Capital Adequacy Test 1 – Quantum of assets test - PowerPoint Presentation

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Capital Adequacy

Test 1 – Quantum of assets testAims to ensure that the fund holds sufficient assets so that, after 12 months of adverse experience, it would have more assets that its (then) prudent liabilities.Slide3

Stress Test

Represents the amount by which a fund’s capital could deplete over 12 months under a 2nd percentile stressed scenario. Four elements:Stressed net margin estimate;

Stressed investment income estimate;

Stressed other income estimate; and

Tax.

The insurer needs to use its own method, assumptions and data in order to:

Determine the appropriate percentile to stress the three elements to give a 2nd percentile overall;

Determine the size of each of the stresses at that percentile.Slide4

Stress Test

Stress test amount calculated based on distribution of:Net margin, which in turn is based on:

Expected premium $, with rate increase capped at a level slightly above recent insurer-specific benefit increase (yet to be defined); and

Stressed net margin %;

Stressed investment income $; and

Stressed other income $.

Correlation between these three classes needs to be considered.Slide5

Stress Test - Issues

MethodProbabilistic or stochastic?

Actuarial black box?

Data

What is a 1 in 50 bad year?

At individual component level, what is a 1 in (say) 20 bad year?

Stressed net margin - is past data suitable? If so, for how long?

Stressed investment income

Allows for market risk, credit risk and balance sheet risk (i.e. incorrect value)

Where is the data for these risks?

How is the stress determined?Slide6

Stress Test - Issues

CommunicationBoard of insurer needs to ensure that each element of the Standards is properly calculated.

How do they ensure the stress test is “properly calculated”?

How does the AA engage with Board and management?Slide7

Stress Test - IssuesSlide8

Stress Test - IssuesSlide9

Insights – 2 July 2013 – PHI Capital Standards

Part 2: Other Capital Adequacy Items, &Capital Management PolicySlide10

Other Cap Ad components (“Quantum”)

Operational Risk: - $1m + ½%: - Growth component removed

- Includes ½% of non-insurance-business HRB revenue

Prudent Liabilities: - Pragmatic uplift from insurers 75%

PoA

accounting estimates

- Other liabilities (

eg

loyalty bonus) need 98%

PoA

estimates

- Pragmatic use of commencing liabilities

Supervisory Adjustment: - As always, PHIAC have room to intervene, but subject to AAT

Subordinated Debt: - Tougher rules: “genuinely loss absorbing”

- but can keep previously approved S.D.Slide11

Other Cap Ad components (“Concentration”)

“Capital Adequacy Maximum Default Loss Amount” (‘CAMDLA’?): - single maximum counterparty exposure

- excluding Fed/State/Territory government, ADI

- net of recoveries

CAMDLA must exceed: (Prudent liabilities) + (Supervisory adjustment if any)

Practical issues?: - Look through = a continuous responsibility

- Property: related parties, subdivisions, strata titlesSlide12

Capital Management Policy

Has been foreshadowed and informally “required” for years Significantly more formal requirements: Contents and Process

Contents: - Stated risk appetite

- Capital targets

- Triggers for action; and options for action

- Link to pricing policy and implications for prices (i.e. customers)

- Investment policy

- Liquidity management

Process: - Authority (Board approved)

- Timing (at least every 2 years

- Method (probabilistic)Slide13

Issues?

Cap Ad Quantum:Pragmatic Prudent liabilities for Cap Ad – are the value factors too simplistic? Does the pragmatism act unfairly in some circumstances?

Operational risk on non-health-insurance HRB – does this matter?

Are the subordinated debt rules too tough?

Cap Ad Concentration:

Look through = a continuous responsibility; will this limit reasonable actions?

Strata title and similar – insurer’s obligation to self-assess whether parties are related

Cap Ad Overall

:

does Cap Ad produce too low or too high a requirement?

Capital Management Policy:

Significantly more responsibility on the Board – Cap Ad seems lower, so CMP will drive capital from first principles?

What are the headline risks that capital must protect against?

Failure to meet policyholder promises? – previously this has been negligible

Failure to meet regulatory obligations?

Failure to meet shareholder goals?

Are “probabilistic” methods sufficient alone? Are additional analyses necessary?

Greater sophistication required from most insurer’s plansSlide14
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Insights – 2 July 2013 – PHI Capital Standards

Part 3: Solvency requirementsSlide16

Solvency requirement

Overview16

Maximum loss on the largest asset counterparty group (Band 1 assets)

% of future contributions

% of future contributions

Equities @ 50% value

Cash and Aus

gov

. bondsSlide17

Solvency requirement

Comparison to previous capital standards17Slide18

Solvency requirement

Qualifying assets18

Introduction

Not all assets are counted for solvency purposes

Qualifying assets are divided into 2 bandsSlide19

Solvency requirement

Qualifying assets19

Band 1

100% of the value counted

Definition: “highest liquidity and are expected to remain so over any reasonably foreseeable future stressed circumstances”

Prescribed asset types

Cash and cash equivalents (AASB definitions)

Assets with Australian government counterparty (excluding risk equalisation receivable)

Band 2

50% of the value counted

Securities listed on the ASX or a principal foreign exchange

Board must be satisfied that these assets can be readily converted to cash under highly stressed market scenarios

No allowance for other assets not in the prescribed list, even if it satisfies the definition.

Eg

highly liquid foreign government bonds

No guidance on a reasonable methodology in which the Board should adopt its opinion Slide20

AASB107 Para 7

Cash equivalents are held for the purpose of meeting short-term cash commitments rather than for investment or other purposes. For an investment to qualify as a cash equivalent it must be readily convertible to a known amount of cash and be subject to an insignificant risk of changes in value. Therefore, an investment normally qualifies as a cash equivalent only when it has a short maturity of, say, three months or less from the date of acquisition. Equity investments are excluded from cash equivalents unless they are, in substance, cash equivalents, for example in the case of preferred shares acquired within a short period of their maturity and with a specified redemption date.

Solvency requirement

Qualifying assetsSlide21

Solvency requirement

Cash management amount21

8% of the fund’s Health Business Revenue Estimate (HBR) for the next 12 months as per the Cap. Ad. Stress Test

PHIAC’s view is that liquidity requirements are related to contribution income.

Does not give credit to high profit marginsSlide22

Solvency requirement

Stressed losses amount22

HBR x min [62% x SEUs

-0.22

,

13%]

Health Business Revenue Estimate (HBR)Slide23

Solvency requirement

Solvency Maximum Default Loss Amount and Solvency Supervisory Adjustment amount23

Solvency Maximum Default Loss Amount

Same as the Cap. Ad. Equivalent but only applied to Band 1 assets

Solvency Supervisory Adjustment amount

As per Cap. Ad – if PHIAC believes any of the other Solvency components are inadequate

Not shown in the graphSlide24

Stressed losses amount – revenue basis

Term deposit treatmentLiquidity, breakability, duration to maturity, AASB definitions clarityCash management amount – revenue basis versus claims + expensesSolvency requirement

Solvency Maximum Default Loss Amount and Solvency Supervisory Adjustment amountSlide25