2008 General Meeting Assemblée générale 2008 Toronto, Ontario 2008 General Meeting Assemblée générale 2008 Toronto, Ontario Canadian Institute of Actuaries Canadian Institute of Actuaries L’Institut canadien des actuaires L’Institut canadien des actuaires

2008 General Meeting Assemblée générale General Meeting Assemblée générale 2008 Introduction to Economic Capital Jean-Yves Rioux, Deloitte FCIA, FSA, CERA ERM Applications Committee This presentation provides a brief introduction for those unfamiliar with Economic Capital (EC) concepts

2008 General Meeting Assemblée générale General Meeting Assemblée générale 2008 Introduction to Economic Capital What is Economic Capital? Measure of risk capital Often defined as “sufficient surplus to cover potential unexpected losses over a specific time horizon within a given confidence level” VaR = L* - E[L] Where * means value under stressed scenario, often using percentiles

2008 General Meeting Assemblée générale General Meeting Assemblée générale 2008 Introduction to Economic Capital What is Economic Capital (cont’d)? Sometimes defined as the difference between Equity under “normal conditions” and Equity under stressed conditions VaR = E[E] - E* VaR = (E + E[∆E]) - (E + ∆E*) VaR = E[∆E] - ∆E* VaR = (-E[L]) - (-L*) To be consistent, both definitions should use a total loss approach (value & income)

2008 General Meeting Assemblée générale General Meeting Assemblée générale 2008 Introduction to Economic Capital Alternative calculation basis Fair Value Balance-Sheet (Statutory/ GAAP) Alternative measurement include Standard deviation Conditional Tail Expectation

2008 General Meeting Assemblée générale General Meeting Assemblée générale 2008 Introduction to Economic Capital Possible approaches Parametric/ Closed forms Historical scenarios Stochastic simulations

2008 General Meeting Assemblée générale General Meeting Assemblée générale 2008 Introduction to Economic Capital Because of imperfect correlations, total EC is likely to be less than the sum of independently calculated projects/LOBs EC A project/LOB viewed as risky on its own can contribute to reducing the other risks the firm undertakes e.g. death vs. survivorship Risks of a project/LOB should be viewed in the context of the contribution to the risk of the firm as a whole

2008 General Meeting Assemblée générale General Meeting Assemblée générale 2008 Introduction to Economic Capital Considerations Types of risks tested Risk aggregation and correlations EC Allocation Allocation of diversification benefits

2008 General Meeting Assemblée générale General Meeting Assemblée générale 2008 Introduction to Economic Capital Examples of uses of EC measures LOB/project risk contribution to the firm Acquisitions/ Divestitures Performance Evaluation Residual Income RORAC Profitability/ Pricing Comparison with balance-sheet capital or regulatory capital

2008 General Meeting Assemblée générale General Meeting Assemblée générale 2008 Introduction to Economic Capital Contact Jean-Yves Rioux, FCIA, FSA, CERA Senior Manager, Assurance & Advisory Deloitte & Touche LLP 181 Bay Street, Suite 1400 Toronto, ON, M5J 2V