The Actuarial Society of Hong Kong
Risk Management Practices of the Hong Kong Insurance Industry Survey 2011 Investment & Risk Management Committee, ASHK 26 June 2012
Background
1st industry wide survey conducted in 2008 during the crisis, covering a comprehensive scope. Companies demonstrated an increasing importance towards risk management concept while were still finding their ways through new approaches. 2 years since then with SII introduced and August 2011 US downgrade plus European debt issues have aroused another new situation which is often said to be worse than 2008. 2nd survey to be conducted on similar questions and more specific scopes. Let’s see where the industry is at now……
2
Table of Content
Part 1: Risk Management Overview Part 2 : Regulatory Impact Part 3 : Capital Risk Part 4 : Interest Rate and Equity Risk, the latest “crisis” Part 5 : Currency Risk Part 6 : Stress testing and overall Wrap Up
3
Setting the scene…using 30/9/2011 data
21 companies participated in the survey. Local offices 13 (62%), Regional offices 8 (38%)
Europe 61%
Approach Accountability CRO
75%
Chief Actuary
15%
No explicit owner
5%
Others
5% (legal)
4
Asset and liability positions (local offices only)
Asset class holding
Product portfolio
(rounded to the nearest %)
2011
2009
Corporate bond
49%
62%
Government bond
23%
11%
Equities (and fund)
10%
11%
Cash / money market
14%
9%
Mortgage / ABS
2%
2%
Policy loans
1%
2%
Real estate
0%
1%
Hedge funds
0%
0%
Others *
1%
2%
* Other loans and account receivables
5
Key risks to company Respondents asked to rank 1st to 3rd (1st scores 3, 2nd scores 2, 3rd scores 1) 50 One year ago
45
Current
40
Currency, insurance risks
35 30 25 20 15 10 5 0 Interest rate
Equity
Credit
Liquidity
Operational
Reputation
Capital vol / level
Regulatory
Others
6
Risk management program - Drivers Respondents asked to rank 1st to 3rd (1st scores 3, 2nd scores 2, 3rd scores 1) 50 45
One year ago
Current
40 35 30 25 20 15 10 5 0
Head office requirements
Good business practice
Regulations
GFC impact
Shareholders' need
Rating agency
Manage complex risk exposures
Competitive advantage
7
Risk management program - Challenges Respondents asked to rank 1st to 3rd (1st scores 3, 2nd scores 2, 3rd scores 1) 35 30
One year ago
Current Time constraints and changing regulations
25 20 15 10 5 0 Talent shortage
Buy-in from Lack of industry cross functions best practice
Software / systems
Speed of Quality of Lack of supportBudget approval implementation internal data from the top
Others
8
Satisfactory level to internal capabilities
Risk management components: Framework and governance structure Definition of risk appetites and risk limits
Most
Least
☺☺☺ ☺
Risk indicators and identification Risk measurement and quantification Internal / external risk reporting and disclosure
☺☺
Internal education and communication of risk policies Linking senior management remuneration to risk performance
9
Alignment of Risk to Strategy No explicit alignment
Closely integrated 1. ERM forms part of strategic planning
2. Integration of risk appetite into business decision process
10
Table of Content
Part 1: Risk Management Overview Part 2 : Regulatory Impact Part 3 : Capital Risk Part 4 : Interest Rate and Equity Risk, the latest “crisis” Part 5 : Currency Risk Part 6 : Stress testing and overall Wrap Up
11
Concerns over regulatory risks
Move up in risk priority
Less important
No change 60%
35%
Areas of regulatory changes in concern, in order (tick all apply):
5%
Most important
1. Local country regulations – capital requirements 2. Local country regulations – reserving methodology
43%
3. Local regulators communication / transparency / structure 4. Capital – volatility imposed by economic balance sheet 5. Capital – level required by Solvency II 6. Overall tighter scrutiny on distribution, marketing, disclosure
50% 7%
7. Treatment of residual margin and discount rate with IFRS
12
What are the concerns over regulatory risks? Tick all that apply – sum of responses 20 18
One year ago
Current
16 14 12 10 8 6 4 2 0 Inhouse talent shortage
Uncertainty makes planning difficult
Pace of change is distracting
Model risks related to Impact on profitability new rules and competitiveness
Heavy costs of implementation
13
Views on Solvency II… European Companies
Non Solvency II Practitioners
Top 3 challenges to Solvency II implementation to date 1. Build capacity and flexibility to cope with potential surprises from further guidance 2. Devise detail action plans to define key stakeholders’ role, work flow and procedures 3. Develop adequate subject matter resources 14
Table of Content
Part 1: Risk Management Overview Part 2 : Regulatory Impact Part 3 : Capital Risk Part 4 : Interest Rate and Equity Risk, the latest “crisis” Part 5 : Currency Risk Part 6 : Stress testing and overall Wrap Up
15
Capital measures – what is everyone using now?
Majority using at least 2 capital measures. Most popular combination Solvency I & RBC/EC.
Others include Local, ICA, S&P
16
Capital measures – what is everyone thinking now?
Rank importance (1-3)
17
Capital measures – what is everyone thinking in 5 years time? Rank importance (1-3)
18
Capital calculation – RBC / EC / Solvency II SCR
Measures
Key survey results
Implementation
50% with “5+ years”
Frequency
73% with “Quarterly”
Time horizon
86% with “1 year”
VaR or CTE
75% with “VaR alone”
Satisfaction level (1 = “Not at all” and 5 = “Very”)
53% with “3”; 33% with either “4” or “5”
19
Capital calculation – Benefits
Provides uniform, clear, comparable and transparent quantification and presentation of different type of risks Risk-based and under economic basis regardless of accounting rules
Allows easier communication with senior management
RBC / EC / Solvency II SCR Allows risk management to be embedded in the business decision process
Transparency of risks as the measures set out explicitly the capital requirement for the various risks considered. This provides management with a better view of the key risks.
20
Capital calculation – Weakness
Resource constraint Lack full understanding and adoption of the measure May contradict the result under accounting basis
Reliance on historical data to estimate parameters for probability distributions, and that the model distribution may not fit reality
RBC / EC / Solvency II SCR Correlation is subjective
Lacking credible calibration of the required shocks to use (due to lack of data, various possible calibration approaches, etc)
Large risk charge on equities, and overly complicated methodology which makes it difficult to understand changes and extremely difficult to communicate and explain to management 21
Capital regime and reserving basis Q1: Do you consider a need to review the reserving basis if HK is to move to RBC regime?
75%
Q2: What is your view on when, if ever, Hong Kong should move to a RBC regime?
22
Capital requirement volatility Q3: Should volatility of capital requirement (the risk thereof) be a consideration when designing a regulatory capital base? 1 to 5 with 1 = “Not at all” and 5 = “Very agree”.
23
Capital regime uncertainties
The greatest hurdles when moving towards RBC regime Long-term products require long-maturity assets to reduce asset and liability mismatch risk, but market lack credible HK yield curve. Acceptance of industry to penalise current accepted practices (e.g. ALM mismatch) is difficult. Equity (subject to higher risk charge) would be less attractive to invest thus par products would be penalised. Lack of resources and skills to build and implement RBC for both regulator and insurance players. Subject to capital availability in the market. Multiple solvency requirements for international insurance companies. Only change capital requirement but keep the reserving basis unchanged Should consider both under RBC-type capital regime. Require stochastic modelling capability, calibration of shocks, consistent methodology and transparent reporting. Lack of historical data to set management action and dynamic policyholder behavior.
24
Table of Content
Part 1: Risk Management Overview Part 2 : Regulatory Impact Part 3 : Capital Risk Part 4 : Interest Rate and Equity Risk, the latest “crisis” Part 5 : Currency Risk Part 6 : Stress testing and overall Wrap Up
25
Liability Management: Existing Portfolio Responses on Product Management Closing certain products 2011 2011
20%
80%
2009 2010
66%
De velop new products 2011 2011
54%
2009 2010
46% 69%
Adj Divide nd rate s 2011 2011
31%
87%
2010 2009
Yes
34%
13%
68%
32%
No 0%
25%
50%
75%
• Unprofitable products likely to be closed as of last survey • Resort to dividend mechanisms • More inclined to develop new products
100%
26
Liability Management: New Products
Relative change to / intention to change the product mix of new business sales Decrease
No change
Increase
Pure risk / health
0%
35%
65%
Participating products
28%
56%
17%
Non-participating products
24%
59%
18%
Investment linked (with guarantees)
40%
60%
0%
Investment linked (without guarantees)
12%
41%
47%
Non-life / Others
0%
94%
6%
• Move away from guaranteed products • Move more towards risk products • Move more towards investment linked products
27
Management of assets Responses to the sovereign crisis Cash
Gov’t bond
Corp bond
Equities
Real Estate
Policy Loan
Hedge funds
MBS/ ABS
Increased
30%
33%
30%
0%
30%
6%
12%
0%
No change
70%
62%
55%
67%
65%
88%
82%
82%
Decreased
0%
5%
15%
33%
5%
6%
6%
18%
More dynamic asset allocation Yes:79%
No:21% Shift to Outsource
Asset management arrangement No Change : 85%
5%
10%
Shift to In-house 28
Actions for Unforeseeable Future Events
Non-Guaranteed Products
Unit-linked Products
Dynamic allocation in the investment process
Intention to increase
78%
83%
50%
No change
22%
17%
50%
29
Table of Content
Part 1: Risk Management Overview Part 2 : Regulatory Impact Part 3 : Capital Risk Part 4 : Interest Rate and Equity Risk, the latest “crisis” Part 5 : Currency Risk Part 6 : Stress testing and overall Wrap Up
30
Currency Mismatch Risk
Materiality of HKD Currency Mismatch Immaterial 64%
Significant and should be dealt with 14%
Do your company use separate duration measurement for different currency?
No 80.0%
Somewhat sizeable 23%
31
Level of Currency Mismatch Reserve
32
Changes since 2008 financial crisis
No 80.0% No 46.3%
No 13.3%
33
Instruments use to manage currency exposures
No 80.0% No 46.3%
No 13.3%
•
Participants can select more than one instrument in the survey 34
Managing and taking currency risks
Number of instruments used for managing currency risks
Use One Type 43%
Do your company use asset managers to profit from taking currency risks explicitly? No 95%
No Using
Two Types 80.0%36%
No 46.3%
No 13.3%
Use Four Types 7%
Using Three Types 14%
Yes 5%
35
Table of Content
Part 1: Risk Management Overview Part 2 : Regulatory Impact Part 3 : Capital Risk Part 4 : Interest Rate and Equity Risk, the latest “crisis” Part 5 : Currency Risk Part 6 : Stress testing and overall Wrap Up
36
Purpose of Stress Testing
20 out of 21 companies perform stress testing / 12 local and 8 regional offices What type of risks are covered?
• Other risks covered in stress testing are: implied volatility risk, credit spread risk and expense risk
37
Purpose of Stress Testing (cont’d) Importance of risks vs. risks covered in stress testing 100%
80%
60% 100%
40%
95%
80%
80% 60%
20%
40%
40% 15%
20% 5%
0% Interest rate risk
Equity risk
Credit risk
Operational risk
Liquidity risk
Risk types The 3 most important risks seen by companies
Covered in stress testing
38
Drivers of Stress Testing
100% 80%
10%
25%
30%
60% 40%
90%
75%
70%
20% 0% Regulator - local
Regulator - group Yes
Internal risk management
No 39
Frequency of Stress Testing 100% 15%
80%
20%
Irregular
66%
60%
5%
82%
One-off
Annually Bi-annually Quarterly
40% 6%
55%
Monthly
20% 12%
0%
28%
6% Regulator - local
5% Regulator - group
Internal risk management
40
Frequency of Stress Testing (cont’d)
How often do we perform stress testing for internal risk management in relation to asset portfolio size? 100% 22% 80% 60%
75%
33%
Irregular Annually Quarterly
40% 20%
Monthly
45% 25%
0% <$50 billion
>=$50 billion Asset portfolio size 41
Measurements/ Risk Metrics used
100% 20% 35%
80%
40% 70%
60%
No Yes
40%
80% 65%
60%
20%
30%
0% Statutory Solvency ratio & Capital
Economic Capital
IFRS profit
Statutory profit
Other risk metrics that we have used are: MCEV(EEV), Embedded Value, new business strain, experience variance, liquidity cover 42
Time horizon of stress testing performed Time Horizon used in Stress Testing 100% 90% Not provided 5% Snapshot on current position Projected 5 years only 20% 30%
80%
20% 33%
70%
20%
60% 50%
20%
40% Projected 3-4 years 30%
Projected 1 year 15%
30%
67%
20%
40%
10% 0% <$50 billion
>=$50 billion
Asset portfolio size Snapshot on current position only
Projected 1 year
Projected 3-4 years
Projected 5 years
43
Types of modelling used
100%
15% 90%
30% 80%
70%
20%
60%
50%
40%
85%
30%
50% 20%
10%
0% Deterministic
Stochastic
With dynamic policyholder behaviour
Without dynamic policyholder behaviour
Yes
No
44
Types of modelling used (cont’d) Choice of model type in relation to location of head office European Companies
Non Solvency II Practitioners
Deterministic 25% Deterministic + Stochastic 58%
Deterministic + Stochastic 50%
Deterministic 38%
Stochastic 17% Stochastic 12%
45
Key takeaways (1)…
• Regulatory – General concern over regulatory capital, and how regulators react to current (still) volatile market – Seem overall agreement that RBC is the way to go but not all companies are prepared for the requirements – A portion of non-European based insurers to catch up on sophisticated modeling? – Believe in implementation of SII?
• Product strategy – Moving towards risk products and less guarantees, health an apparent trend – At current economic condition, illustrated yields set PRE? Affordable level? How to manage going forward given the smaller room…. – Dilemma: competition reactions drive behavior and strategy?
46
Key takeaways (2)…
• ALM and profit enhancement – Cautious and gone / going through significant de-risking – Variations in currency risk management – 1/3 said mismatch sizable! – Are we still relying on the peg?
• Industry attitude and mindset to ERM – Multiple perspectives and acquainted with process, more buy-in from the top – Still uncertainty around internal and external disclosures – Overall a good sign to industry
47
The Actuarial Society of Hong Kong
Thank you – Q&A
Risk Management Practices of the Hong Kong Insurance Industry Survey 2011 Presenters: Ms. Ka-Man Wong / Mr. Peter Fang / Mr. Steve Tong / Mr. Andrew Siu 26 June 2012