Challenges of risk based capital for (Re) Takaful Companies Nav Garayal, Aon Global Risk Consulting Master class - International Takaful Summit 30 June 2009, London
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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
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Capital and Risk Approximately 650 impairments* over 38 year period 1969-2006 Cause (1969-2006)
Pct Total
Insurance related risks are driver of overall impairments but there is a strong correlation between insurance and operational risks
Deficient Loss Reserves / pricing
37.6%
Operational risks are significant
Rapid Growth
15.7%
Alleged Fraud
8.1%
Catastrophe Losses
7.7%
Asset risk of secondary importance but now becoming more important due to fair value accounting, current crisis
Impairment of Affiliate
7.2%
Overstated Assets
6.9%
Significant Change
4.4%
Reinsurance Failure
3.3%
Miscellaneous
9.0%
Source: A. M. Best Impairment Study, 2007 * A. M. Best defines impairment as restrictive regulatory action
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Impairment frequency higher for smaller companies than larger companies
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
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RBC approaches to regulation around the World UK ICAS / S2
Netherlands Minimum/ solvency/ continuity test
Switzerland Swiss Solvency Test
Canada DCAT
USA RBC model (NAIC)
Mexico Solvency II Approach
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Denmark/ Sweden New supervisory regimes in planning
Malaysia RBC Approach
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South Korea New RBC approach in 2006 Thailand New RBC approach 2009 Australa GPS 110
RBC modelling overview Insurance risk Reserving risk
Strategy Strategy
Risk Areas
Operational risk
Assessment
Credit risk Liquidity risk Design & Construction
Risk based capital model
Group risk
Choose scenarios based on key performance drivers Deterministic
Market risk
or stochastic model
Bespoke or off the shelf
O u t p u t
Base Capital Requirement
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t
Scenario testing of RBC model
Output
u
p
t
u
O
Risk Mitigation Solutions
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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
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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
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Challenges for takaful market Currently 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
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