nav garayal: challenges of risk based capital for (re) takaful companies

Proprietary & Confidential

Challenges of risk based capital for (Re) Takaful Companies Nav Garayal, Aon Global Risk Consulting

Master class - International Takaful Summit

30 June 2009, London


Why is Capital important?

Capital and it’s Constituents

Investors: want a return on capital

Regulators: solvency capital is important to protect policyholders

Rating agencies: capital adequacy eg BCAR (AM Best) ; S&P model

IFRS / US GAAP / Local GAAP

Research analysts

Each have historically differing views which are now starting to converge ie a risk based approach


Capital and Risk

Insurance related risks are driver of overall impairments but there is a strong correlation between insurance and operational risks

Operational risks are significant

Asset risk of secondary importance but now becoming more important due to fair value accounting, current crisis

Impairment frequency higher for smaller companies than larger companies

Approximately 650 impairments* over 38 year period 1969-2006

Source: A. M. Best Impairment Study, 2007

* A. M. Best defines impairment as restrictive regulatory action

Cause (1969-2006) Pct TotalDeficient Loss Reserves / pricing 37.6%

Rapid Growth 15.7%

Alleged Fraud 8.1%

Catastrophe Losses 7.7%

Impairment of Affiliate 7.2%

Overstated Assets 6.9%

Significant Change 4.4%

Reinsurance Failure 3.3%

Miscellaneous 9.0%

Proprietary & Confidential 4

Importance of risk based capital (RBC) approaches

Aims

• Create a harmonised system based on the assessment of risks thus protecting policyholders / shareholders

• Enhance transparency to the decision making process

• Strengthen competition within the insurance sector

Benefits

• Promotion of risk awareness across the entire organisation

• Alignment of strategy to risk and risk management

• Decision making and risk monitoring linked to capital base

• Strong risk management and brand are rewarded by investors

Framework for dealing with regulators eg Solvency 2

Aligns stakeholder interests – investor / regulator / rating agency


RBC approaches to regulation around the World

UKICAS / S2

SwitzerlandSwiss Solvency Test

AustralaGPS 110

USARBC model (NAIC)

CanadaDCAT

NetherlandsMinimum/ solvency/ continuity test

South KoreaNew RBC approach in 2006

Denmark/ SwedenNew supervisory regimes in planning

MalaysiaRBC

Approach

ThailandNew RBC

approach 2009

MexicoSolvency II Approach


StrategyAssessment

Design & Construction

Base Capital Requirement

Output

Risk Mitigation SolutionsOutput

Ou

tp

ut

RBC modelling overview

Strategy Risk Areas

Risk based capital model

Choose scenarios based on key performance

drivers

Scenario testing of RBC model

Insurance riskReserving riskOperational riskCredit riskLiquidity riskGroup riskMarket risk

Deterministic or stochastic model

Bespoke or off the shelf


Challenges for RBC approaches

According to S&P : Companies are not yet benefiting from Strategic Risk Management

» Risk control: strong but in silos with no focus on correlations of risks

» Emerging risk management: weak and not addressed consistently

» Risk models: weak, but improving

» Many companies are currently investing heavily to improve their modeling capabilities in advance of Solvency II

Key factor “Use Test” – capital modelling tool is embedded into the management decision making process


Implications of RBC for Takaful market

International Association of Insurance Supervisors (IAIS) represents 97% of GWP worldwide through 190 members seeking to improve Insurance Supervision and adopt consistent standards based on an RBC type approach.

Takaful and Re-Takaful markets likely in future to fall under RBC regulatory framework• E.G. Malaysia, Thailand

RBC helps protects policy holder interests and is consistent with sharia’h compliance e.g. reputational risks

Approach will become a permanent fixture due to the changing risk landscape

event driven risks and correlation of risk

stakeholder needs

accounting, regulatory, legislative, corporate governance initiatives

Approach can leverage the significant investment required to compete with conventional insurance

Approach important for growing companies as it minimises the need to incur massive overheads by allocating capital on a risk adjusted basis

Rating agencies may ultimately give credit to RBC models if they are robust and the underlying risk management framework is sound


Challenges for takaful marketCurrently very few operators

allocate capital today

have an integrated capital and risk management model

pay their management based on value created

Today there is an under capitalisation of takaful operators eg where local regulation is under developed

UAE, Kuwait

Promotion of risk awareness across the entire organisation

Human capital constraints limit the development of modelling capabilities and also risk management.

Malaysia has introduced a deterministic approach to RBC

Limited understanding and utilisation of scenarios and correlation of risks or consideration of systemic risk

Embedding the capital model into decision making process.

Do Board of Directors and executive management conflict

Understanding the model output


Published by Aon Limited trading as Aon Benfield.

Aon Limited is authorised and regulated by the Financial Services Authority in respect

of insurance mediation activities only.

Aon Limited55 BishopsgateLondon EC2N 3BDUnited Kingdom

tel: +44 (0) 20 7086 5500

fax: +44 (0) 20 7621 1511

www.aonbenfield.com

nav garayal: challenges of risk based capital for (re) takaful companies

Documents