28 th India Fellowship Seminar RISK BASED CAPITAL

28 th India Fellowship Seminar RISK BASED CAPITAL (RBC) APPROACH - NEED, ROADMAP & CHALLENGES Guide Name: Srinivasa Kumar Chiruvolu Presenters Name: 1. Chetan Goswami 2. Harshada Shringarpure 3. Shivanjali Mittal 4. Vinit Agarwal Date: November 9, 2017 Mumbai Indian Actuarial Profession Serving the Cause of Public Interest

Abbreviations Ø PAB Committee -> Committee on Road Map for Risk Based Solvency approach in Insurance Sector in India under chairmanship of Mr. P. A. Balasubramanian which submitted its report on April 22, 2014. Ø IRDAI Committee -> IRDAI Committee on RBC approach and Market Consistent Valuation of liabilities (MCVL) of Indian Insurance Business which submitted its report on July 17, 2017. Ø Steering Committee -> 10 member Steering Committee formed to implement RBC in India in order dated September 20, 2017 www. actuariesindia. org 2

Agenda Ø Overview on RBC Approach Ø Need of RBC Ø Roadmap towards RBC Approach / Implementation Ø Challenges Ø Way ahead www. actuariesindia. org 3

Agenda Ø Overview on RBC Approach Ø Need of RBC Ø Roadmap towards RBC Approach / Implementation Ø Challenges Ø Way ahead www. actuariesindia. org 4

Overview on RBC Approach Ø What is RBC ? Ø Available methodologies Ø Journey so far www. actuariesindia. org 5

What is RBC? Ø Method of measuring the minimum amount of capital appropriate for a reporting entity to support business operations in consideration of size and risk profile Ø Degree of protection in terms of probability / confidence level Ø Assets backing liabilities together with the required capital sufficient to satisfy all obligations Ø RBC helps in : Ø Calculation of capital to cover adverse scenarios Ø Achieving better risk management Ø Avoidance of undesirable risks Ø Controlling use of risky asset classes Ø Efficient monitoring by the Regulator www. actuariesindia. org 6

Available methodologies Value at Risk (Va. R) approach • Input Data required - Probability Distribution of individual risks, Correlation matrices • Determination of diversification benefit to individual capital components while aggregation • Difficult to calibrate desired confidence level for specified time period (e. g. 99. 5% in 1 year) Formula based approach • Application of factors to accounting aggregates that represent various risks to which a company is exposed • Combining the resultant components using a pre-defined formula. • Approach does not recognizes interactions between assets and liabilities www. actuariesindia. org 7

Journey so far India Ø Insurance Act expected Life Insurance companies to hold assets in excess of liabilities, not less than fifty per cent of the amount of minimum capital Ø Stringent regulations on investments of assets Ø Asset, Liabilities and Solvency Margin Regulations, 2000 Ø Roadmap for moving towards Economic Capital, June 2009 Ø Roadmap for RBC approach in the insurance sector, April 2014 by PAB committee Ø Asset, Liabilities and Solvency Margin Regulations, 2016 Ø Report of IRDAI Committee on RBC Approach and MCVL of Indian Insurance Business, July 2017 Ø Steering Committee for implementation of RBC regime, September 2017 www. actuariesindia. org 8

Agenda Ø Overview on RBC Approach Ø Need of RBC Ø Roadmap towards RBC Approach / Implementation Ø Challenges Ø Way ahead www. actuariesindia. org 9

Need of RBC Ø Current regime & it’s limitations Ø Why RBC? Ø Merits of RBC regime Ø Global context www. actuariesindia. org 10

Current regime – Factor based Advantages Limitations Ø Simple to calculate and validate Ø Capital requirement does not match with risk profile Ø Objective Ø Limited due consideration for riskiness of the underlying investment portfolio Ø Ensures consistency across companies Ø No incentive for risk management initiatives Ø Easier to assess compliance and Ø No diversification benefits across communicate lines of business Ø Certain assets are not permitted www. actuariesindia. org Ø Factors not based on actual experience 11

Why RBC ? Ø Volatile economic conditions has necessitated deeper evaluation of market risks Ø Increasing concern for protection of policyholder’s benefits Ø Promotes efficient risk management practices Ø Greater analysis of capital invested is the need of financially sophisticated shareholder Ø Globally the industry has moved to RBC. India currently an outlier, in Asia and internationally Ø Fits into Market Consistent Valuation regime envisaged by IFRS and Ind-AS Ø Most Life and major Non-life companies in favor of RBC; as per IRDAI questionnaire www. actuariesindia. org 12

Merits of RBC regime Ø Will raise overall prudential standards in the industry Ø Link the level of required capital with the inherent risks Ø Allow for interactions between risks Ø Quantification of some risks will help to avoid unpleasant surprises Ø Identification of other risks should lead to better risk management Ø Facilitate early and effective intervention by the Authority Ø In line with practices adopted by developed countries Ø Maintain policyholder confidence in the system www. actuariesindia. org 13

Global context European Union • Transitioned to Solvency II in 2016 China • Prior to 2012, factor based capital model was followed • In January 2016, the China Insurance Regulatory Commission (CIRC) launched the China Risk Oriented Solvency System (C-ROSS) • C-ROSS follows a three pillar structure, similar to Solvency II Hong Kong • Current regime based on Solvency I framework • In 2013, discussions on RBC started • By 2019 -20, RBC expected to be implemented (after 6 years of analysis) www. actuariesindia. org 14

Agenda Ø Overview on RBC Approach Ø Need of RBC Ø Roadmap towards RBC Approach / Implementation Ø Challenges Ø Way ahead www. actuariesindia. org 15

Roadmap towards RBC Approach / Implementation Ø Roadmap - Phases Ø Roadmap – Research / Study Ø Roadmap – Agreement Ø Roadmap – Implementation www. actuariesindia. org 16

Roadmap – Phases RBC implementation roadmap - analysed into 4 phases Further Refinements Finalisation/ Implementation Phase IRDAI Committee Research / Study Phase Agreement Phase üSteering Committee External Consultants ? ? PAB Committee & Survey on RBC www. actuariesindia. org 17

Roadmap – Research / Study PAB Committee covered various aspects of RBC and submitted the report along with recommendation to IRDAI on April 22, 2014 Methodology Regimes globally Approach Transition mechanism • Quantitative - MCV & Va. R, Standard formula, Intervention Ladder • Qualitative – Standard of Governance , Risk management framework • Singapore, USA, Australia and Canada • EU Solvency II • IAIS, IFRS • Valuation of Assets & Liabilities , Risk margin • Calibration of tail events • Categorization of risks • • Twin Peak approach QIS studies Amendment of various existing regulations Documentation IRDAI committee conducted a survey to cover the views and preparedness of the Indian Insurance industry www. actuariesindia. org 18

Roadmap – Agreement (1/2) IRDAI committee studied the recommendations of PAB committee and following approach has been recommended Ø Market consistent model for valuation Ø Technical provisions – Best estimate liability plus risk margin Ø Technical Provisions to be adjusted with regard to IFRS 17 Ø Use of Standard Model (Internal Model too early for the industry). Ø Expected risk free rate and inflation to come under purview of Institute of Actuaries of India Ø Use of scenarios for management action under participating business for cost of capital Ø Market risk: Equity, Property and Credit Default www. actuariesindia. org 19

Roadmap – Agreement (2/2) Ø Minimum of 3 QIS for implementation Ø Output of QIS study - Setting of parameters and stresses related to cost of capital Ø Risks and risk factors (incl. cost of capital factors) to be revisited periodically Ø Intervention ladder where IRDAI would step in and take appropriate actions if solvency were to breach certain points Ø Parallel identification and implementation of enterprise-wide risk management Ø “Twin Peak” reporting - statutory reporting on current method and on RBC structure www. actuariesindia. org 20

Roadmap – Implementation Two important aspects considered by IRDAI Committee are: Time Frame • Minimum 3 years for full implementation with additional 1 year for aligning the capital with new regime • Technical Studies RBC to be implemented by March 2021 & to coincide with IFRS 17 implementation Technical Studies • • Prior to complete switch over in March 2021, parallel run for two Pooling resources for technical studies (3 QIS) regimes (“Twin Peaks”) • Institute of Actuaries of India • Self Implementation by IRDAI • External Consultants Technical Studies • IRDAI committee has suggested • Engagement of external consultants • Project Steering Committee to work in sync with external consultants • Definition of scope of work and terms of reference www. actuariesindia. org 21

Agenda Ø Overview on RBC Approach Ø Need of RBC Ø Roadmap towards RBC Approach / Implementation Ø Challenges Ø Way ahead www. actuariesindia. org 22

Challenges Ø Practical issues Ø Challenges for India Ø Challenges for the Regulator Ø Challenges for the Industry www. actuariesindia. org 23

Practical issues Ø Lack of data Ø Absence of reliable tools Ø Cost / resource requirement Ø Company culture and decision making Ø Certain risks/risk mitigation factors difficult to incorporate in RBC formula Ø Risks - Risk of fraud, operational Ø Mitigation factors - Loyalty of customers, competitive advantage of the Company www. actuariesindia. org 24

Challenges for India Ø Volatility of the market and size of companies Ø Lack of long term bonds Ø Limiting modelling of asset returns Ø Guarantees Ø High cost of setting up risk and implementing risk measurement modelling techniques www. actuariesindia. org 25

Challenges for Regulator Ø Pace and timing of change – it will take time to get it right Ø Expected to take more than three years to be implemented Ø The systems to adopt Ø The calibration* of a system Ø Impact of other changes e. g. fair value accounting Ø Testing period Ø Consistency with other industries e. g. Banks *Calibration is a comparison between a known measurement (the standard) and the measurement using your instrument. www. actuariesindia. org 26

Challenges for Industry Ø Cost and source of capital Ø Impact on products and pricing Ø Ability to carry out the calculations Ø Choice of parameters etc. Ø Business structures of public sector insurers and private insurers is different Ø RBC cannot be same for both entities Ø Perception of risks can be subjective www. actuariesindia. org 27

Agenda Ø Overview on RBC Approach Ø Need of RBC Ø Roadmap towards RBC Approach / Implementation Ø Challenges Ø Way ahead www. actuariesindia. org 28

Way ahead – Initial phase Ø Ø Ø Actions/ Decisions from Steering committee Suggestion on finalisation of external consultant Commencement of the project RBC Ø Ø Ø Now is just the beginning…. Modifications in line with IFRS 17 implementation Timelines Ø Ø Study existing EC submissions GAP analysis with current regime Identify key risk relevant to Indian market Materiality of the risk – Phase wise implementation Develop detailed rules including risk calibration Advice on Assets and Liabilities valuation Recommendation on capital adequacy ratio Risk reporting templates design and frequency Educate and train on RBC framework minimum 3 years for full implementation of RBC with additional one year for aligning the capital with new regime Parallel Run Vs One step change Ø parallel run for two regimes till complete switch over in March 2021 www. actuariesindia. org 29

Way ahead – Further steps Ø Ø Ø Ø One size fits all? ? ? Public Vs Private Additional disclosure requirements Frequency of review of risks and risk margins Strengthening of Corporate governance Promotion of Risk governance infrastructure Emphasis on Enterprise Risk Management Changes in existing regulations: Ø Regulations of Investments of assets – lesser stringent in order to meet capital requirements and manage the risk efficiently Ø Market consistent valuation of liabilities – Best estimate plus risk margin Ø Reporting templates Ø Effect on penetration: Repricing of products leading to cheaper or expensive based on company’s risk profile Ø Continuous monitoring for corrective actions www. actuariesindia. org 30

References Ø IRDA Journal Volume VII, No. 7 – July 2009 Ø Report of the Committee on Road Map for Risk Based Solvency Approach in Insurance Sector – April 22, 2014 Ø Assets, Liabilities and Solvency Margin Regulations, 2016 Ø Report of IRDAI Committee on Risk Based Capital (RBC) Approach and Market Consistent Valuation of Liabilities (MCVL) of Indian Insurance Business – Part I, 19 th Nov 2016 Ø Report of IRDAI Committee on Risk Based Capital (RBC) Approach and Market Consistent Valuation of Liabilities (MCVL) of Indian Insurance Business – Part II, 17 th Jul 2017 www. actuariesindia. org 31

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