Development of Risk Based Capital Framework in Singapore

Questor Ng, Raymond Cheung

Singapore Actuarial Society

History of RBC in Asia

2

Solvency I Framework • Hong Kong • China • Macau • India • Vietnam

Singapore

Malaysia Taiwan Indonesia Thailand

South Korea

Enhancing RBC I framework • Singapore • Malaysia • South Korea • Indonesia • Taiwan

Exploring RBC I/RBCII

2000 2003 2004 2009 2011

Pre-RBC Framework in Singapore

3

• Factor based framework

• Liability Reserving

• NPV with prescribed parameters

• Implicit margin on PAD

• Solvency

• Required capital derived as % of reserve and SA; consider liability risks only

• 3% and 2% of reserve on Non-Par and Par reserve; 0.1% and 0.2% on SAR for term <2 yrs and >2 yrs

• Available capital equals to net asset

• Asset

• Lower of book value or market value

• No concentration risk adjustment

RBC 1- Critical Elements

4

• Mix of factors and principle based framework – bears similarities to Australia’s MCR

• Consider some risks explicitly:

Reserving:

• Life: GPV reserve with PAD considering all policy related cashflows • Par fund reserve is set equal to asset value

• Negative reserve zeroised at policy level

• Non-life: • Best estimates (BE) of insurance (claims + premium) liabilities

• Additional PAD reach at least 75% level of sufficiency

Components Type of Risk Requirement

C1

Life: Insurance risk on mortality, morbidities, expenses: 10% to 40% PAD

on assumptions

Non-Life: Specific risk charges on premium & claims liabilities by Business

lines

C2 Asset risk, ALM risk: factor based and sensitivity to risk free rates

C3 Concentration risk: factors based on types of assets and institutions

RBC 1- Critical Elements

5

• Solvency:

• Capital on market value basis

• Company solvency ratio must exceeds 120%. Most insurers in Singapore, however, have CAR well in excess of 150%

CAR = Tier 1 + Tier 2 + Par non-guaranteed bonus

C1 + C2 + C3

Type of capital Description

Tier 1: high quality Paid-up capital, net asset (except Par fund), Par

shareholders' account

Tier 2: moderate quality Irredeemable, cumulative preference shares,

subordinated loan etc

Par Non-guaranteed Bonus Min[ 50% * (Asset - Guaranteed reserve on BE return) ,

(Asset - Guaranteed reserve on risk free rate) ]

RBC 1 – Pros and Cons

6

• Pros

• More assurance on sufficiency of reserve

• Risks are included explicitly and therefore provided for both assets and liabilities

• Differentiate “good” insurers (with less risks) vs “bad” insurers (with more risks)

• Cons

• Still does not consider all aspects of risks and their interaction

• P&L and B/S more volatile on market value basis

• PAD and prescribed parameters may not be sufficient

• No explicit escalated level of supervisory intervention

• Does not include a risk management framework

Factors driving RBC 2

7

1. Development in global supervisory principles and framework (e.g., ICPs issued in 2011 by the International Association of Insurance Supervisors (IAIS))

• ICP 14 Valuation: requires assets and liabilities valued consistently; reflecting risk adjusted cashflows

• ICP 17 Capital Adequacy: capital to be adequate based on nature, scale and complexity of risks, and feasible in practice

2. Development of Solvency II in Europe and Basel III framework

• To align Singapore RBC I to the international standard – Singapore government’s aim to develop Singapore as a key financial hub of Asia

• Synergy and alignment with supervisory framework of other sectors in Singapore, particularly, the banking sector

3. More volatile investment and operating market

• The financial and environmental risks posed to the insurance sector (e.g., GFC)

• Movements in consumer protection and safeguarding policyholders’ interests

• Better protection against insolvency – capital alone is insufficient

• Now a “best practice” to have comprehensive risk management framework

4. Economic mismatch between assets and liabilities valuation

• Assets are on market value basis but liabilities are not

RBC 2 – Expected timeline

8

Q2 2012 MAS issued Consultation Paper on RBC 2

Apr 13 MAS issued regulations on ERM & Public Disclosure

Q4 13 QIS I calibration Factors

Q1 14 Parallel run RBC I & RBC II

Q1/2 14 QIS II calibration Factors

Q3 14 - Finalization of Calibration factors -Study Internal model for the next 2/3 years

Q2 2012 April 2013

Q4 2013

Q1/Q2 2014

Q3 2014

RBC 2 – Critical Elements

9

1. Assets and liabilities to be valued on more consistent basis

• Assets continues to be value using market value or net realisable value

• Liabilities on best estimate basis, without PAD + explicit risk margin

• Liabilities to be discounted using risk free rates (SG government bond yields), instead of historical average risk free rates

• Illiquidity premium not included on risk free rates

2. Solvency available capital rules:

• Aligned to Basel III framework

• Par non-guaranteed bonus reserve continue to be positive adjustment

• Negative reserve to be recognised as positive adjustment (Outstanding)

3. Consider comprehensive list of risks facing insurers.

• Additional risks: Operational, catastrophic, spread

• Liquidity risk is not included but monitored through stress test

RBC 2 – Critical Elements

10

4. Solvency requirement to cater to 99.5% confidence level over a one year period • No allowance for diversification benefits when aggregating capital risk requirements (i.e.

between risk categories) (Outstanding)

• Which means it could be more conservative than 99.5% as a whole

• (Diversification benefits within certain risk categories are allowed)

5. Two regulatory intervention points: • MCR: calibrated to the 90th percentile scenario over 1 year period

• Strong regulatory intervention expected: Stop NB, withdrawal of license, transfer of portfolio to other insurer

• PCR: calibrated to the 99.5th percentile scenario over 1 year period

• Required to submit capital plan to restore financial strength within 3 months

6. Partial or full Internal model in replacement of standard: Not expected in 1st phase

7. Introduce Enterprise Risk Management requirements, including ORSA • ORSA mentioned as MAS’ continuing efforts to enhance risk management and capital

management in an integrated and enterprise-wide manner

• Stress testing requirements will split into 2 parts from 2014, with “self-select” scenarios covered under ORSA scope

Regulatory B/S: RBC 1 vs RBC 2

Assets (MV)

MCL

Risk Charges

Assets (MV)

Best Estimate Liability

Prescribed Capital

Reqmnts (PCR)

Capital Buffer

Calibrated to 1-in-7yrs

Calibrated to 1-in-200yrs

Risk Margin

• Best Est.+ PAD • Disc @ LTRFDR

Min CAR 120%

Capital Buffer

Capital Buffer of at least 80% of RC

Min CAR ???

• Best Est. • Disc @ SGS

Explicit RM for Ins. & Ops Risks

Min Req. (MCR)

Calibrated to 1-in-10yrs

11

RBC 2 – Main Issues

12

1. Alignment between Insurance and Banking sector framework

• Banking and Insurance sector are fundamentally different

• Insurance sector is less susceptible to systemic / contagion risks than banking sector (reference source: Geneva Association, IAIS Conference)

2. Alignment between Life and Non-life insurance sector

• Life insurance and Non-life insurance sector are different

• Difference in nature of life & non-life sector should be considered in designing requirements on discounting, margin calculation (PAD or CoC), CAT risk charge, etc

3. Tight timeline proposed for calibration and implementation is a concern

4. Diversification between risks

• Each risk scenario is calibrated to 99.5th percentile

• No diversification is proposed – Likely significant increase in capital requirement is a concern

5. Discount rate

• Government bond yields or swap curve?

• Illiquidity premium?

6. Negative reserve

• Not as tier 1 capital but a positive capital adjustment

• Should 100% negative reserve be recognized?

RBC 2 – Likely Impact

13

1. Insurance Market as a whole

• Overhaul in capital requirements may reduce the attractiveness of Singapore as an Asia insurance hub

• Changing level playing field between insurance and other sectors (e.g., banking)

• Changing competitiveness between insurance companies

• Increased cost of doing business will eventually be passed on to consumers through more costly premiums or lower coverage

2. Business Strategy

• Likely to have higher minimum capital cost

• More reinsurance for those who need capital?

• Change in product mix offered?

• Change in the focus on distribution channels?

3. Decision making

• A comprehensive enterprise wide risk management framework, strategy and culture

• Help to create more awareness of risk and reward?

• Better decision making, ie using capital more efficiently?

• Invest and develop in Internal Model for decision making?

4. Disclosure

• More disclosure on various aspects of insurers

• More disclosure translates to higher transparency?

• Does it help to minimize insolvency risk? Systemic risk?