How Emerging Accounting and Regulatory Developments Will Impact the Insurance Industry Actuaries’ Club of Boston - Annual Meeting
Jeff Johnson – John Hancock Financial ServicesDom Lebel – Towers WatsonSeptember 22, 2011
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Agenda
Introduction Solvency II Own Risk and Solvency Assessment Principles Based Reserves Future IFRS
AGENDA
Introduction
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A global shift in regulatory requirements is prompting change in the U.S.
Broader financial sector regulation International Monetary Fund
Financial Sector Assessment Program (FSAP)
U.S. Department of the Treasury Financial Stability Oversight Council
Evolving insurance regulation International Association of Insurance
Supervisors Insurance Core Principles
European Insurance and Occupational Pensions Authority Solvency II
INTRODUCTION
The International Monetary Fund reviewed the U.S. system of financial regulation in 2010 as part of its Financial Sector Assessment Program and will perform a peer review in 2012
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Solvency Modernization – FrameworkInternational
Global alignment to implement international standards
INTRODUCTION
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The emerging importance of theInternational Association of Insurance Supervisors (IAIS) IAIS is an association of insurance regulators, representing 190 countries
around the globe, with two stated objectives Promote effective and globally consistent supervision of the insurance industry Contribute to global financial stability
IAIS publishes regulatory principles and standards, defining requirements for effective insurance supervision of the insurance industry
NAIC must demonstrate that it observes IAIS principles and standards under Financial Sector Assessment Program (FSAP) FSAP created jointly by IMF and World Bank in 1999 in response to Asian financial
crisis, applies to all financial services sectors 2010 review indicated that NAIC generally observes 25 of 28 core principles, but
recommended strengthening of group supervision, risk management and corporate governance— Also, greater need for PBA
INTRODUCTION
Solvency II
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High-level overview of Solvency II Risk-based regulatory framework for
all insurers based in EU (may be extended to pension schemes at some point)
Principles-based not rules-based Aims to harmonize standards
across the EU Currently due to be implemented on
January 1, 2013, but the timeline is a subject of debate
SOLVENCY II
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Solvency II framework
SOLVENCY II
Assets and liabilities measured market-consistently
Eligibility and classification of own funds
Solvency Capital Requirement (SCR)
Minimum Capital Requirement (MCR)
Risk margin
Supervisors shall review system of governance, capital structure and capital needs, and take any actions required
Corporate governance and effective risk management
Own risk and solvency assessment (ORSA)
Public disclosure in form of Solvency and Financial Condition Report (SFCR)
Disclosure to supervisors in Report to Supervisors (RTS)
Information includes details of business and performance, system of governance, risk exposures, concentrations, mitigation and sensitivities
Quantitative reporting templates
Pillar 3Disclosure requirements
Pillar 2 Qualitative requirements
Pillar 1 Quantitative requirements
SOLVENCY II
Integrated risk and capital management framework
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The Solvency II Balance Sheet
SOLVENCY II
SCR
Best Estimate Liabilities
Ownfunds Required
capital
Risk Margin
Excess Assets
Market Value of Assets
Technical provisions
MCR
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Solvency II – SCR and MCR
Technical Provisions (TP) – amounts set aside in order for an insurer to fulfil its obligations towards policyholders and other beneficiaries; market consistent valuation
Solvency Capital Requirement (SCR) – level of capital that enables an institution to absorb significant unforeseen losses and gives reasonable assurance to policyholders and beneficiaries; 99.5% VaR over 1-year
Minimum Capital Requirement (MCR) – a safety net that reflects a level of capital below which ultimate supervisory action would be triggered; 85% VaR over 1 year
Best estimate liability
Risk margin
Level of MCR
Level of SCR
Internal model
Standard approach
Ladder of Intervention
SOLVENCY II
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Different methods to calculate the SCR
Solvency II provides a range of methods to calculate the SCR, which allows undertakings to choose a method that is proportionate to the nature, scale and complexity of the risks that they face
Full IM
Standard formula and PIM
Standard formula with USP
Standard formula
Standard formula with simplifications
SOLVENCY II
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The EU has established a program to harmonize Solvency II with other regulatory schemes via Equivalence and Transition European subsidiaries of a U.S. parent:
Will need to calculate local Solvency II capital requirement using the Solvency II methodology regardless of the final decision on equivalency
If the U.S. is not granted equivalence, then the European supervisor could require the U.S. group to set up a European insurance holding company
European parent company with U.S. subsidiaries If the U.S. is granted equivalence, capital for U.S. subsidiaries will be based on (lower)
NAIC RBC capital requirements in group Solvency II calculations If the U.S. is not granted equivalence, Solvency II rules will need to be applied on a
consolidated basis (i.e., including their U.S. business) The first three countries to undergo equivalence assessments under the
Solvency II regime are Bermuda, Switzerland and Japan Rather than undertake a full assessment of the U.S., the European
Commission has instead proposed a transitional regime Countries eligible for this regime would be deemed equivalent for 5 years It seems clear that the U.S. will be included in this transitional regime
SOLVENCY II
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Potential implications of Solvency II for U.S. companies
U.S. subsidiaries of European multinationals are currently undertaking multimillion dollar projects to prepare for Solvency II
If the U.S. is not deemed equivalent and current standards are ultimately implemented Capital increases for U.S. subsidiaries of European multinationals for certain products
(e.g., spread based products such as payout annuities) — Competitive benefit for U.S. domestic companies— Decreased credit ratings for U.S. subsidiaries of European multinationals— Withdrawal of U.S. subsidiaries of European multinationals from these product lines
U.S. subsidiaries of European multinationals enjoy better risk management framework— Better link between risk identification, risk appetite, risk management and economic capital— More timely risk information— Improved risk culture
U.S. parent companies of European subsidiaries set up European holding companies U.S. regulatory and rating agency changes
SOLVENCY II
ORSA
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The IAIS and Solvency II both require an ORSA as part of solvency regulation; the NAIC and others are following suit
Territory/ Domicile
Regulatory/ Supervisory Authority
Risk and Solvency Assessment Status/Comment
European Insurance and Occupational Pensions Authority (EIOPA)
Own Risk and Solvency Assessment (ORSA)
Expected implementation January 2013
US National Association of Insurance Commissioners (NAIC)
Own Risk and Solvency Assessment (ORSA)
Under consultation — implementation would presumably be in 2013
Bermuda Monetary Authority (BMA)
Commercial Insurer’s Solvency Self Assessment (CISSA)
To become effective in 2011
Swiss Financial Market Supervisory Authority (FINMA)
Risk Management/Internal Control System Tool (RM/ICS Tool)
Developed in 2007 as part of the Swiss Quality Assurance (SQA)
Australian Prudential Regulation Authority (APRA)
Internal Capital Adequacy Assessment Process (ICAAP)
Final standard expected to be implemented in 1 January 2013
Superintendent of Financial Institutions Canada (OSFI)
Dynamic Capital Adequacy Testing (DCAT)
In 2009, OSFI published guidance on stress, scenario, and sensitivity testing to extend the use of testing beyond DCAT
ORSA
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Overview of current (8/5/11) ORSA guidance manual draft
ORSA shall be completed at least annually Regulator may or may not request the
confidential filing each year
Some insurers/groups may be exempt Individual insurers with gross premium less than
$500M Groups with gross premium less than $1B
Insurer’s/Group’s ORSA should contain three major sections: Section 1 – Description of the Risk Management
Policy Section 2 – Quantitative Measurements of Risk
Exposure in Normal and Stressed Environments Section 3 – Group Economic Capital and
Prospective Solvency Assessment
ORSA
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The NAIC has been developing a Guidance Manual for regulators to use in the implementation of ORSA
February March June July
NAIC issues “U.S. Own Risk and Solvency Assessment (ORSA) Proposal”
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Comment period
Comment period ends
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NAIC issues initial guidance draft, “NAIC Own Risk and Solvency Assessment (ORSA) Guidance Manual”
NAIC hosts “2011 ERM Symposium”: CRO Council members present on ERM
NAIC releases revised guidance manual draft
ORSA
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The Manual will be refined over the next couple of months and will be ready for use at the end of the year
August November
NAIC target date to finalize guidance manual draft to send to industry for comments
GSIWG National Meeting (to review newly revised draft of ORSA proposal)
GSIWG Public Hearing on ORSA (final edits before adoption)
October
5 28 – 31
SMI Task Force Receive and discuss proposal
ORSA
The NAIC has not announced an exact date for ORSA implementation the NAIC feels pressure to meet 2012 FSAP requirements but companies are pushing for a longer timeline
PBR
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U.S. NAIC Principle-Based Reserves Why PBR
150 years of prescription Change, complexity and capability
What is PBR Reserves calculated using deterministic and stochastic (stochastic interest and equity) modeling Many assumptions are based on company experience when credible, but some assumptions are
prescribed Reserves set at a conservative level consistent with statutory reporting Reserve greater of NPR, DR and SR
Evolution of PBR Asset adequacy analysis/cash flow testing (1989 in New York, 1992 and later for other states)
— Can only increase formula reserves Actuarial Guideline 35 – Reserves for equity-indexed annuities (1998) Actuarial Guideline 43 – Reserves for variable annuities (2009)
— VASFRI to address
– Disincentives to hedge risks– Domination of the standard scenario– Volatility of results– Pro-cyclicality of capital requirements– Unpredictable results
— Tax reserve issues
PBR
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U.S. NAIC Principle-Based Reserves
Where is PBR Today NAIC adopted SVL to permit PBR November 2009 Life Product Methodology being tested (VM-20 Impact Study) NAIC Earliest completion date March 2012 2014? 2015? (US State approval and US Treasury Guidance)
— Valuation Manual 20 – Reserves for life insurance — Valuation Manual 22 – Reserves for fixed annuities — Will only apply to business issued after the effective date
PBR
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VM-20 participation summary and product coverage
Count of Products Being Tested in VM-20 Impact Study
Product Original Count Current Count
Phase I Submitted
CountPhase I
ResubmissionsPhase II
Submitted CountULSG 10 10 10 9 4
UL without SG 5 4 2 1 1
Term 13 12 12 3 5
Traditional Whole Life 5 5 5 3 3
Simplified Issue Whole Life 4 3 3 2 3
Variable Universal Life 6 5 4 1 2
Indexed Universal Life 2 0 0 0 0
Reinsurance 3 3 0 0 0
Total 48 42 36 19 18
We recently received a significant amount of resubmissions to the Phase I submissions All values in this presentation include the resubmitted results
Indexed Universal Life products are not included in this impact study due to lack of participation Six participants have not submitted Phase I results yet, but expect to submit by mid September
In general, Phase I results often took participants much longer to submit than initially planned Phase II results are coming in much quicker than Phase I results
At least a couple reinsurers had issues with resources, delaying obtaining mirror reinsurance reserves
PBR
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Not all companies provided all aspects of VM-20VM-20 Impact Study – Participation and Exclusion Test Statistics for 1
year of businessULSG Whol
e LifeSimplified Issue VUL 10 year
Term20 year Term
30 year Term
Aggregate Term
Initial number of products planned for study 10 5 4 6 6 7 5 7
Usable products submitted 9 5 3 4 5 6 4 6Average number of model segments per product 1 1 1 1 1.2 1.2 1.3 1.2
Model segments with usable Phase I results 9 5 3 4 6 7 5 7
No. of cos. who supplied CRVM 8 5 3 4 6 7 5 7No. of cos. who supplied NPR 6 5 3 4 5 6 5 7No. of cos. who supplied DR Alt 1 7 3 1 3 4 5 3 6No. of cos. who supplied DR Alt 2 7 3 1 3 4 5 3 6No. of cos. who supplied SR Alt 1 9 - 1 3 2 1 2 5No. of cos. who supplied SR Alt 2 9 - 1 3 2 1 2 5
Usable products submitted is less than initial number of products planned for study due to: A few products lost due to dropouts A few products yet to be submitted
Average number of model segments per product is sometimes greater than one because some Term participants also provided results for ROP Term
As you can see, not all participants provided all reserves or exclusion tests
PBR
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Summary impact of VM-20 on 1 year of business – Product “Per $1,000’s” are averages across participants, weighted by each participant’s amount
CRVM Total Reserve VM-20 Alt 1 Reserve VM-20 Alt 2 Reserve
VM-20 Overall Impact
($M)Face Inforce Amount
Per $1,000 Amount
Per $1,000
Change from
CRVM AmountPer
$1,000
Change from
CRVM1 Year – Direct SIWL 2,689 4 1.4 4 1.5 9% 4 1.5 6% Whole Life 65,598 142 2.2 142 2.2 0% 142 2.2 0% ULSG 24,493 1,433 58.5 2,158 88.1 51% 1,690 69.0 18% VUL 6,343 143 22.5 142 22.5 0% 142 22.5 0% Term 10 34,758 65 1.9 73 2.1 12% 73 2.1 12% Term 20 64,648 184 2.9 109 1.7 -41% 92 1.4 -50% Term 30 41,516 191 4.6 99 2.4 -48% 77 1.8 -60%
Agg. Effect 0 0 (82) (71) Agg. Term 115,915 327 2.8 568 4.9 74% 524 4.5 60%
1 Year – Net SIWL 2,689 4 1.4 4 1.5 10% 4 1.5 6% Whole Life 64,723 133 2.0 133 2.0 0% 133 2.0 0% ULSG 16,469 1,416 86.0 1,774 107.7 25% 1,415 85.9 0% VUL 2,175 115 52.8 115 52.7 0% 115 52.7 0% Term 10 22,158 34 1.5 38 1.7 12% 38 1.7 12% Term 20 48,229 166 3.4 55 1.1 -67% 48 1.0 -71% Term 30 31,027 186 6.0 74 2.4 -60% 56 1.8 -70%
Agg. Effect 0 0 (39) (35) Agg. Term 72,953 257 3.5 533 7.3 107% 488 6.7 90%
PBR
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Comments on the summary impact of VM-20 to today’s reserve levels For Term, in most cases the reserves decrease, but because of one large term participant that gave us
results in the aggregate, we get conflicting results for Aggregate Term Were it not for this participant, Aggregate Term reserves would have decreased by 26% under Alt 1 and 31% under Alt
2 for 1 year of direct business, and decreased by 52% under Alt 1 and 53% under Alt 2 for 5 years of direct business, which is more in line with the other Term results
For ULSG we see reserves increasing under VM-20 1 year of ULSG increased 51% and 25% under Alt 1 on a direct and net basis, respectively 5 year of ULSG increased 22% and 7% under Alt 1 on a direct and net basis, respectively The increase is less pronounced under Alt 2 and reserve even decrease 8% for five years of ULSG business under Alt
2 on a net basis It is notable that statutory reserves increase, but tax reserves decrease
Whole Life reserves didn’t change because the DRET and SRET are always passed so the VM-20 reserve equals NPR which is defined to be CRVM for Whole Life
For VUL, there is not much change in the aggregate But one VUL participant shows a slight increase, one show VM-20 reserves at zero, and the others show no change
SIWL reserves increase, which is counterintuitive and being investigated This is due to one SIWL participant showing significantly increasing reserves while the others show no change
PBR
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VM-20 Observations
We are awaiting the results of Phase II, follow up questions and a survey, but so far we can say: With help, companies have been able to work their way through VM-20 and calculate a number
— However, this required hundreds of questions and much clarification
— Plus, results took longer than expected
– Often due to constraints on resources, but not always– The mortality process, NPR issues and starting asset iterations also played a role
Results are sometimes counterintuitive and unexpected
— ULSG results are generally higher than CRVM/AG-38
— There are some outliers in the SRET
— More data and analysis is needed to answer these questions
– Certain results may be due to specific product features and specifications Results often vary by significantly by product, and sometimes even within products Aggregation results in lower VM-20 reserves for Term participants (by 25%, but only a small
sample) The number of scenarios ran by participant varied widely
PBR
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VM-20 Other Concerns
Mature block impact Reinsurance Initial scope of VM Consistency with international standards
PBR
Future IFRS
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Measurement of long-term insurance contracts The discounted future cash
flows represent a market-consistent value of the obligations arising from the contract Include time value of money Reflect all possible scenarios Use current estimates Reflect options and
guarantees
A hybrid approach has been proposed that includes both economic as well as deferral and matching elements
Discountedfuture
cash flows
Risk adjustment
Residualmargin
Eliminates any gain at inception (cannot be negative)
Estimate of the effects of uncertainty about the amount and timing of cash flows
Estimate of future cash flows, adjusted for the time value of money
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Discountedfuture
cash flows
Compositemargin
IASB FASB
FUTURE IFRS
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Presentation Statement of comprehensive income
Item Year X
Year X−1
Comment
Change in risk adjustment +2 −1 From subsequent re-measurement
Release of residual margin +1 +1 Subsequent release of residual margin
Gains and losses at initial recognition 0 −1 Unprofitable contracts (and other reasons)
Non-incremental acquisition costs −1 −1
Experience adjustments −1 0 Differences between actual cash flows for the current period and previous estimates of those cash flows
Changes in estimates of cash flows +2 −1 Impact of subsequent changes in non-financial and financial assumptions underlying the discounted cash flows, including discount rates
Investment income +3 +1 Investment return on assets
Interest on insurance contract liabilities −2 −2 Unwind of discount rate over period
Items from other standards −1 −1 Potentially including general overhead costs (if not part of experience adjustments)
Profit +3 −5
Illustrative and simplified
Insurance contracts standard Financial instruments standard Other standards
FUTURE IFRS
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Several key issues still unclear
Unbundling Current proposal to unbundle embedded derivatives and certain explicit
account balances Guidance based on revenue recognition standard
Presentation ED proposed a “release of margins” presentation Significant pushback from industry has led to redeliberation
Transition ED proposed a simplified method for transition that would not require
significant margins for IF business Significant negative feedback has led to redeliberation
FUTURE IFRS
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Timeline
Revised Exposure Draft/Review Draft – Q2 2012 Likely to be much more limited in scope for soliciting comments
Further timing now uncertain Final standard now unlikely before end of 2012 Effective date uncertain – will not be before YE 2015
FUTURE IFRS
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Implications
Responding to exposure drafts and quantifying financial impact of changes Practical Implementation Concerns
Significant increase in actuarial input necessary Derivation of numbers might require new systems (software and/or hardware) Reengineering of reporting function including increased controls
Communication of results Results will behave differently than before
— Likely to be increased volatility due to current nature of framework— Increased focus on explanation of results
May require reconciliation to other reporting frameworks Interpretation/Usability
“Rules of thumb” may no longer be applicable Likely need for different analytics Might other metrics be necessary?
New business strategy and product design/pricing Management of potentially unprofitable lines of business under the new accounting framework
Managing the potentially increased earnings volatility, for example, via improved asset/liability management and/or hedging
FUTURE IFRS
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Contacts
Jeffrey L. Johnson, FSA, MAAAJohn Hancock Financial ServicesAVP and Actuary – Actuarial Policy US [email protected]
Dominique LeBel, FSA, FCIA, MAAATowers WatsonDirector and Leader, Hartford Life [email protected]
