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STRESS TESTING FOR LIFE INSURERS Friday, 30th November 2012

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Thanita Anusonadisai The Office of Insurance Commission

AGENDA What is the definition and roles of stress testing?

What are the stress test requirement of other regulators?

Implementation plan of stress testing by OIC Stress test design and scope of scenario test for Thai life insurers Key areas of concerns and OIC’s expectations

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DEFINITION AND ROLE OF STRESS TESTING 3

DEFINITION OF STRESS TEST Prospective test to evaluate the financial position under specified conditions An important tool which can be used to assess the impact of various risks on its financial condition

unlikely but not impossible

Results can be incorporated into Capital Management Plan Main responsibility of actuary to conduct such tests It should be noted that they do not predict what will happen

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DEFINITION OF STRESS TEST

In Oct 2003, IAIS has launched the guidance paper “ Stress Testing by Insurers”

“Stress Tests are a tool for examining what might happen in a particular stress scenario. However, it should be noted that they do not predict what will happen”

“Stress tests are a necessary risk management tool for both insurers and supervisors to ascertain whether insurers are financially flexible to absorb possible losses that could occur under various scenarios”

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ICP 16: ENTERPRISE RISK MANAGEMENT FOR SOLVENCY PURPOSE

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ROLES OF STRESS TEST Allows for non-standardized investigations on vulnerability to key shocks Assess whether insurer has sufficient resources to withstand certain adverse shocks Determined the possible range of management actions that can be taken to recover from the shocks, and Identify measures that can be implemented to mitigate its exposure

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ROLES OF STRESS TEST

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STRESS TEST REQUIREMENT OF OTHER REGULATORS 9

BOT

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BANK OF THAILAND

2 type of stress tests

Supervisory stress test Economic factors (i.e. GDP, inflation rate, exchange rate, loan rate, etc) are prescribed by BOT Stress Scenarios are developed by commercial bank

Internal Capital Adequacy Assessment Process (ICAAP)

Both economic factors and stress scenarios are determined by each CM

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BANK OF THAILAND risk categories

frequency (at least)

credit risk and concentration risk

annually

market risk (for sale account)

quarterly

interest rate risk (for banking account)

quarterly

liquidity risk

quarterly

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BANK OF THAILAND risk categories

period

credit risk and concentration risk

at least 1 year

market risk (for sale account)

at least 10 days

interest rate risk (for banking account)

at least 1 year

liquidity risk

1 day, 7 days, 14 days and 1 month 13

OSFI

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STRESS TEST OF OTHER REGULATORS Canada: OSFI ICAAP: Internal Capital Adequacy Assessment Process DCAT: Dynamic Capital Adequacy Testing Based scenario; according to business plan Adverse scenario; 10 factors

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APRA

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STRESS TEST OF OTHER REGULATORS Australia: APRA Market risk Liquidity risk Credit risk Capital

ADI housing lending portfolio 2. IMF 7Macro 3. Capital Market 2007 1.

2002-2003 2005-2006 17

MAS 18

OVERVIEW STRESS TEST OF MAS

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MAS: ROLE AND RESPONSIBILITY OF STAKEHOLDERS

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MAS - FACTORS FOR SHORT-TERM SCENARIO

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MAS - FACTORS FOR SHORT-TERM SCENARIO (CONT.)

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MAS - FACTORS FOR MEDIUM-TERM SCENARIO

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MAS - FACTORS FOR MEDIUM-TERM SCENARIO (CONT.)

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MAS - FACTORS FOR SHORT-TERM FLU PANDEMIC SCENARIO (PRESCRIBED SCENARIO)

Additional prescribed Scenario a:

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MAS - FACTORS FOR SHORT-TERM FLU PANDEMIC SCENARIO (PRESCRIBED SCENARIO) (CONT.)

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MAS - FACTORS FOR SHORT-TERM FLU PANDEMIC SCENARIO (PRESCRIBED SCENARIO) (CONT.)

Additional prescribed Scenario b:

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MAS - FACTORS FOR SHORT-TERM FLU PANDEMIC SCENARIO (PRESCRIBED SCENARIO) (CONT.)

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BNM 29

ICAAP MALAYSIA Responsibility of insurers Dialogue

Internal Capital Adequacy Assessment Process (ICAAP) Comprehensive risk assessment

ICAAP & Regular Updates

of insurer’s risk profile and quality of risk management

Conduct stress testing base on plausible adverse scenarios and incorporating insurer’s risk profile and business plan Individual target capital level

Supervisory Review

Supervisory Review of ICAAP

Supervisory review under the Risk-based Supervisory Framework (RBSF)

Supervisory evaluation of on-going compliance with minimum standards and requirements

Review of ICAAP: Offsite reviews, onsite reviews, discussions with board and senior management, discussion with external parties involved in ICAAP Overall assessment and conclusion

Capital management plan

Board range of supervisory measures

Not Satisfactory

Satisfactory

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OVERVIEW STRESS TEST OF BNM

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BNM: ROLE AND RESPONSIBILITY OF BOARD AND SENIOR MANAGEMENT

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BNM - FACTORS FOR SENSITIVITY ANALYSIS

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BNM - FACTORS FOR SENSITIVITY ANALYSIS (CONT.)

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BNM - COMMON STRESS TEST SCENARIO Category

Historical

Hypothetical

Equities

Black Monday 1987 Asian financial crisis 1997 Bursting of IT bubble 2000 Terrorist attacks 2001 Historical equity market decline

Hypothetical stock market crashes New Economy scenarios Risk arbitrage market boom Equity exotics stress Geopolitical unrest Terrorist attack Global economic outlook 35

BNM - COMMON STRESS TEST SCENARIO (CONT.) Category Interest Rate Products

Historical Historical interest rate increases and decreases Bond market sell-off 1994, 2003 Asian financial crisis 1997 LTCM 1998 Russian devaluation 1998 Japan 1998 (termination of Japanese MOF Bond Purchase operation) Terrorist attacks 2001

Hypothetical Global tightening (focusing on increasing of short term and long term interest rate) US tightening Differential shocks to short rates Spike in repo rates Yield curve twist US economy outlook Global economic outlook Increase in inflation expectations China Japanese monetary 36 outlook

BNM - COMMON STRESS TEST SCENARIO (CONT.) Category Credit

Historical Russian devaluation and default 1998 Asian financial crisis 1997 Terrorist attack 2001

Hypothetical Widening spread Emerging market economic outlook Euro area economic outlook Global economic outlook Natural disaster China change in currency arrangement US government sponsored 37 enterprises Terrorist attack

BNM - COMMON STRESS TEST SCENARIO (CONT.) Category Others

Insurance

Operational

Historical

Hypothetical

Gulf war 1990 Iraq war 2003

Volatility disruption Bank funding Global economy

1918 Influenza Pandemic Equitable Life 2000 HIH 2001 Terrorist attack 2001 Tsunami 2004

Pandemic (such as Bird Flu, SARS, etc.)

Major natural disaster Terrorist attack

Confederation Life 1993 Kidder, Peabody & Co 1994 Barings bank 1995

Denial of reinsurance cover due to error in reinsurance contract wording Mis-pricing of risk encouraged by lack of check and balance in underwriting department 38

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STRESS TEST DESIGN AND IMPLEMENTATION PLAN OF OIC

DESIGNING STRESS TESTS - IAIS

It is appropriate that each insurer design its stress tests considering its own risk profile and the complexity of its business including -

Solvency position lines of business current position within market / group investment policy business plan General economic conditions

Supervisor may require some standardized tests in order to obtain a measure of consistency and for baseline monitoring purpose.

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TYPE OF STRESS TESTING Sensitivity analysis Scenario analysis Reverse stress-testing

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METHODOLOGY TO MODEL STRESS TESTING Prescribed model

Both shock factors and magnitude of shock are prescribed

Factor

Only shock factors will be provided Shock magnitude must be developed by each insurer

Internal model

Both shock factors and their magnitude are developed internally by each insurer

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STRESS TEST MODEL Internal Target CAR Prescribed Target CAR Stress Test Ordinary Sensitivity Test

Scenario Test

Reverse Sensitivity Test

Scenario Test

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IMPLEMENTATION PLAN 2012

2013

2014

2015

2016 (Feb) onward

Phase1

Studying technical specification of ST Encouraging companies to develop ORSA & Capital Model (Optional) Reviewing RBC risk charges (to be reviewd consistently) TLAA playing an active role : Coordinate and provide education to enhance understanding of ERM for solvency purpose Suggested companies to exercise the necessary tests together with projecting future cash flow

Phase2

Implementing the first version of Stress Test Report submission to OIC is required New set of RBC risk charges become effective Scope of stress test

1. To identify material risk which impacts high volatility of CAR 2. Test on inforced business only,not including projection according to business plan in the test

Phase3

Implementing full version of Stress Test Require cash flow projection based on business plan

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Long term plan is to implement stochastic model for certain type of risks which is complex in nature

OIC PROPOSED METHODOLOGIES

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SCOPE OF SCENARIO TEST FOR THAI LIFE INSURERS

SUMMARY OF STRESS TEST REQUIREMENT FOR LIFE INSURERS

Base scenario: project future financial position for next 3 years where all cash flow determined based on company’s 3- year business plan Scope of Scenarios required 3 prescribed scenarios At least 1 Self selected scenarios - OIC will provide the list of risk factors and prescribed the main factor required to be included. An insurer must determine the magnitude for shocking according to its company profiles 1 reverse stress test ( could be sensitivity test or scenario test) Role and responsibility of key persons Likewise BNM, the stress test report must be signed off by SM and BD Number of report: submit the report once a year 47 Submission date: within 6 months after year end

COMPARISON OF STRESS TEST REGIMES

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COMPARISON OF STRESS TEST REGIMES

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COMPARISON OF STRESS TEST REGIMES

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Scenarios Base Scenario Short Term Scenarios

Medium Term Scenarios

Projection Period 3-Years

Immediate, Year 1

Prescribed* Self Select

1-Year

Stress to Failure

For Stress Test phase 2 Stress to Failure

Year 1 Year 1 Immediate, Year 3

Prescribed* Self Select

Point of Reporting N/A

3-Years

Year 3 Year 3

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3 PRESCRIBED SCENARIOS

Medium Term (3-Yr)

Short Term (1-Yr Projection)

Scenarios Prescribed #1: Macroeconomic Scenario Prescribed #2: Financial Crisis Prescribed #3: Flu Pandemic At least one additional ST scenario Stress-to-Failure

t s e T s s e r t At least one additional MT scenario 2 S e r s o F pStress-to-Failure ha

Prescribed: Medium Term (with Low Interest)

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PRESCRIBED#1: MACROECONOMIC SCENARIO Purpose: To test relevant scenario applicable to financial sector Remarks: Same scenario used in the industry wide banking stress test. Scenario is revised each year, depending on perceived risks to the financial sector Shocks: Factors Sources Equity Prices

SET

Property Prices

REIC*, the treasury department

Sovereign Yield Curve

BOT, ThaiBMA

Credit Spreads

BOT, ThaiBMA

Exchange Rates

BOT

Change in NB Premiums

Insurance Industry

Termination Rate

Insurance Industry

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* Real Estate Information Center, Government Housing Bank

PRESCRIBED#2: FINANCIAL CRISIS SCENARIO Purpose: Remarks:

To test the effects of a financial crisis Parameters calibrated largely to 2008-2009 financial crisis. Consists of mainly investment shocks.

Shocks: Factors

Sources

Equity Prices

SET

Property Prices

REIC, the treasury department

Sovereign Yield Curve

BOT, ThaiBMA

Credit Spreads

BOT, ThaiBMA

Exchange Rates

BOT

Change in NB Premiums

Insurance Industry

Termination Rate

Insurance Industry

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PRESCRIBED#3: PANDEMIC SCENARIO Purpose: Remarks:

To test the effects of a flu pandemic Combination of Macroeconomic Scenario and insurance pandemic shocks.

Insurance shocks involved inputs from Ministry of Health.

Shocks: Factors

Sources

Equity Prices

SET

Property Prices

REIC, the treasury department

Sovereign Yield Curve

BOT, ThaiBMA

Credit Spreads

BOT, ThaiBMA

Exchange Rates

BOT

Mortality Rate

Ministry of Health, Insurance Industry

Hospitalisation Rate

Ministry of Health, Insurance Industry

Change in NB Premiums

Insurance Industry 55

Termination Rate

Insurance Industry

Reinsurance Recoverable

Insurance Industry

SCENARIOS Stress to Failure (Reverse Stress Test) Scenario Purpose: To test the combination of factors that can lead to the failure of the insurer, at the end of 1 year Remarks: Actuary to consider combination of factors that would most likely lead to insurer breaching its capital adequacy requirements, or MAS imposed requirement, whichever is higher.

Shocks: To be decided by insurer

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THANK YOU 57