ORSA's Beneficial Impact on Capital Management
ORSA’s Beneficial Impact on Capital Management Matt Berasi, FCAS, FRM Tom McIntyre, FCAS, CERA, MAAA
Any views or opinions expressed in this presentation are solely those of the presenters and do not necessarily represent views or opinions h ld b held by Th The H Hartford tf d Fi Financial i lS Services i G Group, IInc. or KPMG LLP. LLP
2
June 2014
Agenda ORSA Update Capital Analysis 101 Multi-year vs. Prospective Analysis Forward Estimates & Scenario Analysis Accounting Regime
3
June 2014
ORSA Update
4
June 2014
ORSA Two main objectives:
Enhancement of ERM Group solvency
ORSA Summary Report
ERM framework Risk measurement Solvency assessment We’ll focus primarily on the solvency assessment
Source: NAIC.org 5
June 2014
ORSA Pilots (2012 & 2013) NAIC findings: Quality of ORSA Reports “significantly significantly improved” improved First time reports generally met expectations Confidentiality remains a critical consideration Recommendations: Focus on the ERM information provided to the Board Highlight/explain g g /e p a changes c a ges from o yea year to o yea year Readability in general Source: NAIC.org 6
June 2014
ORSA Guidance Manual (March 2014) NAIC updated the ORSA Guidance Manual 1 ORSA Summary Report should be consistent with 1. the insurer’s reporting to its Board 2. Clarified how US operating p g entities are expected p to report global ORSAs (if applicable) 3. Prospective solvency assessment should address changing exposures and emerging risks
Source: NAIC.org 7
June 2014
ORSA Solvency Assessment Required
Group Prospective Business plan oriented Board oriented* oriented
Not Specifically Mandated
Time horizon Accounting regime Quantification method Risk capital metric Security standard Aggregation gg g method
*Not strictly “required”, but implied and strongly recommended. Source: NAIC.org 8
June 2014
Session Objectives We will focus on two key issues to show how they meet ORSA requirements Time Horizon
One-year horizon Prospective solvency assessment including a focus on scenario analysis
9
Accounting Regime
Pros/cons of economic, GAAP & statutory y Tangible financial resources Reconciliation to published statements June 2014
Capital Analysis 101
10
June 2014
What is Required Capital? Required q Capital p
E pected Loss Expected
Nth P’tile Loss
Required capital is derived from a model (or factors) S l Solvency assessmentt is i th the comparison i off actual t l capital it l to required capital (often as a ratio) ((Note: ote Factor acto based methods et ods solve so e for o tthe e Nth t pe percentile, ce t e, rather at e than t a the t e full u curve.) cu e )
11
June 2014
Capital Ratio Actual Capital
2014
2015
Required Capital
2014
2015
Ignore 2015 & 2016 momentarily
2016 2016
Capital Ratio14 = Actual Capital14 / Required Capital14
This of course is a simple case
12
June 2014
What’s What s the solvency assessment question?
How much capital do we need to run the business this year?
Do we have enough available capital to cover our risks? i k ?
How much risk do we plan to take this year?
Are we taking too much risk in light of our available capital?
It’ss essentially the same question It 13
June 2014
How much risk do we plan to take?
Planning is an annual event
Insurers develop p and execute p plans using g a one-year y at a time perspective Even multi-year plans are typically developed and reported upon using one-year one year time steps We tend to think about taking risks in one-year increments, but capital models often use multi-year horizons
The case for a one-year modeling horizon: 14
Aligns with planning practices Enables prospective analysis Enables strong scenario testing June 2014
Multi-Year vs. Prospective y Analysis
15
June 2014
Common “mistake” mistake with multi-year multi year models
2014
Actual Capital Required Capital
2014
2015
2016
Capital Ratio?? = Actual Capital14 / Required Capital14-16
g answered is how much risk do The q question being we need in 2014 on average for risks through 2016? Changes in time horizon will change the estimates and allocation of capital. 16
June 2014
Prospective analysis
Start with a one year view
How much risk do we plan to take in 2014?
ORSA requires a “prospective prospective solvency assessment assessment”
How much risk do we expect to take in 2015 and 2016?
We need W d a currentt solvency l assessmentt and a forward estimate(s) of solvency. 17
June 2014
Current and Forward Estimates of the Capital Ratio Actual Capital
2014
2015
2016
Required Capital
2014
2015
2016
Capital Ratio14 = Actual Act al Capital14 / Required Req ired Capital14 Capital Ratio15 = Actual Capital15 / Required Capital15 Capital Ratio16 = Actual Capital16 / Required Capital16 18
June 2014
Multi-Year ≠ Prospective Multi-Year
Mixes time horizons and compares risks in future periods to capital in the current period Estimates solvency position relative to current capital only C be Can b affected ff t d b by choice of time horizon Imprecise in later years 19
Prospective
Aligns with customary business p planning g processes Estimates future capital position(s) May require assumptions for non nonmodeled factors Imprecise in later years June 2014
Forward Estimates & y Scenario Analysis
20
June 2014
Year one is easy! Capital Ratio14 = Actual Capital14 / Required Capital14
p Actual capital is read off of the balance sheet
Adjust for new business Restate the balance sheet as needed (e.g., remove intangible assets)
Required capital is based on the one-year model
21
June 2014
Forward Estimate of the Capital Ratio Year 2 is a prediction of next year’s one-year ratio Capital Ratio15 = Actual Capital15 / Required Capital15
Actual capital must be estimated
Year 1 business plan Year 2 starting capital Adjust for new business in Year 2 Restate as needed (e.g., remove intangible assets)
Required capital is based on the one-year model
22
Derive D i capital it l ffactors t ffrom Year Y 1 required i d capital it l over investments, loss reserves, premium, TIV, etc. Apply company specific factors to derive Year 2 required capital
June 2014
Insurers *might* might tell an interesting story Evaluation Year
2012
2013
2014
Ratio Year 2012
1.60
2013
1 76 1.76
1 80 1.80
2014
1.65
1.75
1.78
Current Estimate
1.90
1.95
1-Year Forward
1.95
2-Years Forward
2015 2016
Ambitious modelers might consider tracking:
Trends within an evaluation Accuracy of forward estimates Y might You i ht consider id th thatt someone will ill ttrack k your numbers b
23
June 2014
Scenario Analysis “It (p (prospective p solvency y assessment)) should also consider the prospect of operating in both normal and stressed environments.” – March M h 2014 NAIC ORSA G Guidance id M Manuall P Page 10 10.
p q y considerably y Interpretations of this requirement vary The forward estimates outlined above cover the “normal environment” requirement. Scenario testing with alternative business plan outcomes covers the “stressed environment” requirement requirement. 24
June 2014
Scenario analysis with forward estimates Initial Balance Sheet14
Mega Cat Year 1
Year Y 1 stressed t d environment
Est. “Actual” F Forward d B/S15
Forward Required q Capital15
Est. “Actual” Forward B/S15
Forward Required Capital15
Apply Capital Factors14
CAT Forward C it l Capital Ratio15 Interest Forward Capital Ratio15 Ratio “Actual” Actual / Required
Note that the scenarios are potential outcomes for the business plan under stressed conditions
25
June 2014
Benefits of Forward Estimate
Easy to follow and well suited for the Board Enables strong scenario analysis Can leverage complex stochastic but in an easy to deliver manner Build a forecasting track record Better back testing g
F Forward d estimates ti t are aligned li d with ith h how we think about risk. 26
June 2014
Accounting Regime
27
June 2014
Valuation framework - Economic
Economic
28
Many flavors in the US Most intellectually pure Needed in some cases where vastly different businesses are combined Hard to follow - market value margins Easy to manipulate - illiquidity premium Impact of taxes is a complication Hard to reconcile to p published results
June 2014
Valuation framework - GAAP
US GAAP
29
Familiar to audience Easy to exclude intangibles (w/o losing audience) AFS investments are most common and at MV Adjustment to discount loss reserves is not a huge complication Easy to reconcile to published results (for GAAP filers of course)
June 2014
Valuation framework - Statutory
US Statutory
30
Familiar to audience Already excludes intangibles Restating investments at MV and discounting loss reserves is not a huge complication Easy to reconcile to published results
June 2014
Thank you
31
June 2014
Contact Information Matt Berasi, FCAS, FRM Office: +1 860 547 4801 [email protected] Tom McIntyre, FCAS, CERA, MAAA Mobile: +1 1 860 930 4544 [email protected]
32
June 2014
Any views or opinions expressed in this presentation are solely those of the presenters and do not necessarily represent views or opinions h ld b held by Th The H Hartford tf d Fi Financial i lS Services i G Group, IInc. or KPMG LLP. LLP
2
June 2014
Agenda ORSA Update Capital Analysis 101 Multi-year vs. Prospective Analysis Forward Estimates & Scenario Analysis Accounting Regime
3
June 2014
ORSA Update
4
June 2014
ORSA Two main objectives:
Enhancement of ERM Group solvency
ORSA Summary Report
ERM framework Risk measurement Solvency assessment We’ll focus primarily on the solvency assessment
Source: NAIC.org 5
June 2014
ORSA Pilots (2012 & 2013) NAIC findings: Quality of ORSA Reports “significantly significantly improved” improved First time reports generally met expectations Confidentiality remains a critical consideration Recommendations: Focus on the ERM information provided to the Board Highlight/explain g g /e p a changes c a ges from o yea year to o yea year Readability in general Source: NAIC.org 6
June 2014
ORSA Guidance Manual (March 2014) NAIC updated the ORSA Guidance Manual 1 ORSA Summary Report should be consistent with 1. the insurer’s reporting to its Board 2. Clarified how US operating p g entities are expected p to report global ORSAs (if applicable) 3. Prospective solvency assessment should address changing exposures and emerging risks
Source: NAIC.org 7
June 2014
ORSA Solvency Assessment Required
Group Prospective Business plan oriented Board oriented* oriented
Not Specifically Mandated
Time horizon Accounting regime Quantification method Risk capital metric Security standard Aggregation gg g method
*Not strictly “required”, but implied and strongly recommended. Source: NAIC.org 8
June 2014
Session Objectives We will focus on two key issues to show how they meet ORSA requirements Time Horizon
One-year horizon Prospective solvency assessment including a focus on scenario analysis
9
Accounting Regime
Pros/cons of economic, GAAP & statutory y Tangible financial resources Reconciliation to published statements June 2014
Capital Analysis 101
10
June 2014
What is Required Capital? Required q Capital p
E pected Loss Expected
Nth P’tile Loss
Required capital is derived from a model (or factors) S l Solvency assessmentt is i th the comparison i off actual t l capital it l to required capital (often as a ratio) ((Note: ote Factor acto based methods et ods solve so e for o tthe e Nth t pe percentile, ce t e, rather at e than t a the t e full u curve.) cu e )
11
June 2014
Capital Ratio Actual Capital
2014
2015
Required Capital
2014
2015
Ignore 2015 & 2016 momentarily
2016 2016
Capital Ratio14 = Actual Capital14 / Required Capital14
This of course is a simple case
12
June 2014
What’s What s the solvency assessment question?
How much capital do we need to run the business this year?
Do we have enough available capital to cover our risks? i k ?
How much risk do we plan to take this year?
Are we taking too much risk in light of our available capital?
It’ss essentially the same question It 13
June 2014
How much risk do we plan to take?
Planning is an annual event
Insurers develop p and execute p plans using g a one-year y at a time perspective Even multi-year plans are typically developed and reported upon using one-year one year time steps We tend to think about taking risks in one-year increments, but capital models often use multi-year horizons
The case for a one-year modeling horizon: 14
Aligns with planning practices Enables prospective analysis Enables strong scenario testing June 2014
Multi-Year vs. Prospective y Analysis
15
June 2014
Common “mistake” mistake with multi-year multi year models
2014
Actual Capital Required Capital
2014
2015
2016
Capital Ratio?? = Actual Capital14 / Required Capital14-16
g answered is how much risk do The q question being we need in 2014 on average for risks through 2016? Changes in time horizon will change the estimates and allocation of capital. 16
June 2014
Prospective analysis
Start with a one year view
How much risk do we plan to take in 2014?
ORSA requires a “prospective prospective solvency assessment assessment”
How much risk do we expect to take in 2015 and 2016?
We need W d a currentt solvency l assessmentt and a forward estimate(s) of solvency. 17
June 2014
Current and Forward Estimates of the Capital Ratio Actual Capital
2014
2015
2016
Required Capital
2014
2015
2016
Capital Ratio14 = Actual Act al Capital14 / Required Req ired Capital14 Capital Ratio15 = Actual Capital15 / Required Capital15 Capital Ratio16 = Actual Capital16 / Required Capital16 18
June 2014
Multi-Year ≠ Prospective Multi-Year
Mixes time horizons and compares risks in future periods to capital in the current period Estimates solvency position relative to current capital only C be Can b affected ff t d b by choice of time horizon Imprecise in later years 19
Prospective
Aligns with customary business p planning g processes Estimates future capital position(s) May require assumptions for non nonmodeled factors Imprecise in later years June 2014
Forward Estimates & y Scenario Analysis
20
June 2014
Year one is easy! Capital Ratio14 = Actual Capital14 / Required Capital14
p Actual capital is read off of the balance sheet
Adjust for new business Restate the balance sheet as needed (e.g., remove intangible assets)
Required capital is based on the one-year model
21
June 2014
Forward Estimate of the Capital Ratio Year 2 is a prediction of next year’s one-year ratio Capital Ratio15 = Actual Capital15 / Required Capital15
Actual capital must be estimated
Year 1 business plan Year 2 starting capital Adjust for new business in Year 2 Restate as needed (e.g., remove intangible assets)
Required capital is based on the one-year model
22
Derive D i capital it l ffactors t ffrom Year Y 1 required i d capital it l over investments, loss reserves, premium, TIV, etc. Apply company specific factors to derive Year 2 required capital
June 2014
Insurers *might* might tell an interesting story Evaluation Year
2012
2013
2014
Ratio Year 2012
1.60
2013
1 76 1.76
1 80 1.80
2014
1.65
1.75
1.78
Current Estimate
1.90
1.95
1-Year Forward
1.95
2-Years Forward
2015 2016
Ambitious modelers might consider tracking:
Trends within an evaluation Accuracy of forward estimates Y might You i ht consider id th thatt someone will ill ttrack k your numbers b
23
June 2014
Scenario Analysis “It (p (prospective p solvency y assessment)) should also consider the prospect of operating in both normal and stressed environments.” – March M h 2014 NAIC ORSA G Guidance id M Manuall P Page 10 10.
p q y considerably y Interpretations of this requirement vary The forward estimates outlined above cover the “normal environment” requirement. Scenario testing with alternative business plan outcomes covers the “stressed environment” requirement requirement. 24
June 2014
Scenario analysis with forward estimates Initial Balance Sheet14
Mega Cat Year 1
Year Y 1 stressed t d environment
Est. “Actual” F Forward d B/S15
Forward Required q Capital15
Est. “Actual” Forward B/S15
Forward Required Capital15
Apply Capital Factors14
CAT Forward C it l Capital Ratio15 Interest Forward Capital Ratio15 Ratio “Actual” Actual / Required
Note that the scenarios are potential outcomes for the business plan under stressed conditions
25
June 2014
Benefits of Forward Estimate
Easy to follow and well suited for the Board Enables strong scenario analysis Can leverage complex stochastic but in an easy to deliver manner Build a forecasting track record Better back testing g
F Forward d estimates ti t are aligned li d with ith h how we think about risk. 26
June 2014
Accounting Regime
27
June 2014
Valuation framework - Economic
Economic
28
Many flavors in the US Most intellectually pure Needed in some cases where vastly different businesses are combined Hard to follow - market value margins Easy to manipulate - illiquidity premium Impact of taxes is a complication Hard to reconcile to p published results
June 2014
Valuation framework - GAAP
US GAAP
29
Familiar to audience Easy to exclude intangibles (w/o losing audience) AFS investments are most common and at MV Adjustment to discount loss reserves is not a huge complication Easy to reconcile to published results (for GAAP filers of course)
June 2014
Valuation framework - Statutory
US Statutory
30
Familiar to audience Already excludes intangibles Restating investments at MV and discounting loss reserves is not a huge complication Easy to reconcile to published results
June 2014
Thank you
31
June 2014
Contact Information Matt Berasi, FCAS, FRM Office: +1 860 547 4801 [email protected] Tom McIntyre, FCAS, CERA, MAAA Mobile: +1 1 860 930 4544 [email protected]
32
June 2014
