OIC RBC 2

1 2014 Towers Watson. All rights reserved. oic rbc 2 Stage 3 Parameters and overview of market testing (Non-Life Insurance) Date: 4 April 2014 i 2014 Towers Watson. All rights reserved. Table of Contents Preface .. iii Section 1 : Introduction to market testing .. 1 Objectives and scope .. 1 Submission requirements .. 2 Materiality .. 2 Questions and answers .. 2 Section 2 : Framework changes to be tested .. 3 Overview of framework .. 3 Summary of changes .. 5 Details of changes (Life and Non-life insurance) .. 6 Section 3 : Parameters for testing .. 13 Market risk .. 13 Credit risk .. 16 Asset correlation .. 21 Non-Life insurance risk .. 22 Operational risk .. 24 Section 4 : Market testing template .. 25 Overview .. 25 Input process .. 26 Details of RBC 2 additional input .. 31 Appendix A : Guidance notes for asset risk charge 38 Market risk .. 38 Credit risk .. 40 Derivatives .. 40 Appendix B : Guidance notes for Long Term insurance calculations.

2 43 Contract recognition and boundaries .. 43 Liability discount rates for long-term contracts .. 45 Appendix C : Guidance notes for operational risk charge testing .. 50 ii 2014 Towers Watson. All rights reserved. This page is intentionally blank iii 2014 Towers Watson. All rights reserved. Preface The implementation of risk-based capital (RBC) regulations on 1 September 2011 was the first time the OIC introduced principles-based supervisory regulation. The OIC wants to continuously monitor and develop its supervisory approach to the industry; since 2012 the OIC has sought feedback and comments on the current RBC regime from related parties. In line with its aim to pursue continuous improvement, the OIC has now launched Phase 2 of the RBC framework development, and has engaged Towers Watson to work together with the OIC in further developing and refining the RBC framework. Project stages There are five stages to this project, namely: Stage 3 (current stage) In the current Stage 3, companies will be able to test the impact of the proposed changes to the RBC framework, to understand what the likely impact to the capital adequacy position will be from each proposed change.

3 This document provides an overview of the items and parameters that will be market tested. Current stage Stage 4 Stage 1 Stage 2 Stage 3 Review and proposal development Stage 5 Market calibration / Proposal refinement Market testing Regulation / guidance assessment Finalisation 1 2014 Towers Watson. All rights reserved. Section 1: Introduction to market testing Objectives and scope The objectives of market testing are to enable: companies to assess the impact of potential changes to the RBC framework, and provide feedback; the OIC to make informed decisions based on quantitative testing of possible changes; and an assessment of appropriate transition periods for proposals that will be adopted in the RBC framework. The market testing has two main parts: Testing the impact of proposed changes to the RBC framework; and Testing the impact of changes to the parameters Details of the potential framework changes to be tested are provided in Section 2.

4 Details of the potential parameter changes to be tested are provided in Section 3. In particular, the parameters will be tested at the following target sufficiency levels: Potential changes to parameters Market testing Potential changes to framework 85% 1-year VaR 90% 1-year VaR 95% 1-year VaR 1-year VaR 1-year VaR Target sufficiency levels to be tested. These target sufficiency levels will apply to both asset and liability risks. 2 2014 Towers Watson. All rights reserved. Submission requirements The market testing will be based on the 31 December 2013 financial position, using the 31 December 2013 RBC submissions as a base starting point. The latest date for submission is 6 June 2014 (8 weeks starting from 9 April). There is no requirement for the market testing submission to be certified by an auditor. The submissions are to be sent directly to the OIC at the following email address: Materiality As the objective of the market testing is to understand the impact of the potential changes to the RBC framework and parameters, it is not expected that the testing be performed to the same degree of accuracy as the quarterly submissions.

5 Examples are provided in the guidance notes. Companies are allowed to use judgement to determine if approximations for certain calculations can be used, and should describe such approximations where used in their submissions to the OIC. Questions and answers Questions may be submitted via the following email address: Answers to frequently asked questions ( FAQs ) will be distributed once a week to the industry, and will be available at the following website: 3 2014 Towers Watson. All rights reserved. Section 2: Framework changes to be tested Overview of framework Under the current Thai RBC framework, capital adequacy is measured based on the Capital Adequacy Ratio ( CAR ): The definitions of the Total Capital Available and Total Capital Requirement components are shown in the diagram below. CAR Total Capital Available ( TCA )Total Capital Requirement ( TCR ) Fair value of assets Best estimate liability Liability risk margin (Value of PADs@75%) Total Capital Requirement Inadmissible assets Total Capital Available Fair value of liabilities 4 2014 Towers Watson.

6 All rights reserved. Components of TCA The proposed RBC 2 changes to components of the Tier 1, Tier 2 and Deductions ( goodwill, intangibles, etc.) are discussed in more detail in the following sub-sections. Components of TCR Tier 1 Capital Tier 2 Capital Total Capital Available Deductions RBC 1 and RBC 2 Insurance risk Market risk Credit risk Concentration risk Current RBC 1 RBC 2 to be tested Insurance risk Market risk Credit risk Concentration risk Operational risk To be assessed in market testing first 5 2014 Towers Watson. All rights reserved. Summary of changes The table below summarises the potential changes to the framework that are to be assessed in market testing. Summary of potential changes to framework to be market tested ID Proposed potential change Affects Non-life? Affects Life? Comments on input / calculations required by companies 1 Inclusion of investments in associates and subsidiaries in TCA Yes Yes Companies need to determine the value of investments in associates / subsidiaries 2 Calculation of exchange rate risk Yes Yes Automated in market test template 3 Reflecting risk mitigation characteristics of derivatives Yes Yes Companies will need to apply judgement 4 Inclusion of an operational risk charge Yes Yes Automated in market test template 5 Inclusion of diversification between asset, insurance and operational risk charges Yes Yes Automated in market test template 6 Contract recognition and boundaries Yes Yes Companies will need to apply judgement 7 Calculation of premium and claims reserves and risk charges Yes Yes Automated in market test template 8 Testing insurance (premium)

7 Risk under two bases Yes No Automated in market test template 9 Commodity risk is to follow that of equity risk Yes Yes Automated in market test template 10 Inclusion of a catastrophe risk charge Yes No Automated in market test template Details of each of the changes are discussed in the following sub-sections below. 6 2014 Towers Watson. All rights reserved. Details of changes (Life and Non-life insurance) ID 1 Investments in associates and subsidiaries It is proposed that the TCA recognises the value of investments in associates and subsidiaries. For investments in associates and subsidiaries that are licensed to conduct insurance business, these associates / subsidiaries must be subject to regulatory capital requirements by the OIC, and the value of the investment will be subject to the following deductions: Intangibles; Minimum required regulatory capital. Intangibles are to be defined as per the current RBC 1 regulations, the value of deductible intangible assets is to be the same as the value of intangibles that the subsidiary / associate deducts from its current RBC 1 TCA.

8 For market testing purposes, the minimum required capital is defined as 140% of an insurance subsidiary s current TCR ( under the current RBC framework). ID 2 Exchange rate risk calculation It is proposed that the calculation of exchange rate risk be changed to the following: Where A numerical example is provided below: Exposure Calculation details Currency Asset - Long position Asset - Short position Net liability Currency Swap swap THB for foreign currency at maturity Currency Swap swap foreign currency for THB at Net exposure 7 2014 Towers Watson.

9 All rights reserved. maturiy USD 1,000 -300 -200 -300 0 200 = abs{1,000 + (-300) + (-200) + (-300) } SGD 200 -700 -100 0 500 100 = abs{ 200 + (-700) + (-100) + 500 } MYR 500 -500 -300 0 0 300 = abs{ 500 + (-500) + (-300)} Total 600 200 + 100 + 300 Risk charge applicable 10% Risk charge amount 60 = 600 x 10% The change in calculation method will be reflected in the market testing templates, and companies will not need to modify the calculations themselves. ID 3 Reflecting risk mitigation effects of derivatives Under the current RBC framework the stresses to assets are generally applied as asset value x risk charge , and therefore full risk mitigation / hedging strategies are not captured appropriately in the solvency assessment. It is proposed that the risk mitigating effects of derivatives be allowed for by allowing companies to reflect the change in the value of the asset plus derivative under the prescribed stress. An illustration of this is shown below: RBC 1 Proposed RBC 2 Original asset value Stressed asset value Risk charge Original asset value Derivative Stressed asset value reflecting risk mitigation effects of derivative Risk charge Base scenario Prescribed stress scenario Base scenario Prescribed stress scenario 8 2014 Towers Watson.

10 All rights reserved. ID 4 Inclusion of an operational risk charge It is proposed that the impact of including an operational risk charge be assessed. The operational risk charge calculations to be tested are based on simplified versions of the Solvency II and Australian approaches. The simplifications include: excluding any overall cap that is linked to RBC results for other risks; excluding elements that are associated with large movements in premiums or claims or the excess of these over a percentage of liabilities; and adopting the same formulae for both Life and Non-life companies. The simplified operational risk formulae (parameterised at the target sufficiency level for illustration purposes) for market testing are summarised below: Market test approach 1: Based on simplified Solvency II approach: Where: Market test approach 2: Based on simplified Australia approach: 9 2014 Towers Watson.