KPMG's iCircle - The Smart Soirée 2013

KPMG‘s iCircle

The Smart Soirée 2013

Actuaries of the future – beyond numbers

Auditorium, KPMG AG

Zurich, 14 November 2013

1 © 2012 KPMG AG/SA, a Swiss corporation, is a subsidiary of KPMG Holding AG/SA, which is a subsidiary of KPMG Europe LLP and a member of the KPMG network of independent firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss legal entity. All rights reserved. The KPMG name, logo and “cutting through complexity” are registered trademarks or trademarks of KPMG International.

Agenda

Welcome Hieronymus T. Dormann, Sector Head Insurance, KPMG AG Thomas Schneider, Head Quantitative Finance Group, KPMG AG

Begin of the presentations

SST update: Learnings from Internal Model Reviews and Future Challenges Michael Schmutz, Quantitative Risk Management Insurance, FINMA

IFRS 4, phase II: Recent Developments Thomas Schneider, Head Quantitative Finance Group, KPMG AG

Big Data and Predictive Models in Insurance: More than just buzzwords William Southwell, Head Non-Life Actuarial, KPMG AG

Drinks, food and networking

17:30

19:30

Learnings from internal model reviews and future challenges

Michael Schmutz The Smart Soirée 2013

14 November 2013

The contents of this presentation represent my own view and do not necessarily correspond to the official view of FINMA.

Decisions Taken – as of the end of August 2013

2

0

50

100

150

200

250

Cat. 2 Cat. 3 Cat. 4 Cat. 5 Total

Modules Decision taken

Solo entities liable to SST

59.0 %

88.6 %

88.9 % 65.2 %

80.0 %

0

20

40

60

80

100



Reinsurers liable to SST

40.0 %

60.9 % 91.7 %

70.0 %

0

20

40

60

80



P&C liable to SST

100 % 100 % 88.9 % 61.5 %

0

10

20

30

40

50



Life insurers liable to SST 92.3 %

100 %

93.1 %

66.7 %

89.4 % 67.8 %

0

50

100

150

200

250

Solo Groups Total


Solo entities and groups liable to SST

80.0 %

83.7 %

80.7 %

Decisions Taken – as of the end of October 2013

3

accepted; 6; 9%

conditionally accepted; 35; 54%

rejected; 24; 37%

Company view

Some selected (trivial) observations and a related fundamental question

4

The environment / the objects to be modeled are complex and are changing rather rapidly.

By making modeling decisions we always pay a price!

Fundamental question: Should a model have a clear economical meaning?

Source: Swiss National Bank

1y 3y

5y 10y

20y 30y

1y 4y

7y 10y

25y

100 %

80 %

60 %

40 %

20 %

Option Maturity

Swap Tenor EUR impl. Swaption vol

Source: Bloomberg

Does consistency matter?

5

Essentially the following and similar slides have been presented several times:

Example: Valuation and risk quantification

6

Lessons learned: Tradeoffs in modelling can lead to serious dissents under quants

7

“Too simple”

Considerable calibration errors

optionalities in the liabilities not captured

model working for only a too restricted range of

interest rates / volatilities / …

“Just right”

But right for what?

optimization

w.r.t. a module

vs. w.r.t. the model

Extremely difficult / impossible to reach a stable (and honest)

calibration

“pseudo adequacy” / calibration to noisy data

Economic scenario generators as black boxes

/ not sufficiently transparent

“Too complex / not clear enough”

Further lessons learned

8

Modeling and quantification of risks is a distinctive area of quantitative specialists but the output is a judicial product.

Time constraints: Companies want to be informed as early as possible and decisions should not surprise them.

The dynamic of today’s economic environment is reflected in a highly volatile market. It is increasingly questioned whether or not a principle-based and market

consistent solvency system is the best approach? (Personal point of view: No reasonable alternatives are known)

Increasing political pressure: A major challenge is the creation of an equal playing field in the light of the Solvency II timetable changes.

etc.

Future challenges 1/2

9

Request to apply an (internal)

model

Preliminary checks

Validation

Decision

Periodical review of

internal models Model change process

• Decision of the company

• At the instance of FINMA

Challenge 2: Treatment of applications for model variations: only weeks or days after first authorization, or even weeks after the application for using an internal model.

Challenge 1: Find a good balance concerning the tradeoffs between scientific correctness vs. pragmatism vs. juridical feasibility.

Modelling challenges 2/2

10

Long-term interest rates

(there is some work in progress, e.g. by El Karoui, Mard, Hillairet)

Applicable and stable calibration methods

(suitable regularization of ill-posed problems, better understanding of model-independent arbitrage opportunities / active areas of research in math. finance)

Efficient and sufficiently accurate valuation methods after one year.

Suitable valuation of non-liquidly traded assets and liabilities

(theory of “two prices”, sublinear pricing rules etc. / very hot areas of current research)

etc.

What we should avoid: To go back…

11

12

Eidgenössische Finanzmarktaufsicht FINMA Einsteinstrasse 2 CH-3003 Bern [email protected] www.finma.ch

http://www.finma.ch/


Agenda







17:30

19:30

IFRS 4 Phase II

14 November 2013

Thomas Schneider, KPMG AG


Agenda

Overview

■ A brief history of time

■ Key objectives

Building Block Approach

■ Building blocks 1 - 4

■ Examples

■ Presentation

Summary, Comparison and Impact

■ Focus areas ED

■ Comparison with Solvency II

■ Expected Impacts and Practical Implications

Overview


A brief history of time (1/2)

■ Initiation of IFRS 4, phase I with the idea to implement a common global insurance accounting framework.

■ The IASB (International Accounting Standards Board) was constituted and took over the project.

2001

2004

2007

2010

1997

■ Exposure Draft published.

■ The second phase of the insurance project was launched.

■ The IASB introduced IFRS 4 Insurance Contracts, phase I, an interim standard that represented the first phase of the insurance project.

■ Sought to minimise the amount of change required to current accounting practices (to avoid changes that might be reversed).


A brief history of time (2/2)

20 June 2013: Re-exposure draft published.

25 October 2013: Comment period ended.

1 January 2017 Earliest possible effective date. (IASB states it expects 1 Jan 2017 as earliest possible mandatory effective date)

31 December 2017 Earliest annual period in which proposals could apply. (Restatement of comparatives required, i.e. opening balance sheet 1 Jan 2017)

It will take at least 20 years from the launch

of the project until implementation!

today


Key objectives

1. Improve the transparency of the effects of insurance contracts on an entity’s financial position and performance.

2. Reduce diversity in the accounting treatments of insurance contracts.

3. Ensure that the entity measures insurance contracts using a current value approach that incorporates all of the available information in a way that is consistent with observable market information.

4. Ensure that the approach to measuring insurance contracts provides information that is relevant to the users the financial statements.

The key objectives of the IFRS 4 proposals are to:

Building Block Approach


Overview The measurement model – Building Block Approach (BBA)

Explicit, unbiased and probability-weighted current estimates of future cash flows. 1.

Discounted at current rates to reflect the time value of money. 2.

Risk adjustment to adjust for the effects of uncertainty about the amount and timing of future cash flows. 3.

Contractual Service Margin (formerly called Residual Margin). To remove any profit at inception. Released over coverage period. 4.


Proposed measurement models Fundamentals

Level of measurement

Margins

An insurer would measure the present value of the fulfilment cash flows excluding the risk adjustment at the portfolio level of aggregation for insurance contracts.

No level of measurement prescribed for the risk adjustment.

Unit of account used to determine the contractual service margin should be at portfolio level. Unit of account used to release not prescribed but consistent with the objective of release.

Portfolio

Contracts that are subject to similar risks and priced similarly relative to the risk taken on and managed together as a single pool.


Proposed measurement models Building block 1 – Cash flows

Estimates of cash flows would include all cash inflows and outflows related directly to the fulfilment of the portfolio of contracts. These would:

■ be explicit (i.e. separate from estimates of discount rates that adjust for the time value of money and the risk adjustment)

■ incorporate, in an unbiased way, all available information that relates to the cash flows of the contract

■ include only cash flows arising from existing contracts within the contracts’ boundaries.

Acquisition costs to be included should be all the direct costs that the insurer will incur in acquiring the contracts in the portfolio.

Estimates of cash flows would be updated each reporting period and measured at a portfolio level.


Example bottom-up and top-down approach

Either a top-down or a bottom-up approach may be used to determine an appropriate discount rate. ■ In theory, both

approaches should result in the same discount rate, however in practice, differences are expected.

■ The top-down approach may result in a higher rate, as illustrated.

Market risk premium expected losses (1%)

Market risk premium for unexpected losses (.5%)

Difference between top-down and bottom up approach (.25%)

Liquidity premium (.5%)

Risk-free rate 3%

Top-down approach: 3.75%

Bottom-up approach: 3.50%

Financial instrument yield of 5.25% (based on actual assets held or a reference portfolio)

Proposed measurement models Building block 2 – Time value of money

■ No specific method prescribed.

■ Regardless of the approach used, the discount rate should be consistent with the characteristics of the insurance contract liability, e.g. timing, currency and liquidity.


Key attributes

■ The use of OCI to present the effect of discount rate changes would be required (rather than permitted)

■ To recognise the effect of changes in cash flow assumptions in profit or loss using the ‘locked-in’ rate

Proposed measurement models Building block 2 – Use of OCI to present changes in discount rates

Present in OCI Present in profit or loss

Cumulative OCI Difference between liability discounted at the current rate and the liability discounted at the (locked-in) rate at inception

Current period OCI Equals interest expense at current rate less interest expense at ‘locked-in’ rate

Changes in interest sensitive cash flow assumptions (e.g. minimum interest guarantees)*

Interest expense at ‘locked-in’ rate

* Unless offset against an unlocked contractual service margin


Proposed measurement models Building block 3 – Risk adjustment

Risk Adjustment: “The compensation the insurer requires for bearing the uncertainty about the amount and timing of the cash flows that arise as the entity fulfils the insurance contract.”

■ The measurement of an insurance contract should contain an explicit risk adjustment.

■ IASB has not prescribed a unit of account for measurement of the risk adjustment.

■ The IASB would not limit the range of available techniques and related inputs to the risk adjustment.

■ Re-measured each reporting period and changes are recognised in profit or loss.


Proposed measurement models Building block 3 – Risk adjustment


* defined as the expected present value of the future cash outflows less cash inflows plus risk adjustment

Proposed measurement models Building block 4 – Contractual service margin

Contractual Service Margin

■ Represents the unearned profit and is a “shock absorber”

■ Removes day-one gains: Arises when the present value of the fulfilment cash flows is less than zero*

■ If the present value of fulfilment cash flows is positive, recognise a loss in profit or loss at inception

■ Prospectively adjusted for changes in the estimates of cash flows relating to future coverage or other future services; cannot become negative in subsequent measurement (unlocking)

■ Systematic release over coverage period based on the pattern of transfer of services provided

■ Interest accretion using discount rate at inception (i.e. the ‘locked-in’ rate from inception)

■ Classified as part of the insurance liability


Proposed measurement models Example 1 – Contractual margin approach (IASB model)

An entity issues insurance contracts that form a single portfolio and coverage begins when contracts are issued. The impacts at initial recognition, and on payment of the first premium and incremental acquisition costs would be as follows:


What happens if the actual cash flows are

different to the expected cash flows?

Proposed measurement models Example 2


Proposed measurement models Example 2 (1/3)


Proposed measurement models Example 2 – Analysis (2/3)

Fact: Claims incurred in Year 2 are different from the expected claims, and actual cash outflows for that year equal 150.

Analysis: At the end of Year 2, the entity revises the estimated cash flows for Year 3. As a result, the expected cash flows are as follows:

The changes in estimates of cash flows at the end of Year 2 would be accounted for as follows:

■ the decrease of 50 in the expected future cash flows for Year 3 would increase the contractual service margin; and

■ the decrease of 50 between actual cash flows for Year 2 and previous estimates – i.e. the experience adjustment – would be recognised in profit or loss of Year 2

Yr 1 Yr 2 Yr 3 Expected cash outflows at initial recognition 200 200 200

Revised actual/estimated cash outflows estimated at the end of Year 2 and Year 3 150 150


Proposed measurement models Example 2 – Contractual Service Margin (3/3)

The reconciliation of the contractual service margin would be as follows:

The net amounts recognised in profit or loss would be as follows:

Initial recognition Yr 1 Yr 2 Yr 3

Opening balance 300 200 150

Recognised in profit or loss (100) (100) (150)

Decrease in estimate of future cash flows added to margin - 50 -

Closing balance 300 200 150 -

Total Yr 1 Yr 2 Yr 3

Change in contractual service margin 350 100 100 150 reflecting the transfer of services

Experience adjustments 50 - 50 -

Profit/ (loss) 450 100 150 150


zero

Expected cash outflows

Risk adjustment

Discounting

Contractual service margin

Expected cash inflows

Presentation of changes in profit or loss and OCI:

Initial recognition:

Building block 1 Building block 2 Building block 3 Building block 4

Changes in risk adjustment: profit or loss

Changes in cash flows unrelated to services: profit or loss

Changes in cash flows related to past and current services:

profit or loss

Release of margin: profit or loss

Offset changes related to future

services

Unwind of locked-in discount rate: profit or loss

Changes in discount rate:

OCI

Changes in cash flows related to future services: Offset against the margin *

Recognised in profit or loss if no

contractual service margin

(*) Recognised in profit or loss if no contractual service margin

Proposed measurement models Presentation of the statement of profit or loss and OCI

Summary, Comparison & Impact


Content of the new ED at a glance Key Changes to 2010 proposals

Areas with significant changes Areas with significant clarifications

■ Scope – financial guarantees ■ Separating components of an insurance contract ■ Recognition ■ Contract boundaries ■ Acquisition costs ■ Contractual service margin ■ Participating contracts – the “mirroring” exception ■ Simplified premium-allocation approach (PAA) ■ Reinsurance ■ Presentation of the statement of profit or loss and

OCI ■ Effective date and transition

■ Level of measurement

■ Costs included in measurement

■ Discount rate

■ Risk adjustment

■ Disclosures


Comparing the proposal with Solvency II

IFRS Phase II versus Solvency II

Market value of assets

Assets

Expected present value of future cash flows

Risk margin

CSM

Equity

IFRS 4 phase II

Market consistent value for

hedgeable risks

Best estimate for non-

hedgeable risks

Risk margin

MCR

SCR

Surplus

Solvency II

Liabilities


Anticipated Variance

Objectives

Scope

Coverage

Discount rate

Diversification

Risk adjustment (IFRS) & Risk margin (Solvency II)

CSM

Cash flows

Contract boundary

Acquisition costs

Other expenses

Expected to be significantly different

Expected to reasonably different

Differences expected to be immaterial or non-existent

Key

Comparing the proposal with Solvency II


How will the proposals affect the industry?

Data and systems

Operational performance

Product design and pricing and

asset- liability management

People and processes

Possible volatility in equity and

profit or loss

Capital management


6%

71%

3%

20%

0% 0%

10%

20%

30%

40%

50%

60%

70%

80%

Haven't given this any consideration

Aware of changes but not started to consider the

implications

Started to think through project management implications

Started to think through

numerical impacts

Started to think through

systems implications

Where are firms in their thinking?

Whilst firms are aware of the changes, very few firms surveyed have started to understand the project management, numerical and systems implications of the proposals

Source: KPMG Technical Practices Survey 2013


Feedback from the industry

Hot Topics

Contractual Service Margin

(CSM)

Discount rates

Presentation Interaction with IFRS 9

Clarity of proposals

Acquisition costs Mirroring “Confidence level” disclosure

Loss of volume information for key metrics Investment components excluded from

revenue

Unlocking Subsequent measurement for favourable changes Level of measurement

Determination of discount rate Changes recognised in OCI

Alignment of effective dates Redesignation of financial assets

Feedback :

Very complex High administrative efforts Accounting mismatches remain Does it really reflect the business?

Questions?


Agenda







17:30

19:30

Big data and predictive models – More than just buzz words

14 November 2013

William Southwell, KPMG AG

© 2012 KPMG AG/SA, a Swiss corporation, is a subsidiary of KPMG Holding AG/SA, which is a subsidiary of KPMG Europe LLP and a member of the KPMG network of independent firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss legal entity. All rights reserved. Printed in Switzerland. The KPMG name, logo and “cutting through complexity” are registered trademarks or trademarks of KPMG International.

46

America‘s Cup

1850 2013


47

So what‘s this all about?

Big Data

Predictive Models

Uses


48

Big Data

Volume

Velocity

Variety


49

Predictive Models

High

Low

Reporting what happened?

Analysis why did it happen?

Monitoring what’s

happening now?

Prediction what might happen?

Com

plex

ity

Business Value High

Management Information

Query, reporting, & search tools

OLAP and visualization tools Drill down

Dashboards, Scorecards, KPIs

Predictive models

CHAID Analysis Classification and regression trees

Anova

Cluster Analysis Distribution

Analysis

Bootstrap

SEPATH

Power analysis

Time series/ forecasting

Generalised linear models (GLM)

Generalised regression models

Linear regression

Machine Learning/ Neural Networks

Text mining


50

Drivers

Big Data

Predictive Models

Users

Consumer Focus Sales

Marketing 360º view of customer

Engagement Interactions

Product Focus Underwriting

Features Product research

T&Cs Costs


51

Use in Insurance

Management

Underwriting Claims Management Marketing HR Distribution Actuarial/Risk

Management

■ Risk Selection

■ Pricing ■ Telematics ■ Mortality ■ Price

elasticity ■ Price

optimisation

■ Fraud prevention

■ Faster claims processing

■ Claim classification

■ Customer Segmentation

■ Lapse/ Conversion

■ Lifetime value ■ Cross-sell/

Up-sell ■ Prospect

identification ■ Website

optimisation ■ Campaign

selection ■ Social Media ■ Sentiment

analysis

■ Performancemeasurement

■ Channel optimisation

■ Agent renumeration

■ Talent identification

■ Resignation risk

■ Candidate selection

■ Reserving ■ Audit ■ Risk

identification ■ Compliance

BIG DATA

■ Strategic Decision Making


52

Underwriting Case Study (1/5): Personal Lines Premium Rating

Discounts

Risk Premium

Claims Model Expense Model

Final Premium

Loadings

PRODUCT FOCUS CUSTOMER FOCUS

0.7 0.8 0.9 1 1.1 1.2 1.3 1.4 1.5 1.6

Prob

abilit

y of r

enew

al

Price change

Tenure= 1st renewal Tenure = 2nd renewal Tenure = 3rd renewal

0.6 0.7 0.8 0.9 1 1.1 1.2 1.3 1.4 1.5 1.6 1.7 1.8 1.9 2

Prob

abili

ty o

f con

vers

ion

Ratio of quote to market quote

Female Male

Conversion model

Retention model


53

Underwriting Case Study (2/5): Mortality/ Underwritten Life

Age

Sex

Birth Year

Marital Status

Post Code Demo-

graphics

Annuity Size

Smoker?

Occupation

Type of retirement

Impaired life

Qx = Mortality


54

Underwriting Case Study (3/5): Telematics

■ Attract favorable risks ■ Pricing Accuracy ■ Fight fraudulent claims ■ Reduce claim costs ■ Lower premiums ■ Differentiate brand ■ More engaged customers ■ Reduce theft ■ Environmentally Friendly promotion

Insurer

■ Lower premiums ■ Only pay for what use ■ Value added services:

– Emergency call out – Parking assistance – Stolen vehicle recovery – Vehicle diagnostics – Location services e.g. nearest petrol

station – Road safety information – Traffic information – Driving feedback

Consumer


55

Marketing Case Study (4/5): Direct Marketing


56

Social Media Data Telematics Data

Policy Data Claims Data

Claims Management Case Study (5/5): Fraud Detection


57

Tackling Big Data and Predictive Models

Management

Risk Management

Claims

HR Marketing

Underwriting

Big Data

Communicate what’s possible to management

Identify business challenges which can be addressed with

Predictive Models

Identify data which needs to be collected and develop

required technology

Build models and embed into processes


58

Who does all this?

ACTUARY: Making Financial

Sense of the future


59

Summary


Agenda







17:30

19:30

Contact details

Hieronymus T. Dormann Partner

Sector Head Insurance

KPMG AG Badenerstrasse 172

8026 Zurich

Phone +41 58 249 35 03 Mobile +41 79 438 30 03

[email protected]

mailto:[email protected]

IFRS 4 Phase II

Contact details

Thomas Schneider Partner

Head Quantitative Finance Group


8026 Zurich

Phone +41 58 249 54 50 Mobile +41 79 785 31 57 [email protected]

Patricia Bielmann Partner

IFRS Financial Services


8026 Zurich

Phone +41 58 249 41 88 Fax +41 58 249 48 64

[email protected]



Big data and predictive models

Contact details

William Southwell Senior Manager

Head Non-life Actuarial Services


8026 Zurich

Phone +41 58 249 62 94 Mobile +41 79 176 90 96

[email protected]


Disclaimer:

The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavor to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation.

© 2013 KPMG AG/SA, a Swiss corporation, is a subsidiary of KPMG Holding AG/SA, which is a subsidiary of KPMG Europe LLP and a member of the KPMG network of independent firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss legal entity. All rights reserved. The KPMG name, logo and “cutting through complexity” are registered trademarks or trademarks of KPMG International.

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