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72 Cards in this Set
- Front
- Back
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CIA DCAT
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CIA DCAT |
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Reverse stress testing
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determination of just how far the risk factor(s) in question has to be changed in order to drive the insurer's surplus negative during the forecast period, and then evaluating if that degree of change is plausible
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Goals of stress testing (4) |
1. Risk identification and control 2. Complementary risk perspective to other risk management tools, with simulation of shocks that have not occurred 3. Support for capital management 4. Improve liquidity management RISC |
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Company characteristics for materiality
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a. Size
b. Financial position -more rigorous if weak c. Nature of the regulatory test -use same base |
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Ripple effect (definition +5 examples) |
Definition: event or incident that occurs when an adverse scenario triggers a change in one or more interdependent assumptions or risk factors
Examples: a. Adjustments to base scenario assumptions that have been inappropriate b. Insurer's expected response to adversity c. Policyholder actions d. Regulatory actions, especially when failure to meet minimum capital e. Rating agency action, especially when significant changes in capital/surplus occur f. Likelihood of planned capital injections/distributions |
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Integrated Scenario |
1. Integrated scenario - "type of adverse scenario that results when two or more adverse scenarios are combined" 2. May combine two low-probability scenarios or high-probability and low-probability ones 3. May reflect correlated or uncorrelated risk factors but must produce a result at the 95th/99th percentile 4. May apply stress testing and include ripple effects |
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Single DCAT for group if
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a. Common audience
b. Regulator(s) of legal entities agrees c. DCAT includes both consolidated and legal entity results |
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Satisfactory financial condition |
1. Under base and all plausible scenarios the statement value of assets is greater than that of liabilities. 2. Under base scenario insurer meets the supervisory target capital requirement (150%). |
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Frequency and severity risk (Factors affecting increases in claims costs)
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a. Single catastrophic event
b. Single large claim c. Multiple catastrophic events d. Multiple large claims e. Other frequency and severity f. Social inflation |
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Frequency and severity risk (Possible Ripple effects)
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a. Reinsurer insolvency
b. Forced Sale and Liquidation of Assets c.Rating agency downgrade |
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Frequency and severity risk (Possible Management Action)
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a. Reviewing reinsurance coverage
b. Implementing rate increases c. Reviewing the target mix of business |
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Policy liabilities risk (Possible adverse Scenarios)
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a. Selection of inadequate loss development factors
b. Claims paid faster than assumed |
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Policy liabilities risk (Possible Ripple effects)
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a. Forced sale or liquidation of assets
b. Rating agency downgrade |
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Policy liabilities risk (Possible Management Actions)
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a. Implementing rate increases
b. Reviewing the target mix of business |
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Inflation risk (Possible adverse scenarios)
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a. Significant rapid and sustained increase in the general inflation rate
1) Increases in claim costs and expenses usually linked to a rapid and sustained increase in market interest rates 2) Reflect significant increase in inflation projected in the base scenario, usually with an increase in the market interest rate 3) Base on analysis of historical changes in the CPI over three-year periods of time b. Severe recession in the general economy 1) Increases in the number and size of claims, and claims expenses 2) Maybe linked to general inflation, unemployment level, or market interest rates |
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Inflation risk (Possible ripple effect)
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a. Rapid and sustained increase in market interest rates
b. Increased operating expenses |
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Inflation risk (Possible management actions)
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a. Implementing rate increases
b. Reviewing the target mix of business |
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Premium risk (lower premium volume) (Events that may reduce premium volume)
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a. Increased competitiveness
b. Loss of a key client |
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Premium risk (lower premium volume) (Possible ripple effects) |
a. Increased fixed expense ratio b. Forced sale or liquidation of assets c. Increase in certain expenses e.g. advertising |
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Premium risk (lower premium volume) (Possible Management Actions)
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a. Implementing rate changes
b. Changing the target mix |
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Premium risk (higher premium volume)(Events that may increase premium volume)
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a. Appointment of a key distributor
b. Premium rates too low relative to competition |
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Premium risk (higher premium volume)(Possible Ripple Effects)
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a. Higher loss ratio on new business from inadequate pricing
b. Higher expenses, e.g.,new employees |
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Premium risk (higher premium volume)(Possible Management Action)
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a. Implementing rate changes
b. Reducing some expenses |
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Reinsurance risk (Adverse scenarios)
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a. Insolvency of the reinsurer
b. Reduction in reinsurance capacity, reducing availability |
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Reinsurance risk (Possible Ripple Effect)
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a. Increased reinsurance rates from a new reinsurer
b. Reduced reinsurance availability |
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Reinsurance risk (Possible Management Actions)
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a. Changing reinsurance structure
b. Changing reinsurers |
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Investment risk (Adverse scenarios)
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a. Significant change in the yield curve
b. Decrease in the returns and/or value of equities |
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Investment risk (Possible Ripple Effect)
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a. Forced sale or liquidation of assets
b. Rating agency downgrade |
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Investment risk (Possible Management Effect) |
a. Selling or reinvesting assets b. Implementing rate increases c. Change investment strategy |
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Government and political risk (Adverse Scenarios)
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a. Rate freeze or rollback
b. Nationalization or privatization of LoB |
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Government and political risk (Possible Ripple Effect) |
a. Deterioration of loss ratios b. Forced sale or liquidation of assets c. Increased litigation costs |
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Government and political risk (Possible Management Action)
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a. Reducing business volume
b. Reviewing the target mix of business |
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Off-balance sheet risk (Adverse Scenarios)
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a. Letters of credit and pledged assets -risk of default by the lending institution
b. Pension underfunding |
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Off-balance sheet risk (Possible Ripple Effects)
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a. Forced sale or liquidation of assets
b. Significant positive or negative cash flows that affect liquidity |
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Off-balance sheet risk (Possible Management Action) |
a. Changing the pension plan to a defined contribution plan b. Reducing costs, e.g., layoffs c. Reposition derivative tools |
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Derivative Instruments Risk
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1) Derivative market risk- sum of derivative liquidity and basis risks 2) Derivative liquidity risk - risk of not being able to cancel or unwind one's contract when desired or at a favourable price 3) Derivative basis risk- risk that the derivative's price behavior does notact as expected, undoing the intended hedging benefits 4) Derivative default a.k.a. credit risk -risk that a loss will be incurred due to default in making the full payments when due, in accordance with the terms of the contract 5) Derivative management risk - potential for incurring material,unexpected losses on derivatives due to inadequate management supervision and understanding, systems, controls,procedures, accounting and reporting 6) Derivative legal risk -risk that the derivative agreement is not binding as intended |
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Related company risk (Adverse scenarios)
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a. High level of dependency on group operational resources -may lead to service disruptions
b. Rating agency downgrade refelecting difficulties at group level |
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Related company risk (Possible Ripple Effect)
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a. Providing for service disruption
b. Regulatory protection of local policyholders |
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Related company risk (Possible Management Action) |
a. Reviewing the target mix of business by line or jurisdiction b. Selling or reinvesting assets c. Find alternative operational support funds |
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Main purpose of DCAT
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the identification of possible threats to the financial condition of the insurer and appropriate risk management or corrective actions to address those threats
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OSFI Stress Testing Guideline
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OSFI Stress Testing Guideline |
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Stress testing
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risk management technique used to evaluate the potential effects on an institution's financial condition, of a set of specified changes in risk factors, corresponding to exceptional but plausible events
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Scenario Testing vs. Sensitivity Testing
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a. Scenario testing - stress testing technique using "a hypothetical future state of the world to defme changes in risk factors affecting an institution's operations"
1) Includes ripple effects 2) Use appropriate time horizon 3) Changes in number of factors b. Sensitivity testing - stress testing technique that 'typically involves an incremental change in a risk factor (or a limited number of risk factors)" 1) Conducted over a shorter period 2) Simpler technique using fewer resources |
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Purposes of Stress testing |
a. Risk identification and control: included in risk management at different levels b. Complementing other risk management c. Supporting capital management: part of internal capital management with forward looking stress testing to identity severe events d. Improving liquidity management: stress testing should be a central tool in identifying and measuring liquidity risks |
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Responsibilities Board of Directors for Stress testing
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a. Board has ultimate responsibility for overall stress testing program
b. Ensure that management has adopted policies for use of stress testing c. Knowledge of key threats/findings resulting from stress test |
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Responsibilities Senior Management for stress testing
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1) Ensure plans for risk mitigation strategies and for stress scenarios
2) Be able to understand risk appetite and impact of stress events |
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General considerations stress testing program (4) |
A. Cover Range of Perspectives and Techniques B. Need for Documentation - written policies and procedures C. Need for Flexible Infrastructure - able to adapt changing stress tests at different levels of granularity D. Need for Regular Updating |
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Consideration for methodology and scenario selection (3) |
A. Should Cover a Range of Risks and Business Areas B. Should Cover a Range of Scenarios and Identify Concentrations C. Should Cover a Range of Severities and which scenarios could challenge viability |
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Specific cases of focus for stress testing (5) |
1. Risk mitigation. 2. Securitization and warehousing risks. 3. Risks to reputation. 4. Counterparty credit risks. 5. Risk concentrations. |
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Supervisory duties for stress testing (3) |
1. Evaluate consistency of selected scenarios with institution's risk appetite 2. Assess whether scenarios are appropriate to the portfolio and include severe shocks and periods of severe downturn 3. Request at times standardized sensitivity and scenario tests |
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OSFI Target Capital
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OSFI Target Capital |
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OSFI Capital assessment criteria (4) |
(1) adequacy of capital to support risk profile and business plan, including risks not fully captured in regulatory capital guidelines (2) ability to access capital at reasonable rates to meet projected needs (3) quality of capital (4) quality of insurer's capital management policy and processes |
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Minimum (Capital)
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Minimums: The minimum levels of capital necessary for an insurer to cover the risks specified in the Capital Guidelines.
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Supervisory targets
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The target levels of capital necessary for an insurer to cover the risks specified in the Capital Guidelines as well as to provide a margin for other risks
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Internal targets
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The target levels of capital, determined as part of an insurer's ORSA, needed to cover all the risks of the insurer, including the risks specified in the Capital Guidelines
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If available capital < Internal target
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If Available Capital levels fall below its Internal Targets (or is anticipated to happen within two years)
a) Insurer should inform OSFI promptly b) Provide plans for managing risks and/or restoring Available Capital levels to its Internal Targets |
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Capital Management policies established by ORSA should include (3) |
B. ORSA and strategic/business plans should support Senior Management and the Board in establishing capital management policies that include:
1. Clearly defined roles and responsibilities with respect to the design and execution of relevant policies and procedures
2. A policy that states capital adequacy goals relative to risk, taking into account the insurer's strategic focus and business plan, and that sets its Internal Targets
3. A policy with respect to the Board's regular review and discussion of the insurer's capital management policy and ORSA. |
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OSFI ORSA
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OSFI ORSA |
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Key elements of ORSA (5) |
A. Comprehensive Identification and Assessment of Risks B. Relating Risk to Capital - adequacy of capital for risks taken C. Board oversight and Senior Management Responsibilities - ultimate responsibility vs implementing D. Monitoring and Reporting - include risk appetite statement and risk management, consider risk tolerance E. Internal Controls and Objective Review - periodic reviews of ORSA for integrity, accuracy and reasonability |
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Relating risk to capital considerations (3)
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A. Determine own capital needs
B. Set Internal Target C. Integrate with other business processes |
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Insurer should consider materials from other researchers for own capital needs (4)
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Insurers should consider materials dealing with quantification of risks and mitigates such as from researchers such as:
i. Regulators, consulting firms, professional and other associations, academia, credit rating agencies and other purveyors of research, data, models and publications relating to the measurement of risks and risk mitigates; ii. Empirical data, evidence and studies of the different and varying manifestations of historical and potential new risks in different markets for similar and dissimilar business activities and products; iii. Developments in the insurance, financial and other markets and their potential impact on the continued appropriateness of current measurement tools, data and assumptions used by the insurer; iv. Bench-marking exercises with respect to risk measurement and mitigation tools and their results, whether in the insurance sector or in other sectors where similar risks exist. |
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Board responsibilities ORSA (4) |
1. Should review ORSA and any changes to it
2. Should understand decisions taken by senior management, plans and policies
3. Should make sure that decisions from senior management consistent with Board's decisions, business and risk strategy
4. Should make sure that internal controls are sound and effectively implemented |
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Review areas ORSA by insurer (4)
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1. Reasonableness and validity of the ORSA results, including the embedded assumptions and inputs from stress tests, scenarios, models and other methodologies and tools used in the assessment process;
2. Reasonableness of overall ORSA results and of individual risk and components; 3. Consistency of ORSA results with insurer's risk limits and risk appetite 4. Documentation for ORSA and report to Board 5. Effectiveness of Information systems that support ORSA |
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ORSA areas checked by supervisor (4) |
1. Risks not fully captured (e.g. concentration, contagion and aggregation of risks) and/or not explicitly captured (e.g. reputation and strategic risk) by regulatory capital guidelines
2. External factors not already considered, including stress testing, impact of economic cycles and other external risks
3. Level and quality of insurer's capital, and assessment by insurer using stress scenarios included or referenced in the ORSA
4. Limitations of insurer's ORSA and how these are communicated to Board |
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Social inflation |
Claims inflation resulting from changes in the likelihood of claimants suing, size of awards, standards of liability or attitude towards settlement. |
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Once supervisory approval is given for internal model, the insurer should (4) |
1. Monitor the performance of its internal model and regularly review and validate its appropriateness of the model's specifications. 2. Notify the supervisor of material changes to the internal model. 3. Document internal model changes. 4. Report information needed for supervisory review and ongoing approval of internal model. |
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What steps to undertake before using internal model (4) |
1. Prior supervisory approval needed. 2. Adopt risk modelling techniques and approaches appropriate to the nature, scale and complexity of its current risks. 3. Validate internal model with at least three test: statistical quality test, calibration test and use test. 4. Demonstrate that model is appropriate for regulatory capital purposes. |
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Two control levels for solvency (2) |
1. Prescribed Capital Requirement (PCR). Control level above which supervisor does not intervene on capital adequacy grounds. 2. Minimum Capital Requirement (MCR). Solvency control level at which, if breached, the supervisor invokes it's strongest actions in the abscence of appropriate corrective action by the insurer. |
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Three tests to validate internal model (3) |
1. Statistical quality test to assess the base quantitative methodology of the internal model. 2. Calibration test to demonstrate that the regulatory requirement determined by the internal model satisfies the modelling criteria. 3. Use test: embed the internal model into the insurer's risk strategy and operational processes. |
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Recommendations of OSFI with respect to risk aggregation and diversification benefits during ORSA (2) |
1. Should consider if exist during periods of stress. 2. Should also consider potential concentrations, dependencies and interactions of risk that could exacerbate situations. |
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Similarities ORSA and DCAT (4) |
1) Both involve the identification of material risks 2) Both must be filed with regulator 3) Both include scenario/stress testing 4) Both can be used to identify corrective management actions |
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Differences DCAT and ORSA (3) |
1. DCAT must be prepared by the AA and include actuarial opinion, whereas ORSA is management's responsibility 2. ORSA contains a large qualitative component whereas DCAT is mostly quantitative 3. DCAT contains alternate assumptions between the 95th and 99th percentile, whereas in ORSA the scenarios are tailored to risk appetite. |
