April 3rd, 2013

What About the “S” in ORSA? Actuaries Raise Their Hands: Part I

Posted at 1:00 AM ET

Micah Woolstenhulme, Senior Vice President
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At the 2012 Casualty Actuarial Society (CAS) Annual Meeting in Orlando, Florida, the general session, “Economic Capital Modeling for ORSA in the U.S. Property and Casualty (P&C) Industry:  The Stakeholders Convene,” afforded participants a novel opportunity to satisfy their continuing education credits. In that session, attendees hypothetically viewed the P&C industry as a single large company. Audience members were shareholders and session panelists adopted various executive and leadership roles in the company.

The meeting’s task was to vet an economic capital model before the board of directors, allowing individual shareholders the freedom to openly question the model’s input and results. This model, if properly developed and embedded into the company’s strategic management, would represent a key component of the Own Risk and Solvency Assessment (ORSA) Summary Report that will be required of large companies in the industry as early as 2015.

Along the way, we interrupted the presentation and board discussion to poll the audience members on several interesting questions. Readers can find the model presentation on the CAS website for the 2012 Annual Meeting. (1)

Is Solvency Modeling Necessary at the Industry Level?

Before we detail the questions and responses to the audience polling, one anonymous respondent raised an interesting question. Is a stochastic model useful in addition to Risk-Based Capital (RBC) and Best’s Capital Adequacy Ratio (BCAR) for assessing the solvency of the industry?

Figure 1

orsa-chart-1

In Figure 1, RBC Ratio is defined as the ratio of aggregate Total Adjusted Capital to Authorized Control Level RBC for each of 111 combined insurance groups. Plotted against BCAR, there is clearly a strong correlation between the measures, though the relationship is not perfect.

One explanation of the mismatching is that intentions are different between the measures. RBC provides legal authority to regulators to take control of companies clearly in distress. BCAR, in contrast, is intended to assess the financial capacity of a company to pay claims.

The NAIC has stated that, “Group risk capital should not be perceived as the minimum amount of capital before regulatory action will result . . . rather, it should be recognized that this is the capital needed within a holding company system to achieve the group’s business objectives.”(1)

In light of the variances between RBC and BCAR, and recognizing that the intention of ORSA requirements are to establish economically efficient capitalization targets, there is plenty of room for discussion of an industry economic capital model to enter our actuarial forums.

Link to Part II >>

Note:

1. See NAIC Own Risk and Solvency Assessment (ORSA) Guidance Manual, p. 8, http://www.naic.org/documents/committees_e_orsa_wg_orsa_manual.pdf.

From: Actuarial Review, Vol. 40, No. 1, ©2013 Casualty Actuarial Society. Used by permission.

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