2006 General Meeting Assemblée générale 2006 Chicago, Illinois

1. Canadian Institute of Actuaries L’Institut canadien des actuaires 2006 General Meeting Assemblée générale 2006 Chicago, Illinois

2. IP – 11 International Capital StandardsStuart Wason Terri Vaughan 2006 General Meeting Assemblée générale 2006 Chicago, Illinois

3. Current Developments • Insurance regulators & actuarial profession working together • International Association of Insurance Supervisors (IAIS) & International Actuarial Association (IAA) • US (NAIC and American Academy of Actuaries) • Europe (European Commission, CEIOPS & Groupe Consultatif) • Switzerland (FOPI & Swiss Association of Actuaries) • Canada (OSFI, AMF & CIA)

4. IAA Developments • Solvency Sub-Committee • “Blue Book” on “Towards a Global Framework for Insurer Solvency Assessment • Internal Model Best Practices paper • Work in support of IAIS Solvency Sub-Committee • Risk Margin Working Group • Draft paper on risk margins

5. European Developments • EC and CEIOPS • Developing Solvency II framework • New insurance directive expected fall 2007 – full implementation by 2011 • Solvency II framework based on principles in IAA “Blue Book” • Groupe Consultatif • Working together with CEIOPS to address practical and theoretical issues of Solvency II

6. Swiss Developments • Federal Office of Pensions and Insurance (FOPI) • Introduced first comprehensive framework (called Swiss Solvency Test or SST) in line with IAA “Blue Book” in 2004 • Extensive period of implementation and testing is underway – final implementation will likely be integrated with European Solvency II • Swiss Actuarial Association • Worked together with FOPI to address practical and theoretical issues of SST

7. Key Initiatives • IASB/IFRS • EU Solvency II • IAIS Solvency Subcommittee

8. International Accounting Standards Board • Developing International Financial Reporting Standards (IFRS) • Discussion document for insurance contracts will be issued next year • Market consistent valuation of liabilities • Trading price/settlement values • Loss reserve discounting • Risk margin • Numerous unresolved issues

9. Solvency II • Three pillars • I: Quantitative requirements to ensure capital adequacy • II: Internal risk management processes and supervisory review • III: Increased transparency • Total balance sheet approach – broad set of risks • Technical provisions with risk margin (Cost of capital vs. percentile approach) • Standard approach and internal models • Solvency control levels • Focus on qualitative aspects of risk management in pillar II

10. IAIS Papers • A New Framework for Insurance Supervision: Towards a common structure and common standards for the assessment of insurer solvency • Toward a Common Structure and Common Standards for the Assessment of Insurer Solvency: Cornerstones for the formulation of regulatory financial requirements • Roadmap for a Common Structure and Common Standards for the Assessment of Insurer Solvency • The Common Structure for the Assessment of Insurer Solvency

11. Supervisory supervisory Supervisory supervisory assessment and intervention supervisory assessment and intervention Assessment assessment Action Common Solvency Structure and Standards LEVEL 3 Regulatory regulatory regulatory financial financial governance governance market conduct market conduct Requirements requirements requirements LEVEL 2 the insurance supervisory authority the insurance supervisory authority basic conditions for the basic conditions for the Preconditions preconditions preconditions effective functioning of effective functioning of the insurance sector and insurance supervision the insurance sector and insurance supervision LEVEL 1 IAIS Framework Paper Outline of the Framework for insurance supervision

12. Supervisory Assessment of the financial position of the insurer Public financial reporting capitall available capital capital requirement value of admissible assets risk margin liabilities liabilities best estimate policy obligations assets liabilities and capital requirement financial position assets liabilities IAIS Cornerstones Paper The supervisory assessment of the financial position of an insurer and the public financial reporting of an insurer

13. Roadmap and Structure papers • Roadmap Paper outlines a work plan. • First step is the development of a “Structure Paper”: • Draft paper issued in June. Revised draft issued October 9. comments due by November 1. Intent is to have it ready for IAIS Technical Committee adoption in January. • Elaborates on main elements of the structure, including total balance sheet approach • Identifies respective roles of capital and technical provisions • Market consistent valuation of assets and liabilities • Technical provisions include risk margin based on settlement value/transfer pricing; ideally consistent with IFRS • Executive Summary ties together the Framework, Cornerstones, and Structure papers

14. Structure paper • Framework Level 1: preconditions for solvency assessment • The supervisor must have adequate powers • Framework Level 2: regulatory requirements (financial, governance, market conduct) • Framework Level 3: Supervisory assessment and intervention • There should be a number of solvency control levels triggering different levels of intervention • Disclosure • The supervisory regime should specify which solvency information should be made public to enhance market discipline

15. Level 2Supporting Principles • Provide the basis and incentives for optimal alignment of risk management by the insurer and regulation • Address all relevant potentially material risks • Quantifiable • Non-quantifiable • Market consistent models used where no deep liquid secondary markets • Market consistent valuation of technical provisions based on the risk characteristics of the portfolio • Total balance sheet approach • Technical provisions include a risk margin

16. Level 2Supporting Principles (cont.) • Purpose of capital: to ensure that obligations will be covered over a predefined period, to a required level of safety • Technical provisions should be calibrated based on the assumption of a market level of diversification of the relevant risk factors. • Mismatch risk exposure assumed voluntarily by the insurer should be reflected in required capital • Risk margin reflects risk related to all liability cash flows and thus to the full time horizon • Require insurers to maintain corporate governance policies, practices and structures and undertake sound risk management. • Require insurers to have sound market conduct policies and procedures.

17. Common Themes of All Efforts • More risk sensitive measures • Encouraging effective risk management • Encompassing a broader set of risks (credit, market, underwriting, and operational) • Relevance of internal models (Stochastic modeling, scenario testing) • Market consistent valuation of assets and liabilities Consistency with IFRS Risk Margin in liabilities • Total Balance Sheet Approach • Issues • Measures of variability/risk margins • Risk aggregation; group vs. individual company • Role of the actuary • Regulatory oversight processes

18. Issues and Questions • No deep, liquid market for insurance liabilities • Consistency of rules vs. consistent implementation • Implications for cost of capital, product design, investment strategy and capital markets • Costs to implement • Regulatory oversight • Expertise • Need for new oversight processes • Model validation?

19. U.S. Developments • Increased product complexity, international trends, changing competitive landscape • Limitations of formula-based reserving; traditional US RBC measures

20. Principles* • Principles-Based Approach (PBA) means an approach to calculate statutory reserves and capital requirements for insurance companies that incorporate the following concepts • Captures all identifiable, quantifiable and material risks, benefits, and guarantees associated with the contracts • Utilizes risk analysis and risk management techniques to quantify the risk • Incorporates assumptions and methods that are consistent with, but not necessarily identical to, those utilized within the company’s overall risk assessment process • Permits use of company experience • Provides for use of assumptions, set on a prudent best estimate basis, that contain an appropriate level of conservatism when viewed in the aggregate. * Prepared by the Consistency Work Group of the Life Financial Soundness/Risk Management Committee, American Academy of Actuaries. This is a summary of the principles.

21. Evolution in the U.S. • RBC C-3 Phase 1 (2000) • Single premium interest-sensitive life and annuity business • RBC C-3 Phase II (effective December 31, 2005) • Variable annuity products with guarantees • Capital charge based on greater of • CTE 90 ( average of worst 10% scenarios) under stochastic modeling • Regulator-defined deterministic scenario • Under development • VACARVM: variable annuity reserves; expected to become effective Dec. 2007. • SVL 2: life and fixed annuity reserves • C-3 Phase 3: life and fixed annuity capital

22. Related Developments/Issues • Governance (Corporate Governance for Risk Management Act - Draft 9/28/06; Corporate Governance for Risk Management Model Regulation - Draft 9/28/06) • Role of Board and Management • Risk Management policies and procedures • Certifying Actuary • PBA Review Actuary (Principles-Based Valuation Review Opinion Draft Model Regulation - Draft September 8, 2006) • Development of preferred mortality tables • Centralized review? • Taxes

23. Canadian Developments • OSFI & AMF • Currently working with key stakeholders on a new vision for solvency assessment of life insurers in Canada through an MCCSR Advisory Committee (MAC) • Work of MAC supported by Solvency Framework Sub-Committee (SFSC) • Expect 2011 implementation • Canadian Institute of Actuaries • Working as part of MAC and SFSC to address practical and theoretical issues of a new Canadian approach

24. Canadian Developments • MAC accomplishments to date • Forum for all Canadian stakeholders • Agreement on key principles for new solvency framework • Directs work of SFSC • Currently drafting a “Vision” paper for the new framework • SFSC accomplishments to date • Time Horizon paper • Terminal Provision paper • Internal Model best practices paper

25. Canadian Developments • Draft Vision • Future Canadian life insurer capital requirements determined using “total balance sheet” (TBS) approach • Insurer’s true financial strength for solvency purposes requires appraisal of all its assets & liabilities on integrated basis under a system that depends on realistic values, consistent treatment of both assets & liabilities • TBS approach delivers realistic view of financial position of insurer independent of any financial reporting requirements

26. Total Balance Sheet Approach

27. Canadian Developments • Why change? • Leading insurers are moving toward advanced capital models for internal risk management, capital management, regulatory reporting requirements, and rating agency assessments. • MAC believes it is important to support these developments in risk management as all stakeholders benefit from a better determination and allocation of capital to risk.

28. MAC Key Principles • Consider all risks • Determineassets and liabilities on a consistent basis. • Be practical, but technically sound. • Reflect existing risks on going concern basis and consider winding-up and restructuring. • Use risk measures that are comparable across risks and products. • Ensure that capital is prudent.

29. MAC Key Principles • Encouragegood risk management. • Adaptinternational principles and best practices. • Allowcomparison of similar risks across financial institutions. • Betransparent, validated and based on credible data. • Usereliable processes with assumptions sustainable in times of stress. • Bepart of intervention levels for supervisory action.

30. Additional Criteria • Current risk-based multi-level supervisory approach retained • Time horizon of one year; after one year remaining funds must enable insurer to fulfill its policyholder obligations or pass the risks on to a succeeding insurer • Assets must be adequate to provide for obligations of insurer with a high degree of confidence. • Recognition of risk diversification and concentration • Advanced approaches using internal models will be encouraged for large insurers and for certain complex risks • Standardized approaches derived from industry experience according to the preceding principles available for all insurers • Regulatory target capital requirement & lower minimum capital requirement

31. International Developments • Challenges and opportunities – exciting times ahead! • ERM • Stochastic modelling expertise • Risk aggregation • Advanced & standardized approaches • Model calibration and validation • Communication

32. IP – 11 International Capital StandardsStuart Wason Terri Vaughan 2006 General Meeting Assemblée générale 2006 Chicago, Illinois