1. IAIS-ASSAL Training Seminar 24 November 2009, Lima Peru Jason Park – Principal Administrator International Association of Insurance Supervisors (IAIS) Panel 5 Solvency - Valuation of Liabilities & Value at Risk Methodology

2. Solvency - Valuation of Liabilities & Value at Risk Methodology2 November 2009 Jason Park Presentation Overview Part I : Introduction of the IAIS Part II : International Solvency Requirements (ISRs) within the IAIS Framework for Supervision Structure of regulatory capital requirements Use of internal models for regulatory capital purposes Value at Risk Methodology in IAIS document Valuation of assets and liabilities for solvency purposes

3. Solvency - Valuation of Liabilities & Value at Risk Methodology3 November 2009 Jason Park IAIS: a global forum for insurance regulators Founded in 1994 Members from more than 190 jurisdictions in over 140 countries Membership classes Members Insurance Supervisors The NAIC International Governmental/ Statutory bodies Observers Other interested parties

4. Solvency - Valuation of Liabilities & Value at Risk Methodology4 November 2009 Jason Park Standards Insurance Core Principles (ICPs) Guidance papers Issues papersApplication papers Supervisory papersSupporting papers Standard setting activities aim at global convergence of supervisory practices

5. Solvency - Valuation of Liabilities & Value at Risk Methodology5 November 2009 Jason Park ICPs provide globally-accepted framework for insurance regulation and supervision Benchmark for insurance supervisors Used to establish new regimes Used to improve existing regimes Used in evaluation of supervisory regimes – FSAPs Applies to all insurers and reinsurers but not intermediaries, unless indicated Principles Assessment criteria Explanatory notes Essential criteria Advanced criteria

6. Solvency - Valuation of Liabilities & Value at Risk Methodology6 November 2009 Jason Park ICPs cover all insurance supervisory aspects

7. Solvency - Valuation of Liabilities & Value at Risk Methodology7 November 2009 Jason Park Presentation Overview Part I : Introduction of the IAIS Part II : International Solvency Requirements (ISRs) within the IAIS Framework for Supervision Structure of regulatory capital requirements Use of internal models for regulatory capital purposes Value at Risk Methodology in IAIS document Valuation of assets and liabilities for solvency purposes

8. Solvency - Valuation of Liabilities & Value at Risk Methodology8 November 2009 Jason Park Solvency requirements are integral in the Framework for insurance supervision Preconditions Regulatory requirements Supervisory assessment LEVEL 1 LEVEL 2 LEVEL 3 Supervisory assessment and intervention Basic conditions for the effective functioning of the insurance supervisory authority the insurance sector and insurance supervision Financial Governance Market conduct Common Solvency Structure and Standards Framework for Insurance Supervision

9. Solvency - Valuation of Liabilities & Value at Risk Methodology9 November 2009 Jason Park ISRs: a comprehensive and cohesive set of solvency assessment documentation International Solvency Requirements (ISRs) ISR 1 Capital requirements (adopted) ISR 2 Capital resources (adopted in 2009) ISR 3 Valuation of assets & liabilities (due Oct 2010) ISR 4 Investments (due Oct 2010) ISR 5 Enterprise risk management (adopted) ISR 6 Internal models (adopted) STANDARDS ISR 1 Capital requirements (adopted) ISR 2 Capital resources (adopted in 2009) ISR 3 Valuation of assets & liabilities (due Oct 2010) ISR 4 Investments (due Oct 2010) ISR 5 Enterprise risk management (adopted) ISR 6 Internal models (adopted) GUIDANCE PAPER

10. Solvency - Valuation of Liabilities & Value at Risk Methodology10 November 2009 Jason Park ICPs related to Prudential Requirements ICP 23 Capital adequacy and solvency Requires insurers to comply with the prescribed solvency regime. This regime includes capital adequacy requirements and requires suitable forms of capital that enable the insurer to absorb significant unforeseen losses. –Capital Requirements –Capital Resources –Internal Models

11. Solvency - Valuation of Liabilities & Value at Risk Methodology11 November 2009 Jason Park ICPs related to Prudential Requirements ICP 18 Risk assessment and management Requires insurers to recognise the range of risks that they face and to assess and manage them effectively. –Internal Models ICP 21 Investments Requires insurers to comply with standards on investment activities. These standards include requirements on investment policy, asset mix, valuation, diversification, asset-liability matching, and risk management. ICP 22 Derivatives and similar commitments Requires insurers to comply with standards on the use of derivatives and similar commitments. These standards address restrictions in their use and disclosure requirements, as well as internal controls and monitoring of the related positions. –Investments

12. Solvency - Valuation of Liabilities & Value at Risk Methodology12 November 2009 Jason Park ICPs related to Prudential Requirements ICP 20 Liabilities Requires insurers to comply with standards for establishing adequate technical provisions and other liabilities, and making allowance for reinsurance recoverable. The supervisory authority has both the authority and the ability to assess the adequacy of the technical provisions and to require that these provisions be increased, if necessary. ICP 21 Investments Essential criterion b) requires that investments are valued according to a method prescribed by or acceptable to the supervisory authority. ICP 23 Capital Adequacy and Solvency Essential criterion a) requires that the solvency regime addresses the following in a consistent manner: Valuation of liabilities, including technical provisions and the margins contained therein Quality, liquidity and valuation of assets Matching of assets and liabilities, etc. –Valuation of Liabilities and Assets

13. Solvency - Valuation of Liabilities & Value at Risk Methodology13 November 2009 Jason Park Presentation Overview Part I : Introduction of the IAIS Part II : International Solvency Requirements (ISRs) within the IAIS Framework for Supervision Structure of regulatory capital requirements Use of internal models for regulatory capital purposes Value at Risk Methodology in IAIS document Valuation of assets and liabilities for solvency purposes

14. Solvency - Valuation of Liabilities & Value at Risk Methodology14 November 2009 Jason Park Standard & Guidance on the Structure of Regulatory Capital Requirements Total balance sheet approach –Recognise interdependence between assets, liabilities, regulatory capital requirements and capital resources –Ensure that determination of available and required capital is based on consistent assumptions for the recognition and valuation of assets and liabilities for solvency purposes Establishment of a range of solvency control levels –with appropriate supervisory interventions Allowance of a range of approaches –standardised approaches and more advanced approaches, such as internal models Determination of prescribed levels of RCRs –MCRs and PCRs –relationships between different levels

15. Solvency - Valuation of Liabilities & Value at Risk Methodology15 November 2009 Jason Park Public financial reporting capital liabilities assets liabilities Supervisory assessment of the financial position value of assets for supervisory purposes current estimate policy obligations risk margin capital requirement liabilities available capital assetsliabilities and capital requirement financial position technical provisions Standard & Guidance on the Structure of Regulatory Capital Requirements Total balance sheet approach to recognise interdependencies

16. Solvency - Valuation of Liabilities & Value at Risk Methodology16 November 2009 Jason Park 16 Standard & Guidance on the Structure of Regulatory Capital Requirements Solvency Control Levels and Regulatory Capital Requirements Minimum Capital Requirement (MCR) Technical Provisions (TP) and Other liabilities Capital Resources (CR) Required Capital Risk Margin (RM) Current Estimate (CE) Regulatory Capital Requirements Insurer’s Financial Position Prescribed Capital Requirement (PCR) Other liabilities (OL) Other liabilities (OL)

17. Solvency - Valuation of Liabilities & Value at Risk Methodology17 November 2009 Jason Park Standard & Guidance on the Structure of Regulatory Capital Requirements Prescribed capital requirement (PCR) level Supervisory intervention not required Capital Adequacy Ratio = Capital Available Capital Required 190% 160% 100% 130% Submission of business plan to improve capital buffers Increased on-site supervision Additional stress and scenario testing Limit shareholder dividends Restrict new business acquisition Delay approval of new products Minimum capital requirement (MCR) level Winding-up of operation Progressive intervention levels to ensure timely corrective measures – an example

18. Solvency - Valuation of Liabilities & Value at Risk Methodology18 November 2009 Jason Park Presentation Overview Part I : Introduction of the IAIS Part II : International Solvency Requirements (ISRs) within the IAIS Framework for Supervision Structure of regulatory capital requirements Use of internal models for regulatory capital purposes Value at Risk Methodology in IAIS document Valuation of assets and liabilities for solvency purposes

19. Solvency - Valuation of Liabilities & Value at Risk Methodology19 November 2009 Jason Park Standard & Guidance on the Use of Internal Models for Regulatory Capital Purposes What are internal models? –A risk management system developed by an insurer to analyse and quantify its risk position and to determine the commensurate economic capital The internal model approach is suitable only if certain preconditions are met –Level of sophistication of insurers / markets –Corporate governance structures –Competent / accountable insurance professionals and management –Supervisory resources and expertise Standards and guidance paper applies only in jurisdictions where internal models are recognised for regulatory capital purposes

20. Solvency - Valuation of Liabilities & Value at Risk Methodology20 November 2009 Jason Park Value at Risk Methodology in IAIS document Guidance on the use of Internal Models briefly comments about VaR –The IAIS notes that some solvency regimes which allow the use of internal models to determine regulatory capital requirements currently set a confidence level for regulatory purposes, which is comparable with a minimum investment grade level. Some examples of modelling criteria include a 99.5% VaR calibrated confidence level over a one year timeframe, a 99% VaR over one year and a 95% TVaR over the term of the policy obligations. Different criteria apply for PCR and MCR.

21. Solvency - Valuation of Liabilities & Value at Risk Methodology21 November 2009 Jason Park A sample target criteria – VaR at 99% confidence level, 1 year time horizon Probability Losses Current estimate 75% percentile 99% percentile Technical provisionCapital requirement 1 in 100 years event

22. Solvency - Valuation of Liabilities & Value at Risk Methodology22 November 2009 Jason Park Presentation Overview Part I : Introduction of the IAIS Part II : International Solvency Requirements (ISRs) within the IAIS Framework for Supervision Structure of regulatory capital requirements Use of internal models for regulatory capital purposes Value at Risk Methodology in IAIS document Valuation of assets and liabilities for solvency purposes

23. Solvency - Valuation of Liabilities & Value at Risk Methodology23 November 2009 Jason Park Ongoing works of “Joint Valuation Working Group” (by the Solvency and Insurance Contracts Subcommittees) –Summary of Requirements / Guidance on the Valuation of Assets and Liabilities, including Technical Provisions for Solvency purposes –Appropriate valuation of assets and liabilities for solvency purposes is a fundamental part of a solvency regime and contributes to the consistent assessment of insurer strength –Characteristics of technical provisions are similar to those being considered by IASB Standard & Guidance on the Valuation of Assets and Liabilities for Solvency Purposes

24. Solvency - Valuation of Liabilities & Value at Risk Methodology24 November 2009 Jason Park Standard on the Valuation of Assets and Liabilities for Solvency Purposes Key Principle The IAIS believes that it is most desirable that the methodologies for calculating items in general purpose financial reports can be used for, or are substantially consistent with, the methodologies used for regulatory reporting purposes, with as few changes as possible to satisfy regulatory requirements.

25. Solvency - Valuation of Liabilities & Value at Risk Methodology25 November 2009 Jason Park Standard on the Valuation of Assets and Liabilities for Solvency Purposes General valuation requirements for assets & liabilities The valuation for solvency purposes of assets and liabilities should be undertaken on consistent basis Assets and liabilities should be valued in a reliable and transparent manner The valuation for solvency purposes of assets and liabilities should be an economic valuation An economic valuation of assets and liabilities should reflect the risk adjusted present values of their CFs Key requirements – provisional

26. Solvency - Valuation of Liabilities & Value at Risk Methodology26 November 2009 Jason Park Standard on the Valuation of Assets and Liabilities for Solvency Purposes Valuation of technical provisions The solvency regime should require the valuation of technical provisions to exceed the current estimate of the cost of meeting the insurance obligations (Current Estimate) by a margin to reflect the inherent uncertainty of those obligations (Margin over the Current Estimate or MOCE) The Current Estimate should reflect the expected present value of all relevant future cash flows that arise in fulfilling insurance obligations using unbiased current assumptions Key requirements – provisional (continued)

27. Solvency - Valuation of Liabilities & Value at Risk Methodology27 November 2009 Jason Park Standard on the Valuation of Assets and Liabilities for Solvency Purposes Valuation of technical provisions The MOCE should reflect the inherent uncertainty related to all relevant future cash flows that arise in fulfilling insurance contract over the full time horizon thereof The valuation of technical provisions should allow for the time value of money. The solvency regime should establish criteria for the determination of appropriate interest rates to be used in the discounting of technical provisions Key requirements – provisional (continued)

28. Solvency - Valuation of Liabilities & Value at Risk Methodology28 November 2009 Jason Park Standard on the Valuation of Assets and Liabilities for Solvency Purposes Valuation of technical provisions The value of technical provisions should not reflect the insurer’s own credit standing The solvency regime should require the valuation of technical provisions to make appropriate allowance for embedded options and guarantees Key requirements – provisional (continued)

29. Solvency - Valuation of Liabilities & Value at Risk Methodology29 November 2009 Jason Park www.iaisweb.org Asociación Internacional de Supervisores de Seguros Muchas Gracias ! jason.park@bis.org