CIA.FCT&OSFI.ORSA&Stress Flashcards
FCT def
is one several stress-testing processes within an insurer’s overall risk management process.
Goal of FCT
- identify threats to the insurer’s financial condition.
- take corrective actions to address those threats. (It should be performed at least once during each financial year.)
How often should AA investigate insurer’s financial position / condition
AA should make an investigation at least once each year of insurer’s financial position & financial condition, as revealed by FCT for selected scenarios.
AA report regarding to FCT findings
AA should write report to board of directors or appropriate committee of the board.
Report should identify possible actions & reasons dealing with any threats to satisfactory financial condition; comment on consistency of the results & possible actions with ORSA
Goal of ORSA
enhance an insurer’s understanding of the relationship between risk profile & capital needs.
why does an insurer perform stress-testing [Hint: risk-complement-Cap-Liq]
[1] risk
- identify & control risk
[2] complement
- provide a complement to other risk management tools AND simulate shocks
[3] Cap
- support capital management
[4] Liq
- improve liquidity management
describe the stress-testing purpose: ‘risk identification & control’
- risk identification:
- identify concentrations & interactions of risks
- risk control:
- adjust individual portfolios or overall business strategy
describe the stress-testing purpose: ‘complementing other tools’
- test statistical models used to determine Value-at-Risk
- simulate SHOCKS to test model robustness to economic changes
describe the stress-testing purpose: ‘supporting capital management’
- identify severe events and/or compounding events that impact capital requirements
describe the stress-testing purpose: ‘improving liquidity management’
- assess liquidity profile and adequacy of buffers FOR institutional & market-wide stresses
describe how stress-testing is a key risk management tool for coverage of overland flooding
company won’t have historical data
==> identify flood risks using stress-testing models
==> estimate capital required to support flood risk in different scenarios
==> stress-testing could complement publicly available flood data
describe board vs. management responsibilities regarding a stress-testing program (3,3)
Board of Director’s responsibilities: * ultimate responsibility for program
* ensures implementation of program by management
* should be aware of key findings
Management’s responsibilities: * implement & manage stress-testing program
* identify PAS (Plausible Adverse Scenario)
* develop& implement risk mitigation strategies
* Identifying and describing the company’s risk appetite
identify 4 rudimentary considerations in stress-testing
R: RANGE (stress-testing should use a range of perspectives & techniques)
U: UPDATE (the stress-testing framework should be updated regularly)
D: DOCUMENTATION (proper documentation of methodology should be available)
I: INFRASTRUCTURE (the stress-testing infrastructure should be flexible if assumptions or methods change.)
What OSFI looks for in assessing a stress-testing program.
AFSV
APPROPRIATENESS: Are the scenarios appropriate for institution’s risk profile? Appetite?
VIABILITY: are scenarios included that compromise viability
FREQUENCY: is stress-tesing frequent enough for timely management action
SEVERE SHOCKS: do scenarios include severe shocks & sustained downturns
Regulator Considerations - stress testing
- scenarios chosen consistent w. risk appetite
- scenarios include severe shocks & downturn
- whether the frequency and timing of stress testing is sufficient to support timely management action
- capital might not be freely transferable within groups under adverse scenarios.
Evaluation of creating scenarios in a stress-testing program.
Comprehensive: scenarios should cover all important BUSINESS & PRODUCT lines
Non-historical: create NON-HISTORICAL scenarios (events that haven’t happened but COULD happen)
Downturn: severe & sustained DOWNTURNS (includes large losses, loss of reputation, legal problems,..)
compare and contrast scenario-testing with sensitivity-testing
scenario-testing:
- significant changes to risk factors
- observe future state including ripple effects & management actions over a longer time horizon
- more complex & comprehensive
sensitivity-testing:
- incremental changes to risk factors
- shock is more immediate & time horizon shorter
- simpler fewer resources required
focus areas in response to financial market turmoil (5)
- risk mitigation
- S&W (Securitization & Warehousing)
- Reputation (reputational risk)
- Credit risk (& Counter-party Risk)
- Concentration risk
describe focus areas when designing a stress-testing program for flood & provide examples
focus 1: - risk mitigation
focus 2: - reputation risk
focus 3: Counterparty credit risk
focus 4: Risk concentrations
focus 5: Capital management
focus 6: Liquidity risk
focus 7: Multiple perspectives
focus 8: Infrastructure for regular updates
identify & briefly describe the key elements of FCT (Financial Condition Testing) (5)
- Base scenario - must develop a base scenario (usually the insurer’s current business plan)
- Adverse scenario - must develop multiple adverse scenarios
(Ex: COVID, climate change, one of Alice’s legendary all-night dance parties) - Corrective action - identification and analysis of corrective management actions to mitigate risks
- Report - submit recommendations to management and the board of directors (or chief agent)
- Opinion - Appointed Actuary signs an opinion regarding the financial condition of the insurer
identify key metrics that must be understood when performing FCT (2)
- regulatory capital minimum(s)
- insurer’s internal target capital requirements ← determined by ORSA
identify the ‘preliminary’ step and the ‘extra’ step in addition to ‘BACRO’ when performing FCT
preliminary step:
- review financial position at year-end for each year in historical period
extra step at the end:
- identify possible regulatory action
what is a review of operations and financial position
- review balance sheet, statement of income, and source of earnings for an appropriate number of years
- analyze any trends in these numbers
what is the forecast period for FCT
- the forecast period should be long enough to capture
[1] risk emergence
[2] financial impacts
[3] ripple effects
[4] corrective action
→ generally 3-5 years although there is no minimum (should also be consistent with ORSA)
how do you determine the materiality standard for FCT
FCT sets the materiality standard with management input and by specifically considering:
- size of insurer
- financial position
- nature of regulatory test
define the term base scenario
a set of assumptions on risk factors that are consistent with the business plan over the forecast period
(if plan is realistic & consistent)
define the term adverse scenario
a scenario that is developed by stress-testing assumptions used in the business plan
(look specifically for risk factors that threaten financial condition)
define the term solvency scenario
a plausible adverse scenario (an adverse scenario that has a non-trivial probability of occurring)
* should fall above the 95th percentile on the loss distribution (if distribution is available)
* or possibly as high as the 99th percentile and beyond depending on circumstances
define the term going-concern scenario
an adverse scenario that is more likely and/or less severe than a solvency scenario
* should fall above the 90th percentile on the loss distribution (if distribution is available)
* could include risks not considered in solvency scenarios
what is a ripple effect
- an event that occurs when an adverse scenario triggers a change in 1 or more inter-dependent assumptions
- can include policyholder actions, management’s routine actions, regulatory actions
Example: a ripple effect of an earthquake may be loss of reinsurance
what is a corrective management action
- an action management takes to mitigate adverse ripple effects
what is an integrated scenario for FCT
- a scenario created by combining two or more risks factors to produce a new plausible adverse scenario
Example: combine a low-probability scenario with a higher-probability adverse scenario
identify considerations in the development of a climate change integrated adverse scenario
Consider these climate-related risks:
* Physical risk → frequency and severity of wildfires, floods, wind events, rising sea levels
* Transition risk → due to economic shift to greener technologies
* Liability risk → exposure to climate-related litigation
Identify examples of IFRS 17 measurement features to consider for FCT scenarios (3)
[1] IFRS 17 liabilities make no provision for:
default risk
reinvestment risk
asset-related risks
[2] IFRS 17 liabilities do not reflect certain benefits such as:
impact of discounting arising from deferred tax assets
impact of discounting arising from risk premiums that are deducted in determining discount rates
[3] IFRS 17 liabilities only include maintenance expenses directly attributable to administration of contracts
[4] Risk adjustment incorporates the entity’s view of risk and may incorporate diversification benefits not realized in adverse scenarios
[5] IFRS 17 liabilities includes the CSM when evaluating solvency scenarios (see FCT Reporting for further details)
identify key elements that an FCT model should reproduce (4)
[1] balance sheet: assets, liabilities, retained earnings,..
[2] income statement: revenue & expenses
[3] regulatory measures of capital adequacy: MCT ratio, and possibly others like BCAR or MSA ratios
[4] sources of earnings: detail on sources of premium and investments
what is the recommended loss distribution percentile for a going-concern scenario
90th → 95th percentile (if the loss distribution and percentiles are available)
what is the recommended loss distribution percentile for a solvency scenario
95th → 99th percentile (if the loss distribution and percentiles are available)
* or even beyond the 99th percentile in some cases (the source text didn’t provide details)
how does an actuary validate an FCT model on an accounting basis
verify: statement of income = (cash flows) + (change in balance sheet items)
how does an actuary validate a FCT model in a static environment
base scenario should show continuity of results from year-to-year (cash, liabilities, surplus,..)
how does an actuary validate a new FCT model or model update
NEW MODEL: run with data at (t-1) & compare to actual data at t (should be close)
MODEL UPDATE: do a retrospective test (compare prior base scenario projection to current data)
how does an actuary validate a FCT model in a changing environment
ASK: does model properly QUANTIFY changes in results under different assumptions
COMPARE: 2 adverse scenarios (magnitude & direction of change should be consistent with assumptions)
when is a stochastic FCT model appropriate (2)
- when risk distributions are easily inferred (Ex: cats)
- capital market risks
when is a deterministic FCT model appropriate
- when distributions are NOT easily inferred
- actuary then selects scenarios based on (historical experience, credibility of data)
what is a combination stochastic/deterministic model
when RESULTS of a stochastic model are used to DERIVE a deterministic scenario that REPRODUCES the stochastic results
how are ripple effects in a FCT analysis modeled (2)
AUTOMATICALLY: by computer model
MANUALLY: by actuary based on knowledge of situation
what are some considerations in FCT model segmentation (3)
MANAGEMENT: segment around mgmt structure
PRODUCT: smallest subdivision - may combine similar products
INVESTMENT: asset categories
identify an important IFRS 17 concept to consider when creating an FCT scenario
- CSM (Contractual Service Margin) for GMA and VFA approaches
does the PAA (Premium Allocation Approach) have a CSM component? Explain.
- No, but PAA requires a Loss Component (LC) for onerous contracts
(and LC cannot be offset by future profits so ‘level of aggregation’ is an important consideration)
identify aspects of IFRS 17 that should be considered when creating FCT scenarios
- The impact of adverse scenarios on onerous groups is not absorbed by the CSM - it will be reflected in earnings immediately.
- Modelling will need to capture the behaviour of groups of contracts rather than individual contracts
- Groups of reinsurance contracts are modeled separately from the underlying primary insurance contracts issued.
- The business volume forecast requires sufficient granularity to model the timing of recognition of new cohorts.
What is ORSA
is an internal capital assessment procedure that is tailored to an insurer’s own risk appetite and risk profile.
The intent of ORSA is to consider insurer-specific risks that are NOT covered in industry-wide capital guidelines (MCT).
what is the general goal of ORSA
enhance insurers’ understanding of the relationship between (risk profile, capital needs)
does OSFI approve an insurer’s ORSA
NO, but OSFI will REVIEW a company’s ORSA as part of its assessment of the company
what is the relationship between ERM (Enterprise Risk Management) & ORSA
(ERM, ORSA) should be WELL-INTEGRATED so that (analysis, results) are consistent between them
identify ORSA’s key elements (5)
ORR-IO-RM
RISK identification & assessment
RELATE risk to capital
Oversight
(M&R) MONITORING & REPORTING of risks
(I&O) INTERNAL controls & OBJECTIVE review
describe the ORSA key element ‘risk identification & assessment’
[MFE]
identify & assess the MATERIALITY of forseeable & emerging risks
describe the ORSA key element ‘relating risk to capital’
- set ICT (Internal Capital Target) using stress-testing techniques
- must WITHSTAND a specified loss without falling below (Supervisery Capital Requirements)
describe the ORSA key element ‘Oversight’
Senior Management Responsibility: should have a good understanding of:
- nature and significance of the risk exposures
- risk mitigants
- risk management methods
- capital adequacy
regarding ORSA key element #2, ‘relating risk to capital’ , identify possible approaches to calculating ICT (Internal Capital Target) (3)
COMPLEX INTERNAL MODEL: for complex risks
SIMPLE MODEL: with conservative assumptions
QUALITATIVE: includes expert judgment for difficut-to-quantify risks
describe similarities between FCT & ORSA (3)
- both are concerned with risk identification & control
- both are concerned with capital requirements
- both are submitted to BoD (Board of Directors) & regulators
describe differences between FCT & ORSA (3)
[1] GUIDELINES:
FCT: uses CIA SOPs (Statement of Principles)
ORSA: uses OSFI guidelines
[2] METHODS:
FCT: quantitative only
ORSA: qualitative & quantitative
[3] REPORT:
FCT: by AA (Appointed Actuary)
ORSA: management responsibility
identify advantages of ORSA over MCT
ORSA:
|1] includes ALL material rsks
|2] uses stress-testing to set ICT(Internal Capital Target)
|3] qualitative (as well as quantitative)
|4] admits assessment of internal controls
MCT: doesn’t do these things
defn of ‘stress-testing’ (general)
a risk management technique
==> TO EVALUATE effects on financial condition..
==> due to SPECIFIED CHANGES in risk factors..
==> corresponding to exceptional but plausible events
QUIK-SUMM - purpose of stress-testing (4)
RISK:
- identify & control risk
COMPLEMENT:
- provide a complement to other risk management tools + simulate shocks
CAPITAL MANAGEMENT:
- support capital management
LIQUIDITY MANAGEMENT:
- improve liquidity management
