CPI Workshops FCR Modeling

Ingredients of a capital model Requirements Timelines Options FCR report Extracting value from FCR Steps in an internal modeling exercise What is DFA Components of a DFA model Analysis o

Capital modeling from a South

African Regulatory Perspective

Sam Isaacson

1 February 2007

Capital Analytics

problems…

experience in Financial Services…

requirements (2005/2006)

Outline of this presentation

1 Synopsis of the current regulatory framework

2 Practicalities of implementing a capital model

3 Ingredients of a capital model

Requirements

Timelines

Options

FCR report

Extracting value from FCR

Steps in an internal modeling exercise

What is DFA

Components of a DFA model

Analysis of the results

Regulatory background

Assessment for Short-term Insurers, 15 December 2006 (source)

proposed by the FSB

that the benefits outweigh these costs

circumstances

FCR Timelines & Consequences

Industry Consultation

Release of FSB

issues paper

Full Implementation Operational Capital Model

Model Development

FSB Closure for comment

Insurance Amendment Bill tabled in parliament

Implementation of FCR

Transition Arrangements

The FSB has stated that it will consider approval of models that have been in operation for at least a year before implementation

First time implementation for Financial year-ends after

1 January 2009 The creation & calibration of a

company-specific Capital model is not a trivial task

Current options

modeling:

FSB)

specific elements,

stepping-stone)

industry averages)

SA

flexibility within the

prescribed framework

Prescribed Model Alternate Parameters

Non-proportional re-insurance Alternate model structure Actuarial Sign-off Model Review

Increasing Cost, Complexity

& Appropriateness

A continuum of possibilities…

Prescribed Model

Certified Model

Internal Model

Certified Model

Certified Model

OR Internal Model

Internal Model

Scope for certified models

Scope for internal models

A grey area!

this grey area into a healthy

breathing space for companies

Financial Condition Report

all registered Short-Term Insurers

condition of the insurer”

calculations performed by the insurer

report less than larger insurers

approved person – in all likelihood, Actuarial assistance will have been obtained for the calculations etc…

Issues for discussion in an FCR report

Extracting value from FCR

FCR

Risk Management

Strategic Pricing

Reinsurance

Capital Management

Capital Allocation

Expansion

Plans

Accounting

Disclosures: Risk

quantitative insights into your business

Components of an internal capital

modeling project

Structure

It is vital that the structure of the model reflects the structure of the business This assists later in understanding and communication of the model results Further, data is most likely to be available in line with the natural structure of the business.

Key Risks

The list of risks to be discussed in the FCR document can be used as a guide In the majority of cases an insurer would focus on modeling underwriting risk & reserving risk

Software Mapping

Software can assist you in putting together a capital model but does not replace the

crucial modeling elements discussed above! At the end of the day, people perform modeling not software.

Calibration

The structure set-up in the preceding steps needs to be populated with parameters relevant to the key risks identified This will be accomplished with reference to company-specific data and industry-data on a case by case basis

Analysis

While the modeling tasks are complete, the analysis of results can now begin This stage will depend on the particular investigation (capital modeling, reinsurance strategy, etc…)

Company Structure

A

C

C

E

N

G

G T E

L I A B

M I S C

M O T

P R O P

T R A REINSURANCE

treaty1

treaty2

treaty3

RI Layer1

RI Layer2 Aggregate

(c) Reinsurance treaty

centric

(d) Product/Channel centric

Where does DFA fit into FCR?

that computes the results for FCR

Short-Term Insurer applying a dynamic simulation based approach

made – think of producing a budget with excel…

their relative frequency – statistical variability

distribution of year one profit/loss

loss 200 years

Even Actuaries want to be fashionable

however long & complicated

formula

) (

) ( )

( )

4 3

2 2

1

SC i = β + β × + β × + β × + β × + β × ×

thereby encapsulating the uncertainty in a natural manner

becoming a reality for computation due to increases in computing power

DFA building blocks

Premiums

Claims

Commission & Expenses

Investment Return

Line of Business One

Line of Business Two

Line of Business Three

RI Layer One

RI Layer Two

Σ Aggregation (Correlation & Diversification) Σ

How can DFA assist you (I)

the financial outputs – a decision

makers dream!

distribution of profit one, two and

three years into the future

as the projection period increases

Profit

Profit 2007 -Statistical Distribution

Profit

Profit 2008 -Statistical Distribution

Profit 2009 -Statistical Distribution

How can DFA assist you (II)

business

product pricing

Allocation of Capital to Classes of Business

motor

liability

engineering

property

guarantee

Class of business

Expected Claims Expense Allowance Commission

Margin Excess / Shortfall

Return on Capital

How can DFA assist you (III)

(re-insurance, investment, pricing,…)

Efficient Frontier

Downside risk

dominates at the higher risk levels

Questions?

Sam Isaacson

Cell: 073 190 1978

Fax: 086 637 7494

305B Killarney Mall Office Towers

66 Riviera Rd

Killarney 2193

Johannesburg