Milliman Limited registered in England and Wales under Company Number 4076731

Individual Capital Assessment –Individual Capital Assessment –Setting Solvency Capital LevelsSetting Solvency Capital Levels2005 Casualty Consultants’ Forum2005 Casualty Consultants’ Forum

Presented byPresented by

Kyle Mrotek Kyle Mrotek 1616thth June 2005 June 2005

Milliman

Agenda

Components of ICAComponents of ICA Approach to ICAApproach to ICA Modelled RisksModelled Risks Consideration of Capital RequirementConsideration of Capital Requirement Added Value Beyond Regulatory Added Value Beyond Regulatory

RequirementsRequirements

Milliman

Components of ICA

Milliman

Capital

Credit

Market

LiquidityGroup

Insurance

Operational

FSA Risk Types - Defining Capital Requirements

Milliman

• Insurance Risk:Insurance Risk:­ Adequate premiums, pricing methodology, deterioration of Adequate premiums, pricing methodology, deterioration of

reserves, catastrophes reserves, catastrophes

• Market Risk:Market Risk:­ Adverse movements in assets (both capital & interest)Adverse movements in assets (both capital & interest)

• Credit Risk:Credit Risk:­ Reinsurance, intermediaries, quality of counterparties and off Reinsurance, intermediaries, quality of counterparties and off

balance sheet transactionsbalance sheet transactions

• Liquidity Risk: Liquidity Risk: ­ Low liquidity of assets when required Low liquidity of assets when required

• Operational Risk:Operational Risk:­ Administration, compliance, event, fraud, governance, strategic and Administration, compliance, event, fraud, governance, strategic and

technological riskstechnological risks

• Group Risk: Group Risk: ­ Insolvency/credit downgrading of parent, removal of guarantee, Insolvency/credit downgrading of parent, removal of guarantee,

compulsory dividends, performance guarantees, contagion … compulsory dividends, performance guarantees, contagion …

Risk Assessment for ICA Purposes

Milliman

Approach to ICA

Milliman

Overview

• Probability of insolvency over a 1 year time Probability of insolvency over a 1 year time horizon is no greater than 1 in 200horizon is no greater than 1 in 200

• Dynamic Risk Model (DRM) of 2 of the Dynamic Risk Model (DRM) of 2 of the major risks – Insurance and Market risksmajor risks – Insurance and Market risks

• Non-modelled (excluded) risks need to be Non-modelled (excluded) risks need to be assessed separatelyassessed separately

• Combine capital requirements for risk Combine capital requirements for risk factors allowing for diversification benefitsfactors allowing for diversification benefits

Milliman

Estimate correlations between risk areas and determine aggregate capital requirement

Dynamic Risk Model

Individual Capital Assessment

Determining the ICA based on Risk Assessment

InsuranceRisk

CreditRisk

MarketRisk

OperationalRisk

LiquidityRisk

GroupRisk

AdditionalRisk

Consider

Benchmarks

Loss History

Consider

MaximumCash-flow

ContingencyPlans

Consider

CapitalStructure

ContagionRisk

Consider

ConcentrationRisk

SystemControls

Capital requirement for Insurance and

Market Risk

Consider

Counterparties

Off BalanceSheet Items

Milliman

Modelled Risks

Milliman

DRM Overview• Excel spreadsheet with VB add-insExcel spreadsheet with VB add-ins

• Projects on a stochastic basis expected cash-flows Projects on a stochastic basis expected cash-flows for 5 years from the valuation date in respect of:for 5 years from the valuation date in respect of:

– business in-force and asset holdingsbusiness in-force and asset holdings

– planned future business (for next 5 years)planned future business (for next 5 years)

• DRM is run for (say) 5,000 scenarios based on DRM is run for (say) 5,000 scenarios based on realistic assumptions for the mean and variance realistic assumptions for the mean and variance of loss ratios, claim payment patterns, future of loss ratios, claim payment patterns, future investment returns and expensesinvestment returns and expenses

• Additional assets required to cover liabilities and Additional assets required to cover liabilities and deficits emerging at the 99.5deficits emerging at the 99.5thth percentile (over 1 percentile (over 1 year) is the required capital for that scenarioyear) is the required capital for that scenario

Milliman

Outline of Process

SimulateResults

Sample fromDistributions

Model Insuranceand AssetPortfolio

Gross, and Net Results, in Financial Accounting Framework

Loss distributions

Premiums

Balance Sheet

Generate random number

Obtain value from distribution

Milliman

DRM Flow

LOB 1Business characteristics

and patterns

LOB 3Business characteristics

and patterns

LOB 2Business characteristics

and patterns

FinancialCalculator

Starting Balance Sheet

Corporate Elements

Reinsurance Investment

Capital Mix Taxes

Years 1-5 Financial Results

•Balance Sheet•Income Statement

AnalyserMeasures of

•Risk•Return

Capital Requirement

Milliman

Existing Business Assumptions

ClassTraditional Middle Market

Financial Products

Australia Large Risk

Expected Gross OS 5,976 3,899 940 63 33,872CoV 31% 31% 31% 31% 50%Expected ceded OS 2,099 2,817 - 48 22,407CoV 31% 31% 31% 31% 50%Correlation to gross 100% 100% 100% 100% 100%Payout 1 81% 35% 81% 81% 99%Payout 2 96% 64% 96% 96% 100%Payout 3 99% 83% 99% 99% 100%Payout 4 100% 92% 100% 100% 100%Payout 5 100% 96% 100% 100% 100%Payout CofV 50% 75% 50% 50% 75%Loss distrns LogNormal LogNormal LogNormal LogNormal LogNormal

Milliman

Future Business Assumptions

ClassTraditional Middle Market

Financial Products

Australia Large Risk

EPI 1 21,543 10,126 1,213 2,550 134EPI 2 25,178 12,968 1,668 4,196 134EPI 3 27,721 13,617 2,146 5,224 0EPI 4 30,738 14,298 2,647 6,306 0EPI 5 34,027 15,013 2,265 7,042 0Commission 0% 0% 0% 0% 0%ULR attnl 43% 48% 116% 55% 70%StdDev 13% 15% 36% 17% 22%Payout 1 53% 6% 53% 53% 14%Payout 2 91% 35% 91% 91% 55%Payout 3 98% 64% 98% 98% 81%Payout 4 100% 83% 100% 100% 93%Payout 5 100% 92% 100% 100% 97%Payout CofV 50% 75% 50% 50% 75%

Net Premium 10,511 3,421 1,213 1,244 67Net ULR 43% 48% 116% 55% 70%Premium Cession 51% 66% 0% 51% 66%Ceded ULR 43% 48% 0% 55% 70%StdDev 13% 15% 36% 17% 22%Correl to gross 70% 80% 70% 70% 90%Loss distrns LogNormal LogNormal LogNormal LogNormal LogNormal

Milliman

Marketing Surplus Assumptions

Cat 1Type Middle Market

Exposure splitFrequency 0%Loss size 100%

Expected FrequencyExp'd freq 0.63

Expected SeverityMean 337 St Dev 130 Distribution LogNormal

Attritional R/I%age inuring r/i 0%

Payout patternPayout 1 6%Payout 2 35%Payout 3 64%Payout 4 83%Payout 5 92%Payout CofV 75%

Milliman

Economic Assumptions

Hull-White Parametersalpha 50.22%sigma 2.11%V(r) 0.0281%

Black-Scholes Parametersrho (Bond-Equity) -40%Index 4,476.9

Wilkie Parameters InflationQMU 0.035QA 0.58QSD 0.02Current 2.50%

t= 0 1 2 3 4 5 Inv %ageInflation 2.50% 2.81% 2.43% 1.75% 1.52% 1.08%Cash 3.00% 4.31% 3.93% 3.25% 3.02% 2.58% 90.00%1 year bond 3.50% 6.18% 9.12% 10.03% 6.07% 6.13% 0.00%5 year bond 4.00% -0.09% 4.30% 14.59% 5.23% 9.23% 0.00%Equity 6.00% -3.71% 3.05% -12.76% 24.96% -11.01% 10.00%Zero return 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%Overall 3.51% 3.84% 1.65% 5.21% 1.22%Exp'd infl 2.50% 2.92% 3.16% 3.30% 3.39% 3.43%

Models UsedModels Used

Hull-White for BondsHull-White for Bonds Black-Scholes for Black-Scholes for

EquitiesEquities Wilkie for InflationWilkie for Inflation Models simulate future Models simulate future

returns (capital and returns (capital and interest)interest)

Milliman

Correlation Matrix

Tra

ditio

nal

Mid

dle

Mar

ket

Fin

anci

al P

rodu

cts

Aus

tral

ia

Larg

e R

isk

Traditional-H 100% 20% 20% 20% 20%Middle Market 20% 100% 20% 0% 20%Financial Products-H 20% 20% 100% 20% 20%Australia-H 20% 0% 20% 100% 0%Large Risk 20% 20% 20% 0% 100%

Milliman

Capital Requirements

Milliman

Indicative Capital Requirement

Capital required aims to be sufficient to Capital required aims to be sufficient to reduce the probability of insolvency on a reduce the probability of insolvency on a realistic basis in the next 12 months to no realistic basis in the next 12 months to no more than 1 in 200 more than 1 in 200

Emerging as an industry-wide minimum Emerging as an industry-wide minimum standard (although other probabilities of standard (although other probabilities of insolvency over different time horizons can insolvency over different time horizons can be considered)be considered)

Milliman

Draft Results for DGI

Indicative Capital Requirements (£000s)

* excludes non-insurance liabilities

Assets 130,927 130,849 129,322 124,163 122,168

Liabilities*

- UPR 129,176 133,696 138,440 143,461 148,833

- Claims O/S 8,779 9,239 10,199 10,956 12,253

Surplus Emerging -7,027 -12,085 -19,318 -30,254 -38,918

Total Required Assets 137,955 142,934 148,640 154,417 161,086

Capital Required 7,027 12,085

19,318 30,254 38,918

End of Year 5

(2009)

End of Year 3

(2007)

End of Year 1

(2005)

End of Year 2

(2006)

End of Year 4

(2008)

Milliman

Draft Results for DGS

£1.9 million in year 1 with 10% volatility £1.9 million in year 1 with 10% volatility £11.4 million in year 1 with 15% volatility£11.4 million in year 1 with 15% volatility £3.5 million in year 1 with 10% volatility & £3.5 million in year 1 with 10% volatility &

URRURR £22.8 million in year 1 with 15% volatility & £22.8 million in year 1 with 15% volatility &

URRURR

Milliman

Added Value BeyondAdded Value BeyondRegulatory RequirementsRegulatory Requirements

Milliman

Any Other Business?