Solvency II A Work in Progress

1
Solvency IIA Work in Progress
CAE Meeting, Zurich Alessa Quane November 29, 2007
2
Agenda

• Introduction Timing Update
• Implications for Firms Actuaries
• Directive Issues under Debate
• QIS 3 Results
• Conclusions

3
Soundbites
This is an ambitious proposal that will
completely overhaul the way we ensure the
financial soundness of our insurers. Charlie
McCreevy, European Commissioner for Internal
Market and Services We are setting a
world-leading standard that requires insurers to
focus on managing all the risks they face and
enables them to operate much more efficiently.
Its good news for consumers, for the insurance
industry and the EU economy as a whole - Charlie
McCreevy, European Commissioner for Internal
Market and Services Solvency II is not just
about capital. It is a change of behavior.
Thomas Steffan, Chairman of CEIOPS The purpose
of Solvency II is not necessarily to strengthen
the industrys capital base, but more to ensure
that sufficient regulatory and internal risk
management controls are in place to enable
management and regulators to more fully
understand and control the dynamics of the
industrys risk profile. Simon Harris, Moodys
Team Managing Director for European Insurance.
4
Three Pillars of Solvency II
Surplus
Surplus
Assets
Disclosure Requirements
Assets

Add-Ons
SCR
SCR
MCR
MCR
Risk Margin
Risk Margin
Liabilities
Liabilities
Firm Analysis
Supervisory Analysis
5
Solvency II Timetable
2012
2010
2011
2009
2008
2007
2006
2005
Full Implementation
Framework Directive Published
Directive Development
Directive Adoption
QIS 1
QIS 4
QIS 2
QIS 3
Further QIS
SCR/MCR Own Funds Groups Simplifications
6
Implications for Firms

• Require more formal approach to governance
  demonstrating that insurers are aware of the
  risks affecting their business and that they have
  embedded this awareness in the daily running of
  the business.
• Cost of compliance is likely to be significant
  and will be a large change for many
  jurisdictions.
• Likely to be winners and losers due to the
  solvency standards changing.
• Move toward risk sensitive pricing as data begins
  to improve at a more granular level to support
  internal modeling. This will lead to great
  segmentation and value driven products.
• Further fuel the rating agencies shift in focus
  onto companies risk management frameworks and
  desire for disclosure.

7
Implications for Actuaries

• Require more complex analysis and systematic
  approaches to risk management. This will
  increase the demand for actuaries and risk
  management personnel.
• Need to more closely coordinate with finance,
  risk management and other business functions.
• Better explanation of assumptions, sensitivities,
  limitations and methods underlying the
  computations and results to senior management who
  will be relying on this information throughout
  the risk embedding process.
• Increase in the development of advanced
  analytical tools and systems capable of providing
  a more informed basis for control and
  decision-making.

8
Highlighted Concerns with Directive

• Non-EU supervisors and group proposals
• Equivalence of regimes
• Level playing field for EU vs non-EU groups
• Application of a consistent economic assessment
  of available and required capital to all
  businesses, both EEA and non-EEA
• Structure and calibration of the MCR
• Ladder of intervention
• Consistent framework
• Geographic diversification
• Credit should be considered
• Legal entity vs risk exposure
• Group support

9
Goals of QIS 3

• Obtain further information about the practicality
  and suitability of the calculations involved and
  alternatives tested.
• Obtain quantitative information about the
  possible impact on balance sheets and the amount
  of capital required if the approach and
  calibration as set out in QIS3 were to be adopted
  as the standard.
• Collect information about the suitability of the
  suggested calibration for the calculation of the
  SCR and MCR.
• Initial test on the effect of applying the
  specification to insurance groups.

10
Participation in QIS 3
28 out of 30 member states participated 1027 solo
entities increase of 100 over QIS2 51 groups
participated
11
Participation in QIS 3
12
Participation in QIS 3
Average market share coverage was 69 for life,
63 for non-life and 79 for health Internal
Model submissions included
Represents 13 of firms, by submission numbers
13
Financial Impact Based on QIS 3

• No significant overall change in terms of the
  composition or size of the balance sheet compared
  with Solvency I at a European level
• Technical provisions tend to decrease due to the
  implicit prudence in the current regime thereby
  increasing available capital
• 98 of firms would not find it necessary to raise
  additional capital to meet the MCR
• QIS3 solvency ratio is lower than the current
  solvency ratio for most participating firms
• The proposed regime does not require extra
  capital in the European insurance market as a
  whole.

14
Assessment of the SCR

• CEIOPS believes that there is general
  satisfaction with the proposed correlation
  matrix. General consensus for a geographic
  diversification benefit to be included.
• Diversification effects through the correlation
  matrix were 20 on average.
• Many firms want the expected profit/loss element
  returned to the calculation.
• Subjectivity of the cat risk scenarios is
  inappropriate and needs to be reviewed
• Non-life underwriting risk results were excessive
  compared to internal model results.
• Operational Risk
• Opposition to the 100 correlation with the other
  risk factors
• No incentive to develop adequate risk management
  systems
• Suggestion that administrative costs could be a
  more appropriate measure than premiums

15
Composition of Non-Life SCR
Source CEIOPS Report on its Third Quantitative
Impact Study for Solvency II
16
SCR Comparison with Internal Models

• Internal models generally produce a higher charge
  for credit risk than the SCR module
• For non-life insurance, internal models produce
  significantly lower total SCRs than the standard
  formula, with an average reduction of 25
• No clear pattern as to whether internal models
  produce a lower or higher operational risk charge
  than the standard formula

17
Assessment of the MCR
Calibration target is 80-90 value at risk over a
one-year time horizon Non-life firms results
under both alternatives were broadly consistent
with the calibration target. For alternative 1,
the MCR nowhere exceeded 70 of the SCR
Source CEIOPS Report on its Third Quantitative
Impact Study for Solvency II
18
Assessment of the MCR
Problematic interaction with the SCR for life and
composite firms due to the loss absorbing
capacity of future discretionary benefits
methodology
Source CEIOPS Report on its Third Quantitative
Impact Study for Solvency II
19
Own Funds
95 of capital was designated as Tier 1 with the
average proportion over the industry being
94 For those firms with Tier 2 capital, the
average proportion was less than 25 in almost
all countries For those firms with Tier 3
capital, the average proportion was less than 20
for life firms and less than 33 for non-life
firms in almost every country
20
Areas for Further Work

• Technical Provisions
• More guidance on calculation of the risk margin
• Possible simplifications or proxies to make up
  for a lack of data
• SCR
• Segmentation
• Calibration of non-life underwriting risk
• Granularity of equity risk shocks
• Treatment of unrated entities
• Possible simplification of the concentration risk
  component and impact on firms in smaller
  countries with fewer market options
• Clarification of replacement cost in the
  counterparty default risk module and treatment of
  intragroup reinsurance
• Inclusion of expected profits
• Exclusion of free assets in the market risk
  module

21
Areas for Further Work

• MCR
• Testing of additional approaches to enable a
  choice between the MCR being a stand alone
  capital requirement and having it as a percentage
  of the SCR
• Value of Assets
• Clarification on valuation of participations
  (look-through vs market value)
• Own Funds
• Guidance on classification of eligible elements
• Groups
• Non-comparable data has been supplied and
  clarification is therefore needed in order to
  draw conclusions on these issues
• Scope of consolidation
• Group coverage
• Internal model results
• Consideration of the rules to which cross sector
  and non-EEA entities are subject as well as the
  extent to which surplus assets are transferable

22
Conclusions
Industry needs to provide detailed input on key
issues to assist the Council of Ministers and the
European Parliament better understand how the
Solvency II regime will work in
practice. Industry needs to support CEIOPS work
on the development of QIS4 and further
quantitative surveys to assist in developing the
implementing measures of Solvency II. Actuaries
need to stay abreast of the topics and add their
expertise to the debate. In addition, we need to
acquire the necessary skills to assist our
management in meeting the demands that Solvency
II will thrust upon on our firms.