FINANCIAL CONDITION REPORTING Ioana Abrahams 13 November 2009

Financial Services Board 13/11/2009 Slide 2 AGENDA  Current methodology  Background  FCR  FCR to date  FCR Graphical Overview  Model options under FCR  Prescribed Model  Internal Model  Partial Model  Conclusion  Way forward

Financial Services Board 13/11/2009 Slide 3 CURRENT METHODOLOGY  Current methodology  Insurance liabilities:  Outstanding claims reserves (OCR)  Incurred but not reported reserve (IBNR)  Unearned premium provision (UPP)  Unexpired risk reserve (URR)  Contingency reserve: 10% of NWP  Capital requirement:  Additional amount: 15% of net written premium (NWP)  Minimum of R3 million (shortly to be increased to R5 million then 10 million under FCR)

Financial Services Board 13/11/2009 Slide 4 BACKGROUND  Current methodology doesn’t allow for:  Underlying risks  Size of insurer  Diversification / concentration  Risk management  FSB is implementing risk-based supervision  IAIS requirements must be met  Act changes made during 2008 to facilitate FCR  World-wide trend to move to different techniques

Financial Services Board 13/11/2009 Slide 5 FCR TO DATE  The FCR process was started in 2002  Various working groups formed  The first calibration done during 2005  First issues paper released for comment in December 2006  Comments received were taken into account and this resulted in a recalibration exercise  Recalibration exercise started in 2007; now nearly complete

Financial Services Board 13/11/2009 Slide 6 FCR GRAPHICAL OVERVIEW

Financial Services Board 13/11/2009 Slide 7 MODEL OPTIONS UNDER FCR  Prescribed Method  Industry structure  Industry Parameters  Internal Models  Company structure  Company parameters  Peer review (application)  Annual certification by an actuary  Partial Models  A combination of above two options  Revised issues paper

Financial Services Board 13/11/2009 Slide 8 PRESCRIBED MODEL  Based on aggregate industry data – “average” view  Formulae for reserves and margins  Capital requirement allows for proportional reinsurance and expenses  Some shortcomings of initial model:  Non-proportional reinsurance  Data not always reliable  Cell business  Reinsurance companies

Financial Services Board 13/11/2009 Slide 9 PRESCRIBED MODEL  Capital requirement  Consists of:  Asset Capital Charge Very small part of total capital charge Protection against loss in market value of the assets backing the liabilities and other capital elements  Insurance Capital Charge Major part of total capital charge Calculation tool in ST return

Financial Services Board 13/11/2009 Slide 10 PRESCRIBED MODEL  Assets  Use current Act & Directives  Insurance liabilities  Claim liabilities  OCR – best estimate (should be the same)  IBNR – six-year run-off per business class  Premium liabilities  UPP – as before, seen as 75% sufficient  URR – as before  Prescribed margins take liabilities to 75% sufficiency

Financial Services Board 13/11/2009 Slide 11 PRESCRIBED MODEL: REVISED  Small working group was formed in 2007  Considered comments on how previous method could be improved  Terms of reference for recalibration  Deloitte was appointed for the recalibration exercise  Three years of data added (FY )  Aims:  Simplify previous method  More appropriate method for typical insurers

Financial Services Board 13/11/2009 Slide 12 PRESCRIBED MODEL: REVISED  The following changes were made to the previous prescribed model:  Simplify diversification and correlation  Discounted IBNR  Credit Risk: Reinsurance  Credit Risk: Assets  Non-proportional reinsurance (MER)  Remove expense and investment return adjustment  Minimum CAR – will include an allowance for operating expenses and operational risk

Financial Services Board 13/11/2009 Slide 13 PRELIMINARY RECALIBRATION RESULTS

Financial Services Board 13/11/2009 Slide 14 EFFECT OF UPDATES

Financial Services Board 13/11/2009 Slide 15 INTERNAL MODEL  This is (in our opinion) what an insurer should develop – However:  Determining regulatory capital should not be the primary reason  Appropriateness with respect to complexity of risks  Detailed data required  Guidance will be updated, taking international practices into account

Financial Services Board 13/11/2009 Slide 16 INTERNAL MODELS  Qualitative standards  IM based on sound risk management principles and structure  Integral part of day-to-day management  Independent review  Audit trail  Analysis of change

Financial Services Board 13/11/2009 Slide 17 INTERNAL MODEL  Specification of risk factors  Must consider all risks  Rank most important risks  Suitable method chosen – not necessarily stochastic  Allow for correlations between risks (method not prescribed)  Stress testing  Specific tests not prescribed  Test model sensitivity to assumptions

Financial Services Board 13/11/2009 Slide 18 INTERNAL MODEL  Sign-off and review  Board assumes ultimate responsibility  Statutory actuary sign-off of calculations  Actuary to follow professional guidance  IAA guidance on internal models  SA guidance for reserving completed  External review required for approval (at this stage)

Financial Services Board 13/11/2009 Slide 19 INTERNAL MODEL  Proposed model approval process  Approval for calculating regulatory capital  External providers’ models not approved automatically  Application form  On-site visits  Use test, calibration test, statistical quality test  Model used at least one year prior to implementation  Progress from prescribed  partial  internal model  Can’t regress without approval  Application subject to a fee

Financial Services Board 13/11/2009 Slide 20 PARTIAL MODEL  This is a combination of own company specific factors and industry factors  Same approval process proposed as for the full internal model route

Financial Services Board 13/11/2009 Slide 21 CONCLUSION  The FCR model is specific to the short-term environment  The proposed FCR approach fits in with international developments  Risk-based capital requirements  A better model to run an insurance business

Financial Services Board 13/11/2009 Slide 22 WAY FORWARD  New Solvency Assessment and Management (SAM) project  Based on Solvency II  Will encompass both life and short-term insurance  Work done to date on FCR will be the first draft for discussion for short-term insurance  First Steering Committee meeting end November 2009  Full implementation 1 January 2014; however, standardised model for short-term insurance to be implemented on 1 January 2012

THANK YOU Ioana Abrahams Actuarial Analyst: Insurance Tel: