Economic Capital Modelling O 201208

FINANCIAL SERVICES
Economic Capital
Modeling in the
Insurance Industry
A solid foundation
for future advantage?
August 2012
kpmg.com
2012 KPMG International Cooperative (KPMG International), a Swiss entity. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. All rights reserved.
Contents
About the survey
Introduction
Unlocking the value of Economic Capital
Growing pains of implementation
12
New trends emerging
16
Allowing for sovereign default risk
17
Enhancements of the future
18
2 | Economic capital
Economic capital | 3
About the survey*

KPMGs Global Economic Capital (EC) Survey questioned 43 of
the largest global insurers between October 2011 and March
2012, covering four major territories: Europe (35 percent), North
America (32percent), Asia (19 percent) and South Africa (14 percent).
Responses were received from all types of insurers, including life
insurers (47 percent), general insurers (14 percent), reinsurers (9 percent)
and composite insurers (30percent). Over 90percent of responses came
from the head of EC, chief risk officer, chief actuary, head of Solvency II or
other senior director.
The survey asked detailed questions on emerging EC practices. Specifically,
it covered the EC framework; modeling techniques; lite modeling approaches,
such as curve fitting and replicating portfolios; dependency, aggregation and
allocation approaches; projection techniques; and management understanding.
* Please note, for ease of reference, figures have been rounded up or down to the nearest whole percent, so not all graphs,
charts and statistics add up to precisely 100 percent.
Introduction
Economic capital (EC) modeling has the potential to transform the way firms control
risks and manage their businesses right across the global insurance industry,
providing a firm foundation for success. A complex way of calculating how much
capital a business needs to meet its future risks, EC modeling has its roots in the
banking sector in the late 1970s. It is only over the past 10 years, however, that
insurance companies truly started to integrate EC frameworks into their operations.
EC implementation is complex. One-third of respondents to our survey have
spent over US$30 million on implementation costs, some have spent in excess of
US$75million. At the same time, companies commit to significant recurrent costs
to maintain EC after implementation.
A fully-integrated EC model provides companies with tools to better understand
risk and, potentially, the ability to price it more accurately. If used effectively, EC
modeling allows management to identify and quantify the risk exposure of a firm
explicitly, rather than providing for risks with margins and capital requirements
that do not vary according to the risk profile. By improving the transparency of an
insurers risk profile, EC can help management deliver value for shareholders while
ensuring adequate protection of policyholder benefits.
Key findings from our survey

Our survey shows that EC is now used widely across the insurance industry as a
key tool for the financial management of the business. Today, most respondents
use EC to manage and monitor risks, but some companies do not yet use EC
for strategic and business decisions, such as pricing and shareholder value
management. There appears to be a lack of understanding at the very top of
insurance organisations that could be hindering the effectiveness of the techniques.
40 percent of respondents indicated that management understanding of EC is
limited, suggesting more training on EC is still required. This is particularly important
in an environment where:
EC will be used by regulators to monitor solvency (Solvency II in the
European Union);
Companies are beginning to communicate EC and economic solvency to
investors; and
EC is an integral part of any Own Risk and Solvency Assessment (in the EU under
Solvency II, but also in the United States where the current expectation is that it
will be a requirement from 2014).
As insurance company managers now begin to use EC as an input into business

decisions, companies need up-to-date reporting and are looking to use new
techniques to deliver results more quickly. Curve fitting emerges as the preferred
new approach to update results with over half of companies adopting this approach
or variant in some part of their EC calculation. Key areas for improvement include
a better understanding of dependency between risks, modeling how capital can
be moved around a group and implementing new techniques to project future
economic capital requirements. These improvements are required for a robust
analysis of how economic capital can change over time and as management
decisions are taken.
Despite significant investment, our survey shows that companies have embarked
on a journey of continuous improvement. This includes technical aspects and
methodology, but also education and communication to support wider embedding
across the firm. At the same time, firms need to be agile as new risks emerge and
unexpected issues arise in the future. For example, some two-thirds of respondents
do not allow for risks on sovereign debt. These investments were considered
risk free prior to the 2008 crisis, although it is hard to see how any investment
can be deemed risk free in current turbulent times. This example highlights the
need to challenge assumptions and inputs on a continuous basis as the external
environment develops.
But as the first wave of EC adopters settle into their new modeling frameworks, our
survey suggests there is a danger that a short-term focus on regulatory compliance
is masking a lack of understanding of these complex models. As a result, insurers are
missing the opportunity to build a better understanding of their risk and capital profile
and strengthen the foundations of their business.
Just as a commercial architect knows that for his buildings to stand the test of time,
he needs to use specialist engineering techniques and construction teams to build the
strongest possible foundations. Similarly, senior management of insurance companies
need to fully understand how EC modeling techniques their scope, strengths and
weaknesses can be harnessed to provide a more risk aware, better-protected and
sustainable basis for their businesses over the long-term.
If properly understood and implemented, EC frameworks provide not only a
roadmap for compliance, they may provide invaluable information for risk appetite,
risk management, capital allocation, pricing, underwriting and strategic decisions.
But if used ineffectively, they can become expensive tick-box exercises that
hamper long-term decision making. Moreover, they can mislead management
into falsely believing risks are adequately covered or force them into actions
that go against sound business principles.
Unlocking
the value of Economic Capital
EC has moved beyond the computations and the calculations and is well on its way
to becoming an integral part of the way companies manage their business on a
day-to-day basis.
Our survey indicates almost all the top global insurers are already using EC methods
to support their risk management systems, with 100 percent of those surveyed in
Europe, North America and South Africa adopting it to some extent. In Asia, there
are significant differences in the stages of development between the international
groups operating in the region, regional groups that operate across Asia and domestic
companies focused on a particular market. That said, 63percent of companies
operating in the region have implemented an EC framework, with the remaining
37 percent intending to introduce a framework within the next three years.
While most respondents are using EC for risk management, many have not yet realized
the potential advantage of using it to support wider business decisions (Figure 1).
Figure 1: Application of EC
100%
80%
79%
60%
66%
71%
64%
55%
40%
35%
20%
27%
26%
21%
3%
0%
Risk management
and mitigation
Current
Planned
Strategic
decisions
36%
10%
7%
Internal and external

reporting
Capital allocation
and risk appetite
Pricing/underwriting
decisions
Dont know
Source: KPMG International Economic Capital Survey, 201112
The lower application of EC in this area is linked to the lower perceived benefits in
respect of improving shareholder value and enhancing competitive position (Figure 2).
Figure 2: Benefits of adopting an EC
Improved risk awareness
4.56
4.42
Better risk-return decision making

3.85
Rating agency and regulatory compliance

3.58
Improved shareholder value

Competitive reasons
3.14
Other
4.00
0
All participants
1 = not at all important, 5 = very important
So, what factors inhibit companies from unlocking these benefits? Twopossible
reasons may be a lack of understanding at the top of the organization of the
underlying EC methods and the lack of timely information to facilitate effective
decision making.
Lack of management understanding

Worryingly, 40 percent of responses indicate that management understanding of the EC
framework is limited (i.e. rated less than or equal to two, with one being no understanding and
five beingfully understood). Generally, European companies ranked management understanding
higher than other territories (Figure 3), which is not surprising given that Solvency II requires
firms to explicitly demonstrate this as part of their Own Risk and Solvency Assessment (ORSA)
and internal model approval requirements. However, even in Europe, it is clear that management
understanding needsimprovement.
Figure 3: Management understanding
3.5
3.4
3.0
2.9
2.8
2.5
2.8
2.7
2.3
2.6
2.5
2.3
2.2
1.9
2.0
1.9
1.5
1.3
1.1
1.0
0.5
0.0
EC approach
Europe
Risk function
modeling
Lite models/loss
distribution
Other
Allocation
methodology
Projection
techniques
Dependency
structure
Refinement
techniques
1 = no understanding, 5 = full understanding
There are reasons why current management understanding is not high. The techniques are
relatively new compared to other metrics that have traditionally been the cornerstone of insurance
financial management. Furthermore, the techniques are constantly becoming more sophisticated
to meet desired statistical requirements.
Clearly, the current state cannot continue. Companies will need to address the knowledge gap and
ensure that management stay abreast of the latest developments. The price of potential failure is
high the loss of competitive advantage by not using techniques to drive value or worse, placing
too much reliance on model results without fully considering the boundaries within which they
should be interpreted.
Effective board-level training is also required, including education sessions from experts,
scenario type workshops and continuous training programs. Adequate attention should also
be given to improving the quality of management information and providing sufficient granular
analysis to empower management to make informed decisions.
Lack of timely information

To use EC information effectively, it must be up-to-date and reported on a
timely basis. The rapid changes in financial markets since the 2008 financial
crisis and the associated volatility they brought to insurers balance sheets
have clearly highlighted that previous standards of annual or ad hoc
reporting will no longer be acceptable for company management.
In Europe, quarterly reporting has now emerged as the industry standard,
with 60 percent of companies reporting this frequently. In North America,
no respondents indicated they were reporting more frequently than
quarterly and more than half said they report only once or twice a year.
InAsia, 63percent said they were reporting quarterly and, in South Africa,
50percent are reporting quarterly.
Clearly, the industry has more work to do in this area. An unfavorable
comparison could be made to the hedge fund industry, where it is the
norm to have daily reporting on positions. On any given day, the finance
director of a hedge fund will know precisely what the risk sensitivities are
and what would happen if key risk factors moved in a particular way.
While reporting daily is not yet realistic for insurers, senior management
needs to make a judgment call on what level of frequency is required to
effectively capitalize on the benefits of an economic framework. The more
infrequent and out-of-date the reporting, the less likely it will be seen as a
credible tool that can add value to thebusiness.
Companies that embrace an EC framework and use it throughout their business

will undoubtedly have a competitive advantage in the long term. They will ensure
appropriate returns are achieved for risks they take on, and will be less likely to take
on risks that they dont fully understand. Moreover, through the full integration of an
EC framework into the business, they will have a better understanding of the limits
of EC modeling and when not to rely on it.
Growing pains
of implementation
As with any rapid change, there are challenges in implementation. It is no different for the adoption
of ECwithin the insurance industry. According to our survey, the two main issues related to the
implementation of EC frameworks are data quality and availability, and the complexity of the calculations
required. These two issues were the most highly-rated across Europe, Asia, North America and South
Africa. Other challenges, particularly outside of Europe, included winning executive buy-in and attracting
the appropriate expertise required to build EC tools. Last, but not least, was implementation cost.
Figure 4: Challenges with respect to EC framework in different regions
Executive buy-in
In-house expertise
IT infrastructure
Production requirements
(e.g. model run times
and number of runs)
Complexity and
computation
Data quality and

availability
0.0
Asia
North America
1.0
South Africa
Continental Europe
2.0
UK
3.0
All Participants
4.0
5.0
1 = not challenging, 5 = challenging
Weaknesses in data quality and availability

The challenge of data quality is probably linked to the fact that, historically, insurance companies have not
been strong in the area of data management. A history of mergers and takeovers has left much of the
industry burdened with out-of-date and patched-up legacy IT systems. Extracting quality data from such
systems and being able to report it in a useful way for EC modeling constitutes a significant challenge. In
Europe, companies have been forced to address this problem as part of their Solvency II compliance, largely
through significant investment in data warehouses and other IT infrastructure.
Another factor is the unavailability of data. EC modeling requires a significant amount of historic data to
understand how portfolios have performed in the past. For example, to understand the risks in equity
markets, firms need to understand what has happened in equity markets over the past 100 years. This
is a challenging but achievable task, given the availability of data dating from the early 20th century until
now. But when it comes to companies own internal data, such as the behavior of their portfolios or their
customers over a similar length of time, the data often does not exist, which can compromise the inputs to
the capital models.
The lack of data can lead to a heavy reliance on expert judgment to fill the gap. But expert judgment is by
definition subjective and can materially affect results. This can cause some concern about the objectiveness
of the model and how much management can truly rely onitsresults.
Complexity of computations
EC calculations are complex and can take time to produce accurately. Many companies struggle with
implementing EC modeling frameworks that produce accurate information quickly enough to allow them to
respond in a meaningful way.
Companies are responding to these challenges by introducing simplifications and approximations into their
models. While these are an inevitable part of implementing the model, it is vital that companies understand
the limitations of these adjustments and set appropriate tolerance limits around their application.
Winning executive buy-in

Outside Europe and particularly in Asia,
winning executive buy-in is seen as a
significant challenge. This is not surprising due
to the relative lack of regulatory pressure in other
regions, meaning there is no strong regulatory
driver pushing management to engage with
EC modeling. In addition, if the result of full EC
implementation is expected to lead to higher capital
requirements, then management may be reluctant
to adopt an EC approach. In these circumstances, it
will be harder for companies outside Europe to achieve
buy-in for the investment required to embed an effective
framework across an organization.
Resource constraints
Another challenge highlighted by the survey is the availability
of expertise. In Europe, companies have tended to bring
in large numbers of external consultants and contractors to
develop their EC frameworks to meet Solvency II. With those
frameworks now in place, many are trying to scale back that
resource, running the risk that those people with the most
knowledge of EC techniques will leave the business.
Resources to implement EC will be at a premium for the next several
years and will put pressure on the actuarial and financial resources of
major insurance groups. Groups need to be prepared to pay enough
to recruit the right talent. They must also be willing to structure their
organizations in ways that ensure clear ownership and responsibilities
around EC modeling, perhaps as part of a wider review of their operating
models. In Europe, insurers need to look beyond the traditional actuarial
and risk roles to areas such as banking and more quantitative backgrounds
in order to identify the right skills. In Asia, meanwhile, companies can recruit
from similar fields while also leveraging knowledge from Europe and North
American markets which have already implemented EC modeling and can
bring their practical experience to bear.
High setup and maintenance costs

Figure 5: Distribution of cost of establishing
EC framework all insurers (in EUR million)
19%
Setup costs were unsurprisingly high in Europe,

withmore than 60 percent of companies that
provided a response indicating spends in excess of
US$75 million. The costsin other jurisdictions were
lower, reflecting the lower regulatory incentive to
invest in these techniques(Figure 5).
22%
Ongoing maintenance costs for North America

and Europe are between 2 percent and 10 percent
per annum of the original setup costs. Expected
maintenance costs for otherterritories are between
20percent and 80 percent of setup costs (Figure6).
14%
8%
30%
8%
Less than 1
1-5
5-10
10-20
20-50
50 and above
Figure 6: Distribution of cost of maintenance of

EC framework all insurers (in EUR million)
0%
8%
3%
13%
45%
So, was the extra spend in Europe as a result

of Solvency II necessary to achieve outcomes
in respect of EC? Some market experts believe
SolvencyII is an over-engineered response to the
issue it was designed to address. If this is true,
there has undoubtedly been additional cost to the
industry than was required. Alternatively, it could
be argued that Solvency II triggered a process for
European insurers to address shortcomings in
risk technology and data infrastructure. Perhaps
in some way, this level of investment would be
required at somepoint in the future. One thing is
certain a lackofregulatory guidance and shifting
requirementshave caused additional spend for
European companies, as they continually adapt
to the changing landscape. Hopefully, regulators
outside of Europe will learn from the lessons of
Solvency II in their own development of risk-based
regimes.
32%
Less than 1
1-5
5-10
10-20
20-50
50 and above
New trends
emerging
Even though EC modeling is relatively new and subject to constantly changing requirements, our survey highlighted some
new trends that are emerging. These included the move to sophisticated simulation-based approaches and the wide take-up of
curve fitting techniques (Figures 7 and 8).
Figure 7: Distribution of techniques used for EC computation
Figure 8: Distribution of lite modeling techniques
13%
21%
49%
58%
29%
30%
Stress-based
Simulation-based
Combination of stress and simulation
The decline of the stress approach
Curve fitting
The rise of curve fitting
In Europe, regulators expect companies to demonstrate their

understanding of the full distribution of their risks and this
can only be achieved through a simulation-based approach.
This is a more theoretically correct approach to calculating
EC, as it allows for all the interactions of each risk over
many possible outcomes or simulations. A stress-based
model, in contrast, only shows what losses would be at
a particular point; it does not show the behavior of the
tail of the loss distribution, where the real risk may lie.
This increased sophistication, however,

comes at a price a lack of transparency of
the key capital drivers, unless supported
by adequate management information,
training, documentation and a deep
understanding of the business from
senior management.
Replicating portfolios
The survey results show that industry practice

appears to be moving toward a simulation-based
approach to EC computation. In the UK, 71percent
of respondents said they used asimulation-based
approach, while 71 percent in the rest of Europe
used either simulation or a combination of
simulation and stress-based approaches, as do
86 percent in North America and 88 percent
inAsia.
Least Squares Monte Carlo (LSMC)
In moving toward a simulation-based

approach, insurers are favoring lite modeling
techniques as opposed to full models. Alite
model is a simplified representation ofthe
full actuarial projection or asset model
that can be used as a substitute in some
circumstances. Examples of lite models
include replicating portfolios and curve-fitting
techniques.
Two or three years ago, there was no

consensus about the preferred lite modeling
technique. Early adopters implemented
replicating portfolio approaches, but over
the past 12 months curve fitting (and its
variants) has emerged as the preferred
approach. The increased take-up of curve
fitting is probably driven by its ability to be
applied to the entire risk taxonomy (both
market and non-market risks), as opposed
to a replicating portfolio, which typically
focuses on only market risk.
Allowing for sovereign

default risk
Historically, companies have not felt the need to worry about sovereign default
risk. Governments were assumed to be virtually risk-free, but recent events in
Europe and North America have turned that assumption on its head.
Our survey showed that 65 percent of respondents are currently not allowing for
sovereign default risk in their EC models (Figure 9). Of those that do allow for some
form of sovereign default risk, it is typically European companies (60 percent),
a likely reflection of the Eurozone government debt crisis. It is interesting that only
36 percent of North American companies do allow for this risk, given the recent US
government ratings downgrade. Even where companies do make some allowance
for this risk, the level of sophistication of the techniques used is limited.
Figure 9: Allowance for sovereign debt risk
35%
65%
Yes
No
On the other hand, there is much debate about the issue of whether it is fair to
expect companies to hold capital to provide better guarantees to their customers
than a sovereign government can provide to its bond holders. The situation in Greece
has shown that there are real risks around sovereign bonds. Should insurance
companies have to hold capital to cover the potential losses? Isitfair to ask insurance
companies to provide more security than a solvent state provider? Although it is
Europe that provides the most graphic illustration of the risks involved and where
the risks are arguably higher due to the inflexibility of the single currency this is very
much a global issue and likely to be the subject of further debate in the industry.
Enhancements of
the future
EC has undoubtedly moved out of the laboratory and has become part of the way
businesses are managed. However, there is still more work to do. 93 percent of
respondents indicated they plan to improve at least one of the core components of
their EC framework over the next 12 months, more than 60percent indicated they
would develop three or more components (Figure 10).
Figure 10: Indications of future development
100%
80%
49%
56%
60%
37%
30%
26%
60%
67%
70%
60%
40%
20%
0%
49%
42%
37%
3%
Risk
distributions
Currently satisfied with
Economic loss
modeling
Software
Dependency
modeling
Plan to develop in next 12 months
4%
3%
3%
2%
2%
Projection
techniques
Refinement
techniques
No reply
Correlation and dependency modeling

Respondents in all regions were dissatisfied with the correlation and dependency modeling capabilities of their EC
framework, with 88 percent of those in Asia not satisfied. It is perhaps a reflection of Asias slower take-up of economic
modeling, because these techniques only really come into play once an ECmodel is firmly inplace.
Dissatisfaction with correlation and dependency modeling reflects the lack of hard data to analyze how risks are
interlinked and how chains of events can occur together. In the absence of data, the majority of respondents are using
expert judgment and simplified techniques such as correlation-based approaches to aggregation.
This level of substantial subjectivity in such a core area of the EC calculation (companies diversification benefits
typically range from 30 to 70 percent of pre-diversified capital), needs to be properly considered. European
regulators are already indicating this will be an area of focus in their internal model approval process. For
example, Julian Adams, Director of Financial Supervisory Authority Insurance Supervision, Prudential Business
Unit, in his speech at the City & Financial Conference in April, said firms need to properly consider how risks
interact and how their behavior can change the tails of distribution. Companies will need to have in place
robust, considered and documented processes if they are to emerge unscathed from regulator reviews.
Refinements
Even after the initial calculation of EC, there are a number
of adjustments or refinements that may be required to
reflect items that may not be adequately captured in
the model. Fifty-sevenpercent of UK respondents said
they were unhappy with the current techniques used to
capture these adjustments, rising to 67 percent across
Europe as a whole, 75 percent in Asia and 85 percent of
respondents in NorthAmerica.
The survey results indicate that allowing for fungibility
constraints with the EC calculations was one of the
hardest aspects to incorporate (Figure 11).
Appropriately allowing for fungibility constraints is critical
to ensuring that EC is not understated by taking credit
for capital movements that would be difficult to achieve
in practice. However, it is a major challenge due to the
complex capital structures companies have typically

had in place. These include complex group structures,
contingent loans, internal reinsurance and other support
arrangements.
Such arrangements have normally been developed to
improve tax efficiency, or as part of historic mergers &
acquisitions activity, but they add to the complexity of
EC computation. Advanced companies have started to
include these constraints in their models. This is not a
trivial task. It may require management to think through
restrictions on the transferability of capital in different
geographies, in extreme scenarios, and also the priority
for distributing surplus when more than one entity is in
deficit at thesame time.
Figure 11: Additional EC model considerations

4.0
3.5
3.6
3.6
3.3
3.2
3.2
3.0
2.7
2.5
2.0
1.5
1.0
0.5
0.0
Reinsurance
Group structure
Management
actions
Tail
dependency
Non-linearity
Fungibility
constraints
1 = not effective, 5 = very effective
Projection techniques
Much of the historic development
of EC modeling has focused on
calculating the opening position,
with little focus on projected results.
However, to effectively use EC in
business, it needs to be incorporated
into the business planning and pricing
process both of which require
a robust projection methodology.
In Europe, projected results are
also a key part of the Pillar II ORSA
requirements, compelling companies
to demonstrate an understanding
of the development and emergence
of risk over the business horizon
(typically three years).
The issue that respondents recognize
is that they generally do not have
sophisticated methodologies in
place. 56 percent of respondents
that currently project EC adopt

factor-based approaches, with
the complexity of the factors
varying significantly between
companies. Furthermore, there
is a lack of understanding
about how robust projection
methodologies are in stress
scenarios or how wide the
funnel of doubt becomes as
you increase the projection
period. The combined
effect is that 67 percent
of companies indicated
they were looking to
further develop their
techniques over the
next 12 months.
Figure 12: Distribution of lite modeling

techniques
5%
26%
56%
13%
Factor-based/risk driver approach

Other
Direct evaluation
Nested stochastic simulation
Operational risk modeling

Historically, operational risk has not been a big focus for companies. Therefore, it is not surprising
that this is seen as the least effective part of a companys framework (Figure 13).
Figure 13: Effectiveness of risk modeling
4.0
3.9
3.7
3.5
3.5
3.0
2.5
2.3
2.0
1.5
1.0
0.5
0.0
Market risk
Insurance risk
Increased regulatory focus and a better

understanding of how operational failures
can affect the business are driving
companies to review their approachinthis
area. In Europe, there has been a clear
move to advanced stochastic-based
operational risk models with more
than 60 percent of respondents having
adopted this type of model.
The difficulty is that there are many
areas of subjectivity in the operational
risk framework that complicate
the modeling. For example, leaked
policyholder information may have
resulted from a number of possible
causes, such as IT failure, human error
and fraud, with the exact cause being
difficult to pinpoint. Furthermore, the
Credit risk
Operational risk
1 = not effective, 5 = very effective
potential losses as a result may not be

known for many years, if at all.
Compounding this is the fact that
most companies have not recorded
historic operational losses, meaning
there is a lack of data available to
calibrate the model. To address these
issues, companies are establishing
operational loss databases and looking
to supplement their own limited data
sets with external operational loss data
provided by consortiums such as the
Operational Risk Consortium (ORIC).
It will be many years before the industry
has enough credible data to underpin
their operational risk models. This fact
is reflected in the survey results, which
showed that out of the 14 companies

having adopted a stochastic-based model,
13 rely on expert judgment to calibrate it.
While it is natural to expect refinement
over time, the current level of activity
across the industry is unprecedented
in terms of its extent and nature.
Furthermore, it is unlikely to be replicated
in the near future. Clearly, companies
are investing now in building their EC
framework to give their businesses the
best possible foundations for long-term
advantage. The costs of this investment
are high in the short term, but as any
architect will confirm, investing in solid,
appropriate foundations at the outset is
the best indicator of future stability.
Contacts
If you have any questions about the survey, about EC in general,
or if you would like a copy of the full report, please contact:
Global Insurance
Leadership Team
Frank Ellenbrger
Global Head of Insurance and
EMA Coordinating Partner
KPMG in Germany
T: +49 89 9282 1867
E: fellenbuerger@kpmg.com
Tim Roff
Global Actuarial Lead
Partner
KPMG in the UK
T: +44 20 7311 5001
E: tim.roff@kpmg.co.uk
Simon Donowho
ASPAC Coordinating
Insurance Partner
KPMG in China
T: +852 2826 7105
E: simon.donowho@kpmg.com
Hugh von Bergen

Global Insurance Tax Lead
Partner
KPMG in the UK
T: +44 20 7311 5570
E: hugh.von.bergen@kpmg.co.uk
Laura Hay
Americas Coordinating
Insurance Partner
KPMG in the US
T: +1 212 872 3383
E: ljhay@kpmg.com
Frank Pfaffenzeller
Global Insurance Audit Lead
Partner
KPMG in Germany
T: +49 89 9282 1027
E: fpfaffenzeller@kpmg.com
Gary Reader
Global Insurance
Advisory Lead
Partner
KPMG in the UK
T: +44 20 7694 4040
E: gary.reader@kpmg.co.uk
Editorial Team
David L. White
Principal, Advisory
KPMG in the US
T: +1 404 222 3006
E: dlwhite@kpmg.com
Thomas S. McIntyre
Principal, Advisory
KPMG in the US
T: +1 860 297 5512
E: tmcintyre@kpmg.com
Martin Noble
Senior Manager
KPMG in Hong Kong
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Publication name: Economic capital
Publication number: 120821
Publication date: August 2012

Economic Capital Modelling O 201208

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Economic Capital Modelling O 201208

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FINANCIAL SERVICES

Unlocking the value of Economic Capital

Growing pains of implementation

New trends emerging

Allowing for sovereign default risk

Enhancements of the future

About the survey*

Key findings from our survey

As insurance company managers now begin to use EC as an input into business

Internal and external

Source: KPMG International Economic Capital Survey, 201112

Better risk-return decision making

Rating agency and regulatory compliance

Improved shareholder value

1 = not at all important, 5 = very important

Lack of management understanding

1 = no understanding, 5 = full understanding

Source: KPMG International Economic Capital Survey, 201112

Lack of timely information

Companies that embrace an EC framework and use it throughout their business

Figure 4: Challenges with respect to EC framework in different regions

Data quality and

1 = not challenging, 5 = challenging

Source: KPMG International Economic Capital Survey, 201112

Weaknesses in data quality and availability

Winning executive buy-in

High setup and maintenance costs

Setup costs were unsurprisingly high in Europe,

Ongoing maintenance costs for North America

Source: KPMG International Economic Capital Survey, 201112

Figure 6: Distribution of cost of maintenance of

So, was the extra spend in Europe as a result

Source: KPMG International Economic Capital Survey, 201112

Figure 7: Distribution of techniques used for EC computation

Figure 8: Distribution of lite modeling techniques

Combination of stress and simulation

The decline of the stress approach

The rise of curve fitting

In Europe, regulators expect companies to demonstrate their

This increased sophistication, however,

Source: KPMG International Economic Capital Survey, 201112

Source: KPMG International Economic Capital Survey, 201112

The survey results show that industry practice

Least Squares Monte Carlo (LSMC)

In moving toward a simulation-based

Two or three years ago, there was no

Allowing for sovereign

Source: KPMG International Economic Capital Survey, 201112

Currently satisfied with

Plan to develop in next 12 months

Source: KPMG International Economic Capital Survey, 201112

Correlation and dependency modeling

complex capital structures companies have typically

Figure 11: Additional EC model considerations

Source: KPMG International Economic Capital Survey, 201112

that currently project EC adopt

Figure 12: Distribution of lite modeling

Factor-based/risk driver approach

Nested stochastic simulation

Source: KPMG International Economic Capital Survey, 201112

Operational risk modeling

Source: KPMG International Economic Capital Survey, 201112

Increased regulatory focus and a better

potential losses as a result may not be