Transcript APRA`s GI Capital Requirements: Prescribed Method v Internal Model

APRA’s GI Capital Requirements:
Prescribed Method v Internal Model
Christian Sutherland-Wong
Actuarial Studies
Faculty of Commerce and Economics
University of NSW
Email: [email protected]
Actuarial Studies Symposium, UNSW 14th November, 2003
Purpose of Study

APRA recently introduced two methods to
calculate MCR



Prescribed Method
Internal Model Based (IMB) Method
Aim is to analyse the implications for two key
stakeholders


Insurers
APRA
Contents

Background

Data & Methodology


Results


Internal Model
Implications
Further Work
Background


APRA recently updated their GI Prudential
Standards
External Developments




Basel II
IAA Insurer Solvency Working Party
NAIC, FSA, Canada
Calculating the MCR


Prescribed Method
IMB Method
Data & Methodology

Data Sources




APRA’s June 2002 GI statistics
Tillinghast and Trowbridge Risk Margins
Allianz, Promina, IAG
Methodology

Model Insurer





5 Business Lines – Domestic Motor, Household, Fire & ISR,
Public Liability and CTP
Large, mature portfolio – 10% market share
Industry Investment Mix
6000 simulations
Compare capital requirements
Data & Methodology (cont’d)

Methodology

Scenario Analysis

Different Volatility Assumptions

Riskier Investment Portfolio
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Short Tail only and Long Tail only
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Smaller business size
Internal Model

Prophet DFA model used
Economic
Model
Inflation
DFA
Simulation
Insurance
Model

Economic Model – The Smith Model (TSM)

Insurance Model

3 Claims Processes



Attritional Claims, Large Claims, Catastrophe Claims
Superimposed Inflation – Two state Model
Reinsurance – Individual XoL and Catastrophe XoL
DFA
Output
Internal Model (cont’d)

Assumptions

Expected Claims (incl. expenses and reins. costs)



Set to provide a 15% after-tax return on capital
(capital = 1.5x Prescribed MCR)
Claims Volatility – Tillinghast report
Reinsurance – Maximum Event Retention (MER)
set to $15M
Results
MCR calculated under IMB Method
>
MCR calculated under Prescribed Method
Minimum Capital Requirement (MCR)
IMB Met hod
Prophet MCR
+ Adjust ment for Credit Risk
TOTAL
Prescribed Met hod
TOTAL
233,323
Std Error IMB
Probability
H0: IMB Method MCR = Prescribed Method MCR
HA: IMB Method MCR ≠ Prescribed Method MCR
Original Scenario
$'000
309,396
28,705
338,101
10,912
0.000
Results (cont’d)
99.5th Percentile
± 2 Standard Errors
Results (cont’d)

IMB v Prescribed: Short & Long Tail split
IMB v Prescribed Capital Allocations
80%
70%
% Allocated
60%
IMB
Prescribed
50%
40%
30%
20%
10%
0%
Short Tail

Long Tail
Small difference between IMB and Prescribed Method
Results (cont’d)
IMB v Prescribed: Business line split

Short Tail Allocations
Long Tail Allocations
100%
% Of Short Tail Allocated
Home
80%
70%
60%
50%
Home
40%
Motor
30%
20%
10%
Motor
80%
60%
CTP
IMB Method
Prescribed Method
20%
Public
Liability
Public
Liability
IMB Method
Prescribed Method
Significant differences by business line


CTP
40%
0%
0%

% Long Tail Allocated
100%
90%
Household > Motor under IMB Method
CTP > Public Liability under IMB Method
Results (cont’d)

Scenario Results
Comparisons for All Scenarios
IMB
Met hod
Prophet
Credit Risk
TOTAL
Invest ment Risk
Prescribed Credit Risk
Met hod
OSC Liabilit y
Premium Liabilit y
Concent rat ion Risk
TOTAL
Std Error IMB
Probability
Original
Scenario
$'000
309,396
28,705
338,101
Trowbridge
CVs
$'000
94,586
28,705
123,291
80%
Equities
$'000
370,414
28,705
399,119
Short
T ail
Only
$'000
209,196
10,745
219,941
Long
T ail
Only
$'000
228,828
12,513
241,341
Small
Insurer
$'000
139,951
5,577
145,528
36,391
28,705
91,290
61,641
15,000
233,027
36,391
28,705
88,237
59,415
15,000
227,749
85,366
28,705
91,290
61,641
15,000
282,001
9,157
10,745
7,890
30,885
15,000
73,677
22,656
12,513
80,999
23,789
0
139,956
9,098
5,577
28,808
15,876
15,000
74,359
10,912
0.000
3,469
0.000
13,517
0.000
5,221
0.000
9,056
0.000
5,413
0.000
H0: IMB Method MCR = Prescribed Method MCR
HA: IMB Method MCR ≠ Prescribed Method MCR
Results (cont’d)
Scenario Results

Trowbridge scenario: IMB << Prescribed

Riskier Asset Mix: Greater increase under IMB ($61.0M v $49.0M)

Other scenarios:
MCR as % of Original
% of Original

100%
90%
80%
70%
60%
50%
40%
30%
20%
10%
0%
IMB
Prescribed
71%
65%
60%
43%
32%
Scenario
32%
Implications

Dependence on outcome on volatility assumptions



Insurers will choose different methods depending on
volatility assumed
Need for greater agreement in the industry
Prescribed Method not necessarily conservative


Even if we believe Trowbridge report, the Tillinghast
CVs will be representative of some insurers
APRA may need to address business line capital
charges


Increase CVs for household or CTP
Include diversification discounts, concentration charges or
charges by business size
Implications (cont’d)

Inadequacy of investment risk charge



Increase charges for risky asset classes (equities)
Include diversification discounts or concentration
charges
Lack of an incentive to use the internal model



Lower MCR under Prescribed Method
“Black-box” stigma
Trust in method from financial analysts
Further Work

Results in this study are preliminary and
highly dependent on assumption that the
MCR calculated by the internal model reflects
the actual MCR

Further research:



Consensus on CVs
Different dependence models eg Copulas
Different internal model calibrations