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Tim Harris Ti H i
DRAFT 12 January 2011 V1
and how we use it us 2 .Agenda Economic Capital and its role at Aviva Economic Capital and Solvency II How we calculate our Economic Capital What Economic Capital tells us.
Economic Capital: Part of our continual development of risk management Front line Accountability for y managing all risks CEO. independent dit i d d t actuarial reviews etc • A CEO & CFO team with a comprehensive knowledge & experience in financial services • Deep bench of expertise with strong succession planning • Aiming for a balance of technical & business expertise • Recent recruitment of recognised industry talent • Ongoing and high priority development agenda Economic Capital • A comprehensive range of leading industry advisors actively engaged in independent audits & reviews Solvency II Calculation What & How 3 . CFO. operational management etc Second line S d li defence Risk Management: integral challenge & oversight Executive level appointment Third li Thi d line defence Independent assurance Internal & external audit.
One of a range of measures used for capital assessment Economic Capital • Aviva’s own assessment of both capital available and capital required* • Most appropriate method of assessing capital allocation Rating Agency • Formula-based assessment of both capital available and capital required • Each agency uses a defined set of rules for rating assessment IGD (Solvency I) • Current means for assessing regulatory capital. will be replaced by Solvency II in 2013 • Not a risk-based measure ICA • UK regulated entities risk-based measure which allows some economic principles to be used Solvency II • Detailed requirements and transition rules remain uncertain • Expected to be introduced in 2013 Economic Capital * throughout this presentation this capital is ‘required’ based on internal assessment and capital management policies. The term ‘required’ does not imply required by regulators or other third parties Solvency II Calculation What & How 4 .
5% VAR • Consider all risks • Incentives for improved risk management Solvency II • 2013 • Public • EU market consistent • Based on three pillars • Internal economic models • Prudent person • Own Risk & Solvency Assessment (ORSA)/ incentives for improved risk management Economic Capital Solvency II Calculation What & How 5 .Solvency II Solvency I • 1970s • Public • Not market consistent • Arbitrary • Factor based • No incentive for effective risk management ICA • 2005 • Private • UK regulated entities only • Firms required to assess capital needed to mitigate risk to 99.
Solvency II – on track for a sensible outcome Recent proposals Final requirements and transitional arrangements remain unclear but: • VIF expected to be allowable • Hybrid debt expected to be allowable under transition provisions p • Liquidity premium likely to be allowable • Transition arrangements likely to be put in place to ensure European insurers are not competitively disadvantaged against the USA & other “non equivalent” countries Current outlook Solvency II likely to go ahead on 1 January 2013 • but lengthy transition arrangements likely to be in place QIS 5 is a request for information. y p p • The final Solvency II principles will not be in line with some principles in QIS5 Economic Capital Solvency II Calculation What & How 6 .
insurance risk and operational risk * throughout this presentation this capital is ‘required’ based on internal assessment and capital management policies. which is needed to cover risks taken by the group. such as market risk. assessed on an economic basis basis. The term ‘required’ does not imply required by regulators or other third parties Economic Capital Solvency II Calculation What & How 7 .Economic Capital management Available Economic Capital Capital resources available to the group measured on an economic basis Required Economic Capital Capital* Our Required Economic Capital is the amount of risk capital. credit risk.
5 99 5th percentile 50th percentile This is broadly similar to a 1:2000 calibration consistent with capital of an AA rated firm ith Surplus is expressed as the buffer over 1:200 Important to avoid excessive.Setting the Target Capital Requirement Required Economic Capital • The Target capitalisation of the Group is to have sufficient surplus capital to meet policyholder liabilities following: a 1 in 200 year loss.better to plan management actions to g respond to risks if they occur • Target Surplus • 90th percentile 50th percentile Economic Capital Solvency II Calculation What & How 8 . inefficient. capitalisation by adding a further buffer on top of these two . followed by a further 1 in 10 year loss • 99.
Calculation of Available Economic Capital at Aviva plc Available Economic Capital (AEC) . VIF) and goodwill are excluded • GI businesses adjusted from IFRS basis to an economic valuation (by removing reserve margins and discounting the liabilities) • S bordinated Hybrid debt is treated as a ailable capital Subordinated H brid available £bn Hybrid debt MCEV Balance Sheet Adjustments to a realistic basis £5.2bn FY09 MCEV Shareholders’ Equity* * including preference shares and DCI Adjustments FY09 Available Economic Capital Solvency II Calculation What & How Economic Capital 9 .6bn £14.6)bn Economic Balance Sheet £17.0bn £(1.The amount of Economic Capital we hold Based on the audited MCEV balance sheet adjusted for: • Intangible assets (excl.
). 1 in 200 over (1 year) Pension Scheme risk allowed for through five years of stressed contributions Economic Capital Solvency II Calculation What & How 10 . bodily injury. mortality etc. defaults on bonds. operational interest rate rate.5th percentile t=0 t=1 A L Define the confidence levels and the time horizon Model the impact of these stresses on the economic balance sheet Quantify and model dependencies or p correlations between the risks Geographic. fall in share prices. Equity. foreign exchange Spreads widen. risk and scale diversification effects Identify all of the risks Choose stresses to cover all of these Including Credit. higher lapses. claims inflation. operational. underwriting. fraud. General Insurance (reserving. catastrophe etc. yield curve falls 1 in 10.). floods. longevity. Life Insurance (persistency.Calculating the Required Economic Capital Evolution of risks Balance sheet valuation Distribution of balance sheet outcomes Capital requirement A L 50th percentile A L All-risk scenarios allowing for dependency 99. medical breakthroughs.
8bn £4 8bn Available Economic Capital (AEC) The amount of Economic Capital we hold Surplus Within the range of a AA-calibrated risk appetite i k tit Available Economic Capital £17.8bn Required Economic Capital (REC)* The amount of capital required to cover the i k faced th risks f d * throughout this presentation this capital is ‘required’ based on Aviva’s own assessment and capital management policies.Available and Required Capital at Aviva plc – FY09 £bn Surplus £4. The term ‘required’ does not imply required by regulators or other third parties Economic Capital Solvency II Calculation What & How 11 .6bn Required Economic Capital £12.
To the fullest extent permitted by law. The inherent limitations involved with setting assumptions are highlighted in the basis of opinion Economic Capital Solvency II Calculation What & How 12 . provide a reasonable assurance report* on the Economic Capital in accordance with the International Standard on Assurance Engagements (ISAE 3000) * this report is made solely to the company's directors. Regional teams and then Group Finance teams 2nd Line: Risk function review of results at all levels 3rd Line: Internal Audit review of processes and results Board review Aviva’s external auditors. Ernst & Young do not accept or assume responsibility to anyone other than the company and the company's directors for the opinions. Ernst & Young.Model Review and Governance ICA capital regime in place for the last 7 years Aviva’s economic capital model has years. as a body. Aviva s evolved significantly over that period and will continue to do so There are 3 internal lines of internal model review 1st Line: Review and sign off of results by Businesses.
What does Economic Capital tell us? The graph illustrates the relative importance of the risks we are taking: • Credit is the single largest exposure for the group followed by g g p y general insurance and life insurance risks • Equity risk exposure has been reduced in recent years although there is residual exposure in policyholder funds Aviva’s risk profile – FY09 Other market 8% Operational 12% Credit 25% Equity 12% Life 15% Interest rate 10% GI 18% Credit & Insurance related risks Other i k Oth risks Economic Capital Solvency II Calculation What & How 13 .
scenarios and strategic options • Optimal diversification of risk • Business lines/liability mix • Prosperity and peace of mind for our customers • Optimise capital deployment • Facilitate good risk management on an enterprise wide holistic basis Use of Economic Capital models helps to inform strategy and support decision making to maximise return on shareholder capital while protecting policyholders Economic Capital Solvency II Calculation What & How 14 . risks.How do we use Economic Capital? Economic models (capital & risk) Strategy • Product design • Pricing • Optimise product design • Capital structure Increasingly an integral part of running the business • Reinsurance • Asset/liability matching t hi • Investment management • Hedging • Enterprise risk management • Transparent evaluation of assets.
8 billion at 31 December 2009 £4 8 Economic capital key to optimising financial discipline and performance This reflects Aviva’s own assessment of economic capital and is separate from capital required by regulators 15 .Conclusion Economic capital models calibrated to AA risk appetite Economic capital surplus of £4.
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