Coinsurance – The Other Reinsurance

Presentation to the
Actuarial Institute of the Republic of China

Lawrence S. Carson, FSA, MAAA

Senior Vice President and Chief Pricing Actuary
Global Financial Solutions
RGA Reinsurance Company p y

April 26, 2013

Agenda
 Forms of Reinsurance – Beyond Risk-Premium Reinsurance
 Why Coinsurance?
 Considerations when Using Coinsurance
 Uses of Coinsurance – Case Studies

P.1
Forms of Reinsurance
Beyond Risk-Premium Reinsurance

Forms of Reinsurance
Summary and Nicknames
 Yearly Renewable Term (“YRT”):
 Premium paid in return for mortality or morbidity coverage only
 Often referred to as “risk-premium reinsurance”
 Coinsurance (“Co”):
 Share of g
gross p
premium in return for coverage
g of all benefits
 Sometimes referred to as “original terms reinsurance”
 Coinsurance with Funds Withheld (“Co FW”):
 Coinsurance but ceding company keeps assets
 Also referred to as “coinsurance with deposit back”
 Modified Coinsurance (“Modco”):
 Coinsurance but ceding company keeps assets and reserves

P.2
Forms of Reinsurance
YRT Reinsurance
 Ceding company pays reinsurer a premium, less any allowances, to
cover reinsured mortality (or morbidity) claims
 Reinsurer pays only mortality (or morbidity) claims, and does not pay
other benefits such as surrender benefits
 Allowances and/or profit sharing may be paid to ceding company

Forms of Reinsurance
Coinsurance
 Ceding company pays reinsurer (quota share of) all policyholder
premiums or considerations
 Reinsurer
R i pays ceding
di company (quota
( t share
h of)
f) allll benefits
b fit paid
id tto
policyholders
 Not just mortality or morbidity claims
 Also
Al iincludes
l d surrender d bbenefits,
fit iinterest
t t credited
dit d (i
(implicitly),
li itl ) etc.
t
 Reinsurer pays an allowance / ceding commission designed to cover
ceding company’s expenses + profit share; however:
 Upfront / first-year ceding commission can be positive or negative
 Upfront / first-year ceding commission can be greater than, less than, or equal to
ceding company’s acquisition costs
 Assets and reserves are transferred to the reinsurer
 Reinsurer holds reserves for its share of the business

P.3
 Forms of Reinsurance
Coinsurance Cash Flows
 Ceding Company pays Reinsurer (quota share of):
 Policyholder Premiums
 Initial Consideration ((if an in-force block transaction))
 Reinsurer pays Ceding Company (quota share of):
 Mortality / morbidity benefits
 Surrender benefits
 Oth benefits
Other b fit
 Expense Allowances:
 First-year ceding commission
 Can be less than, equal to, or greater than ceding company’s actual
acquisition
i iti costs
t
 Can be positive or negative
 Initial ceding commission (if an in-force block transaction)
 Can be less than, equal to, or greater than ceding company’s unamortized
acquisition
i iti costs
t
 Can be positive or negative
 Renewal-year expense allowances
 Designed to cover fully allocated renewal-year expenses + commissions
 Trail commission (maybe)
7

Forms of Reinsurance
Coinsurance Cash Flows
Initial First Year Renewal Year

C di C
Ceding Company C di C
Ceding Company C di C
Ceding Company

Benefits + Benefits +
Initial Initial Ceding Policyholder First-Year Policyholder Expense
Consideration Commission Premiums Ceding Premiums Allowances +
Commission T il
Trail
Commission

Reinsurer Reinsurer Reinsurer

P.4
Forms of Reinsurance
Coinsurance Cash Flows – New Business Transaction
Initial 1 2 3
CEDING COMPANY PAYS:
Initial Consideration
Policyholder Premiums 100 95 90
TOTAL PAYMENTS FROM CEDING COMPANY - 100 95 90

REINSURER PAYS:
Mortality Benefits 1 2 3
Morbidity Benefits
Surrender Benefits 5 5 5
Other Benefits
SUBTOTAL - BENEFITS - 6 7 8

Initial Ceding Commission

First-Year Ceding Commission 125
Renewal-Year Expense Allowances 2 2
T il Commission
Trail C i i
SUBTOTAL - COMMISSION AND EXPENSE ALLOWANCES - 125 2 2

TOTAL PAYMENTS FROM REINSURER - 131 9 10

NET PAYMENT FROM CEDING COMPANY TO REINSURER - (31) 86 80

Forms of Reinsurance
Coinsurance Cash Flows – In-Force Block Transaction
Initial 1 2 3
CEDING COMPANY PAYS:
Initial Consideration 1,000
Policyholder Premiums 15 10 5
TOTAL PAYMENTS FROM CEDING COMPANY 1,000 15 10 5

REINSURER PAYS:
Mortality Benefits 10 12 15
Morbidity Benefits
Surrender Benefits 5 5 5
Other Benefits
SUBTOTAL - BENEFITS - 15 17 20

Initial Ceding Commission

First-Year Ceding Commission 200
Renewal-Year Expense Allowances 20 20 20
T il Commission
Trail C i i
SUBTOTAL - COMMISSION AND EXPENSE ALLOWANCES 200 20 20 20

TOTAL PAYMENTS FROM REINSURER 200 35 37 40

NET PAYMENT FROM CEDING COMPANY TO REINSURER 800 (20) (27) (35)

10

P.5
Forms of Reinsurance
Coinsurance versus YRT / Risk-Premium Reinsurance
Risk-Premium Reinsurance Coinsurance

 Covers mortality or morbidity  Covers all benefits, including

benefits only surrender benefits
 Reinsurance
R i premiums
i are  Reinsurance
R i premiums
i are
independent of policyholder defined to be equal to
premiums policyholder premiums
 Ceded reserve = unearned  Ceded reserve = underlying
(reinsurance) premium reserve policy reserve
 Solvency margin relief for  Solvency margin relief for most
mortality / morbidity risk only risks
 May not include business risk, and
there may be an offset for
reinsurer counterparty risk
11

Forms of Reinsurance
Variants of Coinsurance
 Key differences from pure coinsurance are whether the ceding
company keeps the assets and/or reserves
 All three are economically equivalent
 Assuming the same interest rate on reserves / funds-withheld balance / modco
reserve

12

P.6
Why Coinsurance?
Going Beyond Risk-Premium Reinsurance

13

Why Coinsurance?
Reasons to Consider Coinsurance vs. YRT
 Reserve and/or Capital Relief
 For some products – especially accumulation products – the portion of the
reserve and/or
d/ capital
it l corresponding
di tto mortality
t lit or morbidity
bidit risks
i k can b
be a
fraction of the total reserve and/or capital
 Risk Transfer
 Some risks that the ceding company may not be comfortable with – investment
risk, surrender / lapse risk, etc. – cannot easily be transferred via YRT
reinsurance
 Ceding
C di C Commission
i i
 To the extent a ceding company seeks a sizeable ceding commission or override,
there may be a lot more profits available under a coinsurance structure, which, in
turn leads to a higher potential ceding commission
turn,

14

P.7
Why Coinsurance?
Reasons to Consider Coinsurance
 Capacity for asset-intensive (e.g., savings) products
 Companies don’t want to write too much of this business for capital / rating agency /
other reasons, but have to keep their distributors happy
 Reinsurance can act as a “capacity valve” to allow a company to tailor their level of
production to a desired level
 Capital relief
 For products that are capital-intensive, coinsurance can help alleviate that strain
without having to limit sales
 Reinsurer may have a different view of capital intensity due to different accounting or
solvencyy margin
g constraints
 Signaling effect
 A coinsurance treaty tells management, Board of Directors, regulators, rating agencies,
etc. that a third party stands behind your pricing and is willing to put their own capital
b hi d th
behind thatt b
belief
li f
 This is because the reinsurer is economically in the same position as the ceding
company
p
 This works especially y well when the reinsurer has helped
p to develop p the pproduct
 Rather than taking consulting fees, the reinsurer is betting on the success of the
product right alongside the ceding company
15

Why Coinsurance?
Reasons to Consider Coinsurance (continued)
 Investments expertise / ability or willingness to take risk
 Reinsurer may have different constraints on investment risk
 Willingness or ability to invest in different currencies
 Access to various asset classes
 Willingness to invest in alternative asset classes
 Access to various hedging or derivative strategies
 Different capital constraints
 Ceding company may be limited by availability of various asset classes,
regulatory restrictions, management or Board preferences, rating-agency
constraints, etc.

16

P.8
Considerations when Using Coinsurance

17

Considerations when Using Coinsurance

Investments
 Investment guidelines and agreed-upon investment strategy:
 Ceding company will want the reinsurer to agree to investment guidelines if the
assets
t are placed
l d in
i trust
t t
 Reinsurer may want the ceding company to agree to investment guidelines for its
retained quota share to the extent that credited rates or other non-guaranteed
elements are set off of that investment portfolio
 Key elements may include:
 Issuer and sector limits
 Need to consider what happens when portfolio gets “small”
small
 Duration / key-rate duration / convexity limits
 Cure process / timing

18

P.9
Considerations when Using Coinsurance
Investments (continued)
 Regular communication between ceding company’s and reinsurer’s
investments professionals
 Depending on nature of the reinsurance treaty, may need a separate
/ segregated asset portfolio
 Reinsurer can consider designating the ceding company (or an
asset-management affiliate of the ceding company) as the
investment manager for the coinsured asset portfolio
 Reinsurer can receive the initial consideration in the form of:
 Cash
 Actual assets transferred (at market value – need to consider accounting impacts
if the assets are not currently held at market value by the ceding company)
 Any combination thereof

19

Considerations when Using Coinsurance

Non-Guaranteed Elements
 Includes interest credited (including indexed interest), fund choices
and fees, cost-of-insurance charges, etc.
 Need to agree upon a common framework for managing guaranteed
elements
 Balance between treating reinsurer as a partner in the block of
business versus being able to manage block on a day-to-day basis
 Methodology that has worked well for RGA:
 Ceding company can manage as they see fit as long as pricing spreads (defined
and measured in treaty) are being achieved
 Only if pricing spreads are not being achieved does the reinsurer get involved in
setting
tti non-guaranteedt d elements
l t
 May consider dynamically adjusting ceding commissions to react
automatically to changes in new business

20

P.10
Considerations when Using Coinsurance
Managing Counterparty Risk
 Without further steps, coinsurance creates a large counterparty
exposure for the ceding company facing the reinsurer
 There are a number of different ways to handle this risk:
 Assets in trust
 Other collateral such as letters of credit
 Use of special-purpose reinsurance vehicle (SPRV)

21

Considerations when Using Coinsurance

Managing Counterparty Risk – Assets in Trust
 If liabilities are implicitly or explicitly measured at book value (or
some other system that doesn’t react like market value), then we
don’t want a requirement to hold a certain market value of assets
against that liability metric
 Can consider a book-value of assets trust requirement that turns into a market-
value trust requirement if the market-to-book asset ratio falls below some
predefined level, say, 80%
 Reporting:
 CUSIP-by-CUSIP positions, trading activity, performance attribution, and
compliance with agreed-upon investment guidelines
 Generally, quarterly frequency is sufficient

22

P.11
Considerations when Using Coinsurance
Managing Counterparty Risk – Use of Special-Purpose Reinsurance Vehicle

 SPRV is a standalone legal entity (or a “protected cell” of an

insurance company) designed to assume a single block of business
from a single counterparty
 It essentially “walls off” the block of business, similar to the function
of an insurance company separate account
 Rather than placing assets in trust, the ceding company’s
counterparty protection can be that they take over the voting shares
of the SPRV under
nder certain pre
pre-specified
specified conditions
 By not placing encumbrances on the assets, the reinsurer will have
more flexibility that it can build into the reinsurance transaction and
thus should be able to offer a more competitive price
 This structure also provides more visibility and transparency to the
ceding company in terms of how the reinsurer is managing the block
of business
23

Considerations when Using Coinsurance

Reporting and Administration
 Need to ensure that ceding company’s reinsurance administration
system can handle coinsurance and associated accounting / ledger
entries
 Reinsurer may require seriatim data including detailed account-value
roll-forward; necessary for:
 Risk
Ri k managementt
 Valuation (especially if reinsurer operates under a different accounting standard)
 Check on bulk reporting
 M
May need d tto pay reinsurance
i premiums
i more ffrequently
tl (monthly,
( thl
weekly, or even daily) than claims or other benefits
 Reinsurer needs to invest the proceeds in a timely manner to achieve the same
economics as the ceding company
 Build in flexibility for future changes to reinsurance terms (on new
business), e.g., changes in quota share or product terms

24

P.12
Considerations when Using Coinsurance
Finance, Valuation, and Solvency
 A lot more entries in the accounting ledgers
 Consider tax implications
p carefully
y
 Need to make sure that valuation software can handle the
reinsurance appropriately
 May need some modifications
 Consider solvency margin impacts carefully
 Both local solvency margin, rating agency capital, etc.

25

Considerations when Using Coinsurance

Taiwan Regulations
 In March 2011, Insurance Bureau introduced regulations to allow reserve
credit
 Reserve
R credit
dit requires
i IB approvall
 Reinsurance must transfer all the insurance risks
 Must be reinsured to approved reinsurer
 Reinsurance to locally registered reinsurer:
 Full credit and no collateral requirement
 Reinsurance to offshore reinsurer:
 Must be rated at least S&P A (or equivalent)
 Collateral via cash, CDs, or government bonds placed in trust with, or an LOC
issued by a locally registered qualified financial institution
 Rating must be at least that of reinsurer
 Reserve credit is limited to the amount of collateral provided
 Reduction in reserve credit recognized – 10% or 25% depending on rating
 Can use the rating of the qualified financial institution if it is higher
 Reserve credit is recognized via adding a reinsurance asset to the
balance sheet
26

P.13
Uses of Coinsurance
Case Studies

27

Uses of Coinsurance – Case Studies

Fixed Deferred Annuity In-Force Block (United States)
Overview of Reinsurance Structure
Client Objective:  Exit an underperforming and capital-intensive product line
Rationale:  Parent-company accounting and solvency margin formula leads to
volatility in results, low returns
 RGA, able to factor in some level of credit spreads above risk-free rates,
can better match the underlying economics of this business
Transaction Structure:  90% quota share on a full-risk coinsurance basis
 RGA receives an initial consideration, in the form of cash plus assets,
equal to the sum of:
 Local statutory reserves
 Adjustment for past changes in interest rates (extra consideration)
 P i i adjustment
Pricing dj t t covering
i changes
h iin available
il bl yields
i ld ffrom quoting
ti
date to closing date
 RGA pays:
 All benefit payments
 Reimbursement of maintenance expenses
 Assets placed in trust for benefit of ceding company
Risk Transfer:  Full risk transfer to RGA
 Risks transferred: mortality, lapse / surrender / withdrawal, investment
(interest rates,
rates credit spreads)
Capital Impact:  Client releases capital backing the reinsured quota share
28

P.14
Uses of Coinsurance – Case Studies
Fixed Deferred Annuity In-Force Block (United States) – Considerations

 Initial consideration mostly in the form of assets

 Includes “participation agreements” on some illiquid asset classes, such as
commercial-mortgage
commercial mortgage whole loans and private-placement
private placement securities
 Due diligence on asset valuations
 Be careful of “dirty” vs. “clean” prices (i.e., inclusion of accrued interest)
 Assets in trust
 Book value of assets compared to US statutory liabilities (a book-value type of metric)
 Required top-up if market-to-book ratio falls below a certain level
 Duration limits – not symmetric around liability duration to allow for short investment
strategy
 Regular reporting and communications
 Pricing adjustment formula:
 RGA needed to reposition a significant portion of the portfolio to get to our desired
asset strategy and ALM profile
 Ceding company was in a better position to hedge the risk of changes in the difference
in yields between the portion to be sold and the target reinvestment portfolio
 Pricing
P i i adjustment
dj t t fformula
l uses public,
bli liliquid
id iindices
di and
d passes thi
this risk
i kbback
k tto th
the
ceding company, who then hedged it by purchasing exchange-traded funds
29

Uses of Coinsurance – Case Studies

Seasoned Disabled Life Reserves In-Force Block (Australia)
Overview of Reinsurance Structure

Client Objective:  Freeing up capital to improve return on equity

Rationale:  Statutory capital requirement for long term disabled life reserves is
very high
Transaction Structure:  Full-risk coinsurance
 95% quota share on in-force block of disabled lives
 Assets and reserves transferred to RGA representing the current
reserves for paying the future claims of the disabled lives
 RGA responsible for all future claim payments on reinsured block
 Experience Refund = X% x (Expected Claims – Actual Claims)
 Recapture not allowed except in very limited circumstances, such as
insolvency
Risk Transfer:  Full risk transfer to RGA
 Risks transferred: morbidity, mortality, inflation, investment (interest
rates, credit spreads)
Capital Impact:  No impact on P&L as reserves transferred to RGA were equal to the
statutory reserves
 Client able to free up regulatory capital (around 40% of reserves)
30

P.15
Uses of Coinsurance – Case Studies
Seasoned Disabled Life Reserves In-Force Block (Australia) – Considerations

 Hedging inflation risk embedded in underlying liabilities:

 Combination of:
 Use of inflation-indexed AUD municipal bonds
 Inflation swaps
 US GAAP accounting volatility on inflation swaps
 Investment strategy:
 Inflation-linked AUD municipal bonds
 Other AUD securities
 Some USD investments, hedged back to AUD with cross-currency swaps
 Assets in trust:
 Market
Market-value
value of assets must be ≥ Australian best
best-estimate
estimate liability
liability, which is a
market-value type of metric

31

Uses of Coinsurance – Case Studies

Savings / Long-Term Care Product Development (Japan)
Overview of Reinsurance Structure
Client Objective:  Sell an innovative and unique product to be used in conservation efforts

Rationale:  Ceding company wants a partner willing to be more aggressive in the

investment strategy and who is comfortable with the morbidity and
mortality risks in this product

Transaction Structure:  75% q

quota share on a full-risk coinsurance basis
 RGA pays:
 First-year ceding commission (% of premium)
 All benefit payments
 Reimbursement of maintenance expenses
 T il commission
Trail i i ((x bbasis
i points
i t on sum assured)
d)
 Changes formulaically for each cohort of new business based
on changes in government bond yields

Risk Transfer:  Full risk transfer to RGA

 Risks transferred: mortality, longevity, morbidity, lapse / surrender,
investment (interest rates, credit spreads)

Capital Impact:  Client sets up minimal capital for the reinsured quota share
 Clientt receives
Cli i ttrailil commissions
i i ffor lif
life off product
d t on reinsured
i d portion
ti

32

P.16
Uses of Coinsurance – Case Studies
Savings / Long-Term Care Product Development (Japan) – Considerations

 Product development
 RGA conducted several “Voice of the Channel” exercises to determine product
ideas that agents were interested in
 RGA provided the majority of the material the client needed to file the product
with the regulator
 Concept developed was to not credit anyy interest (i.e.,
( return of premium after 10
years) to avoid competing with aggressive Japanese domestics
 Instead, a sizeable lump sum LTC benefit is provided
 Investment strategy
 Purchase of duration matched JGBs combined with the sale of credit default
swaps to increase the yield
 Very difficult to earn a spread over JGBs with other strategies
 No
N collateral
ll t l requirements:
i t
 Reinsurer is large, “onshore” rated entity
 Not huge premium amounts to start with → little counterparty risk
 Allows
Allo s for modest uplift
plift in pricing → higher ceding commission

33

Conclusion

34

P.17
Coinsurance – The Other Reinsurance
Conclusion
 It’s important to consider coinsurance in addition to YRT or risk-
premium reinsurance, as coinsurance gives the possibility of
 Higher ceding commissions;
 More risks transferred to the reinsurer; and
 More reserve and/or capital relief
 There are a number of additional items for a ceding company to
consider with a coinsurance treaty, including:
 Investments
 Treatment of non-guaranteed elements
 Managing counterparty risk
 Reporting administration
Reporting, administration, finance,
finance valuation,
valuation and solvency
 Coinsurance is an extremely powerful tool that can help solve some
of today’s most pressing problems for life insurance companies

35

P.18
 The ComFrame Initiative
From the International Association 
From the International Association
of Insurance Supervisors
Presented by Tom Herget, FSA, MAAA, CERA

Actuarial Institute of Chinese Taipei                                           April 26, 2013

ComFrame

ComFrame 
Common Framework for the Supervision of Internationally
Active Insurance Groups

But first, a word on its sponsor, the IAIS

P.19
 Introduction to the International
Association of Insurance Supervisors
p

Role and Objectives

The G20 and the financial services world

P.20
IAIS: standard setter for insurance
supervision
• Founded in 1994
• Members from more than 200 jurisdictions in over 140
countries – all regions; all types of markets
• Around 150 Observers
• Hosted by the Bank for International Settlements (BIS)
in Basel
• MoU with IAA
Membership
classes

Members Observers

National Federal
International Other
Insurance Association of Insurance
Governmental/ interested
Supervisors Insurance Office of the US
Statutory bodies parties
Commissioners Dept. of Treasury

IAIS objectives
j

Global financial stability

P li h ld protection
Policyholder t ti Efficient fair,
Efficient, fair safe and
stable insurance markets

Well-regulated insurance markets

Improved supervision

P.21
IAIS Roles and activities

Develop Encourage Develop

implementation of assessment
principles, principles and methodologies
standards, standards
guidance

Identify
potential risks
that may affect
insurance
Encourage co- supervision
Represent field
operation of insurance
amongst Cooperate with supervision
i i
insurance other
supervisors international
organisations
i ti

IAIS Organisation
g Structure
General Meeting

Financial Stability Committee Secretariat

(includes Macro-Prudential surveillance) Executive Committee

Technical Committee Implementation Committee Budget Committee

Accounting and Audit Issues

Education Subcommittee
Subcommittee

Governance & Compliance Standards Observance

Subcommittee Subcommittee

Supervisory Cooperation
ComFrame Oversight
Subcommittee

Insurance Groups &

Supervisory Forum
Cross-sectoral IssuesSubcommittee

Market Conduct Subcommittee

Pension Coordination Group

Reinsurance & Other Forms of

Risk Transfer Subcommittee

Solvency
S l & Actuarial
A t i l IIssues
Subcommittee
8

P.22
 IAIS Organisation
g

Staff
Staff of 25, all in Basel

Revenues ($000)
from Members:135 pay around $25; 13 pay $70; 
from Members:135 pay around $25; 13 pay $70;
One pays $300 (Total $ 3,600)
from Observers:  about 160 pay $15 (Total $2,200)

US input
• Members:  58 states, Federal, NAIC
• Observers:  about 40
• AAA:  through IAA

ComFrame

ComFrame aims to

 Develop methods of operating group‐wide supervision of 
Internationally Active Insurance Groups (IAIGs) in order to make 
group‐wide supervision more effective and more reflective of actual 
d ff d fl f l
business practices

 EEstablish a comprehensive framework for supervisors to address 
t bli h h i f kf i t dd
group‐wide activities and risks and also set grounds for better 
supervisory cooperation in order to allow for a more integrated and 
international approach
international approach

 Foster global convergence of regulatory and supervisory measures 
and approaches
and approaches

P.23
ComFrame

ComFrame should

 be specific, but not rules‐based

 be ever‐evolving (and further look into case experiences)
b l i ( df h l ki i )

 be developed in close collaboration with interested stakeholders

 lead to more consistency and better comparability and alignment regarding the 
supervision of internationally active insurance groups being undertaken by each 
jurisdiction

ComFrame

Timeline

2010 2011 2012 2013

Development Phase
Development Phase Calibration (FT) Phase
Calibration (FT) Phase

Concept Paper

 ComFrame is to be developed within 3 years (“Development Phase”) starting 
July 1, 2010

 At the end of the first year from the starting date, a comprehensive and in‐
depth Concept Paper is to be be available

 Immediately following the three‐year Development Phase, impact assessments 
including those on calibrations (particularly for quantitative requirements) will 
be undertaken (“Field
be undertaken ( Field Testing Phase
Testing Phase”, formerly 
formerly “Calibration
Calibration Phase
Phase”))

P.24
ComFrame

Module 1 Scope of ComFrame
Element 1 Identification of IAIGs
Element 2 Process of identifying IAIGs 
p p
Element 3 Scope of ComFrame supervision 
Element 4 Identification of the group‐wide supervisor and involved supervisors

Module 2 The IAIG
Module 2 The IAIG
Group Governance  Element 1 Governance 
Group ERM  Element 2 Enterprise Risk Management 
Group Structure and Strategy
Group Structure and Strategy
Element 3 IAIG’s legal and management structures from an ERM perspective
Element 4 IAIG’s strategy from an ERM perspective
Element 5 Intra‐group
Element 5 Intra group transactions and exposures from an ERM perspective
transactions and exposures from an ERM perspective
Group Financial Condition
Element 6 Liabilities/technical provisions and assets/investments
Element 7 Valuation 
Element 8 Group Capital Adequacy Assessment
Group Reporting and Disclosure  Element 9 Reporting and disclosure 

ComFrame

Module 3 The Supervisors
Module 3 The Supervisors
Group‐wide supervisory process
Element 1 Group‐wide supervisory process 
Supervisory Cooperation
Element 2 Cooperation and coordination including reliance and recognition 
Element 3 Roles of group‐wide supervisor and involved supervisors 
Element 4 Use of Supervisory Colleges
Crisis Management and Resolution
Element 5 Crisis management among supervisors
Element 6 IAIGs and resolution

Module 4 Implementation of ComFrame
Element 1 Applicability of ComFrame to all IAIS jurisdictions
Element 1 Applicability of ComFrame to all IAIS jurisdictions 

P.25
ComFrame

ComFrame Working Draft dated July 2, 2012

 179 pages 

 Comment period July 1 through August 31
C i dJ l 1 h hA 31

 Comments from AAA, CIA, IAA, NAIC, ACLI, GNAIE and many others

 Over a thousand comments (358 pages) on the original 180  page document

ComFrame

Highlights of Comments (1 of 6) 
Member overarching themes (expressed often but not necessarily 
b hi h ( d f b il
by a majority)
1 Don’t use CF to expand ICPs

2 Don’t repeat/duplicate ICPs

3 Simplify

4 Ambiguous terminology

5 Power and authority issues

6 Lake of clarity about where CF requirements are meant to apply (lead 
L k f l it b t h CF i t tt l (l d
supervisor, all supervisors, the iaig, the subsidiaries)

7 Field testing will be important
Field testing will be important

P.26
ComFrame

Highlights of Comments (2 of 6) 
Member comments at opposite ends of spectrum
1 Converge CF rules vs. use regulations of home country

2 Flexibility vs. consistency

3 Level playing field between iaig’s and non‐iaig’s

4 Role of group supervisor – specified or negotiated

5 Reporting requirements too detailed; detail needed for commonality

6 Criteria too prescriptive; others comfortable

7 Lack of progress on capital adequacy element; others comfortable

8 CF should foster mutual understanding of different capital requirements 
8  CF h ld f t t l d t di f diff t it l i t
but others say capital requirements should be consistent across iaig’s

ComFrame

Highlights of Comments (3 of 6)
Observer overarching themes
1  Many observer comments stem from differences in opinion on purpose of CF

2 CF focus:  focus on module 3 (supervisory cooperation); module 2 too 
prescriptive
3 Field testing / impact assessment should begin asap; do pilot

4 Need clearer CF goals articulation

5 IAIG criteria:  firm up determination; net too big
IAIG i i fi d i i bi

6 Supervisory resources ‐ do they currently have the resources to implement

7 Confidentiality

8 No blurring lines between gsii and iaig  
No blurring lines between gsii and iaig

P.27
ComFrame

Highlights of Comments (4 of 6)
Observer comments at opposite ends of the spectrum

1 Level playing field vs. flexibility 

2 Highly prescribed requirements on supervisors vs.  flexibility
Highly prescribed requirements on supervisors vs. flexibility

ComFrame

Highlights of Comments (5 of 6)
Valuation (module 7)
1 Sole use of IFRS is now in question

2 Mention no accounting standard

3 Various options for an accounting basis

4 Keep IFRS  ‐ G20 advanced use of 1 set of global accounting standards as 
they measure of post‐crisis reforms

5 Don’t need prudential filters; others say we do so supervisors don’t do their own 
thing

6  Where to place filters – to the accounting basis or to the resulting capital 
resources

P.28
ComFrame

Highlights of Comments (6 of 6)
Capital Adequacy (module 8)
1 CF may not be right place to develop a global capital standard

2 Strong opposition from some Observers to a capital requirement

3 Use group‐wide capital requirements of group supervisor

4  Focus more on understanding different approaches

5 Lamenting slow progress on developing capital adequacy
L i l d l i i l d

6 Don’t work on capital adequacy until global accounting basis is settled

7 IAIG competitiveness against insurers not subject to CF

8 Reference to tiered capital (as in banks) not appropriate for insurers
Reference to tiered capital (as in banks) not appropriate for insurers

ComFrame

Timeline from here on out (1 of 2)

• April ‐ Further refinements of the drafts will be discussed in April working party 
meetings

• May ‐ There is a key TC meeting in May to discuss outstanding issues.  Working 
parties will be meeting too.  A full draft made available to Observers

• June ‐ The TC meeting in May will hopefully approve a 2013 Draft ComFrame for 
consultation from July to the end of August 2013 (final consultation in the 
l i f J l h d fA 2013 (fi l l i i h
Development Phase)

P.29
ComFrame

Timeline from here on out (2 of 2)

• Summer – Preparation of a comprehensive report on comments for the General 
Meeting in 2013

• December – Sign off by Executive Committee on the  comprehensive report on 
the end of the Development phase

• 2014 ‐ field testing phase starts ‐ details being discussed internally

ComFrame

Way forward with Stress / Scenario Testing

• Scenarios are projections of financial outcomes for the group/entity
g ,
• Focus on extreme negative scenarios, which are stressed to examine close 
to the full range of extreme possibilities
• The company should survive 99.5% of the possibilities
• The NAIC would like to remove the one in two hundred reference with 
something like “events that occur only rarely, such as once in every 200 
years.”  The reliability in the tail is not as good as we think.
• Supervisors would dictate three types of scenarios:
• Global (e.g. financial, pandemic, man‐made catastrophe or natural 
catastrophe),
• Jurisdictional, and 
• Group‐specific

P.30
 ComFrame

Need a common valuation basis

• Originally was going to utilize the accounting for the IASB’s insurance accounting 
project

• World‐wide adoption of a single standard is now in doubt

• Currently in contemplation is a ComFrame Adjusted Balance Sheet (CABS)

Japanese  Regulatory 
US GAAP
G
GAAP The interim (IFRS 4 phase I) standard allows insurance  B
Bases
undertakings to maintain prior used accounting practices for 
insurance liabilities (IFRS 4.22 ff.). This could result in a lack of 
comparability concerning the measurement of insurance liabilities.

Accounting (incl. 
Capital Resources) 
j
adjustments
CABS for IAIG

Group Legal Entity

L
Level
l Scenarios Approach
Scenarios Approach L
Level
l

GWS/Supervisory College 
/ p y g
KEY:
KEY
including  Capital  CABS = ComFrame Adjusted 
Assessment(s)/Judgements Balance Sheet

Blue = Prepared by IAIG
Green = Prepared by Supervisors
Red = Results: actions by the 
Scenarios, Accounting adjustments,  Group Wide Supervisor &/or 
Supervisory College
Capital Resources – set the uniform 
methodology and any supporting 
requirements 4/15/2013

P.31
 Draft for discussion
IFRS
The interim (IFRS 4 phase I) standard allows insurance undertakings to 
The interim (IFRS 4 phase I) standard allows insurance undertakings to
Japanese  Regulatory 
US GAAP maintain prior used accounting practices for insurance liabilities (IFRS 4.22 
GAAP Bases
ff.). This could result in a lack of comparability concerning the measurement 
of insurance liabilities.

Example + Equity Minority Interest

+ Pre-event catastrophe reserves
+ Prudential margins included in reserves (where clearly identifiable)
- Proposed shareholder dividends not accrued
e Accoun

- Goodwill (% of capital)
- Deferred tax assets (% of capital)
- Other intangible assets
+ Risk margin on property/casualty reserves (where clearly identifiable)
nting Adju

- On-balance-sheet pension surpluses (post tax)

Equity

+ Up to 100% of off-balance-sheet life value of in-force (post tax)

+ Debt down-streamed to subsidiaries
- Property/casualty loss reserve discount
ustments to

- Unearned premium reserve discount

+/- Place fixed income investment grade bonds on amortized cost for Property/Casualty
+/- Place fixed income bonds on amortized cost for Life
- Restricted Assets
- 100% of deferred acquisition costs
+/- Other Group Supervisor Adjustments

ComFrame Adjusted Balance Sheet (CABS) for IAIG

ComFrame Adjusted Balance Sheet (CABS) for IAIG
4/15/2013

ComFrame

Overarching Issues

• We seem to be developing a minimum capital

• Evaluate at just the holding company level or at each subsidiary?

• How to handle non‐insurance companies that could impact the insurance 
companies

• What is the accounting basis for this since IFRS no longer a viable option (TH 
suggestion:  just do assets and cash)
i j d d h)

• Members think that field testing will shed much light 

P.32
ComFrame

Four Key Issues

• Where, in the organization structure, to define the insurance holding company?  
At the lowest level holding company that owns all the insurers in the group.  
Naturally, you would have to watch for impacts from other affiliates

• Financial Assets.  Fair Value vs. Amortized Costs (can be appropriate for long 
term business)

• Technical Provisions (reserves) (liabilities).  Discounting for property & casualty 
reserves?  Discount rate for long‐term life liabilities?
? Di f l lif li bili i ?

• Deferred Tax Assets.  Most would disallow, but might be more significant if P&C 
reserve discounting introduced
reserve discounting introduced

ComFrame

Field Testing ‐ Objectives

• Objective ‐ To perform impact studies of all elements* of the draft ComFrame 
resulting from the Development Phase, to test if they 
lead to effective group‐wide supervision of IAIGs, 
are practical, and
do not lead to excessive costs to IAIGs and their supervisory colleges

• Objective ‐ To assess the results of such field testing so that the IAIS can 
determine any evidence‐based changes that are necessary to the draft ComFrame 
i i
in view of a target date of adoption at the 2018 General Meeting 
f d f d i h 2018 G lM i

•• Field Testing Task Force chair and vice chair appointed; committee being 
Field Testing Task Force chair and vice chair appointed; committee being
populated

P.33
ComFrame

Field Testing ‐ Timeline

• Spring, summer 2013 – how to do it

• Summer, fall 2013 – selection of volunteer iaig’s

• 2014 – perform the field testing

ComFrame

Field Testing – how the IAA may assist

• We have “seat at the table” on the SSC – perhaps get on the FTTF

• Develop prototype understanding of deliverables

• Develop case studies to simulate situations CF could address without waiting for 
year‐long FT turnaround

P.34
 Progress on Insurance
C t t Accounting
Contracts A ti
IFRS and FASB
April 26, 2013
Presented to

Actuarial Institute of Chinese

T i i
Taipei
by T
Tom Herget,
H t FSA,
FSA MAAA,
MAAA CERA

IASB
• Formed April 1, 2001, assuming standards setting
from
o IASC.SC. Governments
Gove e s dictate
d c a e requirements.
equ e e s. IFRS
S
is used in Europe because EU requires it.
• 16 international members – limited insurance
company experience
• Actions taken at monthly meetings
• Staff in London; most meetings in London
• www.IFRS.org
www IFRS org

P.35
 3

FASB
• Formed 1973; 7 members
• Actions taken at weekly meetings
• Staff in Connecticut; most meetings in Connecticut
(or in London if joint with IASB)
• SEC delegates standard setting to FASB; FAS is used
in the US because SEC requires it.
it
• SEC accepts IFRS from foreign registrants and is
considering accepting IFRS for US registrants
• www.FASB.org

Timeline
• IASB
▫ Spring 2007: Phase II Discussion Paper
▫ July
y 2010: Insurance Standard Exposure
p Draft
▫ June 2013: Re-exposure
▫ 2014:
0 : IASBS Insurance
su a ce Contract
Co t act Sta
Standard
da d
▫ 2018?: Insurance Standard Effective
• FASB
▫ September 2010: Insurance Discussion Paper
▫ July 2013: FASB Exposure Draft
▫ 2014: FASB Insurance Standard
▫ 2018?: Insurance Standard Effective

P.36
 5

IFRS Insurance Project Objectives

• Reduce diversity of accounting practices for

insurance
su a ce co
contracts,
ac s, pa
particularly
cu a y in Europe
u ope
• Increase users’ understanding of insurers’ financial
statements
• Help investors make decisions
• Align insurance accounting with other business
sectors, where possible

Overview of IASB Exposure Draft

• Principles-based approach with additional guidance
• Reflects the economics of insurance contracts
• Based on insurance contracts, not insurance
companies
• So this affects banks and others issuing insurance
contracts

P.37
 7

Goals of IASB Exposure Draft

• A measurement model that focuses on the drivers of
profitability and uses current estimates of cash flows
• Presentation of information about insurance contracts that
reflects the changes in those drivers
• A coherent
h fframework
k ffor ddealing
li with
i h complex
l andd ffuture
insurance contracts
• IASB wants insurance accounting to be as consistent as
possible with accounting principles for other financial
institutions (banks)
( )

Premium Allocation Approach

• Keep P&C pre-claims accounting similar to current
(US G
GAAP)) P&C
&C accou
accounting
g

• Gross Unearned Premium for short-term (one year)

contracts

P.38
 9

Building Block Approach (BBA)

• IASB has four building blocks:

▫ Current estimate of future cash flows
▫ Time value of money
▫ Risk Adjustment (RA)
▫ Residual Margin (RM)

• FASB has no RA and merely a single Margin which

is amortized

10

Current Estimate of Future

Cash Flows
• Current; use all relevant information
• Contract boundaries – for some group
group-like
like contracts whose
renewal provisions aren’t guaranteed, those periods cannot be
considered
• Unbiased
• Explicit
• Probability weighted
▫ Expected value (mean), not “best estimate”
▫ Number of scenarios depend on product
▫ Stochastic not always required
• E l d non-performance
Exclude f risk
i k ffor iinsurer bbutt iinclude
l d non-
performance risk for ceded reinsurance
P.39
 11

Acquisition Costs

• Acquisition costs are included within the liability

cash flows; no separate asset for DAC
• The IASB includes unsuccessful as well as successful
sales
l expenses
• The IASB includes only incremental acquisitions
costs
• The FASB ED limits acquisition costs to incremental
at a policy level and only for successful sales
• This is more restrictive than other cash flows which
are to be based on a portfolio of similar contracts

12

Time Value of Money

• Consistent with current observable market prices
• Exclude factors not present in the insurance liability
▫ Independent of assets held unless obligation is a direct
function of a set of assets (e.g. unit linked or variable)
▫ Do not consider non-performance risk of insurer
• Guidance in first ED was risk free plus adjustment for
illi idit (bottom
illiquidity (b tt up))
• IASB and FASB will now allow top-down (earned rate less
provision for default,
default expenses and uncertainty)
• Any discounting claim reserves will be a change for P&C in
the US

P.40
 13

Time Value of Money – Interest Rate Rubik’s Cube

• Always use a current rate at any valuation date

• Do another set of discounting with a locked in rate (at issue)
▫ Thiss iss used for
o ddistinguishing
st gu s g P/L/ aand
d OC
OCI
• Use one set of interest rates where cash flows are dependent
on investment performance and a different set of interest rates
where they are not (this is within the same contract) (IASB
only)
• But
B possibly
ibl more
▫ Mirroring – where liability crediting rates are a legal function of
the underlying asset performance
▫ You may have to unlock the locked-in rate
• And these will be yyield curves,, not yield
y rates
• Need to see next Exposure Draft for clarity

14

IASB - Risk Adjustment

• Objective of Risk Adjustment (RA) is the ‘compensation the
insurer requires for bearing the uncertainty inherent in the cash
flows that arise as the insurer fulfills the insurance contract’
• Not what you’d sell it for; not what someone else would pay
• More like
lik it
i is
i what
h you would ld buy
b it i for
f given
i all
ll the
h
information you already know about it
• The RA quantifies the difference between the certain and the
uncertain liability
• Re
Re-measured
measured at each period
• It is not a PAD (Provision for Adverse Deviation) but it is like
a PAD

P.41
 15

IASB - Residual Margin

• Residual Margin is the plug so that there is no profit
aat issue
ssue
• Residual Margin is re-measured for changes in future
assumptions.
• Current year experience flows through income
statement
• Margin is amortized into earnings based on how
insurance and other services are provided (similar to
revenue recognition)

16

FASB – Single Margin

• Similar to IASB Residual Margin – it is the plug so
that
a there
e e iss noo profit
p o at a issue.
ssue.
• Not remeasured; not unlocked
• Amortized by release from risk (which has not really
been defined yet)
• The FASB is not in favor of running estimates of
future experience changes through the margin.
• Amortized into earnings similarly to IASB’s
IASB s residual
margin

P.42
Key FASB-IASB Differences
• One margin vs. a Risk Adjustment and a Residual
Margin
ag

• Residual Margin unlocks,

unlocks single margin doesn
doesn’tt
unlock

• IASB considers successful and unsuccessful

expenses FASB only successful
expenses,

18

Presentation

P.43
 19

Investments
• Instructions come from IFRS 9, which replaces IAS
37 noo later
a e than
a 2015
0 5

• IFRS 9 is entitled Financial Instruments

▫ Includes assets and liabilities
▫ Being done in three phases
 1 Recognition and Measurement
 2 Impairments
 3 Hedge accounting

20

Investments - Measurement
• Debt instruments (bonds, mortgages) are on
Amortized
o ed Cost
Cos (AC)
( C)
▫ An option – you can use Fair Value (FV) if you can
demonstrate that this avoids an accountingg mismatch
(they support insurance liabilities that move with FV).
All income goes through profit / loss
▫ Another option – report FV, but also calculate AC.
AC is used for profit/loss, but mark to market and
report that difference in OCI
• Equities and derivatives – at FV (and all impact goes
through profit loss
P.44
 21

Balance sheet 20XX

Assets
Reinsurance assets XX
Other assets XX
Total assets XXX

Liabilities
Li biliti
Insurance contract liabilities XX
Other liabilities XX
Total liabilities XX

Equity XX
Total equity and liabilities XXX

IFRS Presentation Income Statement

• Insurers required to present earned premiums, margin released,

change in Risk Adjustment, claims, benefits and the gross
underwriting margin in income statement
• Definition of premium is different from definitions commonly
usedd today
t d – IFRS definition
d fi iti is
i the
th portion
ti off premium
i
allocated to the value of coverage and the expected non-claims
fulfillment costs – equivalent to expected claims and expected
expenses
• “Disaggregate”
gg g – exclude the deposit
p component
p
• Other comprehensive income (OCI)
▫ Changes in liability due to changes in discount rate will be
reflected in OCI

P.45
IFRS Presentation Income Statement - OCI
▫ Pause – just what is OCI?
▫ CI = PL plus OCI
▫ Comprehensive Income, Profit Loss
▫ Again, just what is OCI?
▫ In the major accounting bases, there is no articulation of philosophy in
ascribing elements to OCI
▫ Investors tend to look at PL as gauge of performance
▫ How to assign? Blanket or principles?
▫ Possible principles
 Warranted vs. unwarranted volatility
 Actions within vs. outside of management control
 Ordinary (usual) vs. extraordinary (unusual) events
 Regular results vs. those induced by changes in methodologies or
assumptions
 Current year results vs. prior period adjustment

24

Statement of Comprehensive Income 20XX

Insurance contracts revenue X

Incurred claims and expenses (X)
Underwriting result X

Investment income X
Interest on insurance liability (X)
Net interest and investment X

Profit or loss X

Effect of discount rate changes on

insurance liabilityy ( )
(X)
Total comprehensive income XX

P.46
Presentation – Revenue
• Premium element of revenue stream will look like YRT
premiums
▫ Do not include portion of premium that is deposit-like (e.g.
account values for UL policies) (“dis-aggregate”)
• Cannot
C be
b derived
d i d ffrom collected
ll d andd ddoesn’t
’ affect
ff bbottom
line
• Most items in income statement will come from actuaries

Presentation – FAS60
• Premium 100
• Investment income 10
▫ Revenue 110

• Death claims 15
• Expenses 20
• C h value
Cash l paidid 5
• Increase in Reserves 55
▫ Expense 95

• Profit 15

P.47
Presentation – FAS97
• COI charge 25
• Expense load charge 10
• Investment income 10
▫ Revenue 45

• Death claims (NAR) 5

• Expenses
E 20
• Interest on fund 5
▫ Expense 30

• Profit 15

Presentation – IFRS
• Residual Margin released 4
• Change in Risk Adjustment 6
• p
Expected claims 5
• Expected expenses 20
▫ Revenue 35

• Claims 5
• Expenses 20
▫ Claims and expenses 25

• Underwriting profit 10
• dsf
• I
Investment
t t Income
I 10
• Interest credited to liabilities 5
• Investment profit 5

• Total profit 15

P.48
 30

Disclosures
• Premiums, claims
• Expected PV of future payments and receipts
• Changes in the amount of risk
• Effects of new contracts written
• Processes for estimating inputs and methods used
• Effect of changes in methods and inputs used
• Explanation of reasons for change & identification of contracts
affected
• Nature
N t andd extent
t t off risks
ik
• Extent of mitigation of risks (reinsurance, participation)
• Quantitative information about exposure to credit,
credit market and
liquidity risk
P.49
 31

Transition

Transition
• Measure the present value of fulfillment cash flows using
current estimates
• Derecognize current DAC balances
• Determine the single or residual margin:
▫ Through retrospective application of new principles to
all prior periods where it is practical to do so
▫ For earlier periods where the retrospective application
is not practical, estimate the margin
• Determine
D i the
h discount
di rate for
f a minimum
i i off 3 years
▫ Use difference from a reference rate for prior periods if
necessary

P.50
Recap - Timeline
• New IFRS ED for Insurance Contracts May or June 2013
▫ This will be an Exposure Draft but they are only asking for
comments on five areas:
 Presentation of premium
 Unlocking residual margin
 Changes in discount rate go through OCI
 Transition requirements
 Participating contract mirroring
▫ Will read all comments received
▫ 120 day exposure period
• FASB Exposure Draft for Insurance Contracts expected
J l 2013
July
▫ Asking for comments on entire ED
• Final standards adopted in 2014; effective in 2018?

34

Steps to get ready

• Work on your cash flow models
▫ Where are deterministic models sufficient?
▫ Where do you need to measure embedded guarantees stochastically?
• Comment on what you like and what you don’t like
▫ American Academy of Actuaries will focus on
 Accounting Mismatch (spurious volatility)
 Complexity/Expense/Usefulness
 Guidance – too much, too little
▫ Society of Actuaries will focus on
 Study on earnings impact (US GAAP vs. IFRS) for 15 products
 Will present to you here later this year
• Reconcile your cash flow models from one period to the next
• Stay current with approaches to calculating risk margin
• Consider how you will determine discount rates (i.e. top down or bottom
up)
P.51
 35

Questions & Maybe

Q y Answers

P.52