IRM Risk Survey 2011

The Actuarial Society of Hong Kong Risk Management Practices of the Hong Kong Insurance Industry Survey 2011 Investment...

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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……

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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

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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

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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”

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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.

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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.

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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

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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%

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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%

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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

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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