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9/11/2014 Ca p ita l Ba se Exp ecta tions a nd Solv ency Presented by: Kevin Wick, FCAS, MAAA Kevin.L.Wick@us.pwc.com 206-398-3518 2014 FALL CONFERENCE 2014 FALL CONFERENCE & TRAINING SEMINAR & TRAINING SEMINAR Tw o Distinct

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2014 FALL 2014 FALL CONFERENCE CONFERENCE & TRAINING & TRAINING SEMINAR SEMINAR

Ca p ita l Ba se Exp ecta tions a nd Solv ency

Presented by: Kevin Wick, FCAS, MAAA Kevin.L.Wick@us.pwc.com 206-398-3518

2014 FALL 2014 FALL CONFERENCE CONFERENCE & TRAINING & TRAINING SEMINAR SEMINAR

Tw o Distinct Business Mod els Ha v e Em erged

Surplus Cash Call Risk Surplus Surplus Risk

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2014 FALL 2014 FALL CONFERENCE CONFERENCE & TRAINING & TRAINING SEMINAR SEMINAR

Pools a re a t Different Sta ges

  • Minimal effort in assessing capital needs
  • Same measurement tools that were used 25 years ago
  • “It has worked so why change?” resistant to change attitude

Have not recognized business model has changed

  • Common pitfall is using the wrong measure
  • “90% confidence level” is not conservative
  • Universal set of “financial benchmark ratios” does not exist
  • “Risk based capital” is not a target

Recognized change but are struggling to upgrade financial measures

  • Defined appropriate surplus targets
  • Leverage off recent advances in capital measures
  • Consider impact on surplus needs of key financial decisions.

Understands capital requirements and pool operation is consistent with goals

2014 FALL 2014 FALL CONFERENCE CONFERENCE & TRAINING & TRAINING SEMINAR SEMINAR

Com m on Pool Solv ency Mea sures The “Confid ence Lev el”

  • Incomplete measurement of

program risk

  • Unpaid claims only
  • Misleading
  • Percentage scale
  • Generally misunderstood by

stakeholders

  • Not used in broader insurance

marketplace

  • Made sense in the context of

pooling when use started

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Com m on Pool Solv ency Mea sures Benchm a rk Fina ncia l Ra tios

  • Dependent on benchmark

values

  • Are pools comparable to the

insurance industry?

  • Value of comparing to mostly

unregulated and unrated industry?

  • Individual pools are unique

Exam ples

  • Reserve to Surplus
  • Premium to Surplus
  • Net Retention to

Surplus A “

  • ne size fits all”

set of pool financial ratios to determ ine

  • ptim al capital targets does not

and cannot exist 2014 FALL 2014 FALL CONFERENCE CONFERENCE & TRAINING & TRAINING SEMINAR SEMINAR

Com m on Pool Solv ency Mea sures “Risk Ba sed Ca p ita l” form ula

  • RBC is a Regulatory Tool

– Developed for a specific context – Having sufficient resources left in a troubled company to rehabilitate or liquidate – Not capital you should hold based on your risk “… w ill not com pute the precise am ount of capital an insurer needs to m aintain in a com petitive, dynam ic and uncertain m arketplace.”

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2014 FALL 2014 FALL CONFERENCE CONFERENCE & TRAINING & TRAINING SEMINAR SEMINAR

Are Pools Different tha n Insura nce Com p a nies?

  • Goal is not to make money for

investors

  • Oversight is done by Board of

Directors made up of members

  • Members have voting privileges
  • Policies and business practices

are focused on serving the members

  • Lower cost structure

How different is the underlying business model and need for capital?

2014 FALL 2014 FALL CONFERENCE CONFERENCE & TRAINING & TRAINING SEMINAR SEMINAR

Determ ining Ca p ita l Ta rgets using Ca p ita l Mod eling

Risk Measurement Financial Goals (Risk Appetite)

Capital Requirements

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Fina ncia l Risk Ca tegories

  • Actual unpaid claims may be higher than current

estimates

Reserving

  • Next year’s losses may come in higher than projected

Underwriting

  • Interest rates may go up which results in bond

holdings decreasing in value

  • Excess carrier may default

Asset/Credit

  • Next year’s administrative budget may be exceeded

due to an unforeseen event

Operational

2014 FALL 2014 FALL CONFERENCE CONFERENCE & TRAINING & TRAINING SEMINAR SEMINAR

Risk Mea surem ent (Ca p ita l Mod eling) Process

AL GL APD

Underwriting Reserving Asset & Credit Operational

Int. rate Counter

  • party

Equity External System People

Total Funding Need

PR AL GL APD PR WC WC

Step 1: The uncertainty associated with each of this risk elements is measured. Step 2: The individual risks are aggregated into four broad categories considering interdependencies. Step 3: In a similar manner, the total funding need is determined through a risk aggregation process.

Slide 10

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Exa m p le of Mod eling Outp ut

2014 FALL 2014 FALL CONFERENCE CONFERENCE & TRAINING & TRAINING SEMINAR SEMINAR

Determ ining Ca p ita l Ta rgets

Risk Measurement Financial Goals (Risk Appetite)

Capital Requirements

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2014 FALL 2014 FALL CONFERENCE CONFERENCE & TRAINING & TRAINING SEMINAR SEMINAR

Context for Determ ining Risk Ap p etite/ Fina ncia l Goa ls

Pool Financial Goals

Insurance Industry Standards “Pooling” versus “Insurance” Differences Perspective from Other Pool’s Other Financial Demands of Members

2014 FALL 2014 FALL CONFERENCE CONFERENCE & TRAINING & TRAINING SEMINAR SEMINAR

Exa m p le of Outcom e/ Fina ncia l Ta rgets

In this example, the minimum target funding level is a 1-in-100 year

  • event. The board felt

members are expecting at a minimum that level of protection. The board consensus was that funding which exceeded what is necessary to cover a 1-in-500 year event is excessive. The current funding level is below the target.

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2014 FALL 2014 FALL CONFERENCE CONFERENCE & TRAINING & TRAINING SEMINAR SEMINAR

Mod eling a lso Prov id es Und ersta nd ing on the Source of the Ca p ita l Need s

The current funding level is below the target. Modeling showed a large source of risk and thus capital need was from the long bond duration. Reducing the bond duration reduced risk and thus fund need.

2014 FALL 2014 FALL CONFERENCE CONFERENCE & TRAINING & TRAINING SEMINAR SEMINAR

Decision Fra m ew ork

Representative common “pooling” measures

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Observ a tions from Stud ies Com p leted

  • Common solvency measures being

used by pools provide a false sense

  • f security
  • Comparing to insurance industry

problematic

  • smaller, concentrated exposure,

higher retentions

  • Pool structures and risk profiles are

unique

  • Clarity on funding adequacy is

valuable to the stakeholders

  • Greater risk awareness leads to

better financial decisions

2014 FALL 2014 FALL CONFERENCE CONFERENCE & TRAINING & TRAINING SEMINAR SEMINAR

Key Milestones

Transition from a “cash call” to a “risk transfer” business model

  • Business model has matured
  • Surplus is important
  • Common pool solvency measures developed in a “cash call” context

Recognition

  • Consideration of all financial risks
  • Extreme enough events measured

Understand Capital Requirements

  • Members/owners make this decision
  • Context provided by management and consultants

Financial Goals Defined

  • Understanding of how financial decisions impact risk and funding

adequacy

  • Surplus is used efficiently – proper financial controls and framework

Ongoing Financial Discipline

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Reca p of Session Objectiv es

1. Provide clarity on the “appropriate pool surplus” question

  • 2. Critique the common measures used

by many pools to evaluate funding adequacy

  • 3. Present at a high level an alternative

approach to develop target surplus levels

  • 4. Relate how the results of a capital

modeling study can be used to answer common pool financial questions

  • 5. Outline key milestones for making the

transition from a “cash call” to a “risk transfer” business model 2014 FALL 2014 FALL CONFERENCE CONFERENCE & TRAINING & TRAINING SEMINAR SEMINAR

Questions a nd Com m ents

For further discussion regarding pool solvency measures and framework, please contact: Kevin L. Wick, FCAS, MAAA Hyeji Kang, FCAS, MAAA Craig J. Scukas, FCAS, MAAA Managing Director Director Director +1 (206) 398 3518 +1 (312) 298 4167 +1 (206) 398 3585 Kevin.L.Wick@us.pwc.com Hyeji.Kang@us.pwc.com Craig.J.Scukas@us.pwc.com