Economic Capital Survey 2011 Indian Life insurance companies

Enterprise and Financial Risks Advisory Group seminar August 2010

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17 Indian Life insurers participated in the survey

10,025 Rent

EC survey Participant Profile Indian Life insurance companies

Enterprise and Financial Risks Advisory Group seminar August 2010

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Profile of the participants - Geography

Profile of the participants Size of operations

Below 2,000 Cr

Between 2,000 and 5,000 Cr

Between 5,000 and 20,000 Cr

Above 20,000 Cr

EC Target audience and motivations Indian Life insurance companies

Enterprise and Financial Risks Advisory Group seminar August 2010

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IRDA is rated as the top audience for Economic Capital

IRDA Rating agencies Internal management JV Partner
If one were to look at European companies only, the target audience rating increases for the JV partner

Quite unexpectedly no significant correlations were found with size of the insurers

Survey question: What is your target audience while calculating economic capital?
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Current Motivations for calculating economic capital

Solvency assessment Value measurement Risk adjusted performance measurement Pricing

ALM/reinsurance

Decision making

Survey question: What are your current motivations for calculating economic capital?

Current Motivations for calculating economic capital

Overall European JVs Solvency assessment Value measurement Risk adjusted performance measurement Pricing

5.8

5.7
Top motivation for EC calculation is solvency assessment followed by inputs to decision making process

1.9

2.1

1.9

2.5

1.6

1.8

However if one were to look at European companies only, it appears that the usage of economic capital concepts is more widespread ratings being materially higher in areas of performance measurement, pricing and decision making process

ALM/reinsurance

1.2

1.5

For the largest insurers, the motivation for use of EC is in the decision making process is very high; second only to Solvency

Decision making

2.2

2.7

Survey question: What are your current motivations for calculating economic capital?

Future Motivations for calculating economic capital

Current Next 2 -5 years Solvency assessment Value measurement Risk adjusted performance measurement Pricing

5.8

5.4
On an average, participants plan to use EC concepts in wider areas in future

1.9

1.9

1.9

2.6

1.6

2.5

ALM/reinsurance

1.2

2.2

Significant increase in scores are seen in areas of Performance measurement, Pricing and ALM/Reinsurance

Decision making

2.2

2.4

Survey question: What are your future motivations for calculating economic capital?

EC financial outcomes Indian Life insurance companies

Enterprise and Financial Risks Advisory Group seminar August 2010

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Financial Outcomes Liabilities , Capital and free assets

Statutory < Economic liability 1 participant

For all participants barring one, economic liabilities were lower than statutory liabilities

Key reasons could be the margins for adverse deviation and other surrender value/negative value floors that are prescribed in statutory reserving

Statutory > Economic liability 16 participants

Survey question: Statutory liabilities Vs economic liabilities Which one is higher?

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Financial Outcomes Liabilities , Capital and free assets

Economic < Statutory free capital 3 participants

For a majority of participants economic capital is higher than statutory capital

This might be due to the fact that a more holistic set of risk factors are explicitly considered in economic capital assessments

Economic > statutory capital 14 participants

Also a significant portion of the excess economic capital might also be explained through the release of prudential margins in statutory reserving which now flow through in capital

Survey question: Statutory capital Vs economic capital Which one is higher?

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Financial Outcomes On a total balance sheet basis economic free assets are higher than statutory
Economic < Statutory free assets 3 participants

For a majority of participants, economic free assets were higher than statutory free assets

Putting this in perspective implies that for a majority of participants although economic capital is higher compared to statutory capital; the release of margins from statutory reserves is enough to result in excess economic free assets

Economic > statutory free assets 14 participants

All 3 participants for whom economic position is weaker than the statutory position belong to sub 2000 Cr category

Survey question: Statutory free assets Vs economic free assets Which one is higher?
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Total asset ratios None of the participants exhibit a ratio less than 1

Size of the insurer

Less than 1

Between 1 and 1.2

Between 1.2 and 1.5

Above 1.5

No participant seems to be insolvent on an economic basis No correlation of TARs with respect to size of the insurer

Survey question: What best describes your Total asset ratio on an economic basis ?

Financial Outcomes Diversification benefit in the range of 25% to 40% for most of the participants

1 3

For a majority of participants (12) diversification benefit fell in range of 25% to 40% There were 3 participants for whom the diversification benefits were lower in the range of 0% to 25% - All three had AUM less than 2000 Cr One company had a diversification credit of more than 40% - This company was out of a handful that employed internal model methodology

12

Survey question: Quantum of uncapped diversification benefit while aggregating risks?

16

% EC contribution - Risk categories

70%

2 8 4 1

50%

4
30%

3
10%

3
Insurance Market

11
Operational

16
Credit

Survey question: Relative share of risk components out of total economic capital?

% EC contribution Operational risk & size of operations

70%

50%

30%

10%

Operational risk

Size of the insurer

Top three sub risk contribution

Top three risks contribution < 30% 1 participant

For a majority of participants (15) Top three sub risks contributed more than 70% to their EC

One company had this contribution as low as 30%- This company was one of the few using internal models

Top three risks contribution > 70% 15 participants

Survey question: What is the proportionate contribution of top three sub risks in your portfolio?
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EC calculation methodology Indian Life insurance companies

Enterprise and Financial Risks Advisory Group seminar August 2010

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Choice of risk free rates

Swap rates 3 participants

For a majority of participants (14 out of 17) Indian Govt yield curve is the preferred choice to calibrate the risk free curve 3 participants employ swap rates (or variants thereof) All three are mid to large European JV players

Indian Govt yield curve 14 participants

Survey question: Methodology employed to arrive at the risk free curve?

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Cost of capital charge

Above 6% ,, 2 Less than 4% , 4

5% to 6% , 5

4% to 5% , 2

Out of the 13 such participants, there is a wide variation as far as CoC charge is concerned

Survey question: CoC charge in case using cost of capital approach?

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Methodology for arriving at RCMs

18 16 14 12 10 8 6 4 2 0 13 1 3

Others Percentile COC Approach

A majority of participants (13 out of 17) use cost of capital approach to assess Risk capital margins

3 participants mention percentile approach to arrive at RCMs. Interestingly only one out of the 3 mentions use of internal models

Survey question: Methodology employed to arrive at Risk capital margins?

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Cost of Guarantee methodology

Others 2 participants

All 6 companies that are performing stochastic simulation techniques for guarantee valuation are at least 5000 Crs in size This seems to be a major area of improvement for the industry

Stochastic techniques 6 participants

Modest guarantees and hence not assessed 9 participants

Survey question: What is the method you employ to evaluate cost of guarantees in your portfolio?
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Time period and confidence intervals

18 16 14 12 10 8 6 4 2 0 Time Period Confidence interval One Year (16) 99.5% (15) Liability Run-off (1) More than 99.5% (2)

One participant employs TVAR methodology at 99.5% which is equivalent to more than 99.5% VaR

IRDA circular mentioned the use of 99.5% VaR as one standard. The survey intended to ask whether the participants agreed with the standard or did they believe that their internal standard was or would be something different From the results it appears there is an overwhelming preference for one year 99.5% VaR approach. However, it is also acknowledged that this survey question might not have probed the intended information by the participants who seem to have responded as per the IRDA circular

Survey question: What is the time period & confidence interval you employ to assess economic capital?

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Aggregation methodology

Covariance/Correlation matrices No Diversification

16

Almost all participants employ use of covariance/correlation matrices for aggregating individual risk capital charges

Survey question: What is the method you use to aggregate risks across categories?
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Capital calculation methodology

Internal model 3 participants

A majority of participants employ standard formula approach for calculating economic capital

All 3 participants that employ the internal model approach have a minimum size of 5000 Cr

Out of the three one of them employed liability run off approach and one employed TVaR for calculation of economic capital
Standard formula approach 14 participants

Survey question: Methodology used towards calculation of economic capital?

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Calibration of stress parameters

QIS factors QIS factors [Overall adjustments] QIS factors [Specific adjustments for local conditions] Others 2 Number of participants 2 3

Majority participants (12 out of 14) employed QIS 5 calibrations on one form or the other 9 of these 12 participants made an attempt to allow for local conditions In the stress calibrations 1 participant seems to be doing internal calibrations. The participants also happens to be a large insurer with perhaps lot of experience information and wanting to develop internal models

Survey question: Methodology used towards calibration of stress parameters if using standard formula approach?

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Operational risk calculation methodology

JV partner/external loss database 2 participants

Majority participants (15) use a factor based methodology to arrive at operational risk capital

2 participants employed use of external loss database or JV partner loss data base. Both have European JV partners and size greater than 5000 Cr. These are also the players who employ internal models to arrive at overall EC

Factor based methodology 15 participants

Not enough internal operational loss data may be available. Although survey didnt ask a specific question around this but key point is that insurers above a certain size should start looking at this area

Survey question: Methodology employed to assess OR capital?

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Drivers employed to arrive at OR capital assessment

Capital itself (excluding Ops capital)

Reserves

Expenses

Premiums

10

Number of participants

Survey question: If using factor approach to estimate Ops risk capital, what is your choice (s) of drivers?
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Principal challenges
Key challenge for the participants is lack of technical expertise followed by time and human resources

Time/Human resources Software

Lack of Technical expertise

For the largest insurers, not unexpectededly, time and human resources is less of a challenge. The pressure on time and human resources increases as the size of the insurers is decreasing

Lack of experience data was rated by 2 insurers as their top challenge

Survey question: Principal challenging in evaluating economic capital?

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Help items from IAI

15 participants 14 participants 10 participants

Technical knowledge through seminar workshops

Guidance on areas like COGs/risk free rates/assumption setting

Guidance on seting calibrations/stresses/factors

Survey question: Help items from IAI?

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There are other topics where participants wanted to get support

1 2 Economic Capital for the participating business Economic Scenario Generator on the basis of Indian conditions Expense Risk calibration and in particular dealing with the expense over runs Create awareness about Economic Capital so that it is appreciated better QIS for India Without proper understanding it might be perceived as an academic exercise
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5 6

It is agreed that there many requirements to get full benefit of Economic Capital
1 The complexity of the calculation increases with type of products under consideration Data requirements and modeling capabilities vary and increase with the sophistication of the methods adopted to quantify the risks They will vary from setting lapse assumptions to the using of Monte Carlo methods for diversification benefits Traditional non-participating is simple followed by unit linked without guarantees, with guarantees and participating business

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but one step at a time

1 2 It has taken years for something like QIS, and It takes time for developing methods to quantify risks under the Indian conditions The capability has to be developed by the individual companies while The quantifying methods and guidance to be developed through co-ordinated efforts from the Profession and the Industry

3 4

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and there are few immediate steps that can be taken by the companies
1 Identification of all risks and maintaining the risk log related to each risk and initiatives taken by the insurance companies to manage the risk An internal discussion with the key stake holders on how these risks can be managed Integrating the risk management in to key areas such as product development and pricing, business planning and reporting embedded and appraisal values Identifying a road-map for moving from simple EC calculations to a more complex calculations

4 5

Quantification of risks is important but identifying and managing the risks is more important

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Thank You

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