Newsletter-volume 4 - 2011 (Draft) - Actuarial Society of Hong Kong

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Protected cell growth has proven to be advancing rapidly in all domiciles that have introduced it.Although no reliable statistics are available we estimate there to be more than 2000 cells operatingworldwide as smaller versions of property/casualty captives. It is referred to as the growth area for themature captive domiciles.Other new captive concepts to be considered are branch captives and special-purpose financialcaptives.Direct SaleHong Kong should work to convince the China Insurance Regulatory Commission to allow Hong Kongcaptives to write business directly in China. Currently, corporations must purchase insurance fromlicensed insurance companies. If these corporations want to pass their risks onto its captive they needto use a fronting company and have risk ceded to the (reinsurance) captive either as a participant onthe fronting insurer's reinsurance program or passing through by way of retrocession. If the CIRCwould allow Hong Kong captives to directly write business in China, this would cut down administrativecosts and credit risks.China as a stepping stoneThe demand for alternative risk financing mechanisms is expected to grow rapidly with the utilization ofrisk management in Asia. According to a study by Aon Benfield, only a quarter of the Asian Global 500companies currently have a captive, and therefore it is foreseeable that demand for captives willemerge. Labuan and Micronesia are new captive domiciles trying to position themselves for the futuregrowth of Asian captives. Hong Kong, in under going insurance regulatory reform, should treasure this“second chance” to promote itself as an attractive captive domicile. The upcoming reformed HongKong Insurance Authority should take a more proactive approach on captive business development.The success and captive experience of Mainland Chinese companies will provide incentives for otherAsian companies to consider establishing their captives in Hong Kong.Ronald T. KozlowskiTowers WatsonJohnny HoTowers WatsonThe Actuarial Society of Hong Kong, 2202 Tower Two, Lippo Centre, 89 Queensway, Hong KongTel (852) 2147 9420 Fax (852) 2147 2497 Website: www.actuaries.org.hkNote: Views expressed are not necessary those of The Actuarial Society of Hong Kong12
This article was first published in the November 2011 issue of the Asia Insurance Review.Why Risk Margin?In a perfect world, Actuaries would be able todetermine best estimate reserves which willexactly be equal to the actual future lossesincurred by an insurer. Unfortunately, in reallife, things are not as simple. There are manyuncertainties and surprises which will causethe best estimate reserves to be higher orlower than the actual future losses incurred.For example, past and future claimfluctuations, future economic or environmentalconditions, errors in data or incorrectprojection models selection.A risk margin on top of the best estimatereserves provides for situations where theactual future losses may be higher than thebest estimate reserves. This extra comfortlevel helps maintain the financial soundness ofinsurers and to protect policyholders.Risk Margin DeterminationThere are numerous approaches to determinerisk margin. It may be determined as a fixedmonetary amount or a percentage of the bestestimate reserves. In slightly morecomplicated form, the reserving actuarycarries out an alternative set of reserveprojections using more conservativeassumptions, such as claim inflation, to arriveat a more conservative reserve estimate. Thedifference between this conservative reserveand the best estimate reserve represents therisk margin.Both approaches are simple to implement, butthey fail to describe the degree of prudencequantitatively represented by the risk margin.There is little statistical reasoning or basisbehind the choice of the risk marginassumptions.A number of methods have been suggested toestimate the risk margin with more solidstatistical basis.Two commonly used methods which can beeasily adapted in Asia are (1) the Mack methodand (2) bootstrapping. In addition, there arethe cost-of-capital method integrated in theSwiss Solvency Test and the to-beimplementedSolvency II framework in Europe.Mack methodThe Mack method is a natural extension of thechain ladder method commonly used forestimating best estimate reserves. The chainladder method involves using run-off claimsdata to estimate development factors (measureof the speed of reporting and settling claims),then using the development factor to project theultimate cost of claims. Subtracting the paidclaims from the projected ultimate cost ofclaims gives the claims reserves of theportfolio. Even without any changes in theclaims management process, claimsdevelopment would still fluctuate over time dueto randomness of claims occurrence, claimsseverity and the speed at which the claims arereported and settled. Therefore the estimationof development factor is inherently uncertain.In statistical term, a number representing themeasure of uncertainty is called the standarddeviation. The uncertainty in claimsdevelopment can naturally be used to infer thestandard deviation of the ultimate cost of claimsand the reserves.The risk margin may be decided as a certainmultiple of the standard deviation of thereserves (e.g. 0.5 times, 1 time, 1.5 times, etc).Furthermore, it can be assumed that thereserves follow a particular statisticaldistribution to infer a full distribution of thereserves to calculate the level of sufficiency atvarious levels of reserve. Typically, the range ofsufficiency level insurers is interested in forreserving purpose is between 75% to 90 %sufficiency. In this case, a normal distributionmay be assumed. For more extremescenarios, e.g. stress testing purpose, thismethod is not recommended.The Actuarial Society of Hong Kong, 2202 Tower Two, Lippo Centre, 89 Queensway, Hong KongTel (852) 2147 9420 Fax (852) 2147 2497 Website: www.actuaries.org.hkNote: Views expressed are not necessary those of The Actuarial Society of Hong Kong13
Page 1 and 2: V O L UM E04D e c 2 0 11ASHK Newsle
Page 3 and 4: The Asia Regional Support Committee
Page 5 and 6: ConclusionFinally, I would like to
Page 8 and 9: As one of the top financial centers
Page 10 and 11: ReputationAs the most successful ca
Page 14 and 15: BootstrappingThe bootstrapping meth
Page 16 and 17: Risk margin in Hong KongFor Employe
Page 18 and 19: Happy Holidays!Darwin Rhodes is the
Page 20 and 21: MEMBERSHIP UPDATE & ACTUARIES ON TH
Page 22 and 23: Actuaries on the MoveFellow Associa
Page 24 and 25: PRIZE TO GIVE AWAY!A prize will be
Page 26 and 27: EVENTS’ HIGHLIGHTSASHK Annual Din
Page 28: ASHKNEWSLETTER Volume 04/2011Editor

Newsletter-volume 4 - 2011 (Draft) - Actuarial Society of Hong Kong

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