1、,IFRS Seminar Solvency II,Alan ChanPrudential Corporation AsiaAugust 06, 2009,2,Topics,Introduction of Solvency II CapitalWhat is and why develop Solvency II? Case Study Management of Economic CapitalExample EC of a Traditional Life InsurerPractical ConsiderationsHow to Manage it?Summary,3,Topics,In
2、troduction of Solvency II CapitalWhat is and why develop Solvency II? Case Study Management of Economic CapitalExample EC of a Traditional Life InsurerPractical ConsiderationsHow to Manage it?Summary,4,Introduction Why Solvency II is needed?,Solvency I CapitalDifferent from companys economic capital
3、 requirementUndefined level of prudenceLimited recognition on diversifying benefitsGreater prudence in technical provisions lead to increased solvency margin for life companiesDifferent insurers have different interpretation of valuation of liabilityLimited credit on risk management quality,5,Introd
4、uction Why Solvency II is needed?,Traditional valuationis a black Box to outsider,Transparent underSolvency II framework,Minimum Capital RequirementSupervisory ReviewMarket Disclosure,6,Introduction Pros and Cons?,Aims of EU Regulator:Improved consumer protectionUniform standards for all EU entities
5、Market integration with other financial institutions (Basel II)Better risk management by insurersPros:Reduced capital requirements for insurers with good risk managementImproved share price performance for better disclosureCons:Extensive reporting and administrative requirementsMethodology not consi
6、stently well-suited to all insurance marketsStill under development, with effect from 2012,7,Introduction - What is Solvency II?,Basic architecturePillar 1: Quantitative requirementsMinimum capital levelPillar 2: Qualitative requirementsNeed to integrate capital management with day-to-day operations
7、Rigorous processes for identifying, measuring and managing riskPillar 3: Disclosure requirementsRegular publication of solvency information to regulators and the public,8,Introduction What is Solvency II?,Pillar 1Minimum capital levelValue at risk concept,VALUE DISTRIBUTION,Expected value,Capital re
8、quired to achieve rating,KBBB,KAA,VALUE,AA,BBB,PROBABILITYOF OUTCOME,TAILPROBABILITIES,9,Introduction What is Solvency II?,Pillar 1Minimum capital levelRequired capital to cover the VaR (Potential Loss) at 1 in 200 chance over 1 yearApart from insurance risk, it covers financial and operational risk
9、sTake into accountDiversificationManagement actionRisk Mitigation, e.g. reinsuranceInternal model is allowed, but insurer has to pass the use test,10,Risk and capital assessment (including internal models),Governance, organizationand policies,Management information,People, change and reward,Technolo
10、gy and infrastructure,Risk strategy,Risk appetite,Risk profile,External communication and stakeholder management,Introduction What is Solvency II?,Capital management is part of the Enterprise Risk Management (“ERM”) framework,11,Solvency II - Highlights,Risk FocusRequired capital depends on riskA to
11、tal risk management concept, involving the whole companyOne needs to identify, measure and manage risk activelyMore disclosure publicly to encourage market discipline,12,Topics,Brief Introduction of Solvency II CapitalWhat is and why develop Solvency II? Case Study Management of Economic CapitalExam
12、ple EC of a Traditional Life InsurerPractical ConsiderationsHow to Manage it?Summary,13,Company A A traditional Life Insurance Company,Traditional Participating and Non-Participating ProductInvestment Mix: 80% in A+ bond and 20% in equity,Liquidity and credit risk,Operation risk,Insurance risk,Marke
13、t risk,DISTRIBUTION OF ECONOMIC CAPITAL,14,Company B Life Company targets Selling Unit Linked,Mainly selling Unit Linked ProductInvestment Mix: 80% in A+ bond and 20% in equity,DISTRIBUTION OF ECONOMIC CAPITAL,Insurance risk,Market risk,Operation risk,Liquidity and credit risk,15,Case Study Points t
14、o Ponder,To reduce the Economic Capital, what are the considerations?Available Resources and Priority?Approach in Mitigating the Risk?Management Team and stakeholders buy in?,16,Case Study,What is the priority?,- Portfolio Interest Risk- Equity Risk,- Misestimated pricing assumptions - Volatility of
15、 assumption - Catastrophic loss,Operation risk,Liquidity and credit risk,Insurance risk,DISTRIBUTION OF ECONOMIC CAPITAL,Market risk,17,Case Study What to do?,Insurance RiskUncontrollable risk outcome or pricing errorVia reinsuranceImprove the data collection process and quality of statisticsOperati
16、on RiskComputer system error, non-complianceStrengthen internal controlsStandardize proceduresEstablish operation risk committee,18,Case Study What to do?,Credit RiskPotential for the counterparty to fail to honor the payment Set up the processes to control the maximum exposure per counter-party, in
17、cluding the reinsurerMarket RiskPortfolio Interest Rate RiskAsset and liability matching - avoid backing long term liability with short term assetsProduct design - high guarantees must be backed by investment strategy or sufficient surrender penalty (e.g. high net-worth universal life product)Equity
18、 RiskSell all equities?,19,100% in bond,Capital Strain,Policyholder Expectation,Shareholders Earning, Lower capital requirement, Lower expected earnings but more stable earnings, Lower expected return to policyholderand product becomes less competitive,Case Study What happen if we sell all equity?,2
19、0,Case Study An alternative approach to reduce equity risk,To buy an out-of-money put optionIf volatility is 50%, buy a put with an exercise price 20-40% below the current market level. # Put option is a right to sell the stock to the contract writer at a specific price, it can be used to hedge risk
20、 when anticipating the market to fall,Loss under extreme scenario,Before hedging,After hedging,99.5% loss,Exercise price,Current price,21,Case Study What is diversification?,1 + 1 = ?,22,1 + 1 2,Case Study Benefit of Diversification,23,Case study Benefit of Diversification,Economic Capital,24,Unit-L
21、inked,Traditional,Combined,Interest rate,Company value,Case Study - Risk mitigation by managing product mix,DIVERSIFICATION ALSO BENEFITS COMPANY VALUE,25,Topics,Introduction of Solvency II CapitalWhat is and why develop Solvency II? Case Study Management of Economic CapitalExample EC of a Tradition
22、al Life InsurerPractical ConsiderationsHow to Manage it?Summary,26,Summary,ChallengesPeopleCommunication and negotiationSecure management and stakeholders to buy-inEmpathy Balance the interests of shareholder, policyholder, sales forceNeed to understand their risk appetitesInvestment market has limi
23、ted hedging vehiclesNo standard approach,27,Summary,Art rather than scienceTry to benefit from:Involvement in defining the management action policyActive management of product mix to diversify the portfolioBetter management of asset and liability matching positionProper product design to minimize the anti-selectionUtilization of equity exposure hedging to control the maximum loss,28,28,Q & A,29,29,Thank you!,
