Pakistan Society of Actuaries Seminar 3 March 2007

1. Pakistan Society of Actuaries Seminar 3 March 2007

2. Pakistan Society of Actuaries Seminar 3 March 2007 Threats to Solvency Poor mortality experience Poor expense experience Expense inflation Poor lapse and surrender experience Inadequate investment returns Asset default and depreciation Mismatched investments Guaranteed surrender values/investments returns Liquidity Options Lack of new business Inadequate capital to support financing strain of new business Inadequate reinsurance Operational risks

3. Pakistan Society of Actuaries Seminar 3 March 2007 Management actions Role of the Appointed Actuary Risk based capital/solvency margin Regulations Timely intervention by regulator Holistic and integrated approach to risk management Handling Threats to Solvency

4. Pakistan Society of Actuaries Seminar 3 March 2007

5. Pakistan Society of Actuaries Seminar 3 March 2007

6. Pakistan Society of Actuaries Seminar 3 March 2007 EU Solvency I Risk Based Capital Scenario-based Stochastic Hybrid Solvency Capital Approaches

7. Pakistan Society of Actuaries Seminar 3 March 2007 EU Solvency I Liability valuation � generally Net Premium Method Asset valuation � generally lower of cost or market value Investments - regulated Solvency I requires insurers to hold capital funds equal to required solvency margin or the minimum guaranteed fund, whichever is higher The required solvency margin is calculated as: 4% (1% in case of unit linked business) of mathematical reserves X retention rate mathematical provision plus 0.3% of sum at risk X retention rate sum at risk

8. Pakistan Society of Actuaries Seminar 3 March 2007 EU Solvency I Advantages Simple Low compliance costs Results easy to understand Avoids subjectivity Disadvantages Arbitrary capital requirements The proxies only consider certain types of risks Does not differentiate between good and bad companies Does not provide incentive for good risk management

9. Pakistan Society of Actuaries Seminar 3 March 2007 Risk Based Capital Similar to EU Solvency I in using proxies for risk measures Looks at both assets and liabilities Asset and liability values based on US statutory accounting rules which do not reflect the market value of asset and liabilities Required solvency margin will reflect the nature of business written and the assets held to meet those obligations. The US regulators adopted the RBC model to better predict troubled insurers and to require regulators and companies to take specific action once a company triggered a certain level.

10. Pakistan Society of Actuaries Seminar 3 March 2007 Risk Based Capital

11. Pakistan Society of Actuaries Seminar 3 March 2007 Risk Based Capital Advantages Enhancement to the EU Solvency I approach Explicit consideration of risk categories Simple, low compliance costs, results easy to understand, avoids subjectivity Disadvantages Arbitrary capital Little predictive power for insolvency Not dynamic or forward looking May encourage under- rating or under provisioning as premiums and reserves used as proxies.

12. Pakistan Society of Actuaries Seminar 3 March 2007 Hybrid Approach Solvency Margin in India � Combination of EU Solvency I and RBC Presently, no ratios prescribed for assets and so the solvency margin is similar to EU Solvency I Assets � bonds values at amortized cost, equities at market values Policyholders liabilities � gross premium valuation Investments � regulated except for unit linked

13. Pakistan Society of Actuaries Seminar 3 March 2007 Solvency Margin - India

14. Pakistan Society of Actuaries Seminar 3 March 2007 Scenario Based Approach Balance sheet and/or cashflow projections are done under a number of scenarios (generally prescribed by the regulator) Capital requirements are determined based on the results of the worst case scenario Resilience testing, Dynamic Solvency Testing Generally used to supplement minimum regulatory requirements

15. Pakistan Society of Actuaries Seminar 3 March 2007 Scenario Based Approach Advantages Simple to understand Takes into account underlying nature of asset and liability risks (can also consider correlation of different risks) Results can be used by management for decision making Forward looking Disadvantages Number of scenarios are fixed and may not consider other probable outcomes Models may be complex Considerable data requirements

16. Pakistan Society of Actuaries Seminar 3 March 2007 Stochastic Approach Statistical models are used to make balance sheet and/or cash flow projections in a simulation process Statistical measures such as confidence intervals are used to determine capital requirements Realistic valuation of assets and liabilities Example: Individual Capital Assessment in the UK is done on the basis of 99.5% probability over a one year time frame that the value of assets will exceed the value of liabilities.

17. Pakistan Society of Actuaries Seminar 3 March 2007 Stochastic Approach Advantages Sophisticated Considers a wider range of outcomes Capital requirement is based on statistical principles rather than arbitrary requirements Takes a holistic and integrated risk approach Disadvantages Complex Expensive � may need to buy modeling software Extensive data requirements Statistical concepts may not be easy to understand for non-actuaries

18. Pakistan Society of Actuaries Seminar 3 March 2007 Changing Face of Solvency Assessment

19. Pakistan Society of Actuaries Seminar 3 March 2007 Pakistan � The Present Solvency Assessment Regime Assets � lower of cost or market values Admissibility limits for assets Policyholders liabilities� NP (if gross premium valuation liability is higher, this needs to be disclosed in the FCR) Only admissible assets can be counted towards the solvency margin Appointed Actuary has to express opinion that the life insurer has adequate capital to continue its business at planned levels for a period of not less than five years. Fixed solvency margin in shareholders fund of Rs 75 million There are provisions in IO 2000 for solvency margins within statutory funds, but these have not been prescribed.

20. Pakistan Society of Actuaries Seminar 3 March 2007 Pakistan � Solvency Assessment Increase in minimum paid-up capital requirement for life companies to Rs 500 million from present 150 million Insurer Financial Strength rating for life companies Admissibility limits of assets � unreasonable differences between life and non-life limits, investments in mutual funds, bank deposits, etc Before arriving at a solvency margin regime, issues related to valuation of assets and liabilities need to be tied in. Need to consider world-wide trends and incorporate best practices The solvency margin regime should not be so simplistic so as to disregard the nature of asset and liability risks.

21. Pakistan Society of Actuaries Seminar 3 March 2007