarial

Function

• Actuarial Function was added to OSFI’s

revised Supervisory Framework (2010)

• There are 7 oversight functions that may

exist in a FRFI, including Compliance

• The organization of the Actuarial Function

varies considerably across the industry and

is a function of the insurer’s nature, size,

and complexity.

Advisory on New Directors

• International regulatory movement toward

increased involvement in due diligence on

new Board and senior management

members (though some go much further)

• OSFI Advisory not intended to supersede

independent decisions by FIs, but rather

formalize existing process for OSFI to

express any specific concerns regarding

the appropriateness of a candidate

Cyber Risk Self-Assessments

• Set out OSFI’s expectations in 6 areas of

self-assessment with detailed criteria

• Deliver a standard assessment tool to the sector

• Assist a financial institution to carry out a point-in-time self-assessment of maturity of its cyber security function and capabilities

• Encourage a financial institution’s management to develop an action plan setting out initiatives or work needed to achieve a rating of "Fully Implemented”

OSFI P&C Capital Updates

New MCT Standard Approach

• More risk sensitive capital requirements

• Final guideline & returns publication – Fall 2014 • Implementation effective January 1, 2015

MCT Internal Models Approach

• Criteria and guidance under development • Insurance risk – Target completion 2016 • Non-insurance risks – Target 2016/18

OSFI Life Insurance

Regulatory Framework

New MCCSR Standard Approach

• QIS6 Publication October 2014 / responses due January 2015

• QIS6 Additional tests

• Final guideline & reporting forms 2016 • Implementation target of January 2018

Internal Models Approach

• Work on hold until new standard approach finalized

Insurance Capital Frameworks

• Major areas of change

– Definition of available capital – Interest rate risk

– Credit for Diversification

– Credit for Par Policies (Life only) – Mortality (Life only)

International Insurance

Capital Developments

SOA Annual Meeting, 28 October 2014, Session 119 PD Richard Daillak

G20 member states, working through their Financial

Stability Board, have sought to strengthen global financial

resilience

Members: Argentina, Australia, Brazil, Canada, China, France, Germany, India, Indonesia, Italy, Japan, Republic of Korea, Mexico, Russia, Saudi Arabia, South Africa, Turkey, United Kingdom, United States and the European Union.

The FSB has directed sectoral standard-setters to

enhance solvency standards and to help it identify

globally important financial institutions

G-SIBs

Basel III

G-SIIs

BCR/HLA

ICS

Switzerland:

SST legislation in place since 2008, revision in 2015 to adapt to SII

China: C-ROSS project 2015 C-ROSS II ahead? Europe: Solvency II legislation 2016 South Africa:

SAM as part of Twin peaks

Australia: PCR in place Singapore/ Malaysia: RBC 2 (currently postponed) Mexico: LISF 2015 Chile: Japan:

QIS in preparation of the economic risk based solvency regime

Indonesia: Starts to work on ICPs with IAIS

In addition to the global standards developed by the IAIS, local solvency

Insurance solvency modernization is also

happening locally around the globe

United States: SMI, USGCS?

IAIS: Supervision, Capital

and Risk Management

ICPs

Insurance Core Principles

• For all insurers

• Standards for supervision • Requirements for the insurer • Requirements for the supervisor • Used by World Bank/IMF to

assess national regimes (FSAP)

ComFrame

Project in Progress

• For Internationally Active Insurance Groups (IAIGs)

• Common framework for supervision

• Consistent with the ICPs but elaborated and extended

• Modules: Scope, IAIG (including capital requirements), Supervisor • Targeted completion: end 2018

IAIS Projects

Globally Systemically Important Insurers

• For G-SIIs

• At FSB direction, IAIS created a project to identify globally systemically important insurers (G-SIIs) and to devise additional policy measures to apply to them

Initial outcomes of the G-SII project

Initial list of G-SIIs

designated by FSB July 2013 • Allianz • AIG • Assicurazioni Generali • Aviva • Axa • MetLife

• Ping An Insurance (Group) • Prudential Financial (US) • Prudential plc (UK)

GSII list redetermined annually by FSB

Enhanced supervision Effective recovery and resolution

•First: BCR- a straightforward, "basic capital requirement" to serve as foundation for HLA

•Apply to all group activities

•Balance simplicity and risk sensitivity

•Provide more comparable foundation than local capital requirements

•Then: HLA- which will focus on systemic risks and nontraditional, noninsurance activities

Higher loss absorbency (HLA)

Work begins on new capital standards

BCR, HLA and ICS

ICPs

ComFrame

BCR HLA

Enhanced Supervision

Effective Recovery & Resolution FSB

designates Identify

All Insurers All IAIGs

• The IAIS has committed to develop a risk-based insurance capital standard (ICS) for all IAIGs, including all G-SIIs.

• FSB supports the development of the ICS.

• Intended to be more risk-sensitive than the BCR, and therefore expected to be more complex than BCR.

• For G-SIIs, the ICS is expected to replace the BCR as the foundation for HLA.

• For IAIGs generally, the ICS will replace ComFrame Module 2, Element 5, Capital Adequacy Assessment, a long-debated component of ComFrame.

ICS bridges between the G-SII and ComFrame efforts

2014 2015 2016 2017 2018 2019+

Dec: Consultation on design of ICS

First ICS test Second ICS test ICS reporting to supervisors (all IAIGs) ICS reporting to supervisors + public disclosure (?) _{Adoption of} ComFrame by IAIS including ICS ICS full implementation 2013

Current focus of the IAIS is to complete the BCR for G-SIIs

in order to achieve comparability and apply HLA

Basic Capital Requirements (BCR) for G-SIIs – BCR to apply to all group activities (including

non-insurance) of G-SIIs

– BCR as initial foundation for HLA requirements for G-SIIs – BCR to be finalized by November 2014 and reported, to

supervisors only, from 2015

– IAIS using a factor based approach for the BCR

Higher Loss Absorption Capacity (HLA) for G-SIIs – HLA implementation details by end of 2015; will apply to

then designated G-SIIs starting from January 2019

– HLA requirements to be met by the highest quality capital fully available to cover losses at all times

– Location of HLA undecided

Insurance Capital Standard (ICS) for G-SIIs+IAIGs – Global standard to apply to all IAIGs including G-SIIs – Framework completed in 2016; public disclosure from

beginning of 2018; enforcement expected 1 January 2019 – Development of BCR will inform the ICS

 _{BCR to be reassessed once ICS is developed}

ICS BCR HLA Insurance Capital Standard, for

IAIG _{Basic Capital} Requirements, for G-SII Higher Loss Absorbency, for G-SII Planned outcome

ICS replaces BCR as the foundation for HLA

Basic Capital Requirement (BCR) for G-SIIs

Higher Loss Absorption Capacity (HLA) for G-SIIs

• On 28 May the IAIS published a memorandum on the ICS, including an overview of the approach the IAIS plans to apply for the ICS

– ICS will define a consolidated, group-wide, globally comparable risk-based measure of capital adequacy addressing all material risks and financial activities

– The valuations of assets and liabilities must respond to stresses over a specified time horizon – The amount of qualifying capital resources is to be compared to the capital requirement to

determine the ICS ratio

• IAIS states that the ICS will enhance supervisory cooperation and coordination group-wide, support financial stability, enable policyholder protection, facilitate cross-border insurance activities and contribute to a level playing field.

• On 12 September, IAIS also issued principles for ICS development. See appendix. • Thus far, work on ICS has taken a back seat to work on BCR.

 While NAIC has strongly questioned the need for a global ICS, it remains engaged at IAIS to help influence the standard.

 NAIC has just begun work toward a U.S. group capital standard (USGCS).

• NAIC ICS Forum, August 2014, Louisville; follow-up meeting, September 2014. • USGCS likely would apply to U.S.-parented insurance groups.

• Intended to complement but not replace U.S. RBC. Fills a clear gap left by the legal entity approach taken by RBC.

• Once USGCS is developed, NAIC says it plans to argue that the U.S. solvency regime is at least as robust as that provided by the ICS. The possibility of making such an argument is suggested by paragraph 30 of IAIS's May 2014 consultation.

30. Within the ICS, the IAIS will consider what other risk-based methods of implementation jurisdictions may introduce to address additional risk coverage and/or

– maintain higher prudential targets than the standard, as long as these methods

– produce outcomes at least as robust as the ICS standard method.

• NAIC appears open to separate USGCS approaches or models for P&C and Life.

 Many are engaged. For example, non-IAIGs are active because they believe that ICS would ultimately affect them, through competition and consumer pressure to report.  Industry has been divided. Some argue the U.S. should "just say no." Others, believe

ICS is coming and industry needs to help make it work.

 _{Groups with significant life and annuity spread business are concerned if a} market-consistent economic approach is pursued. Many of the same issues are raised as were raised in European Solvency II.

– Volatility

– Disincentives to long-term business

 Some U.S. companies are exploring what they describe as a valuation-agnostic approach based on projection of asset and liability cash flows under stressed scenarios.

– Scenarios might be prescribed by the supervisors, for comparability, rather than determined from internal models.

– Being addressed: Translating pass-fail results to a solvency ratio that can be reported. Determining how to create the scenario set, and how to combine results from scenarios for distinct types of business.

– A cash flow projection approach to P&C has been opposed by a number of companies.

Appendix

3 constructive principles

Key features of BCR according to the IAIS

3 substantive principles  Major risk categories considered _{Comparability of outcomes across jurisdictions}  _{Resilience of BCR to stress}

 _{Simple design and presentation}  _{Internal consistency}

 _{Optimise transparency and use of public data}

Balance Sheet valuations  Liabilities: Current estimates (best estimate) as proxy

 _{Assets: Local GAAP with adjustments}

 Operational risk and liquidity risk not included in BCR Operational and Liquidity risk

BCR

BCR Adequacy Ratio = Qualifying Capital Resources / Required Capital Required Capital = Σ (Liability factors x Liability measures)

+ Σ (Asset factors x Asset measures) + Σ (NI factors x NI measures)

Qualifying Capital Resources = Capital Resources +/– Adjustments

• The IAIS issued its second and final consultation on BCR in July 2014 • The IAIS consultation has clarified certain elements of the BCR:

– calculation on a consolidated group level

– three basic risk components (insurance/banking/non-insurance) and 15 factors applied to specific segments

– simple and comparable basis as foundation for HLA – diversification and ALM not explicitly factored

• However open items remain:

– overall calibration has not yet been fixed

– treatment of margin over current estimate, MOCE (cost of holding capital) – segmentation of assets and liabilities

– determination of current estimates (i.e. best estimates) for certain products – treatment of non-qualifying reinsurance

– calibration of risk factors – tiering of available capital

• The FSB is expected to review and approve the BCR proposal in October 2014 in order for the G20 to endorse it in November 2014.

IAIS principles for HLA development

• Outcomes should be comparable across jurisdictions Comparability

• HLA should reflect the drivers of the assessment of G-SII status G-SII risks

• HLA should internalise some of the costs that the G-SII's failure or distress would cause the financial system and economy

Internalise costs

• HLA should work and remain valid in a wide variety of economic conditions Resilient

• HLA should assume G-SIIs are"going concerns" Going concern

IAIS principles for HLA development

(continued)

• HLA capital requirement is to be met by the highest quality capital

Quality of Capital

• Design needs to be pragmatic and practical, with an appropriate balance between granularity and simplicity

Pragmatic

• Structure should be consistent and applicable over the range of insurance and non-insurance entities it will need to cover

Consistent

• Level of transparency, esp. with regard to results and use of public data, should be optimized

Transparent

• HLA will be refined over time in the course of field testing

IAIS principles for ICS development

• Consistent valuation principles for assets and liabilities, definition of qualifying capital resources, and a risk based capital requirement

Consolidated group-wide standard; globally comparable risk measure

Main objectives: protect policyholders; contribute to financial stability

• Replacing BCR as that foundation

ICS becomes the foundation for HLA

• Taking into account- assets, liabilities, non-insurance risks, off-balance sheet activities

Reflects all material risks to which an IAIG is exposed

• Can contribute to a level playing field and reduce capital arbitrage

Aims at comparability of outcomes across jurisdictions,

IAIS principles for ICS development

(continued)

• By IAIGs and G-SIIs

Promotes sound risk management

• Does not encourage the IAIG to take actions that exacerbate a stress event Promotes prudentially sound behavior while minimising

inappropriate pro-cyclical behavior by supervisors and IAIGs

• Sufficient granularity and complexity, but sensitive to tradeoff in benefit Balances risk-sensitivity and simplicity appropriately

• Particularly with regard to the disclosure of the final results Transparent

• Reflects the level of solvency protection deemed appropriate by the IAIS Requirement based on appropriate target criteria

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