solvency ii to identify, measure, manage and report risk and support scr scr qualitative...

© Lloyd’s 1

Solvency II IMSCR workshop

8 &11 May 2012

© Lloyd’s 2

We’re not here to debate…

…the rights and wrongs of the 99.5th …

© Lloyd’s 3

…purpose is to help set adequate and equitable member capital for 2013

Permission to utilise Solvency II models to meet ICAS requirements

Guidance and discussion so that

Lloyd’s Capital Return quantitative contents allows agents to demonstrate

ability to identify, measure, manage and report risk and support SCR

SCR qualitative documentation allows agents to ensure [Lloyd’s] is able

to understand the design and operation of the model

Lloyd’s and agents prepared for intensive and fair review

To agree SCR: NOT authorisation of the internal model

© Lloyd’s 4

Agenda

Introduction

Lloyd’s Capital Return

Methodology documentation

Table discussions and play back/Q&A

Lloyd’s review and validation

Table discussions and play back/Q&A

Next steps and feedback

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Introduction

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Although out of scope for today, following also under urgent consideration

Economic capital uplift

Transitional measures

Notification of continuous capital adequacy

Review process under BAU 2013 and beyond

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Cash flows and aggregate capital resources materially unchanged…

Total 1:200 asset stack

Solvency II Technical Provisions

UK GAAP Technical Provisions

ICA SCR

(one year risk)

Ultimate Risk

Uplift and Central Assets

Now Solvency II

Adjust for premium debtors moving to TPs

© Lloyd’s 8

…and Ultimate SCR can be reconciled to ICA

Both exclude FAL and surplus syndicate assets, including FIS

ICA includes discounting credit as profit offset within capital

Risk free in TPs and additional discounting credit as profit offset within capital

GAAP Technical Provision

ICA

Reserve Margin etc.

Risk margin

SII Technical Provision

Ultimate SCR

© Lloyd’s 9

Reconciliation from GAAP TPs to Solvency II possible and required

Change in reserves from half-year 2011 to projected year-end 2011

50%

55%

60%

65%

70%

75%

80%

85%

90%

95%

100%

Current basisnet reserves as

at half year-2011

Removal of100% UPRrequirement

and margins forprudence

Inclusion offuture

premiums*

Change ofexpense basis

Allowance forbinary events

Discountingcredit

Inclusion of riskmargin

Solvency II nettechnical

provisions as athalf-year 2011

Solvency II nettechnical

provisions as atyear-end 2011

Source of change in reserves

% o

f hal

f-yea

r 201

1 cu

rren

t bas

is h

eld

rese

rves

* Includes profit from unincepted contracts

© Lloyd’s 10

Ultimate SCR provides equivalent policyholder protection

Required to demonstrate syndicates meet ICAS requirements for 2013

Aggregate capital resources materially unchanged

Account for TPs difference in basis

Measured against ICAS not full Solvency II tests and standards

Delivered through

Lloyd’s Capital Return : quantitative, equivalent to Art 101

Methodology documentation : qualitative, equivalent to Art 121 to 124

Rigorous Lloyd’s review as “knowledgeable party” : Art 125

© Lloyd’s 11

LLOYD’S CAPITAL RETURN (lcr)

© Lloyd’s 12

LCR ground rules…

Submit via Core Market Returns by 19 July and final 20 September

All syndicates…all forms

Attachments via Form 990

Numbers are in £m to two decimal places

In UAT from 30 May, live release 18 June

Unsure of format / requirements…

Ask in June NOT 5pm 19 July

Contact Kevin Barnes ([email protected]) or Tom Grace ([email protected]) or email [email protected]

mailto:[email protected]



© Lloyd’s 13

LCR Form 309: Risk by category

Evidence that each risk component modelled at 1:200 stress

Evidence that diversification appropriate

Critical data for benchmarking and peer analysis

Follow instructions for allocation to ensure consistency

Recognise constraints: sense check presentation of findings

Insurance Risk total: After diversif ication betw een Premium and Reserve Risk 1

Diversif ied Insurance Risk Total

w : if A1 = (A2 + A3)v: if A1 > (A2 + A3)

split: Premium Risk (see note below ) 2 +ve w : if -ve

split: Reserve Risk (Note 309.4) 3 +ve w : if -ve

Market Risk (see note below ) 7 +ve w : if -ve

… 8 +ve w : if -ve

TOTAL (Note 309.3) 9 A1 + A4 + A7 + A8

© Lloyd’s 14

LCR Form 310: Balance sheet projection

Purpose to calibrate / validate LIM

Using mean and intervening distributions up to 99.5th

Expected net assets projected forward to T1 / Ultimate from Nil “basic own funds” at Dec 2012

All on Solvency II basis, not GAAP

Provides measure of volatility

Compare to modelled claims – Form 311

MeanA

Distribution of balance sheet position on One-Year basis (Note 310.1) -ve w : if +ve

Distribution of balance sheet position on Ultimate basis (Note 310.2) -ve w : if +ve

© Lloyd’s 15

LCR Form 311: Modelled claims…

Gross and net CLAIMS and claims expenses (ALAE)

Stand-alone claims volatility from mean to 99.5th

Not premiums…not admin expenses…not ULAE…not exchange risk…not discounted…not bad debt provisions…

All claims cash flows from 1 January 2013 for risks within each SCR definition

Claims TPs at T0 (from Form 312) plus emerging on new business

Percentiles

Mean 99.5th

A G

One-Year basis (Note 311.2)

1 Net of reinsurance +ve v: if -ve+ve v: if -vev: if F1 < E1

+ve v: if -vev: if G1 < F1

© Lloyd’s 16

…and includes expected claims by YOA

Opening balance sheet claims and claims expenses from Form 312

Consistency in projections of TPs across the firm so limited adjustments

Add claims emerging on new business (bound from 1 Jan 2013)

One year SCR contract boundary definitions

Compare to SBF projections

Net Insurance Claims brought forward Adjustments New Business Total Claims

(complete form 312 column H to populate this section) (Note 311.8) (Note 311.9)

2010 Pre-populated = form 312,

column H, 2010 yoa +ve w : if -ve

w : if > 0 Sum: (H + I + J)


column H, 2011 yoa Sum: (H + I + J)


column H, 2012 yoa Sum: (H + I + J)


table 2, column H Sum: (H + I + J)

© Lloyd’s 17

LCR Form 312: Technical Provisions at Dec 2012

Projected gross and net claims and premiums as at T0 (Dec 2012)

Assume expected development for balance of 2012

Discounting, r/I bad debt and risk margin separately disclosed

Compare to other return information and latest actuals to sense check

Claims(Note 312.2)

Expenses (Note 312.4)

Discount Benefit

Premium (Note 312.3)

Acquisition Cost

Discount Benefit

1

Forecast Technical Provision cash flows by Underlying Pure Year of account

(Note 312.7) H I J K L M NO = H + I - J - K +

L + M + N P Q = O + P

1993w : if A <> 0

but H is emptyw : if B <> 0

but I is empty w : if J > (H + I)w : if D <> 0

but K is emptyw : if E <> 0

but L is empty w : if M > (K - L)

…

2012w : if A <> 0





2Unincepted Legal Obligations Proposed yoa

(Note 312.6)w : if A <> 0





Future Premiums

Net

Risk Margin(Note 312.5)

Technical Provisions

Best Estimate Liabilities

Discounted Bad Debt Provision

(Note 312.8)

Insurance losses(Note 312.2)

© Lloyd’s 18

LCR: Form 313: Catastrophe risk summary

All NET claims and claims expenses under syndicate definition of Catastrophe

For exposures from 1 January 2013

Include the five peak perils within the LCM

One year and Ultimate SCR definitions – undiscounted, see Form 311

Diversification is within insurance risk modelled losses

Commentary on treatment of whole account reinsurance

(Note 313.1)Net Mean Net 99.5th

F G

1 +ve w : if -ve +ve w : if -ve

2 +ve w : if -ve +ve w : if -ve

3 -ve w : if +ve -ve w : if +ve

4 Sum: F1 + F2 + F3

v: if <> Form 311 A1 Sum: G1 + G2 + G3v: if <> Form 311 G1

One-Year

Catastrophe Losses only

All Other Insurance Losses

Diversification Credit

Total

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METHODOLOGY DOCUMENTation

© Lloyd’s 20

Methodology documentation

Principles

Quantitative analysis

Model change

© Lloyd’s 21

Cover full methodology to demonstrate appropriate and adequate SCR

Mapping where covered in existing material

Platform, theory, assumptions and mathematical basis

Validation overlap recognised

Sensitivity tests on key drivers

Stress tests and reverse stress tests

Refer to ICA Minimum Standards & Guidance (2010)

Critical - Universe of evidence: If you think it would be useful, include it!

© Lloyd’s 22

Assess all risks at required stress

No requirement for implicit or explicit prudence

Don’t offset margins – limited, if any, credit

Recognise limitations and uncertainties

Quantifying ranges is clearly useful

What would cause insolvency?

reverse stress tests

© Lloyd’s 23

Guidelines for detail required

How assess lines of business correlation across currency / YOA

Why method is appropriate for own risk profile

Why model output deemed insufficient and basis for loading

Data validated model to an extent; data limitations so also used [say US F&P] as relevant to these classes

State H / M / L correlations used

Market practice

Added [20%] on top for uncertainty

“Limited data so used benchmarks”

© Lloyd’s 24

Set out the mean, the stress applied for each risk and diversification benefit

Risk category Mean £m Stress £m Reserves Nil – set at pure best estimate

[+£20m] – risk margin run-off [£-100m] – main classes, YOA,

Premiums [+£50m] – 2013 risks and 2012 binder that are not bound at T0

[£-150m] – catastrophe, attritional…

Market [+£30m] – excess over risk free

[£-60m] – above aggregate of risk free discounting and additional return, exchange, FX, liquidity

Diversification n/a [+£60m] – compare to dependence (Nil) and independence (£120m)

Totals Expected [+£100m] SCR [£150m]; stress of [-£250m] above expected [+£100m]

© Lloyd’s 25

Reconcile the one year and ultimate SCRs

Risk from 1 January 2013 1 Year Ultimate

Premium income exposed to adverse stress 2013 calendar year Full 2013 YOA

Booked profit on unexpired risk and ULO (2014) Credit in T1 B/S Mean plus stress on

2013 YOA;

2014 ULO excluded

Risk (loss) emergence 12 month volatility Ultimate volatility

Risk margin Movement to T1 Run-off from T0

© Lloyd’s 26

Expected additional analysis to support SCR

Material reinsurance arrangements

exhaustion, frequency “in play”, major counterparties

1:200 ULRs and implied reinsurer loss and loss ratio at stress

Dominant risk and implied incremental capital for adding other risks

Sensitivity to new business

Interaction of premiums and market risk to claims experience

Again, if you think it would be useful, include it!

© Lloyd’s 27

Our primary method for allocation of the SCR by risk category is…

A. Direct model output

B. Average VaR at less improbable return

periods

C. Average VaR around 99.5th percentile

D. TVaR

E. Expert Judgement

8 May results

11 May results

44%

A

4%

B

31%

C

18%

D

2%

E

33%

A

4%

B

42%

C

16%

D

4%

E

© Lloyd’s 28

To me, “SCRs are not materially misstated means…

A. Nothing…it can’t be done”

B. Within + / - 20% of the stated number”

C. Within + / - 10% of the stated number”

D. It is right – SCR is true and fair”

E. Other

8 May results

11 May results

13%

A

30%

B

34%

C

15%

D

9%

E

20%

A

20%

B

47%

C

7%

D

7%

E

© Lloyd’s 29

Our calculation basis for the ultimate SCR is based on …

A. All risk categories to ultimate

B. Risk to ultimate except operational risk (1

year)

C. Risk to ultimate except market risk (1 year)

D. Insurance and r/I credit risk to ultimate; all

others to 1 year

E. Other

8 May results

11 May results

43%

A

28%

B

9%

C

20%

D0%

E

56%

A

9%

B

9%

C

27%

D0%

E

© Lloyd’s 30

How often do you plan to run your model to calculate the SCR?

A. Every month (or more frequently)

B. Every quarter

C. Only when we think we need to

D. Only when Lloyd’s require it

E. Other

8 May results

11 May results

4%

A

60%

B

30%

C

2%

D

4%

E

0%A

59%

B

33%

C

9%

D0%

E

© Lloyd’s 31

How do you plan to deal with model re-runs during the year?

A. Accurately, eg quarterly time periods and quarterly reparameterisation

B. Using year end inputs, but updated business plan

C. Adjusting year end inputs to reflect in year experience using updated business plans

D. Something else

8 May results

11 May results

2%

A

28%

B

65%

C

4%

D

4%

A

31%

B

49%

C

16%

D

© Lloyd’s 32

Model change transition to BAU

Solvency II not live – no prior authorisation required

Analyse movements between submissions

model change v revised inputs (e.g. updated TPs, business plan

adjustments)

Backtesting of changes – what would SCR stand at on previous inputs

Include Dec 2011 “as if” SCR where major model change in 2012

© Lloyd’s 33

Consistency with SBF

Match July and September submissions with preceding SBF

Approval sought for planned volumes and exposures (RDS)

Capitalise for these risks as a minimum

Analyse movements between SBF submissions

Consider impact of late plan changes on SCR

Lloyd’s will explicitly consider the risk that while plan profitability is realistic

and achievable, true best estimate is worse than plan

© Lloyd’s 34

Table discussions

© Lloyd’s 35

Suggested topics

What’s missing?

What should be highlighted?

Clarity around requirements?

Can your model deliver the analysis and meet the risk category definitions?

© Lloyd’s 37

Professional scepticism…

Auditors’ code of conduct

Goodwill and good intent

Challenge management assertions

Factual agreement before conclusions

Alert to inconsistent responses

Persistence to reach a conclusion

Justification of conclusions

© Lloyd’s 38

…to test credibility and transparency

LCR and validation/documentation joined up

Actuals and projections are consistent with explanations for differences

Reasoned and persuasive responses

Realistic assessment of 1:200 at risk level

Prompt supply of available evidence

Inconsistent documents and / or model outputs

History dismissed (“We don’t write that anymore”) X

“Better model so it is lower”/ Offsetting “prudence”

Improbably thin tailed risk distributions

Jumble of emails and meeting notes hastily cobbled together

© Lloyd’s 39

Horses for courses…

Risk category Primary Team Areas of focus Reserves MRC - actuarial Tail risk

Dependencies between YOA

Premiums MRC – actuarial PMD support

Drivers of tail risk – market cycle, etc. Historical performance

Catastrophe Exposure Management

LCM 5 peak perils “Un-modelled risks” Reinsurance coverage

Market Treasury & Investment Management

Fixed interest – credit and duration Volatility; expected to 1:200

Diversification MRC - actuarial Joint return periods in outputs High granularity & low tail dependence

© Lloyd’s 40

Lloyd’s “Lines of defence”

Line Description Tests Outcome

1 LCR data validation

• Defective values • Unintended input errors

LCR that agent can “sign-off” on

2 LCR benchmarking

• Risk vs. reward & other comparisons

• By SCR/main risks

Identification of areas of focus for Line 4

3 SCR document review

• Methodology and assumption descriptions

• Review of required quantitative information

Completed SCR document review template

4 Model walkthrough

• Focus on issues identified in Lines 1-3

• Similar format to Dry Run walkthroughs

Revisions to model if required

5 Validation Report review

• Review against VR guidance requirements

Completed VR document review template

© Lloyd’s 41

Thoughts on disclosure…

Exposing all SCRs to scrutiny by other agents may enhance transparency and hold Lloyd’s more accountable

Provision of benchmarks / peer comparisons supports internal acceptance of divergent Lloyd’s views

MI helps agents understand differences and calibrate models

The information gets out anyway; better to have control

Expected to be public (SFCR)

SCRs confidential

Syndicates all have different risk characteristics

Time consuming explanations

Syndicates’ capital should be different: peer review will trend all to a central view

Allocation of extreme risk by component compounds statistical uncertainty

© Lloyd’s 42

Should syndicate capital ratios be made public?

A. Yes

B. Can see arguments both ways

C. No

11 May results

8 May results

40%

A

50%

B

10%

C

38%

A

46%

B

17%

C

© Lloyd’s 43

Should Lloyd’s provide market benchmark information to agents?

A. Yes, by risk category

B. Yes, at overall syndicate level

C. No

8 May results

11 May results

78%

A

16%

B

6%

C

88%

A

10%

B

2%

C

© Lloyd’s 44

Should Lloyd’s provide syndicate specific information to agents regarding the benchmark?

A. Yes, by risk category

B. Yes, at overall syndicate level

C. No

8 May results

11 May results

88%

A

4%

B

8%

C

71%

A

13%

B

17%

C

© Lloyd’s 45

SCR uncertainty is a given. With duty to be equitable, expect Lloyd’s to adjust member capital…

A. By up to 20% solely to address outliers

B. By up to 10% solely to address outliers

C. Both up and down solely to address outliers

D. Only if evidence of understatement by model

E. Other

8 May results

11 May results

2%

A

6%

B

23%

C

66%

D

2%

E

6%

A

10%

B

41%

C

43%

D0%

E

© Lloyd’s 47

Suggested topics

Preparation of peer groups – basis and disclosure

What MI would be useful

For Lloyd’s review

For agents to benchmark and own validation

© Lloyd’s 50

What happens next?

Slides will be made available on lloyds.com after both workshops

Feedback on draft SCR guidance by 18 May - PLEASE

Final instructions issued 31 May

FAQs published as agents work through requirements

LCR and SCR documentation by 19 July on initial SBF

Mix of Olympics and SCR reviews…

…Final LCR by 20 September…

….…CIL November!

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