Post on 14-Jan-2016
description
Office of the Superintendent Bureau du surintendantof Financial Institutions Canada des institutions financières Canada
Dynamic Capital Adequacy Testing
Michael Hafeman
Assistant Superintendent, Specialist Support Sector
IAIS Annual Conference – Santiago, Chile – October 10, 2002
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OSFI’s Approach
• Promote understanding and management of risks by companies’ boards of directors and senior management
• Establish capital requirements
• Assess performance and strength
• Promote effective disclosure
3
Dynamic Capital Adequacy Testing – DCAT
• Process of projecting and analyzing the trends of a company’s capital adequacy under a variety of future scenarios
4
Purpose of DCAT
• Assist board of directors and senior management in planning and risk management
• Defensive in nature• Identify
– Plausible threats to satisfactory condition– Actions which lessen likelihood of threats– Actions which mitigate a threat if it occurs
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Historical Context
• OSFI began developing risk-based capital requirements for Life in mid-1980s
• Actuaries (CIA) developed a forward-looking approach to assessment
• Life capital and DCAT requirements since 1992
• P&C DCAT since 1998; new risk-based capital requirements from 2003
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DCAT Process
• Development of base scenario
• Identification and examination of possible threats
• Development of plausible adverse scenarios
• Projection and analysis of capital adequacy
• Reporting of results
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Base Scenario
• Normally, consistent with the business plan
• All scenarios include inforce policies, forecast sales, and non-insurance operations
• Realistic assumptions
• Forecast period is usually 5 years for life companies and 2 years for P&C companies
• Modeling software is available
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Plausible Adverse Scenarios
• Adverse, but plausible, assumptions about matters to which an insurer’s financial condition is sensitive
• Stress testing to assess plausibility
• Differ among insurers
• May change over time for an insurer
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Threats to Consider – Life
• Mortality • Morbidity• Persistency• Cash flow mismatch• Deterioration of asset
values• New business
• Expense• Reinsurance• Government and
political action• Off-balance sheet• Others, if material
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Threats to Consider – P&C
• Frequency and severity
• Pricing• Misestimation of
policy liabilities• Inflation• Interest rate• Premium volume
• Expense• Reinsurance• Government and
political action• Off-balance sheet• Others, if material
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Refinements Required
• Integrate scenarios, if the probability of an adverse scenario is high
• Consider ripple effects– Impact on other base assumptions– Company’s response to adversity– Regulatory action, e.g., where minimum capital
is not met– Policyholder actions
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Reporting
• Primarily for board of directors and senior management
• Copy of report is sent to OSFI
• At least base scenario and three most risky scenarios must be tested and reported annually
• Professional opinion is required
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Capital Adequacy Targets
• Actuarial standard for satisfactory opinion:– Meet minimum regulatory capital requirement under
the base scenario
– Meet all future obligations under the base scenario and all plausible adverse scenarios
• OSFI expects more – acceptable capital levels• OSFI encourages active discussions amongst the
actuary, board and management of any scenarios where minimum capital is not met
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More Information
• OSFI – www.osfi-bsif.gc.ca
• Canadian Institute of Actuaries – www.actuaries.ca– Standard of Practice, Dynamic Capital
Adequacy Testing, December 1998– Educational Note, Dynamic Capital Adequacy
Testing – Life and P&C, June 1999
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DCAT Case Study
• Company in weakened position in 1992, due to investment losses
• DCAT used to develop business plan to improve solvency position within five years
• DCAT used to test viability of business plan under plausible adverse scenarios
Forming a Business PlanMCCSR Ratio
Level of New Business (MCCSR ratio)
60
80
100
120
140
160
180
1992 1993 1994 1995 1996 1997Year
MC
CS
R R
ati
o
Lower new sales Level New Sales
Double New Growth No New Business
Forming a Business PlanAvailable Surplus
Level of New Business (Available Surplus)
60,000
70,000
80,000
90,000
100,000
110,000
1992 1993 1994 1995 1996 1997
Year
Le
ve
l of
Av
aila
ble
S
urp
lus
Lower new sales Level New Sales
Double New Growth No New Business
Forming a Business PlanAnnual Income
Level of New Business (Annual Income)
3,000
6,000
9,000
12,000
15,000
18,000
21,000
1992 1993 1994 1995 1996 1997
Year
Lev
el o
f A
nn
ual
Inco
me
Lower new sales Level New Sales
Double New Growth No New Business
Business Plan – Base Scenario
CHOSEN BASE SCENARIO: Lower New Sales
60
80
100
120
140
160
180
1992 1993 1994 1995 1996 1997Year
MC
CS
R R
atio
Base Scenario
Scenario 1: Mortality
Worsening Mortality: 3% per annum
60
80
100
120
140
160
180
1992 1993 1994 1995 1996 1997
Year
MC
CS
R R
atio
Base Scenario Worsening Mortality
Scenario 2: Morbidity
Worsening Morbidity: 3% per annum
60
80
100
120
140
160
180
1992 1993 1994 1995 1996 1997
YEAR
MC
CS
R R
AT
IO
Base Scenario Worsening Morbidity
Scenario 3: PersistencyMCCSR Ratio
Worsening Withdrawal Rates: (2 or 0.5)MCCSR Ratio
60
80
100
120
140
160
180
1992 1993 1994 1995 1996 1997
YEAR
MC
CS
R R
AT
IO
Base Scenario Withdrawal
Scenario 3: PersistencyAvailable Surplus
Worsening Withdrawal Rates: (2 or 0.5)Available Surplus
60,000
70,000
80,000
90,000
100,000
110,000
120,000
1992 1993 1994 1995 1996 1997YEAR
Le
ve
l of
Av
aila
ble
S
urp
lus
Base Scenario Withdrawal
Scenario 3: PersistencyAnnual Income
Worsening Withdrawal Rates: (2 or 0.5)Annual Income
4,000
6,000
8,000
10,000
12,000
14,000
16,000
1992 1993 1994 1995 1996 1997Year
Lev
el o
f A
nn
ual
In
com
e
Base Scenario Withdrawal
Scenario 4: Interest Rate Risk
Interest Rate Risk
60
80
100
120
140
160
180
1992 1993 1994 1995 1996 1997
Year
MC
CS
R R
ati
o
Base Scenario Increasing 0.6% per annum
Decreasing -0.6% per annum
Scenario 5: Credit Risk
Credit Risk
20
40
60
80
100
120
140
160
180
1992 1993 1994 1995 1996 1997
Year
MC
CS
R R
atio
Base Scenario
Doubled Asset Defaults
Doubled Asset Defaults & Default Provisions
Scenario 6: Expenses
Unit Expenses inflate 3% more than base rate
60
80
100
120
140
160
180
1992 1993 1994 1995 1996 1997
Year
MC
CS
R R
ati
o
Base Scenario Expenses
Scenario 7: Integrated Scenario
Integrated: Doubled Asset Default & Provisions with Worsening Mortality
20406080
100120140160180
1992 1993 1994 1995 1996 1997
YEAR
MC
CS
R R
ati
o
Base ScenarioDoubled Defaults & Doubled ProvisionsWorsening MortalityIntegrated: Asset defaults & Worsening mortality
Scenario 8: Ripple Effects
Ripple Effect Scenarios: Higher Sales with Higher Expenses
20
40
60
80
100
120
140
160
180
1992 1993 1994 1995 1996 1997
YEAR
MC
CS
R R
AT
IO
Base Scenario Higher Sales Higher Sales and Expenses
Scenario 9: Ripple Effects
Worsening Morbidity with Premium Change
80
100
120
140
160
1992 1993 1994 1995 1996 1997
YEAR
MC
CS
R R
AT
IO
Base ScenarioWorsening Morbidity no premium changePremium change with 2 year lagPremium change w 1 year lag
DCAT Case Study: Base Scenario versus Actual Outcome
BASE SCENARIO vs. ACTUAL OUTCOME
60
80
100
120
140
160
180
200
1992 1993 1994 1995 1996 1997YEAR
MC
CS
R R
AT
IO
Base ScenarioActual Outcome