Own Risk Solvency Assessment (ORSA)

2013 ASNY Annual Meeting

Josh Windsor, NAICMark Yu, General Re-New England Asset Management

2

Today’s ORSA discussion is presented by:

Josh Windsor Mr. Windsor recently joined the national Association of Insurance Commissioners (“NAIC”) after nearly 20 years insurance related experience. He is a member of the NAIC’s financial regulatory affairs international and market surveillance unit where he will work on a variety of national and international projects. He was previously associated with a consulting firm that serves regulators with a variety of projects including risk focused examination of insurance companies, risk assessment and capital requirements for various insurance entities. Josh is a Fellow of the Society of Actuaries, Fellow of the Institute and Faculty of Actuaries, a member of the American Academy of Actuaries and the Secretary of the Actuarial Society of New York.

Mark M. YuMr. Yu joined GR-NEAM in 2012 as an Enterprise Risk Management professional focusing on the capital management and corporate development activities for Life insurance companies.

Prior to joining GR-NEAM, Mr. Yu was a senior risk manager within the Governance and Strategy team at AIG Enterprise Risk Management. Prior to working at AIG ERM, he was a Senior Vice President and Treasury Director within the Group Capital Management division of Swiss Re. Mr. Yu holds a B.A. from National Tsing Hua University in Taiwan and a M.S. from the University of Iowa.

He is a Fellow of the Society of Actuaries, a CFA charter holder, a Financial Risk Manager, and a Member of the American Academy of Actuaries.

The views presented by the speakers are as individual professionals and are not the opinion of their employers or of

the Actuarial Society of New York.

3

A. ORSA OVERVIEW

B. ASSET RISK EVALUATION – METHODOLOGY & APPROACH

C. ASSET RISK EVALUATION – SAMPLE ANALYTICS AND REPORTING

D. Parting Remarks

Table of Contents

Own Risk and Solvency Assessment Overview (ORSA)

5

It is an own-risk review with the following key questions:

What is our strategy? What level of risk are we willing to assume in pursuit of this

strategy? What are the key risks that could hinder our ability to achieve our

strategy? How much capital do we need to cover those key risks? What risks – individually or collectively- would subject us to losses

that exceed our tolerance? What risk scenarios would cause us to fail or stop operating as a

going concern?

What is ORSA?

6

Building a bridge between risks, capital needs and available capital. [Note the distinction between capital needs and RBC requirements]

Elevated risk awareness Improve risk governance processes and techniques Evolving by nature (business mix, environment factors, best

practices) ORSA will lead insurer management teams to be much

more deliberate and explicit in how they identify measure and manage enterprise risks

ORSA - Key Points

7

A robust ORSA addresses current and prospective risk in five key categories:

Underwriting Credit Market Operational Liquidity

ORSA - Key Points (Cont’d)

8

Solvency Modernization Initiative

NAIC Own Risk and Solvency Assessment

Background

• Solvency Modernization Initiative (SMI) adopted by the NAIC in 2008 to respond to financial crisis and international regulatory solvency developments

• Risk Management and Own Risk and Solvency Assessment (ORSA) Model Act adopted in September 2012 with effective date of January 2015

• ORSA Guidance Manual to provide guidance regarding the reporting of insurer’s own risk and solvency assessment

• ORSA not required for Individual insurers with annual gross premium (“AGP”)< $500 million and/or Insurance groups with AGP of less < $1000 million

Governance &Risk Management

Statutory Accounting & Financial Reporting

Reinsurance

Group SupervisionSolvency

Modernization Initiative

Capital Requirements

Timeline

ORSA and Form F Timeline

2010 2012 2013 2014 2015

NAIC ORSAGuidance ManualNov. 2011

ORSA Model Act adopted onSept 12, 2012

1st ORSA Pilot (June-July 2012)

NAIC ORSA Model Actproposed effective dateJan. 1, 2015

2011

NAIC 2010 Model Law(Form F on ERR)

First Form F reporting for some states (July 1, 2013)

2nd ORSA Pilot (May-Sept 2013)

The NAIC launched the Solvency Modernization Initiative (SMI), a critical “self-examination” to update the U.S. insurance solvency regulation framework.

No fundamental revision of the regulatory capital formula (called Risk Based Capital) but only revision to include CAT and Operational Risk. Also introduction on Principle Based Reserving for life companies.

Two new formats of statutory reporting have already been approved by the NAIC as part of the SMI:

• Form F Enterprise Risk Report (ERR) – in effect from 2013 in some states (see article in the Fall 2013 Examiner magazine).

• ORSA Summary Report – in effect from 2015.

9

Implementing the NAIC ORSA can be structured around segmented building blocks, each with its own principles. The following represents an illustrative building block model that has been developed for ORSA.

The main building blocks of the NAIC ORSA

Capital forecasting and prospective

solvency assessmentRisk reporting and communication

Risk culture and governance structures

Risk monitoring methods

and controls

Risk identification and categorization

Group risk capital adequacy

determination, approaches and

assessment

Stress testing methodologies and

documentation

Qualitativerisk assessment

Quantitativerisk assessment / economic capital

modelling

Model validation and calibration

Risk prioritization and assessment tools

Risk appetite, tolerances and limits

Risk policies, procedures, and

programs

Board of Directors oversight

Integrating capital management into

decision-making (“Use Test”)

Group risk capital and prospective solvency

assessment

Assessment of Risk Exposures

Risk management framework

Evaluation and feedback loop

Section 1 Section 2 Section 3

10

11

Own Risk and Solvency Assessment

Overview

ORSA’s Two Key Requirements:

► NAIC ORSA involves a self-assessment of the insurer’s risk management framework and solvency position

The ORSA is a process

• ORSA is an insurer’s own process for assessing its risk profile and the capital required to support its business plans in normal and stressed environments on a forward-looking basis

• The Guidance Manual requires insurers/insurance groups to carry out this risk and solvency assessment process on a regular basis

The ORSA report is a regulatory filing

• On an annual basis, insurers will be required to provide a regulatory filing that explains their ORSA process and results

• The filing does not have a prescribed format but should at the present time contain 3 sections: 1) description of ERM framework; 2) assessment of risk exposures; and 3) group risk capital and prospective solvency assessment

12

NAIC Own Risk and Solvency Assessment

Filing Requirements (1/3)

• High level summary of key ERM elements

• Identification and assessment of relevant and material risks for executed business strategy

• Documentation of assessment tools

• Description of accounting basis and legal entity structure

• Definition of critical risk management policies and procedures

1. Description of ERM Framework

Source: North America CRO council presentation

13

Typical Enterprise Risks(not consistent with Official ORSA Guidance)

14

NAIC Own Risk and Solvency Assessment

Filing Requirements (2/3)

• Relevant and material risks

• Both quantitative and qualitative assessments

• Under normal and stressed environments

• Model validation, calibration and assumption setting process

• Methodology and approach

• Multiple perspectives including regulatory, economic and rating agency, etc

• Tolerances and limits setting process

2. Assessment of Risk Exposures

• Qualitative vs. Quantitative• Normal vs. Stressed scenarios• Tolerance and limits• …….

Market Risk

Credit Risk

Insurance Risk

Operational Risk

…..

15

NAIC Own Risk and Solvency Assessment

Filing Requirements (3/3)

• Group level “available” capital versus “risk” capital evaluation

• Intra-group transactions, debt leverage and diversification benefits

• One to three years forward-looking solvency assessment

• Link business strategy and capital actions to prospective assessment

• Different tolerances at different confidence levels under different valuation bases

3. Group Risk Capital and Prospective Solvency Assessment

Time

Risk Tolerance

Normal Environment

Stressed Environment

16

NAIC Own Risk and Solvency Assessment

ORSA vs. Statutory Risk-Based Capital (RBC)

US Statutory RBC (Ongoing) NAIC ORSA (1/1/2015*)

Focus Factor based and meant to identify weakly capitalized companies

Emphasize process and both qualitative and quantitative

Perspective Backward looking; historical data based

Forward looking with stressed scenarios considerations

Considerations No consideration of business plan and strategy

Incorporate business plan and corporate capital actions

Entities All regulated insurance entity Subject to minimal gross premium threshold

Approach Prescriptive; factor based Non-prescriptive; own & discretionary

View Individual legal entity view Aggregated group level approach

Capital Requirement

Specific thresholds for regulatory actions triggers

None but meant to address “target” capitalization level

*Filing date: states might set a filing date; the NAIC has discussed allowing companies to submit around their business processes, but some states might require these to be submitted once a year at a particular time

17

As of August 5, 2013, five States have adopted Model Reg 505: RI, IA, NH, ME  and VT. It is under active consideration in 8 more (see map following).

The American Academy of Actuaries has a working party that is preparing a model ORSA report for regulators.

Another (2013) round of ORSA testing by the NAIC.

Recent Developments

18

Recent Developments (Cont.)

19

Reports did not always specify the accounting approach used (e.g., GAAP, SAP, IFRS)

The organizational and legal structures were not always clearly explained

A comparison of material changes over time

A comparative look back for three years

Legal entity mapping

Glossary of terms used by the company

Deficiencies in the 2012 ORSA Pilot Study addressed by the NAIC (Absent Items)

20

Detailed explanation of the company’s risk limits, including key risks and materiality

Combined stress test scenarios in addition to the single stress tests

Descriptions and explanations of tables and graphs

Details on capital model calculations

Risk owner assignment

Deficiencies in the 2012 ORSA Testing by the NAIC (Absent Items Cont.)

21

Compensation and incentive linkage to risk, including how this is determined by the company

Heat maps of risks

Graphical comparison of different capital models if mentioned or used

Executive summary

Stronger, more detailed prospective risk sections

Deficiencies in the 2012 ORSA Testing by the NAIC (Absent Items Cont.)

Asset Risk Evaluation – Methodology and Approach

The world is usually not normal

• Assumptions of normality translate into misleading results

• It is essential to maintain a broad understanding of the risk characteristics of the portfolio

• Risk analysis and evaluation should capture and understand the impact of asymmetry on a portfolio’s risk / return profile

Enterprise Decision

VaR / T-VaRProspective

Returns & Vols

Identify

Model

Consequences

Asymmetric, Non-Normal Returns

*4P = four parameters, where normal skewness = 0.0; normal tail = 2.0

*

0.02

Source: GR-NEAM Analytics

Prudent Model Assumption: Normal vs. Asymmetric

23

24

Measures may be Expressed:

At Multiple Confidence Intervals

Multiple Periods: Daily, Weekly, Monthly, Quarterly, Annually

As Portfolio or Capital Loss

High Degree of Customization

• Maximum Loss Not Exceeded With a Certain Probability

VaR Value-at-Risk

• Expected Loss if Loss Event Occurs

T-VaR Tail Value-at-Risk

End-of-Period Intra-Period “At any time within the period”

Downside Risk Metrics

Normal Market Conditions Extreme Tail Risk

• Levy with alpha-Stable Methodology, Heavy Tailed

• Allows For Jumps

• Diffusion Process, Intra-Period: DIP

• Neglecting Extreme Market Movements

• Standard Normal, End-of-Period: SNEOP

Statistical Distribution

Tail Risk Evaluation: Multiple Approaches with Various Implications

Source: GR-NEAM Analytics

25

Portfolio Annual Returns

Hypothetical 99.6 VAR ~ similar in concept to a 1-in-250 year event

Hypothetical 99.5 VAR ~ similar in concept to a 1-in-200 year event

Hypothetical 99.0 VAR ~ similar in concept to a 1-in-100 year event

Value-at-Risk and Tail Value-at-Risk : Traditional Measures with an End-of-Period View

Value-at-Risk (VaR) DefinedThe amount of loss not to be exceeded with a certain probability in a given time frame; typically expressed as a percent of capital

Tail Value-at-Risk (T-VaR) DefinedThe expected amount of loss if the VaR loss threshold is exceeded

Source: GR-NEAM Analytics

26

Traditional VaR/T-VaR methods underestimate

Intra-period downside risk by focusing on end-of-

period return distributions Solely. (E.g. -1.6%

annual portfolio return)

Intra-period VaR/T-VaR estimation approach

reflects realistic downside risk. (E.g. -19.7%)

Intra-Period vs. End-of-PeriodPortfolio Annual Returns

Intra-Period Losses May Be Significant And Require Advanced Techniques To Avoid Pitfalls of Traditional VaR

& T-VaR Metrics

Source: GR-NEAM Analytics

27

Asymmetric Measures Capture Extreme Events When Markets Are Not Normal: Compare Annual T-VaR @ 6.1% vs. 13.8%

Source: GR-NEAM Analytics

Asset Risk Evaluation – Sample Analytics and Reporting

29

Multi-portfolio, multi-currency, multi-time-period views with consideration of hedge effects

Multi Portfolio VaR (T-VaR) Evaluation

Source: GR-NEAM Analytics

30

What-if downside risk analysis under different market cycles, assumptions and approaches

Multi Portfolio VaR (T-VaR) Migration

Source: GR-NEAM Analytics

31

Asset’s downside risk contribution within portfolio context; portfolio downside risk impact from (proposed) changes in asset allocation

Incremental VaR (T-VaR) Analysis

Source: GR-NEAM Analytics

32

Provides insight into portfolios’ downside risk drivers Addresses regulatory / rating agency risk management expectations

VaR Risk Decomposition

$84.6

$36.9

$93.7

$45.8

$27.4

$19.9

$139.1

$32.2

0

50

100

150

200

250

Currency Equity Interest Rate Structure Credit Implicit Correlation

(Diversification)

Correlation Risk 99.5 VaR

99

.5 V

aR

($

MM

)

Portfolio Risk Factor Decomposition

Source: GR-NEAM Analytics

33

Asset Return Forecast – Benchmark Comparison

Prospective benchmarking and expected tracking error; Estimate potential prospective losses by asset class or risk factor

Source: GR-NEAM Analytics

34

Compare and contrast statistical risk results with historical stress events outcome

Stress Test: Historical Relevance

Source: GR-NEAM Analytics

35

3.0%

4.0%

5.0%

6.0%

7.0%

8.0%

0% 2% 4% 6% 8% 10% 12% 14% 16% 18% 20%

Ann

ualiz

ed T

ota

l Ret

urn

99.5% T-VaR (Invested Assets)

Asset TRR vs. 99.5% T-VaR (Excl. Affiliated Equities)(Intersect @ Industry Median)

2012 Life Industry Asset Return vs. T-VaR Distribution

Source: GR-NEAM Analytics

Parting Remarks

37

1. Tail risk evaluations should address non-normal and asymmetric characteristics

2. Intra-period evaluations are equally, if not more than end-of-period results

3. What-if analysis and benchmarking offer valuable insight for contemplated actions

4. Risk analytics and reporting need to provide actionable information

5. Relating statistical results to historical scenarios adds additional context and story

Parting Remarks(not NAIC advice)

38

Today’s ORSA discussion was presented by:

Josh Windsor Mr. Windsor recently joined the national Association of Insurance Commissioners (“NAIC”) after nearly 20 years insurance related experience. He is a member of the NAIC’s financial regulatory affairs international and market surveillance unit where he will work on a variety of national and international projects.  He was previously associated with a consulting firm that serves regulators with a variety of projects including risk focused examination of insurance companies, risk assessment and capital requirements for various insurance entities.  Josh is a Fellow of the Society of Actuaries, Fellow of the Institute and Faculty of Actuaries a member of the American Academy of Actuaries and the Secretary of the Actuarial Society of New York.JWindsor@naic.org212 -398-9000

Mark M. YuMr. Yu joined GR-NEAM in 2012 as an Enterprise Risk Management professional focusing on the capital management and corporate development activities for Life insurance companies.

Prior to joining GR-NEAM, Mr. Yu was a senior risk manager within the Governance and Strategy team at AIG Enterprise Risk Management. Prior to working at AIG ERM, he was a Senior Vice President and Treasury Director within the Group Capital Management division of Swiss Re. Mr. Yu holds a B.A. from National Tsing Hua University in Taiwan and a M.S. from the University of Iowa.

He is a Fellow of the Society of Actuaries, a CFA charter holder, a Financial Risk Manager, and a Member of the American Academy of Actuaries.Mark.Yu@grneam.com860-676-8722

The views presented by the speakers are as individual professionals and are not the opinion of their employers or of

the Actuarial Society of New York.

39

Questions?