Cyber risk and Terrorism risk - Challenges in pricing 27th India Fellowship Seminar Cyber risk and Terrorism risk - Challenges in pricing Topic: General Insurance – Changes in reserving methods as per IRDAI ALSM 2016, Impact on solvency and reserving Guide Name: Mr. Palreddy Vishnuvardhan Presenters Names: Girinker Aggarwal Varun Jain Deepanjali Talwar Supervisor: P.A. Balasubramanian, FIAI Date: 1st June 2017 Mumbai Indian Actuarial Profession Serving the Cause of Public Interest

Indian Actuarial Profession Serving the Cause of Public Interest Agenda Overview of ALSM regulations currently in place (2016) Changes Related to Reserving Changes Related to Solvency Indian Actuarial Profession Serving the Cause of Public Interest

Indian Actuarial Profession Serving the Cause of Public Interest Overview of IRDAI ALSM 2016 Key Areas of consideration under ALSM 2016 Valuation of Assets Estimation of Liabilities Determination of Solvency Margin Indian Actuarial Profession Serving the Cause of Public Interest

Indian Actuarial Profession Serving the Cause of Public Interest Valuation of Assets List of specific assets which should be placed with zero value Outstanding balances and premiums in India, not realized within 30 days Premium receivables from State/Central governments, not realized within 180 days Reinsurance balances outstanding for more than 365 days Co-insurer balances outstanding for longer than 90 days Furniture, fixtures, stock and stationary …… etc Valuation of all other assets in accordance with Regulations and instructions issued by the Authority regarding Preparation of Financial Statements, Auditor Reports Other forms of Capital and Investments Any other regulations applicable Indian Actuarial Profession Serving the Cause of Public Interest

Estimation of Liabilities (1) CLAIMS RESERVES Set across 28 lines of businesses, classified into Motor Health Personal Accident Travel Outstanding Case Reserve (OS Reserves) Estimated using a ‘case by case method’, and amount is to be provided in full Can use a statistical method Incurred But Not Reported (IBNR) Claims Reserve Estimated using actuarial principles and methods, certified by the AA Calculated by each year of occurrence and summed to total Assessed on both NET and GROSS of reinsurance basis Should not discount the estimated future development of the paid claims Fire Marine Other Miscellaneous Indian Actuarial Profession Serving the Cause of Public Interest

Estimation of Liabilities (2) PREMIUM RESERVES Unearned Premium Reserve (UPR) Set using prescribed formula, certified by CFO and Statutory Auditor Premium Deficiency Reserve (PDR) Calculated using actuarial principles Maintained at the entity level Unexpired Risk Reserve (URR) = UPR + PDR OTHER LIABILITIES Provision for bad and doubtful debts Reserves for declared/recommended/outstanding dividends Provision of taxation Foreign Exchange Reserves Sundry creditors and other business expenses Indian Actuarial Profession Serving the Cause of Public Interest

Determination of Solvency Margin AVAILABLE SOLVENCY MARGIN (ASM) Excess of assets over liabilities, subject to key specific adjustments Minimum ASM requirements are set in the regulation REQUIRED SOLVENCY MARGIN (RSM) Estimated for 9 lines of business using a standard formula, taking into account Gross and net written premiums, and gross and net incurred claims Taking higher of premiums-based and claims-based RSM calculations Aggregating individual RSMs for all lines into the INSURER’s total RSM SOLVENCY RATIO Ratio of ASM to RSM “Control level of solvency” is set at 150% solvency ratio, breaching which can lead to regulatory actions Indian Actuarial Profession Serving the Cause of Public Interest

Changes Related to Reserving Indian Actuarial Profession Serving the Cause of Public Interest

Detailed Business Split for Reserving Reserves needs to be set for 28 lines of business, increased from 10 lines previously Motor is now split into 8 lines across OD (3 lines) and TP (5 lines) Motor OD and non-pool TP need to reserved under 3 lines each – private cars, two wheelers and commercial vehicles Motor TP Pool now needs to be reserved separately for ‘TP Pool’ and ‘Declined Pool’ Liability is now split into 3 lines Product Liability, Liability Insurance and Worker’s Compensation These need to be reserved separately Indian Actuarial Profession Serving the Cause of Public Interest

Detailed Business Split for Reserving Health is now split into 4 lines Individual, Group-Government, Group-Employer and Group-Other These need to be reserved separately Recognition of new lines of business Personal Accident, split into – Individual, Group-Government and Group-Other Crop Insurance Travel Insurance Weather Insurance Credit Insurance Rural Insurance is NOT being specified as separate line anymore Indian Actuarial Profession Serving the Cause of Public Interest

Estimating OS Reserves Actuaries have the provision of using statistical methods for the calculation of reserves for outstanding claims Need to provide justification for the same Appointed Actuary will need to certify the reserves if this method is used Material changes in claims handling practices, leading to changes on outstanding claims reserve pattern should be taken into account and reported Indian Actuarial Profession Serving the Cause of Public Interest

Indian Actuarial Profession Serving the Cause of Public Interest Estimating IBNR IBNR shall be calculated using multiple actuarial methods Loss Ratio Method Basic Chain-Ladder Method (on Incurred and Paid) Bornhuetter-Fergusson Method (on Incurred and Paid) Frequency-Severity Method Rationale for selecting any of the above methods/a different method Detailed notes if estimates from different methods differ significnatly Estimating the IBNR for a line of business IBNR needs to be calculated for each year of occurrence Negative IBNR in any year should be ignored Sum of all years’ IBNR = total IBNR IBNR shall be calculated on a Gross and Net of reinsurance basis You can see there are many possibilities, and no single right method. Any good actuary will want to use as many legitimate methods for which reasonably good information and time is available, and compare and contrast the estimates from these methods. As with pricing, it is often informative to see the spread of estimates derived from different approaches. This helps us understand better the range and distribution of possibilities, and may give us some idea of the sensitivity of our answers to varying assumptions and varying estimation methodologies Indian Actuarial Profession Serving the Cause of Public Interest

Indian Actuarial Profession Serving the Cause of Public Interest Estimating URR UPR to be calculated for existing business, needs to be certified by CFO and Statutory Auditor PDR is to be calculated and monitored at the segment level, but reserves need to be kept at the overall ENTITY level These shall be calculated using actuarial principles URR = UPR + PDR Indian Actuarial Profession Serving the Cause of Public Interest

Changes Related to Solvency Indian Actuarial Profession Serving the Cause of Public Interest

Impact of Changes in Asset Valuation Increased Scope of assets that need to be set to 0 Additional assets that are to be placed with value zero, for e.g.: Premiums receivable relating to State/Central govt. not realized within a period of 180 days Debit balance of profit and loss appropriation account balance Co-insurer’s balances outstanding for more than 90 days Balances of Indian and Foreign reinsurers (having branches in India) outstanding for more than 365 days Leading to a decrease in the Available Solvency Margin (ASM) Regulation requires Appointed Actuary to sign-off asset valuations Govt. premium receivables – were initially 90 days, then increased to 365 days – before finalising to 180 days Indian Actuarial Profession Serving the Cause of Public Interest

Solvency Ratio Requirements Thresholds specified in the Regulation Every (re)insurer shall maintain its ASM as a higher of 50% of minimum capital i.e. higher of Rs.50 crores for General insurers and Rs.100 crores for Reinsurers or 100% of RSM ‘Control level of Solvency’ specified as a minimum solvency ratio of 150% Indian Actuarial Profession Serving the Cause of Public Interest

Controls on Solvency Monitoring No action required from the Regulator Greater than 150% Company shall be asked to submit a financial plan to correct the deficiency within a specified period not exceeding 6 months Greater than Minimum but less than 150% Company shall be deemed to be insolvent and may be wound up by the Court on application made by the Authority Less than Rs.50 crores or 100% of RSM Indian Actuarial Profession Serving the Cause of Public Interest

Categorization of Lines of Business PREVIOUSLY – Fire, Marine and Miscellaneous were the 3 broad categories; With miscellaneous consisting of Motor, Engineering, Aviation, Liability, Rural, Health and Other In the new regulation, Motor, Engineering, Aviation and Liability have been separated as new categories from Miscellaneous Rural has been removed as a separate line of business Indian Actuarial Profession Serving the Cause of Public Interest

Required Solvency Margin Gross Written Premium incl. Inward Reinsurance Premiums calculated as ‘Trailing 12 months data’ Gross/Net Incurred Claims incl. Gross/Net IBNR Incurred claims calculated as maximum of ‘Training 12 months data’ and ‘Trailing 36 months data divided by 3’ RSM1 Factor A is used to scale down Gross Premium. RSM1 is calculated as 20% of HIGHER of Scaled Gross Premium and Net Premium RSM = Higher of RSM1 and RSM2 RSM2 Factor B is used to scale down Gross Incurred Claims. RSM2 is calculated as 30% of HIGHER of Scaled Gross Claims and Net Claims Indian Actuarial Profession Serving the Cause of Public Interest

Revised Factors for Calculation of RSM New Regulation has reduced the Factors used to scale down Gross figures Capital required may be lesser, with everything else remaining the same, for an insurance company with higher ceded premiums as a proportion of gross premium Crop Factor reduced from 0.7 to 0.5 Indian Actuarial Profession Serving the Cause of Public Interest

Indian Actuarial Profession Serving the Cause of Public Interest