This presentation summarises the proposed RBC regime for life insurers in Sri Lanka and explores the challenged they face in meeting the new requirements

1. Life insurance only
Risk Based Capital In Sri Lanka:
Making it happen
13th November 2012, Colombo
Presentation to Sri Lankan Insurance Industry (IASL)

2. Overview
1. Risk Based Capital 101
2. RBC in Sri Lanka : The timetable
3. The Quick “How to” Guide for Life RBC
4. Latest IBSL Draft Regulations – 31st October
2012
5. “C” level discussion : Implementation
strategies & challenges

3. Risk based capital 101
OLD WORLD = Net Premium
and book value – a world of
hidden margins and “one size
fits all”
NEW WORLD = principles
based approach that is market
and insurer related
RBC is part of a journey - it is not the end state e.g. In Europe have Solvency II

4. Risk Based Capital : Board Report SAMPLE
Tier 1 Capital : Fully available Rs Million
Stated Capital 200
Capital reserves 100
Non Cumulative ireedeemeable preference shares 100
Retained Earnings 500
Unallocated Valuation Surplus 100
50% of futue bonuses 150
Total 1,150
Tier 2 capital : Lower quality (Maximum of <50% of Tier 1)
Cumulative ireedeemeable preference shares 100
Irreedemable subordinated debt 200
Available for sale reserves 50
Revaluation reserves (property) 200
Revenue Reserve 0
Subordinated term debts 100
Ireedeemable subordinated debts 100
Total 750
Allowed 575
Capital Deductions : Capital Not available
Goodwill and other reserves (100)
Deferred tax assets (100)
Investment in subsidiaries (100)
How is RBC calculated?
Assets pledged to support credit Facilities 0
Total (300)
Total Available Capital (TAC)
Tier 1 1,150
Tier 2 Allowed 575
Less Capital Deductions (300)
TAC 1,425
Risk Based Capital (RBC) 1,032
Risk Based Capital Adequacy Ratio (RBCAR) 138%
Minimum Capital Required (MCR)
Absolute Minimum TAC 500 OK
Minimum Paid up Capital required 500 Not Compliant
Supervisory minimum RBCAR 120% OK

5. Types of Risk
Credit – “Asset income streams are not guaranteed”
Liability – “insurance experience is not as expected”
Operational -” Non specific risks”
Reinsurance -“Reinsurer fails to meet obligations”
Market - “Asset values are volatile”
Surrender - “All policies are surrendered”
Catastrophic – “Very bad things happen”

6. 2 Impacts
1. Reported Profit – will be more realistic and will
be based on market conditions
2. Capital – will be required on measures closer to
a realistic set of principles
Sri Lanka specific : Interest rate volatility = volatile
profits . Inability to match assets and liabilities =
higher capital (hint : lobby for longer term debt
instruments)

7. Update if regulation published
The timetable for changes
2011 : Accounting regulations move to market
value for investments
2014: Switch to RBC for capital requirements
and Gross Premium valuation

8. Quick Guide to implementing RBC
• What do you need to do to
calculate RBC?

9. Reinsurance Risk (Reinsurer fails to pay)
RBC – Calculation Reinsurer 1
Reinsurer 2
Reduction in Liabilities
Counterparty risk factor
charge for reinsurer
Reduction in Liabilities
300
50%
150
300
Framework RBC Framework Counterparty risk factor
Charge for reinsurer 1
Reinsurance Risk Capital
Market Risk (Fluctuations in value of assets)
50%
150
300
Risk Based Capital (RBC) - Detailed Calculation
Amounts in Rs Million
Interest risk (Risk Fee securities) Base Surplus 100
Shock up Surplus 150
Credit 372
Shock down surplus 50
Liability 400
Operational 23
Which shock? Down
Reinsurance 300 Interest risk capital 50
Market 615 Credit Spread risk (Corporate bonds) Corporate bond 1 50
Surrender -
Catastrophic - Corporate bond 2 70
RBC Required 1,032
Credit Spread risk capital 120
Credit Risk (Assets income streams are not guaranteed) Equity Risk Listed Equities value 300
Charge : Asset tyoes Value of Assets Charge Listed Equities Risk Factor 35%
0% : Govt issued or Govt Guaranteed, 2,000 - Unlisted Equities value 600
Cash, Covered policy loans
Unlisted Equities Risk Factor 45%
1.6%: Assets (bonds/ deposits/ reinsurer 100 2
amounts) rated AAA to AA- (1.6%) Equity Risk capital 375
4%: Assets rated A+ to A- 50 2 Property Risk Direct :Land /Buildings/ Property
8%: Assets rated BBB+ to B- 100 8 rights 150
12%: Assets below B-, unrated assets with 100 112 Real estate investment
term < 1 year, Staff loans/ agent balances /
other assets companies -
16%: Unrated assets (may need approval) 300 48 Own property 300
100%:Inadmissible under existing 200 200 Total Property 450
Regulations Property Risk factor 25%
Credit Risk Charge 372
Property Risk capital 113
Liability Risk
Gold Risk Gold Value 50
Liaibility Using Best estimate 2,000
Gold Risk Factor 15%
Liability Using Stress estimates 2,400
Liability Risk Charge 400 Gold Risk capital 8
Market Risk Capital 615
Operational Risk (Non specific operational risks)
Asset Value 2,300 Surrender Risk (All policies are surrendered)
OR charge as % of assets 1% Surrender value of inforce 1,200
Operational Risk Capital 23 business
Total Policy reserves held 1,300
Surrender Risk Capital -
Needs to be done every quarter – Annual returns not an option

10. RBC – Calculation intensive
Assets Regulatory
Value each asset 6 RBC components
2 Shock tests to each fixed interest asset TAC
MRBCAC
Liabilities
Assumptions – experience investigations
Participating
Bonus investigation
Simulations for guarantees
Many cashflow projections for liabilities
1 Best estimate
6 Runs to determine PAD direction (then 1 PAD
calculations)
6 runs to determine Risk Margins direction (then
1 Risk Margin calculations

11. RBC discussion points
• What happens when interest rates have fallen sharply
and need to apply shock tests when the shock is a
reality ? = HIGH Chance of not meeting capital
requirement. Solution : Relax shock test after a shock –
“buffers”
• How to manage next 2 years – Market value for
investments and NPV (With interest rates on a 3 year
moving average). Solution : apply solvency on book
value / NPV basis until move in 2014?
• Insurers need to consider carefully the management
of with profits funds – and to meet with profits
holders expectations
– Unallocated surpluses (treatment for RBC)
– Implications for bonus policy (terminal bonuses)

12. IBSL Draft Regulations -31/10/12
• Purpose? Very confusing
– Regulations to replace Deloitte proposals?
– Interim regulations to replace Net Premium valuation? How would solvency
be calculated? Very dangerous to apply current solvency calculation to GPV –
entire industry could be left under capitalised.
• Actuaries get to “play god” with these regulations
– Actuaries Should not be allowed to determine interest rates estimates
– Actuaries Should only be allowed to use alternative methods to GPV with
explicit IBSL approval
• Zeroisation of cashflows
– Theoretically wrong if meant to be for RBC – against principles of RBC. Risk of
not meeting surrender values is explicitly addressed in RBC framework)
Best and only credible solution : Maintain status quo :carry on with NPV
& Book value for solvency purposes until new market value based / RBC
regime is ready at end of 2014

13. Implementation strategies and challenges
Key Questions :
1. Can you implement RBC
with existing resources?
2. How much will it cost to
implement RBC?
3. How long will it take?

14. RBC Readiness Checklist
? Software available ? Asset value Calculations
To project cashflows (shock tests)
Able to cope with the calculations ( a
single policy typically requires 30,000 ? People
calculations….) To build the models
Supports an auditable process To check them
Ready with all product modelled? To run them (Quarterly)
Integrated into an RBC framework To document processes and
procedures
? Own investigations done To ensure IT security
Expenses
Lapses
Mortality and morbidity
Bonus investigations - sustainable
bonuses

15. Practical Options
PEOPLE?
YES
• Buy software • Incremental cost
- Rs10-20mn initial • 2 years comfortable
- Rs 2-4 p.a for
support
• 2 years possible YES
NO
TECHNOLOGY?
• 2 years will be • Hire qualified
challenging if have actuary or intensive
no option lined up consulting support
- Rs 20mn p.a. for
NO 2 years (or more)
Reality check :Insurers in Sri Lanka should have already
started work on implementing RBC

16. Is the Sri Lankan life insurance industry ready
for RBC?
PEOPLE?
YES
10% 30%
YES
NO
TECHNOLOGY?
50% 10%
NO
Source : Insight estimates based on market knowledge
Most insurers are not ready for RBC
And need to catch up

17. Turn it into an opportunity – spin off benefits
1. Accurate business plan
projections
2. More accurate estimates of
product profitable
3. Verifiable estimates of
Enterprise Value – allows a
value based strategy to be
followed
Be positive : once in a generation
opportunity for better financial
management