Draft Response to the Solvency II Committee February 2009mof.gov.il/hon/information-entities/solvency2/isum/... · 2014-02-05 · KPMG – Draft Response to the Solvency II Committee

KPMG – Draft Response to the Solvency II Committee February 2009

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Introduction

In June 2008, the Israeli Insurance Association (R.A) appointed KPMG as their official advisors to the Israeli market in relation the new Solvency II regime being introduced by the Insurance Regulator in Israel. The engagement required that KPMG provide professional support for QIS4 in the form of the following actions:

1. Support the work of the Solvency II Committee with respect to the implementation of the quantitative pillar of Solvency II

2. Enable insurance companies to ask questions throughout the QIS4 exercise

and provide timely expert answers

3. Evaluate spreadsheets by insurance companies on behalf of the Committee This document outlines KPMG’s answers to questions posed by the insurance companies. As part of the introduction, it is felt important to explain the process by which the questions arrived to KPMG and the manner in which they have been tackled. After the announcement that Israel is to take up the Solvency II Regulation, four committees were established to deal with the various areas that will be affected by the new rules:

Credit Market

General Insurance

Accounting

Life and Health After a number of meetings, the heads of the committees and in some cases committee members submitted questions either through Magie Braun of the Ministry of Finance, or directly to a member of the Somekh Chaikin ……………. These questions were then collated, translated where necessary, and sent to the various KPMG experts who have been appointed to support the above action points. Once all questions were answered, each was reviewed for accuracy and consistency with the other answers and changes were made where necessary.

Introduction Introduction

ABCD

Draft Response

to the Solvency II Committee

February 2009

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Introduction In June 2008, the Israeli Insurance Association (R.A) appointed KPMG as their official advisors to the Israeli market in relation the new Solvency II regime being introduced by the Insurance Regulator in Israel. The engagement required that KPMG provide professional support for QIS4 in the form of the following actions:

1. Support the work of the Solvency II Committee with respect to the implementation of the quantitative pillar of Solvency II

2. Enable insurance companies to ask questions throughout the QIS4

exercise and provide timely expert answers

3. Evaluate spreadsheets by insurance companies on behalf of the Committee

It is with this therefore that we are pleased to present this initial draft of our answers for the remarks of the committee.

Please find following the questions received from Mrs. Magie Braum on behalf of the Solvency II Committee and the answers according to the common practice as at December 2008. Before releasing this document to the market, it was reviewed by Mrs. Magie Braum and her team.

Note on Abbreviations

We have included a list of abbreviations and their meanings. This can be found on the following page. Please note that full definitions of these and other terms can be found in the Solvency II Glossary accompanying this response.


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Abbreviations (in Order of Use) Abbreviation Meaning

QIS Quantitative Impact Study

EU European Union LGD Loss Given Default BE Best Estimate SCR Solvency Capital Requirement CEE Central and Eastern Europe RM Risk Margin OECD Organization of Economic Co-operation and Development EEA European Economic Area CEIOPS Committee of European Insurance and Occupational Pensions ORSA Own Risk Solvency Assessment VaR Value at Risk VIF Value in Force VNB Value of New Business ASM Available Solvency Margin PVFP Present Value of Future Profits EV Embedded Value PD Probability of Default CDO Collateralized Debt Obligation CDS Credit Default Swap SPV Special Purpose Vehicle MBS Mortgage Backed Security AMC Asset Management Company LoB Line of Business LR Loss Ratio IEULR Initial Expected Ultimate Loss Ratio GAAP Generally Accepted Accounting Principles CoC Cost of Capital IFRS International Financial Reporting Standards LTC Long Term Care PHI Permanent Health Insurance CIC Critical Illness Cover ICA Individual Capital Assessment


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Table of Contents

General ....................................................................................................... 6

Correlations of primary risk and secondary risk categories ...................................... 7

Counterparty default risk ................................................................................................. 8

Credit & Market Risk ................................................................................. 9

Participating policies ...................................................................................................... 10

Pre-1991 Israeli guaranteed-return life assurance policies ..................................... 12

Spread risk and market concentration risk ................................................................. 13

Determination of extreme scenarios – part 1 ............................................................. 14

Determination of extreme scenarios – part 2 ............................................................. 15

Embedded value ............................................................................................................ 16

Inflation risk…… ............................................................................................................. 17

Interest rate risk – part 1 ............................................................................................... 18

Interest rate risk – part 2 ............................................................................................... 19

Spread risk…… .............................................................................................................. 20

Property risk……… ........................................................................................................ 21

Equity risk…………. ....................................................................................................... 22

Counterparty default risk ............................................................................................... 23

Classification of debt instruments for the spread and counterparty model. .......... 24

Investment funds ............................................................................................................ 26

General Insurance ................................................................................... 28

Line of business classification ...................................................................................... 29

Correlations between lines of business ...................................................................... 30

Database for the period of the actuarial calculation ................................................. 31

Standard deviation ......................................................................................................... 34

Risk of catastrophe ........................................................................................................ 35

Adjustment to catastrophe risk ..................................................................................... 36

Use of internal models ................................................................................................... 37

Adjustment to standard factors .................................................................................... 40

Appropriateness of market factors .............................................................................. 42

Market factor confirmation for CMBI ........................................................................... 43

Definition of “Best Estimate” ........................................................................................ 45

Calculation of the risk margin ....................................................................................... 46

Catastrophe risk factors ................................................................................................ 49

Underwriting risk module .............................................................................................. 50


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Accounting ............................................................................................... 51

Insurance groupings ...................................................................................................... 52

Data requirements for Solvency I ................................................................................ 53

Fair value calculation ..................................................................................................... 54

Currency for reporting .................................................................................................... 55

Goodwill…………. .......................................................................................................... 56

Life and Health ......................................................................................... 57

Use of EV assumptions for QIS4 ................................................................................. 58

Operational Risk ............................................................................................................. 59

Alternative information ................................................................................................... 60

Calculation of “Best Estimate” ...................................................................................... 61

Grouping of contracts .................................................................................................... 62

Life mortality scenario .................................................................................................... 63

Catastrophe risk ............................................................................................................. 64

Classification of business lines for life and health .................................................... 65

Approval of premium increases ................................................................................... 66

Hedgeable contracts ...................................................................................................... 67

Counterparty default risk ............................................................................................... 68

Recoverables .................................................................................................................. 69

Taxation…….. ................................................................................................................. 70

Best estimate for special risks ...................................................................................... 71

Segmentation .................................................................................................................. 72

Comments on worked example ................................................................................... 73


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Response from Ministry of Finance ...................................................... 74

Re: Question 1 ................................................................................................................ 75

Re: Question 3 ................................................................................................................ 76

Re: Question 4 ................................................................................................................ 78

Re: Question 7 ................................................................................................................ 80

Re: Question 8 ................................................................................................................ 81

Re: Question 10 .............................................................................................................. 82

Re: Question 17 .............................................................................................................. 83

Re: Question 18 .............................................................................................................. 84

Re: Question 22 .............................................................................................................. 85

Re: Question 23 .............................................................................................................. 86

Re: Question 27 .............................................................................................................. 88

Re: Question 31 .............................................................................................................. 89

Re: Question 37 .............................................................................................................. 90

Re: Question 39 .............................................................................................................. 91

Re: Question 40 .............................................................................................................. 92

Re: Question 43 .............................................................................................................. 93

Re: Question 45 .............................................................................................................. 94

Re: Question 47 .............................................................................................................. 95

Re: Question 48 .............................................................................................................. 96

References: .............................................................................................. 97


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General


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Category: General Subject: Correlations of primary risk and secondary risk categories Question 1

a) Are there countries who defined different correlations between primary risk categories and secondary risk categories? If so, please indicate the newly established correlations and the reasons for the change.

b) Please pay special attention to the correlation between life

assurance business and general insurance business. In Israel a large proportion of companies deal in both areas. For countries in which insurance companies are authorized to deal in both sectors, were the correlations set down in QIS4 taken into account or were they changed?

KPMG Response to Question 1

a) We do not know of any countries that have defined different correlations between primary and secondary risk. Generally the correlations cannot be adjusted and are set so that a standard and consistent approach is applied across the EU, but comments on the appropriateness of them are welcome (i.e. via the factors that have been used within a company's internal models). These comments are then used to calibrate the standard formula factors should it be required.

b) Again no changes have been made and the correlations between Life and General Insurance as set down in QIS4 were used, but appropriateness of these can be commented upon also.


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Category: General

Subject: Counterparty default risk Question 2 To our understanding of the counterparty default risk, the capital savings and the expected loss must be taken into account in the framework of the Loss Given Default (LGD) calculation and the expected loss should be taken into account in the framework of the Best Estimate (BE) calculation of the recoverable from reinsurance contracts (see p.22 & p.23 of the QIS4 Technical Specification). We request your treatment of the issue. KPMG Response to Question 2 KPMG agrees with your understanding. For the counterparty default risk, you are trying to calculate the reinsurance default risk charge under the stressed scenario, should your gross claims reach the 99.5 percentile level, i.e. the reinsurance recoverable if gross claims reach the 99.5 percentile level (£X). To calculate this default risk charge, the £X will need to be allocated to each counterparty (i), and the relevant probability of default applied. Under the QIS4 LGD calculation, in principle one has to calculate both the gross and net BE, with the difference being the BE of reinsurance recoverable (£Y). Then under QIS4, the underwriting SCR (Solvency Capital Requirement) is calculated for both gross and net, the difference between them being the underwriting reinsurance SCR (£Z). So the LGD is (Y+Z) = X. This is calculated, for each counterparty (i). The factor of 50% takes into account the fact that even in case of default the reinsurer will usually be able to meet a larger part of its obligations.


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Credit & Market Risk


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Category: Credit & Market Risk

Subject: Participating policies Question 3 In Israel there exist participating policies (i.e. in investment profits), which do not contain embedded options or guarantees. In these policies, it is the policyholder who bears the investment risk (similar to unit-linked) Until 2004, fixed management fees (0.6% of assets) and variable management fees which are a function of the return (company participation in 15% of the investments) were customary in policies of this type. 1.

a) What is the treatment of policies in which the investment risk is imposed upon the policyholders of the type customary in Israel for each of the market risk models? (It should be noted that in models relating to the spread risk and concentration risk only, there is specific treatment to unit linked policies which contain embedded options and guarantees. We request your treatment of this type as well).

b) What is the method of treating the risks deriving from the profit-participation (for policies with variable management fees)?

2. We request a survey of the treatment methods, in various countries, of unit-linked type policies, where policies similar to those in Israel are customary.

KPMG Response to Question 3 A capital charge for market risk is not required in relation to investment risk for policies where the investment risk is transferred to the policyholder. However, if under these policies a management charge is levied, then companies have a negative reserve (i.e. the expected future management fees, assuming no death benefit payable in excess of return of funds). So companies have to consider, under the stressed market risk components, what the impact on the future management fees is likely to be, for this reduction in future fees is set up as an additional capital charge under the


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Question 3 (continued) market risk component. The key risks for the unit-linked products are market risk (to a lesser extent, arising from the reduction in the fees the issuer of the policy is receiving when there is a fall in the value of the assets backing the unit-linked policies), and expense risk (to a larger extent). Lapse risk needs to be considered through operational risk in a unit-linked product as one should expect, for example, higher lapses when the issuer of the policy gets the unit price wrong to the public. Sensitivity testing on lapse risk is quite common in the UK, but not so in countries located in Central and Eastern Europe (CEE) (e.g. Romania). A possible approach is to test for shocks to market risk, expense risk and the lapse risk, and to test under various scenarios the operational risk. Where policies have either a guaranteed minimum death benefit or a minimum investment return option, the impact of these options on the likely future benefits to the policyholders are considered under each of the market risk stress tests. If under the stressed conditions these options bite then a capital charge is set up equal to the value of the option under the stressed situation. Under with-profit polices, the situation is similar. Companies calculated their insurance liability on a realistic basis (expected future payments, except in Germany where only guaranteed contractible obligations are taken into account), so under the market risk stress tests the impact on any variable management fees would be considered and any reduction set aside as an additional capital charge. Additionally, the net asset movement (assets less liabilities) is adjusted for any anticipated reduction in future profit share (in-so-much as allowed for within the insurance liability above).


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Subject: Pre-1991 Israeli guaranteed-return life assurance policies Question 4 Until 1991, guaranteed-return life assurance policies issued in Israel were backed by unquoted Government-issued bonds, bearing excess yield compared with the return guaranteed by the policy. The designated bonds fully backed the company’s liability for the guaranteed return until the company’s liability ceased. We request a clarification of how to treat such bonds in all of the models. KPMG Response to Question 4 This has not been seen in the EU, but KPMG’s thoughts are that one needs to follow the accounting treatment. The actual treatment will depend on the relationship between contractual liability under the insurance contract and the return from the unquoted Government bonds. If the contractual liabilities are directly linked to the return on the bonds, then the liability under the insurance contract can be treated as a hedgeable liability and one does not need to calculate a BE plus a Risk Margin (RM). The market risk component for the bonds would then not need to be calculated as the asset less liability would be zero. However, if there is a liability floor under the contact (i.e. Liability at time t > Assets at time t under certain scenarios) then a capital charge needs to be calculated when the floor bites. If the situation is such that the contractual liability is not linked to the return on the bond (i.e. it is a non-hedgeable risk), then a BE + RM needs to be assessed. Additionally the resulting capital charge has to be allocated under the insurance risk. On the market risk side, it would need to be treated as a bond (i.e. interest rate risk) with the market value as per in the accounts (if fair value). One then also needs to consider the spread risk and concentration risk assuming the Government credit rating, if these are guaranteed by the Government though unquoted.


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Subject: Spread risk and market concentration risk

Question 5 The State of Israel is rated at international rating A. We would like to know, in countries rated similar to Israel or lower, were Government bonds treated similarly to the treatment method in countries rated AAA (for example, were they excluded from concentration risk and spread risk)? KPMG Response to Question 5 For both concentration and spread risk calculations, Government bonds are exempt. This relates to borrowings by the national Government, or guaranteed by the national Government, of an OECD or EEA state, issued in the currency of the Government. Currently there are 30 members of the OECD (Israel is not a full member - they have been invited to discussion for membership). For Government bonds not exempt, allowance for the credit rating will need to be applied. For Israel this is likely to mean assuming an “A” rating. Generally, companies have applied this rule in their calculations.


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Category: Credit & Market Risk Subject: Determination of extreme scenarios – part 1 Question 6 Are the extreme scenarios under QIS4 fixed over time? If not, are they updated according to a fixed timetable or as a reaction to specific events? Who is the updating party, CEIOPS or the local regulator? KPMG Response to Question 6

1. Nothing definitive has been stated, but KPMG’s view is that:

a) The extreme events would be intended to be largely fixed over time (to prevent arbitrary changes). However, this would not be a permanent fix. As we are looking at extreme tail events, it should be fairly hard to identify new extremes, but clearly external events can occur to change our understanding of the extremities (for example, Sept. 11 changed our views on correlations and the current credit crisis identified a run on a bank as a bigger risk). It is our view therefore that this will always be more of an 'in response to' type review, rather than a review at fixed intervals.

b) As to who would do it! The current thinking is that it would work

similarly to the initial list of catastrophe risks, in that regulators would identify their own changes and CEIOPS would then issue a summary. This seems consistent with the way catastrophe risks are handled within QIS4. Since there might be scenarios having specific impact on individual insurance companies there should be the possibility that insurance companies also add their "own" scenarios, but through the ORSA requirements if not initially within the standard formula.


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Category: Credit & Market Risk Subject: Determination of extreme scenarios – part 2 Question 7 What is the manner of calculation of the extreme scenarios under each of the models? Please address the holding periods and whether the average is taken into account in the framework of the calculation of the Value at Risk (VaR)? KPMG Response to Question 7 Generally, the SCR calculations are made either on an extreme scenario or a factor basis. These have been attained by considering data from a few European insurers (i.e. insurance risk) and either modeling these to obtain the capital charge at a 99.5 percentile to obtain a factor to gross up the Best Estimate to the 99.5% level, or economic scenario generators to obtain the factor (32% for equity) or scenarios over historical averages. With regards to Catastrophe risk there are three methods:

1. Calculated as per the factor calculation, 2. Standard scenarios from local regulators, and

3. Company specific scenarios, (though there is potential for double

counting as averages are not deducted). In obtaining the scenarios, or factors, how long the assets or liabilities will be held for, has not been considered, as assets are valued on a market consistent economic basis and liability provisions implicitly allow for the duration.


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Category: Credit & Market Risk Subject: Embedded value Question 8 How is the Embedded Value (EV) taken into account in the framework of the calculation (please address Value-In-Force (VIF) and Value of New Business (VNB))? KPMG Response to Question 8 Generally, companies have calculated the cash-flows on a best estimate basis for all the business in-force and discounted at the swap rates within QIS4. But you may regard the Available Solvency Margin (ASM) as a form of Embedded Value. (Within Market consistent embedded value in effect the calculation is made up of BE + RM, with the RM containing effectively an allowance for ASM). Of course under the solvency requirement, the calculation is slightly different from that under QIS4 (with a little different calculation of risk margins etc., and no differentiation between net asset value and Present Value of Future Profits (PVFP), or VIF, if you like, and same with the discount rate used and possibly the allowance within the cashflows).


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Category: Credit & Market Risk Subject: Inflation risk Question 9 How was inflation risk dealt with in various countries? KPMG Response to Question 9 Companies have generally built in an allowance for inflation (at the appropriate level, on an expected value) within the cash-flow calculations as outlined in section TS.II.B.9. of the QIS4 Technical Specification. However, there is no specific inflation risk calculation except for expense risk. If inflation risk allowance needs to be made but the QIS exercise (and hence standard formula) has no such allowance within the relevant component then no allocation generally has been made by companies, but they have commented accordingly. Under the solvency II regime this would need to be considered within the ORSA requirements and an additional risk charge calculated and the SCR adjusted accordingly. In countries located in CEE, inflation is assumed to be dealt with implicitly by projecting the claims. However, inflation could be added explicitly to the claim cohorts, for example a loading factor of 10% per annum. When dealt with implicitly however, one could apply a shock of 1% per annum to the claim amounts as a shock test for inflation in the claim cohorts (in line with expense risk as explained), i.e. a 10% shock to inflation per annum. However this would not remove the need to consider this risk under the ORSA requirement. KPMG are aware that in Israel, life insurance premiums for long term business are mostly linked to the cost of living and therefore the expense loading included in the premium will also be linked to the cost of living creating some kind of buffer against inflationary risks.


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Category: Credit & Market Risk Subject: Interest rate risk – part 1 Question 10 Is the market stated in percentage points (absolute) or as a percentage of the interest? KPMG Response to Question 10 The up and down shocks are movements to the relative swap risk free curve, i.e.: rfr * (1+shock). Where rfr = risk free rate


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Category: Credit & Market Risk Subject: Interest rate risk – part 2 Question 11 In section TS.IX.B.9 of the QIS4 Technical Specification, it is written that the calculation should be made for assets and liabilities whose cash flows are not influenced by interest rate changes. Is the intent that the calculation be made only for assets / liabilities bearing fixed and not variable interest? KPMG Response to Question 11 This simplification may be used for assets, non-life technical provisions and other liabilities but should not be used for the life technical provisions. It can therefore be used for assets and liabilities bearing variable interest. However, the condition to be met for using the simplification is that the cash-flows of the item are not interest rate sensitive. In particular, the item has no embedded options.


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Category: Credit & Market Risk Subject: Spread risk Question 12 In non-AAA rated countries, were adjustments made to the F rating and the G rating? KPMG Response to Question 12 No adjustments have been made when considering the credit risk on Government bonds, but the applicable international rating has been used.


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Category: Credit & Market Risk Subject: Property risk Question 13 We request a clarification as to the meaning of indirect “exposures”.

1. To our understanding the model addresses exposure through companies with direct holdings in real estate only and without leverage.

2. To our understanding leveraged companies and venture capitalists

are dealt with using the equity method. KPMG Response to Question 13 This is correct.

1. Participations in real estate companies shall be treated as property as they only give rise to property risk.

2. If the real estate company takes out loans in order to leverage its

investments in properties, the participation should be treated as equity.


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Category: Credit & Market Risk Subject: Equity risk Question 14 Which countries used a “Global” classification for the local stock market and which countries used the “Other” classification? Further, did any countries determine a different rate for “Global” and “Other” from that set in the QIS4 Technical Specification? Finally, if you have a calculation of the extreme scenarios of such markets, please could you provide us with it? KPMG Response to Question 14 The classification of “Global” and “Other” is fairly well defined within QIS4, i.e.:

“Global” comprises equity listed in EEA and OECD countries, and

“Other” comprises equity listed only in emerging markets, non-listed equity, hedge funds and other alternative investments.

All the countries have used these classifications dependent on the underlying investments, e.g. equities on the Israeli market (as non-OECD) would be in the “other” class. Within QIS4 the factors 32% and 45% cannot be adjusted but comments on their appropriateness are welcome. With regards to an example, unfortunately we are unable provide one due to data protection, however if you require us to create one, we will be happy to do so.


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Category: Credit & Market Risk Subject: Counterparty default risk Question 15 Was an adjustment to the probability of default made, or another method of calculation determined in the calculation of the exposure to credit risk of re-insurers or counterparties residing in countries rated lower than AAA (rated by a local rating and not an international rating)? KPMG Response to Question 15 Generally, we have not seen this as yet, and the recent CEIOPS paper didn’t make note of anything. However, generally we believe that if the local rating is consistent with that internationally, then that rating and the associated PD would be applied. Where the local rating is not consistent, either, one can request this from rating agencies such as Standard & Poors, Moody’s etc. (who publish PD and LGD estimates based on their statistics), or the lower of the two ratings (country or entity) could be used as a conservative estimate.


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Category: Credit & Market Risk Subject: Classification of debt instruments for the spread and

counterparty model. Question 16 We request a clarification of the manner of classification of debt instruments for the two models, the manner of their treatment and these issues:

a) To our understanding re-insurers, market derivatives, and counterparties to securitization carried out by the company are handled under the counterparty model, while bonds (including those of non-OECD governments) CDO’s and CDS’s are handled under the spread model.

b) To which model should mortgage-banked loans, loans backed by life

assurance policies and loans to agents backed by flow of future fees be classified?

c) To our understanding, in the counterparty model, the net exposure

less collateral should be considered. Collateral should be considered in the framework of the relevant models. Please clarify which types of collateral are intended.


a) According to TS.IX.F.9 spread risk comprises of spread risk from bonds, structured credit products and credit derivatives. This includes CDO’s and CDS’s etc. Spread risk covers any financial instruments whose value is affected by interest rate spread above the risk free rate. Compared to counterparty risk which examines the likelihood of default by the counterparty independent of the effect of interest rate on the value of the underlying financial instrument. In particular, securitization is in reference to SPV.

b) MBS’s are usually through an SPV so they should be accounted for

by counterparty risk. However, the spread on these securities are sensitive to interest rates. The latter two loans involve a


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Question 16 (continued)

counterparty, so KPMG’s view is that these should be accounted as counterparty risk.

c) This is defined in TS.VII.I and states "A collaterised transaction is

one in which insurers have a credit exposure or potential credit exposure and it is hedged in whole or in part by collateral posted by a counterparty or by a third party on behalf of the counterparty”.

In addition to the general requirements for legal certainty, the legal mechanism by which collateral is pledged, or transferred must ensure that the insurer has the right to liquidate or take legal possession of it in a timely manner, in case of any event of the counterparty set out in the transaction documentation (and, where applicable, of the custodian holding the collateral). Insurers must have clear and robust procedures for the timely liquidation of collateral to ensure that any legal conditions required for declaring the default of the counterparty and liquidating the collateral are observed, and that collateral can be liquidated promptly. Generally, this means a security or guarantee (usually an asset) pledged for the repayment of a loan if one cannot procure enough funds to repay.


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Category: Credit & Market Risk Subject: Investment funds Question 17 Please provide examples of the manner of treatment of investment funds under the look-through approach and of the manner of treatment of investment funds where it is not possible to carry out the look-through approach. KPMG Response to Question 17 Where we have seen the look-through approach being applied is where an insurance company has used, either a sister company, or 3rd party Asset Management Company (AMC) to handle their investment portfolio. These are mainly structured under an investment mandate (legal contract) being put in place, which outlines the type, exposure, duration and volume under each asset category, but usually not the actual asset to be invested in. Depending on the level of reporting agreed with the AMC, participants would either look through to the underlying individual assets or attribute on a best effort basis depending on the investment mandates in place. The other investments that are seen are investment funds or mutual funds which companies had invested, which concentrate either in a specific area of the investment market (i.e. UK small companies, etc) or a general spread of asset classes / territories. For these, if the participants have been able to obtain details of the underlying individual assets then these have been used, but generally this is not available. Here, participants have considered the collective investment fund as an equity investment and applied the global equity risk charge (if the assets within the collective investment scheme are predominately listed in EEA or OECD entities), or the other risk charge (if the assets within the collective investment scheme are predominately unlisted or outside the EEA and OECD). If this was not feasible, the exposure has been attributed on a best effort basis. Furthermore this could be waived if the mutual fund solely invests in European equities with no special individual hedging instruments for


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Question 17 (continued) example. Then it is possible to consider the equity fund as a single equity for the output calculation.


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General Insurance


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Category: General Insurance Subject: Line of business classification Question 18

1. How did countries handle the classification of products where the sector classification does not match the classification under QIS4?

2. What was the practice in countries that have no-fault compulsory

motor vehicle insurance? KPMG Response to Question 18 Most of the countries have regulatory returns which are very explicit about classification of business and these have been used. Where there has been an issue, most companies have either asked the local regulator for clarification or looked at the nature, term and volatility of the claims and assigned to a particular class. If a good match has not been available, companies have generally included them in the “other” class explaining why. No adjustments have been made to the factors but comments have been made as to what would be appropriate.


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Category: General Insurance Subject: Correlations between lines of business Question 19 Are there countries in which the correlations established were different from the average in QIS4? KPMG Response to Question 19 We do not know of any countries that have used different correlations from the average as stated within the QIS4 outline. The factors have been set in QIS and are there to check the appropriateness of such. CEIOPS are looking at whether the correlations and other factors produce, in aggregate in the EU, reasonable but conservative capital requirements. The aim is for the standard formula to be calibrated to be about 20% to 40% higher than internal models.


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Category: General Insurance Subject: Database for the period of the actuarial calculation Question 20 Presently in the liability sector in Israel, most companies calculate the contingent claims on the basis of underwriting year. The QIS4 requirement however is to calculate the contingent claims on the basis of year of damage. Please address the following issues:

1. Are there countries in which it was decided to integrate a calculation on the basis of year of damage and on the basis of underwriting year, according to the method practiced in that country?

2. In cases in which adjustments were made according to underwriting

year, how were the adjustments made with respect to the premium risk, and specifically in dealings not yet signed (in addition to unearned premium)

3. How are companies that account on an underwriting year basis,

dealing with the requirements of section TS.XIII.B.12 of the QIS 4 Technical Specification?

In addition, how do these companies divide the reserve risk between outstanding claims (claims provisions) and unexpired risk (premium provisions) as different factors apply to the different elements?


1. What we have seen a number of Lloyd’s syndicates do, is carry out the calculation on an underwriting year basis and then convert these figures to those required under QIS4. Section TS.II.E.10 of the QIS4 Technical Specification allows companies to ".....use of claims data on an occurrence / accident year basis or an underwriting year basis for the run-off triangles." QIS4 has requested comments / feedback on this matter.

2. The conversions of underwriting figures to earned and unearned

(plus pipeline premium) has been generally to use the underwriting ultimate loss ratio and has been applied to the earned premium. The


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other methods that have been seen is to consider the expected LR applicable to the unearned + pipeline premium (i.e. IEULR) and then take the balance to the reserve risk, adjusting the underwriting payment pattern to obtain the earned duration of reserves.

3. All companies need to comply with the requirement; however, QIS4

does welcome feedback / comments on the difficulty of moving from an underwriting year basis.

Europe Some undertakings commented that applying the model seems to be easier when using accounting designed on an accident year basis, or conversely raises practical difficulties for undertakings with accounting systems based on underwriting years. Comments on the difficulties encountered were mainly developed by one supervisor. The problems identified were as follows:

1. Resource intensive - many undertakings commented that while an underwriting year basis can theoretically be converted to an accident year basis, this is difficult in practice as there are many years of account, lines of business, territories and currencies. This exercise was time consuming, requiring a considerable amount of effort; consequently, the information was provided on an underwriting year basis.

2. Underwriting year and local GAAP - undertakings that use an

underwriting basis but publish accounts on a local GAAP basis with differing assumptions stated that the requirements of Solvency II raise a number of new difficulties:

a) Historical loss ratios on an accident year basis will only be

available from the date GAAP accounting was introduced in the undertaking. This may not be a sufficiently long enough period to easily use undertaking-specific parameters.

b) Underwriting year reserves are split between earned and

unearned proportions. This approach implicitly uses the same


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loss ratio for the earned / unearned portion, but in practice the best estimate loss estimates for the earned / unearned split will be different. Therefore an assumption will have to be made.

c) For discounting purposes, in theory a different run-off pattern

should apply to claims provisions (earned) and the premium provisions (unearned). These run-off patterns are not directly available because claims data on an accident year basis is not collected.

The main conclusion of this supervisor is that providing data on an accident year basis would involve large costs for undertakings accounting for their business on an underwriting year basis if it became a requirement under Solvency II.

Example: German country report

No difficulties have been reported. The QIS4 approach appears to be appropriate to the German market.


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Category: General Insurance Subject: Standard deviation Question 21 Are there countries where the standard deviation for premium risk and reserve risk were updated based on local experience? How was the standard deviation calculated, and (as the deviation was calculated according to large companies) was additional conservatism for use of such deviation taken into account for small companies as well? KPMG Response to Question 21 Generally, companies have not updated standard deviations, but have commented on their appropriateness in their case. According to QIS4 a company specific calculation can be done but only in accordance with the formula specified in section TS.XVII.D. of the QIS4 Technical Specification.


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Category: General Insurance Subject: Risk of catastrophe Question 22 What is the definition of catastrophe in each sector? Does it relate to the effect of multiple independent events on the level of retention of the company? KPMG Response to Question 22 In relation to catastrophe risk, if regional scenarios are available, provided by the local supervisor (the supervisor of the relevant territory, not necessarily the

insurer's own supervisor), they replace the standard formula of method 1. Regional scenarios include natural and man-made catastrophes. In addition, undertakings may, on an optional basis, use personalized catastrophe scenarios according to the classes of business written and geographic concentration, explaining the appropriate definition for the calculation purposes (method 3). To reflect the effect of multiple independent events on the level of retention of the company, the QIS4 participants will have to use either, scenarios provided by the local regulator, or personalized scenarios on an annual basis.


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Category: General Insurance Subject: Adjustment to catastrophe risk Question 23 Since the compulsory motor insurance branch in Israel is no-fault, what adjustments were made to the catastrophe risk in countries in which the same definition exists? In the motor vehicle property branch, there is an option in Israel to purchase insurance against earthquakes, but such insurance is virtually never purchased. Were adjustments made in countries in a similar situation and what were the considerations for making or not making the adjustments? KPMG Response to Question 23 One of the more sophisticated approaches was used in Germany where a specific formula was developed to estimate natural hazard risk in motor comprehensive insurance. Details are available in the guidance notes, however this does not include earthquake. A more relevant example is Portugal where an earthquake scenario has been suggested by the regulator, resulting in an estimated loss of 1.11% of the capital at risk for property insurance policies exposed to seismic perils. This scenario corresponds to an expected 250 year event. Participants are invited to include the estimate of the impact that such an earthquake would have on the other lines of business. Other countries such as France and Belgium have earthquake scenarios affecting all lines of business.


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Category: General Insurance Subject: Use of internal models Question 24 To what extent are companies in the UK and Europe relying on internal models to carry out the QIS4 exercise, or are they adopting the standardized approach as set out in the specification? KPMG Response to Question 24 The QIS4 specification includes a description of the standardized approach. All insurance companies, also those already having internal models in place, have been asked to calculate their SCR using this approach. In addition to this, there is a questionnaire (as described in section TS.XIV of the QIS4 Technical Specification), where companies were asked to provide additional data on their internal models. So for purposes of QIS4, companies were encouraged to calculate their SCR using both the standardized approach and an internal model.

CEIOPS states that 160 firms from 16 countries provided results from their internal model. Of these 160 models,

74 were life firms 63 were non-life firms 21 were composite firms

A list of the results of the internal models shows the median to be 89% of the capital requirement produced by the standardized approach. This median varies by the type of firm:

95% for life 79% for non-life 102% for composites

So for composites, the capital requirement produced by internal models has been slightly higher than that produced by the standardized approach. However these numbers have to be interpreted cautiously since internal models can be quite different from the standardized approach.


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Question 24 (continued) 1. German Country Report

a) Solo undertakings internal models

27% of QIS4 participants, i.e. 58 in 214, already use internal models for some aspects of their business. This does not apply to 25%. The remaining 105 participants, i.e. almost half of all participants, do not provide any information in this regard. The percentage of undertakings that are actively developing and managing internal models for use in their business is 33%, slightly higher. About two thirds of the 74 participants using or developing an internal model are property and casualty insurers. 21 out of the 25 undertakings left are life insurers and the remaining 4 undertakings, reinsurers. Among the 74 participants mentioned, there are approximately twice as many large and medium firms as small ones. In all, about half of all large insurers, one third of all insurers of medium sized and one-fifth of all small insurers are using or currently developing internal models. About one-third of all the 74 QIS4 participants plan to use an internal model in the future for calculating the SCR, at least partially. However, undertakings which prefer the standard formula for SCR calculation state with almost no exception that the development of an internal model is too expensive and too demanding. Half of these undertakings argue that the administrative burden is too high and that the standard formula works well for them. About two thirds (48) [one third (25)] of participants with plans to use an internal model for regulatory capital requirements intend[s] to seek full [partial] internal model approval. Almost all of them give improved risk and capital management and more transparent decision-making as a main reason for the intended application for approval. A lower regulatory capital seems not to be the most important incitement, as only slightly more than half of the participants state this as a reason.


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Question 24 (continued) b) Group internal models

6 out of the 19 participating insurance groups, i.e. about one third of the groups, already use internal models for some aspects of their business. 4 other groups stated that the question does not apply to them. One of these groups reported, however, that it is actively developing and managing an internal model for use in its business. The remaining 9 groups did not provide any information on internal model usage or corresponding plans for the future.

Each of the 6 insurance groups that are already using an internal model for some aspects of their business plans to use it in the future for calculating the SCR, at least partially. 5 out of the 6 insurance groups mentioned above intend to seek full model approval. The one remaining group will apply for partial model approval for market risk. All 6 groups stated better capital management and more transparent decision-making as the main reasons for the intended application for full or partial model approval.


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Category: General Insurance Subject: Adjustment to standard factors Question 25 Are countries attempting to adjust the standard factors as set out in sections TS.XIII.B.25, TS.XIII.B.27, TS.XIII.B.28 TS.XIII.B.36 and TS.XIII.C.6 of the QIS4 Technical Specification to make them more country specific? KPMG Response to Question 25 Countries are generally allowed to adjust the standard factors yet we are not aware that this has happened up to now. Calibration paper (CEIOPS-DOC-02/2008) issued centrally by CEIOPS states that parameters referred to in TS.XIII.B.25, TS.XIII.B.27 and TS.XIII.C.6 have been re-calibrated from QIS3 to QIS4 for example.

For catastrophe risks however, regional scenarios were generally well accepted nationally when available, but criticised for not being harmonised throughout Europe, and allowing for the possibility of there being an un-level playing field between undertakings in different countries. For natural catastrophes (such as earthquake, floods, storms etc.), regional factors, index tables and scenarios have been used. For example, for Germany there exist regional indices for the calculation of the regional exposure factor for storm property, earthquake property, and natural hazard motor.

Example:

Reference in QIS4: TS.XIII.B.25 and TS.XIII.B.27: “Following feedback from QIS3, the factors used within the SCR non-life underwriting risk module were adjusted to better reflect the relative and overall riskiness of different lines of business. Based on the QIS3 calibration of premium risk in the German market, the recalibration reflects information collected through QIS3 on internal models, the results from current regulatory regimes and other market information from several


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Question 25 (continued) Members States (United Kingdom, Portugal, The Netherlands). Results from over 46 firms were used to recalibrate the factors.”


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Category: General Insurance Subject: Appropriateness of market factors

Question 26

How do the regulators view the use of the market factors which are incorrect for both small and large companies? KPMG Response to Question 26 It is agreed that any model using market factors can only reflect a certain set of companies, i.e. those having characteristics close to the “market average”. As typical examples, large insurance groups and niche players with a special product portfolio do not fall into this category. However, as page 10 of the CEIOPS paper on ORSA (Ref: CEIOPS-IGSRR-09/08) points out, the “Framework Directive Proposal allows undertakings to use entity-specific parameters when calculating the life, non-life and special underwriting risk modules. The use of these specific parameters is subject to supervisory approval.”


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Category: General Insurance Subject: Market factor confirmation for CMBI Question 27 Should the Israeli companies approach ISO-Israel to produce relevant market factors for the reserve and underwriting risk for the Compulsory Motor Bodily Injury sector, as they hold and analyse data for the whole market? In addition, the tariff has been radically reduced over the last 10 years rendering historical loss ratios invalid, how would you suggest that we deal with this problem? KPMG Response to Question 27 It may be a good solution to take data from a reliable source which has a sufficient overview of the Israeli market. As to the trend in the tariffs, two different effects have to be separated:

level change - i.e. the reduction in tariffs over the last 10 years. This effect could be tackled by a trend correction. This effect does not directly reflect the risk within the product. i.e. although the product might be in deficit, the risk might be deemed minor if the fluctuation around this (low) average is small. In this case the results from the product can be estimated quite reliably.

risk - i.e. the possibility that the true losses out of the product deviate strongly from the assumptions used in pricing the product. This risk might, as is done in QIS, be measured by some means based on the standard deviation of loss ratios after trend correction. If you do not correct the inherent trend you would overestimate the risk in the product since the trend produces additional fluctuation.

Another way to look at this is as follows: If the rates have been reduced across the market then the impact should be the same. However, you can analyze the data in two groups: before rate changes


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Question 27 (continued) and after rate changes. Or adjust the historical loss ratio for rate changes to a specific balance date and utilize this for calculations. This will capture any impact of rate changes (or at least dampen the effect on standard deviation).


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Category: General Insurance Subject: Definition of “Best Estimate” Question 28 Is any change to the definition of "Best Estimate" expected, or will any guidelines be published as to the method of calculation? How are companies coping with the current definition? KPMG Response to Question 28 There are no standard guidelines on how the Best Estimate should be calculated as the company can use a wide range of actuarial methods. The consistency is achieved through the definition of Best Estimate as opposed to the method employed. Companies have been producing BE on a best effort basis, but concerns have been raised by CEIOPS that there is inconsistency in Best Estimates (i.e. is it mean, median, etc). In light of this there may be some guidance. It is making the setting of reserves more explicit by splitting out any explicit or implicit margins previously allowed for in the best estimate. It is thought that guidance is more likely to come from Actuarial professional bodies.


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Category: General Insurance Subject: Calculation of the risk margin Question 29 What are the latest thoughts regarding the calculation of the risk margin or is the Cost of Capital (CoC) method the most likely approach also in the future? KPMG Response to Question 29 Generally, companies have used the standard method provided within QIS4 (within the helper sheets) to calculate the risk margins. This uses the CoC approach. Currently, it looks as if the CoC method is going to be the approach most likely to be adopted for Solvency II to calculate the RM. German Country report Regarding the data collecting issues, many participants consider the calculation of the risk margin to be too complex. They complained about the effort to derive CoC margins separately for each line of business. Thus most of them used simplifications. The majority of the participants assessed the risk margin using the duration simplification. Many other participants estimated future SCR’s via best estimate ratios. Only one participant stated to have employed a proxy. The assumption defines a situation which is too complex to be modelled in detail. For example, the calculation of the risk margin requires the projection of the SCR until run-off of the liabilities. However, it is usually not feasible to determine in detail the future SCR’s for long time periods.

Risk margin (all insurance types) To determine the CoC margin, most of the participants needed to apply simplifications since a comprehensive projection of all future SCR’s and their allocation to individual LoB’s was not practically feasible for them. For this purpose, some participants followed their own approach, while others used one of the simplifications provided in the specification (which were partly implemented in the helper tab on risk margins contained in the QIS4 package).


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Question 29 (continued) In non-life insurance, some participants also applied the simple risk-margin-proxy which determines the risk margin as a fixed percentage of the best estimate, irrespective of the size of the SCR or the duration of the liability. Some participants drew attention to the fact that in the ordinary course of business, insurance companies will normally retain insurance liabilities and will not transfer them to a third party. Thus, in contrast to the valuation principle set out in part TS.II.C.3 of the QIS4 Technical Specification, they believed it to be more economically faithful to value insurance liabilities on the basis that they are kept in the company’s own portfolio, including the company’s existing servicing platform and cost structure, rather than to base the valuation on a hypothetical transfer. Only few participants found the CoC rate not to be appropriate.

Again, in non-life insurance, some participants applied both the main approach provided by the helper tab, and also the simplified method outlined in formula TS.II.C.25 of the QIS4 Technical Specification, and found that these two approaches yielded materially different results. In view of these technical difficulties, some participants (in particular small insurers) resorted to using the Risk Margin Proxy, arguing that this was justified in view of the immateriality of the risk margin with respect to the size of the best estimate. Concerning the helper tab for the non-life risk margin, a number of participants pointed out that the method implemented in this tab produces separate risk margins for premium provisions and claims provisions, and commented that the computations would lead to unsuitable results with regard to the premium provision risk margin. In the context of the determination of the risk margin, some participants raised the issue of diversification effects and took the view that the risk margin relating to the insurer’s book of business as a whole should reflect diversification benefits across different segments. Quantitatively the risk margin amounted to:

1.1% of the BE provisions in life insurance,

9.3% of the net BE provisions in property & casualties insurance, and

1.5% of the net BE provisions in health insurance.


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Question 29 (continued) With respect to the determination of the risk margin, it is apparent from the participants’ responses that more guidance is needed on the choice of the various simplifications proposed, which differ in their degree of complexity and risk-sensitivity. Considering that some form of simplification for the calculation of the CoC margin seems inevitable, it could for example be clarified that the first level of simplification described in the specification could be used as a “default” calculation method. For other, cruder simplification methods, application criteria should be established to ensure that they are only applied in circumstances where this is justified with respect to the nature of the insurer’s risk profile. It should however be noted that the risk margin of life and health insurers is large compared to the amount of own funds. Therefore, simplifications should be applied in a prudent manner in life and health insurance. It is unclear whether the level of sophistication of the QIS4 risk margin calculations is sufficient to produce accurate results. From KMPG’s point of view, despite the difficulties listed above the CoC method will be the most likely approach in the future.


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Category: General Insurance Subject: Catastrophe risk factors Question 30 For Catastrophe risk, the only catastrophe that appears to be relevant is earthquake. What adjustments should be made to the factors in the table in section TS.XIII.C.6 of the QIS4 Technical Specification? KPMG Response to Question 30 From KPMG’s point of view not only earthquake appears to be relevant. There are other natural perils (e.g. flooding or drought) that might be considered depending on the possible impact on the insurance companies. For the Israeli market, it is felt that acceptable standard catastrophe risks to be considered should be set in conjunction with the regulator, as has been done in the EU (i.e. method 2). Though, within method 3, use of personalised catastrophe scenarios is allowed.


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Category: General Insurance Subject: Underwriting risk module Question 31 The underwriting risk module requires input of historic loss ratios. As actuarial reserving only became a requirement in Israel within the last few years (3 to 5 depending on the business line), such historic data is not available. How do you recommend we proceed? KPMG Response to Question 31 The same problem exists in European countries. If historic loss ratios are not, or only partially available, you could use a credibility approach to smoothly move from market data to company-specific data as the company-specific database develops over time.


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Accounting


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Category: Accounting Subject: Insurance groupings Question 32 Can a company that is interested in conducting the QIS4 exercise do so at the solo entity level rather than at the consolidated level of all of the companies of the group? KPMG Response to Question 32 Yes. Many companies in Europe that are part of insurance groups have taken part as individual companies, not in a group context. Also often only the biggest companies of a group have taken part.


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Category: Accounting Subject: Data requirements for Solvency I Question 33 Israel was never subject to the Solvency I regulation, so the column relating to Solvency I is therefore not relevant to Israel. Should the column be filled with information relating to our current model? KPMG Response to Question 33 We would encourage you to do so in order to have a basis to compare both the current regulation and the future Solvency II regulation. This will help companies better understand the likely impact of solvency II on their current solvency capital requirements.


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Category: Accounting Subject: Fair value calculation Question 34 Would it be correct to say that the definition of fair value in the IFRS is also good for use in QIS4? KPMG Response to Question 34 Concerning the valuation of insurance liabilities, Solvency II uses a specific method which is comparable, yet not the same as IFRS Phase II. However, IFRS4 still uses local GAAP, so on the liability side this is very unlikely to be the same as required under QIS4. On the valuation of assets and other liabilities, QIS4 requires you to calculate an economic value (fair value) so if under IFRS the fair value option is used, this is acceptable. However, if within IFRS, accounting assets are not valued under the fair value option then companies need to consider an adjustment so as to get to a true economic value. You can find a comparison of valuation in section TS.III (Annex I) of the QIS4 Technical Specification.


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Category: Accounting Subject: Currency for reporting Question 35 Was the spreadsheet adjusted for use by the various countries for the currency used by them? Should the spreadsheet be adjusted for use for Shekels and if so how? KPMG Response to Question 35 The excel spreadsheet has been prepared for input in thousands or millions of Euros depending on what is more appropriate for the firm. The Financial Services Authority (the UK regulator) has provided appropriate conversion factors in order to be able to use it in the UK. Term structures have been provided for many different currencies. In order to use the spreadsheet in Israel, similarly, term-structures and conversion factors are necessary.


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Category: Accounting Subject: Goodwill Question 36 What is the method for treatment of goodwill? KPMG Response to Question 36 The value of goodwill and intangible assets within QIS4 is zero.


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Life and Health


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Category: Life and Health Subject: Use of EV assumptions for QIS4 Question 37 The committee has agreed that the method and assumptions for calculating the BE under QIS4 should follow the Rules and Guidance for calculating EV approved by the Israeli Insurance Commissioner with required adjustments where necessary. Also the same model used for EV can be used to calculate the shocks under SCR. Please could you comment? KPMG Response to Question 37 This seems reasonable but we do not know the details of what constitutes EV in Israel. We would expect that the adjustments would allow for a market consistent assessment of costs of guarantees and options.


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Category: Life and Health Subject: Operational Risk Question 38 Within the formula of SCRop (p.126 of QIS4 Technical Specification):

a) Does the EXPul item (in respect of expenses) include payments in respect of commissions or other contractual sales remuneration agreements, which are not at risk, i.e. the commission and sales remuneration payments that are 100% guaranteed to be paid out?

b) Should this item include acquisition costs? In our opinion, these expenses are one-off and hence should not be included. Please could you comment?

KPMG Response to Question 38 Expul are annual administrative expenses incurred and therefore exclude both commission and acquisition costs (see footnote on p.126 of the QIS4 Technical Specification).


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Category: Life and Health Subject: Alternative information Question 39 The committee agreed that in case a company does not posses reliable information based on which it can perform investigations, any other alternative relevant information, such as reinsurance data / information, circulars published by the insurance commissioner etc, would be considered as Best Market Practice and therefore the use of such alternative information would not be considered a "simplification". Please could you comment? KPMG Response to Question 39 This seems reasonable to the extent that the alternative information is relevant.


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Category: Life and Health Subject: Calculation of “Best Estimate” Question 40 The committee understand that BE should include all future cash-flows including future premiums of existing contracts. Please could you comment? KPMG Response to Question 40 For contractual premiums, this is correct. There is currently a debate around future premiums that are not contractual, however the general principle would be to include all future cashflows that one would expect. See sections TS.II.B.32 to TS.II.B.35 on pages 24 and 25 of the QIS4 Technical Specification for more detail.


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Category: Life and Health Subject: Grouping of contracts Question 41 Regarding section TS.II.D.9 of the QIS4 Technical Specification, we understand that valuation on a cover-by-cover basis (by risk profile, as opposed to policy-by-policy basis where each policy can contain a number of different covers) is equally acceptable. Is this correct? KPMG Response to Question 41 We don't see any issues with this, although you would need to demonstrate that the approximation is not materially misrepresenting the underlying risks or mis-stating cost / capital requirement. Care should be taken when valuing guarantees and options.


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Category: Life and Health Subject: Life mortality scenario Question 42 With respect to life mortality scenario, it is our understanding that contracts with a death benefit as well as a survivorship benefit can be treated as one unit for both mortality and longevity risk (Option 1 on p.162 of the QIS4 Technical Specification) – e.g. deferred annuities. However contracts with either a death benefit or a survivorship benefit should only be included in the scenarios where the mortality shock is likely to lead to an increase in technical provisions. Please could you comment and advise on the following examples: 1) Deferred annuities are considered in both Lifemort and Lifelong 2) Annuities in payment are only included in Lifelong KPMG Response to Question 42 This is KPMG’s view also. Only include contracts where their inclusion gives rise to an increase in the technical provisions. Contracts where both risks apply should be considered in both.


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Category: Life and Health Subject: Catastrophe risk Question 43 With respect to catastrophe risk, should all the policies be grouped together regardless of their individual effect on technical provisions? KPMG Response to Question 43 One needs to consider whether the catastrophe risk is likely to have an adverse effect on the portfolio.


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Category: Life and Health Subject: Classification of business lines for life and health Question 44 The committee has categorized products as follows: Life: LTC, PHI and Critical Illness Health: Surgery and Medical Expenses Could you please comment? KPMG Response to Question 44 This seems to be reasonable except within the UK, “Annex SCR 6: UK alternative disability risk-sub-module within Life underwriting” is used for LTC, PHI and CIC business. If our understanding is correct these contracts have a similar structure in Israel as in the UK, so would recommend use of the SCR 6 method.


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Category: Life and Health Subject: Approval of premium increases Question 45 Some of the policy contracts include a clause to the effect that companies may apply to the Commissioner of insurance for approval of a premium increase in the case of heavy losses. Can this possibility of premium increases be considered for the various shocks? If so, how and when should this be applied? KPMG Response to Question 45 Is 'heavy losses' defined? If so then there is a clear trigger, but this would then depend on the likelihood of the Insurance Commissioner approving the premium increase. This would seem most likely to be applicable as a management action.


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Category: Life and Health Subject: Hedgeable contracts Question 46 There is a debate in the committee regarding which contracts are considered hedgeable. For example:

a) Are unit linked policies to be considered non-hedgeable (considering the lapse, mortality and expense risk)?

b) Savings policies, partially backed by "Hetz" bonds (Guaranteed

designated government bonds).

c) Could you provide examples of contracts which are considered hedgeable?

KPMG Response to Question 46 In theory, a contract is only hedgeable if there exists a market price in a deep and liquid market. This rules out most products, except potentially variable annuities. In practice, you would need to look through as to whether individual risks are hedgeable; for example all market risk is currently considered hedgeable (in that the market risk element is explicitly removed from the risk margin calculation), even though in practice there may not be a deep and liquid market. Therefore, most products have reserves calculated using the BE + RM method. For unit-linked policies the unit fund is considered hedgeable but one needs to calculate using BE + RM for benefits in excess of the unit fund payable to the policyholder. Not forgetting that under the stress test if the unit fund falls below a floor under the policy then an additional capital charge needs to be set aside. For more information about how to treat hedgeable and non-hedgeable contracts, please refer to the answer to question 4.


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Category: Life and Health Subject: Counterparty default risk Question 47 According to Israeli laws relating to employee remuneration protection, in the case where the employer does not pay premiums to his employees' qualifying personal pension policies, the insurer is required to guarantee several months worth of premiums. Should the counterparty default risk apply in this case and if so how? KPMG Response to Question 47 It is unsure from the question whether the term “insurer” relates to 'the insurer of the employer' or 'the provider of personal pensions policies'. In either case, in economic terms, this would appear to be a risk. The approach taken should be proportionate to the size of the risk. If you would like a more comprehensive answer, we would need to understand the mechanism of payment in more detail.


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Category: Life and Health Subject: Recoverables Question 48 Reinsurer counterparty default risk: expected loss (pages 22-24 of the QIS4 Technical Specification)

a) How are "recoverables" defined? Are they net of reinsurance premiums?

b) If recoverables take reinsurance premiums into account, then in the

normal course of events, i.e. in the best estimate model (where the net payment is due to the reinsurer), the expected loss should be zero. Is this correct? This does not fit in with the simplification formula.

c) In general, should the simplification formula (and hence allowance

for EL) be applied only when BErec is positive (i.e. payments from reinsurer)?


a) "Recoverables" are amounts recoverable from reinsurance contracts and SPVs. They are net of reinsurance premiums.

b) The simplification formula gives an approximation on the adjustment

to the expected loss in order to account for counterparty default.

c) Yes, this is correct.


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Category: Life and Health Subject: Taxation Question 49 Can we reduce the tax reserves in the case of future catastrophe or counterparty default losses? KPMG Response to Question 49 In principle it should be allowable to take account of the potential reductions of tax provision under the applicable as a management action. Within the UK Individual Capital Assessment (ICA) regime this has been allowed after discussion with the regulator and has been an asset on the balance sheet. This would depend on the local tax regulation and how this allowance would come through, so it depends on the trigger, but then would depend on the likelihood of such a tax refund.


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Category: Life and Health Subject: Best estimate for special risks Question 50 How should the Best Estimate be calculated for special risks (e.g. continuation option on group life)? Can we use the reserve in the accounts? KPMG Response to Question 50 If the reserve in the accounts is the best estimate then this would seem reasonable, but generally companies have come up with an estimate on a best effort basis with comments of assumptions.


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Category: Life and Health Subject: Segmentation Question 51 Segmentation (Reference p. 32 of QIS4 Technical Specification): Below is the committee's agreement as to how the products in the Israeli market should be classified. Product Life / Non-Life Second Level of Segmentation

Endowment Life Saving Contracts

Whole life Life Saving Contracts

Deferred annuity Life Saving Contracts

Adif Savings Life Saving Contracts

Unit-linked 2004 Life Saving Contracts

Term Life Life Death protection

Double indemnity Life Death protection

Accidental disability Life Disability / morbidity

CI Life Disability / morbidity

PHI Life Disability / morbidity

LTC Life Disability / morbidity

Annuities in payment Life Survivorship protection

PHI in payment Life Survivorship protection

LTC in payment Life Survivorship protection

Medical Expenses Health A&H Health - long term Please comment. KPMG Response to Question 51 On the whole these seem reasonable, (but please refer to question 44) for LTC, PHI and CIC. For whole of life, you would need to consider the extent of the death benefit compared to premium paid, as this could be classified as death protection. Please note however that for KPMG to provide assurance on the classification we would need to gain a deeper understanding of the underlying contracts.


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Category: Life and Health Subject: Comments on worked example Question 52 Attached is a calculation of the RM based on the actual method and the simplification for a term life contract. It seems as though the simplification gives a much lower Risk margin than the actual method. Please comment as to whether there is an error? KPMG Response to Question 52 We haven't looked at the first simplification in any great detail, but it does seem as though the simplification for the mortality capital requirement as in TS.XI.B10 looks to be incorrect. We do note that the simplification should only be used where there is no significant change to the sum at risk over the policy term, which is not the case in the example.


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Response from the Ministry of

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Category: Response from the Ministry of Finance Subject: Re: Question 1 Question MR. 1 We would like to know whether in England, a different correlation factor between life and non-life was established for insurance companies that can sell both life and non-life business. By your understanding, since we are not members of the EU – is there room to agree different correlations between significant risks (such as life and non-life) and if so, is this only by way of worsening the correlations relative to what has been defined in the QIS4 exercise? KPMG Response to MR. 1 In the UK certain composites do apply correlations between life and

general business within their internal economic capital models used by management, but these are applied for internal proposes only. The actual figures are private company specific information. Although within the QIS4 specification, no allowance is made for correlations between life and general business, it is likely that under the internal model or via the ORSA requirements companies may allow for such a correlation. It is not certain whether the regulators will allow these, as under Solvency II there is a general principle that in the future no new companies in the EU should, in general, be authorized to write both life and general business.

However, as the situation in Israel differs from that in the EU, we think there is plenty of room to agree correlation factors which are specific to the Israeli market. This adaptation should be done irrespective of the particular levels of the correlation factors in Europe.

We assume also that in Israel a similar path should be followed as was done in Europe, i.e. that correlations factors should include a certain amount of prudence. This is to take account of the fact that a standard model generally reflects an “average” firm and has been calibrated to require on average about 20% to 40% higher capital requirement than an internal model.


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Category: Response from the Ministry of Finance Subject: Re: Question 3 Question MR. 2

1. According to point TS.IX.A.2, for policies where the policyholders bear the investment risk and where the value of management charges taken from these policies is dependent on fund performance, one needs to consider market risk. Furthermore in point TS.IX.F.1 and TS.IX.G.1 it was explicitly set forth that those assets allocated to policies in which the policyholders bear the investment risk are not included in the concentration risk and spread risk model.

2. In Israel, management charges relating to policies that were issued

pre-2004, include variable management fees at the rate of 15% of the profits (the insurance company cannot collect variable management fees for periods in which losses were recorded until losses have been recovered) and fixed management fees at the rate of 0.6% of the assets. Management fees relating to the policies that were issued from 2004 include management fees from the assets and the premiums.

3. In light of that said above, please clarify how the market risk derived

from management fees regarding these policies should be taken into account, specifically how are those risk components which were not explicitly excluded taken into account (interest, equity, commodities and foreign exchange).

4. In addition, regarding market risk as it relates to profit participating

policies, are there any specific additional considerations that need to be taken into account regarding these policies?

KPMG Response to MR. 2 Management Fee (Fixed % of Investment Fund) For policies where the policyholder takes the investment risk, no capital charge needs to be calculated for the investment fund, but what you do need to do is calculate the expected amount of your management fees and see how these change when your investment fund is flexed to a 1 in 200 year event. If the management fees go down as a result of this flexing, an


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additional capital charge will need to be set up equal to the difference between the reduced value of the management fees and the expected amount. For Example If you have a management fee equal to 0.6% of the asset value where 50% of assets are bonds and 50% are equities, then your additional capital charge is calculated by enforcing the equity shock on the equities part of the portfolio and multiplying this by 0.6% and enforcing the bond shock on the bond part of the portfolio and multiplying this by 0.6%. Then any resultant shortfall in management fee, from the expected, would need to be set up as an additional capital charge, i.e. the economic value under the shock scenario. With-Profit Participating Policies Under with profit policies, companies should calculate their insurance liabilities on a realistic basis, i.e. expected future payments (guaranteed benefits plus expected future bonuses, i.e. net asset values). Then under the market risk stresses you consider the impact, not only on the variable management charges but also on what your likely variable bonus payments are going to be under the stressed position, as well as the affect on the assets. The net value (i.e. A(t) – L(t) under stressed conditions) is the additional amount you put in as a capital charge. If as a result of a stress, you are able to reduce the bonus payments that you make, these can be netted off the increase in the SCR.


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Category: Response from the Ministry of Finance Subject: Re: Question 4 Question MR. 3

1. What is the meaning of the paragraph beginning with the sentence, “However, if there is a liability floor under the contract (i.e. L(t)>A(t) under certain scenarios”?

Is this point related to profit participating policies, in which the policyholder is given a guaranteed minimum benefit (i.e. he was sold an option by the insurer when the savings are managed under the best effort principle?) KPMG Response to MR. 3 We think that your view is right. In the case of policies with a guaranteed minimum benefit there is a risk that L(t) > A(t) under the stressed position, and this risk has to be taken into account in the calculations. With-Profit Policies In with-profit policies, as a result of the participating element (which is depended on asset returns), an asset shock may impact the value of the liabilities, i.e. an increase in the value of assets may lead to an increase in the value of the liabilities (due to an increase in the participating element) and a decrease in the value of assets may lead to a decrease in the value of the liabilities (due to a decrease in the value of the participating element. If a drop in the value of the liabilities is less than the drop in the value of assets due to for example, a guaranteed minimum benefit kicking in, additional capital will need to be held. For example No Additional Capital Scenario If the asset value decreases by 10% and so too does the value of the liabilities (due to a drop in the value of the participating element), no additional capital will need to be held, however Additional Capital Scenario If the asset value decreases by 10% but the value of the liabilities only drops by 5%, either because the participating element of the policies is


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unable to absorb the loss or due to the guaranteed benefit kicking in, an additional capital amount equal to the difference between the value of the assets and liabilities will need to be set aside as a capital charge.


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Category: Response from the Ministry of Finance Subject: Re: Question 7 Question MR. 4 In the calculation of market risk, was the average VaR deducted? KPMG Response to MR. 4 We are not sure what is meant by the average VaR in the question but a brief explanation of the method used to establish the factors for equity risk can be found below: To come up with the factors of 32% and 45% for equity risk, historical data was taken, and using various economic scenario generators and assumed distributions, a calculation was made to establish what would be the drop in value of equities for a one in 200 year event. A margin was then added. For additional information, please see page 33 of the calibration paper issued by CEIOPS entitled “QIS 3 – Calibration of the Underwriting Risk, Market Risk and MCR”.


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Category: Response from the Ministry of Finance Subject: Re: Question 8 Question MR. 5 The answer is not clear. Is VIF considered an asset for the purpose of capital requirement? KPMG Response to MR. 5 It should be noted that under the solvency II / QIS4 requirement, the calculation is slightly different with a little different calculation of risk margins, discount rate used and possibly the allowance within the cashflows.


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Category: Response from the Ministry of Finance Subject: Re: Question 10 Question MR. 6 Is the shock relative or absolute?

KPMG Response to MR. 6 The shock is defined relative to the current interest rate curve.


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Category: Response from the Ministry of Finance Subject: Re: Question 17 Question MR. 7 Will trust funds always be calculated under the equity model, even if they specialize in bonds? KPMG Response to MR. 7 No, the equity model is just kind of an emergency exit. In the case described above it is advisable to take a look-through approach as described in our original answer.


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Category: Response from the Ministry of Finance Subject: Re: Question 18 Question MR. 8 In Israel, Car insurance is split into two main LOB:

1. Compulsory Insurance which is no-fault bodily injury and 2. Casco – which is car damage for both first and third party

Do you know of similar categories in EU countries and what was the subdivision for the QIS purpose? (For example we understand that in Sweden there is a no-fault clause). KPMG Response to MR. 8 Originally the QIS motor lines are split into motor liability and motor hull This segmentation is obviously not valid for the Israeli market So we’d show three options:

Use the QIS 4 spreadsheet as given and allocate, for example Compulsory Insurance to motor liability and Casco to motor hull

Use the segmentation from the QIS 4 spreadsheet as given and recalibrate the parameters and correlation to your country’s specifications

Total re-segmentation. Develop your country specific model with Israel specific LoBs, parameters, correlations etc. It will then not be possible to map your own model with the European spreadsheet but you still conform with Solvency II principles.


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Category: Response from the Ministry of Finance Subject: Re: Question 22 Question MR. 9 Earthquake is a major catastrophe risk for Israel. Do you know in the setting of the "c" factors, what is the contribution of earthquakes to these factors? Do the "c" factors contain allowance for multiple catastrophic events?

KPMG Response to MR. 9

If a factor-based approach for measuring catastrophe exposure is chosen, then in principle the factors for the various lines of business affected by the peril (here: earthquake) should reflect the loss which is caused by a 1-in-200 year event. This information can only be revealed by an exposure analysis based on the particular exposure data in Israel. In principle a PML (probable maximum loss) curve for the loss has to be evaluated, and the point reflecting a 99.5% probability has to be evaluated. This should take into account the possibility of multiple events causing the overall market loss within one year, too.


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Category: Response from the Ministry of Finance Subject: Re: Question 23 Question MR. 10 Are there examples of adapting the catastrophe risk for a no-fault situation (e.g. Sweden)? Can we receive more details about the calculation made in Portugal to allow for earthquake? KPMG Response to MR. 10 Catastrophe risks can be measured by either a factor-based approach (method 1), by the more sophisticated method of regional scenarios defined b the local supervisor (method 2), or by scenarios defined individually by insurance companies (method 3). Each of these methods has to be individually calibrated taking into account the exposure of the lines of business against the particular peril. This results in very different national approaches, see section TS.XVII E of the QIS 4 Technical Specification. If a factor-based approach is chosen, then in principle the factor for motor insurance has to reflect the possible market loss which is caused by a 1-in-200 year event in motor insurance. This information can only be revealed by an exposure analysis based on the particular earthquake exposure of Israeli motor insurance. It is questionable to try and derive a specific number from other countries’ perils or lines of business. If a peril is too complex to be modeled by a simple factor approach a scenario approach should be considered. As an example we’d describe how the scenario for German motor insurance has been derived. In order to ease discussion, we do not take reinsurance into account. Then the formula simply consists of a calibration factor MSB (see page 262 of the QIS 4 Technical Specification), the number of motor contracts in the portfolio, plus a portfolio-specific regional exposure factor. The latter is necessary since in Germany motor insurance is mainly affected by hail events. These events mainly happen in “hot spot” areas. So if an insurance company is exposed in such areas, i.e. has written many policies there, then the regional exposure factor will be relatively high as compared to portfolios which are not exposed in these areas.


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For Portugal no specific scenario is pre-defined for motor insurance by the regulator. Insurance companies are invited to judge on their own to which extent an earthquake event affects motor insurance (method 3).The Swedish regulator does not define a specific scenario for motor insurance. In both cases method 1 has to be applied as the default method, i.e. a factor of 0,075 has to be applied on the estimated net written premium for the forthcoming year and accumulated with capital charges for other natural perils based on the formula TS.XIII.C.6


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Category: Response from the Ministry of Finance Subject: Re: Question 27 Question MR. 11 For CMBI, the premium trend is due to regulation of the premium and so a trend adjustment seems justified. However for other LOB's, there may be a natural trend – in this case would it be correct to leave it in the loss ratio and therefore have a greater standard deviation? KPMG Response to MR. 11 If it is difficult to do a trend correction or if there is a chance that the

trend is over-estimated it may be appropriate to accept the greater standard deviation.

If you leave the trend as it is then you are at least sure to not underestimate the risk inherent to the line of business.


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Category: Response from the Ministry of Finance Subject: Re: Question 31 Question MR. 12 What about years where no loss ratio data is available at all for the whole market? Would we then take the prescribed standard deviation as the company standard deviation? KPMG Response to MR. 12 Please explain. If there is no loss data at all for the whole market you do not

have standard deviations? Is this realistic? In this case it might be a reasonable solution for this line of business to search

for another LoB with similar characteristics and sufficiently available data. Then this line of business can be used as a substitute – after appropriate scaling of the volume.


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Category: Response from the Ministry of Finance Subject: Re: Question 37 Question MR. 13 Are you familiar with a similar approach (taking the EV calculation as a basis for the BE calculation) taking place in other countries? If so, what were the typical adjustments that were made when moving from EV to QIS4? KPMG Response to MR. 13 Yes, the EV calculation can be taken as a basis, for example in UK. Roughly the EV calculation needs three elements, expected cash flows,

discounting and risk margin. These are calculated by assuming EV specific rules or assumptions. You then have to substitute these with QIS 4 rules / assumptions. The main adjustments in calculation are QIS interest rates for discounting or Risk Margin according to the CoC Method from QIS instead of EV rules (in UK).

Therefore, it is possible to use the EV calculation as a basis with taking the QIS 4 rules as substitute.


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Category: Response from the Ministry of Finance Subject: Re: Question 39 Question MR. 14 This question relates particularly to small companies – have you seen cases where reinsurance rates have been widely used to calculate the best estimates? Are there cases where the "simplified" method has been used more than set out in TS.II.A.38? KPMG Response to MR. 14 We would not interpret the use of reinsurers’ data as being a proxy

method in general, assuming that the reinsurer’s market information (in terms of market loss data, exposure information or the like) is used. This might be seen as an appropriate substitute for data small insurers do not have, especially if data from more than just one reinsurer is used and checked against each other.

However just using the reinsurer’s rate (for a quota share contract) as a substitute for the best estimate seems to be problematic. The reason is that a quota share rate (which might be deemed closest to a best estimate) includes many other factors than just the loss estimate, e.g. cost and profit elements, a significant commission or brokerage fees.

Groupe Consultatif has made up a list of proxies which might be used. Please see the CEIOPS report entitled “Report on Proxies” to get a better understanding of what is meant by proxy methods.


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Category: Response from the Ministry of Finance Subject: Re: Question 40 Question MR. 15 Please explain “not-contractual”. For example, are premium increases linked to future expected salary increases not-contractual? Yet, would those be included since they are expected? KPMG Response to MR. 15 We think that the premium increases should be included insofar that

they are legally enforceable or already fixed at subscription date, or if these additional cash flows can be expected with a reasonable persistency.

The additional cash flows should not be included if these are part of expected future renewals that are not included within the current insurance contracts and if the renewal has not de facto taken place already at reporting date


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Category: Response from the Ministry of Finance Subject: Re: Question 43 Question MR. 16 Can you expand on the reason why annuities are not taken? Is that the approach in other countries also? Is this set out in the QIS 4 Technical Specification? KPMG Response to MR. 16 There has been a mixed response on whether annuities can be taken

into account. A number of companies have followed their internal models which have not allowed for annuities. Additionally, in the Technical specification, they have taken to mean benefits (either lump sum or multiple payments) contingent on either mortality or disability to be applicable to non-annuity business. However, CEIOPS propose to revisit this topic following QIS4, when they shall also look further at the consistency between the scenario approach and the simplified factor-based approach.


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Category: Response from the Ministry of Finance Subject: Re: Question 45 Question MR. 17 There is no current definition of "heavy losses", and it is likely that the commissioner would consider other possible sources of profit before allowing premiums to increase. With this extra information, would you still consider it appropriate to be included as management action? KPMG Response to MR. 17 Premium increase might be seen as a management action. It has a risk-

dampening effect. This is comparable to the risk-dampening effect which can be applied in

some countries’ life contracts. Where it is possible to reduce to future (not guaranteed) profit participation thus reacting to reduced profits from assets.

This reduction also dampens the risk and thus can be accounted for as an equivalent of risk capital. This effect can either be calculated in the QIS4 model or be simulated in an ALM model. In the latter case it is subsumed under the notion “management action”.

However the premium reduction is under the discretion of the commissioner, and we would also expect him to first consider other sources of profit. So the risk damping is not under immediate discretion of the company, so it is problematic to see it as a management action. However the company might try and assess the probability and extent to which the commissioner would allow premium increases. If this does not seem feasible, in our opinion it is more prudent to ignore this option in the calculation, i.e. to discard this risk dampening effect.


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Category: Response from the Ministry of Finance Subject: Re: Question 47 Question MR. 18 In this case the provider of pension policies is responsible for providing risk benefits to the insured for a limited period (13 months) even if it does not receive scheduled premiums from the employer. Should the employer default be considered here and how? KPMG Response to MR. 18 Yes, the provider of the pension policies clearly runs the risk that the

employer defaults without having paid due premiums, if we understand this correctly. The employer default should be accounted for by standard credit risk models, e.g. based on ratings and the appropriate probability of default or by other means of statistical analysis of the default risk. The provider of the pension policies just seems to grant a loan which amounts to the outstanding pension premium.

This possible situation should already be included in the calculation of net premiums.


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Category: Response from the Ministry of Finance Subject: Re: Question 48 Question MR. 19 What about cases where the net payment is due to the reinsurer, but there is a time difference between premium payment and claim payment (for example long-tail non-life) – where there still is a potential risk due to reinsurer default? KPMG Response to MR. 19

Yes, there is a risk of reinsurer default, since the reinsurer might go into default (e.g. by another event) in the meantime between premium payment and claim payment.


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References: Solvency II Framework Directive Proposal – COM(2007) 361 Final – Brussels 10.7.2007 QIS4 Technical Specification (MARKT/2505/08) – Brussels, 31 March 2008 CEIOPS Issue Paper (IGSRR-09/08) – Own Risk and Solvency Assessment (ORSA) CEIOPS-DOC-02/2008 – QIS4 Background Document, Calibration of SCR, MCR and Proxies – 1 april 2008 German Country Report CEA – Groupe Consultatif – Solvency II Glossary (version 1.0) CEA – Groupe Consultatif – Valuation of Best Estimate under Solvency II for Non-life Insurance – Interim Report – 11 November 2008 CEIOPS-FS-14/07 – QIS3 Calibration of the Underwriting Risk, Market Risk and MCR CEIOPS –DOC-27/08 – Report on Proxies


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Draft Response to the Solvency II Committee February 2009mof.gov.il/hon/information-entities/solvency2/isum/... · 2014-02-05 · KPMG – Draft Response to the Solvency II Committee