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Implications of Solvency II
Phil Ellis 10 Sept 2007
Context Amlin
Lloyd’s and Bermuda based general insurerMarine around 15% to 20% of our account
Phil Ellis, Group Actuary since 1999 Not an underwriter or a marine specialist (But not an accountant, either!)
UK ICAS experience Similar in concept to Solvency II regime
This talk is intended to develop key themes and skate over detail
Structure of today’s talk
Reminder of the background Implications for balance sheets Company effects Capital calculation Internal effects Final thoughts
Background: The big questions
Where? The European Union … but as a model for the world to follow
What? Different view of Solvency (Balance Sheets) … but consistent with IFRS, so P&L too
Why? Improve behaviour to reduce risk… aiming for a coherent risk framework
How? A change to internal procedures & modelling … but with the fallback of a standard model
When? 2012 (after latest deferral) … but impacts will be felt sooner
Who? Accountants, actuaries, analysts … but everybody, including marine underwriters
Very Simple Balance Sheet A simplified balance
sheet
Capital is Assets less Liabilities
Regulator specifies
minimum capital required
Assets100
Liabilities70
Capital30
Simplistic Balance Sheet A simplified balance
sheetIf Min Capital is 20 Solvency ratio is
30 / 20 = 150%
Solvency II changes each of: Assets Liabs Min Capital (SCR)
Assets100
Liabilities70
Min Capital20
Free 10
Basis of Solvency II CalcsAssets Market Values (or as close as possible) Liabilities Best Estimate Economic Values (≈ transfer cost) Discounted for Future Investment Return Loaded with a prescribed Risk Margin (cost of capital) Minimum Capital (Solvency Capital Requirement) 1 in 200 chance of insolvency over one year horizon Reflects actual risk profile for company (realistic
values) Either from complex set of cross-EU standard factors Or from agreed internal model All more realistic than what we’re used to!
Balance Sheet Impacts - 1Current Position (150%) Solv II – “Plausible” (143%)
Assets100
Liabilities70
Min Capital20
Free 10
Assets110
Liabilities60
SCR35
Free 15
Balance Sheet Impacts - 2Current Position (150%) Solv II – “Good” (233%)
Assets100
Liabilities70
Min Capital20
Free 10
Assets120
Liabilities50
SCR30
Free 40
Balance Sheet Impacts - 3Current Position (150%) Solv II – “Bad” (62%)
Assets100
Liabilities70
Min Capital20
Free 10
Assets100
Liabilities75
SCR40
UNDER 15
Who are the Winners?Relative Solvency Position improves where: Asset Valuations currently well below market values Liability Valuations currently well above best estimates Reduction for discounting exceeds risk margin addition SCR increase is relatively small
nature and scale of risks small and/or risk controls excellent
Some impacts are “guessable” from outside a company Others may be very hard to spot in advance Large companies may well gain (recognition of diversity)
Company effects?
Market positions altered Some companies may be too weak to carry on Others may be impaired and change operations “Big winners” may become more aggressive More M&A activity in next few years Various capital market solutions
Rating agents not there yet, but pushing before 2012
Sensitivity of SCR to RatingSCR reflects all risks, valued at extreme probabilities(!) Time horizon is one year A key driver is prospective rating levels If rates have cycle ±20% around the mean Then SCR may vary by 2.5x over cycle
Self-correcting mechanism Reduce volumes of risky and/or unprofitable lines at bottom
(A key element of SCR is new business risk) But lines do not move perfectly in phase with each other Pressure within companies on poorest rated areas
Internal effects? (1)
More actuaries, less barrow boys Pressure towards more modelling Price with explicit discounting, capital charge? Reserve at best estimates, discount & load? Detailed capital allocation(?!) Tails at extreme probability vital for capital Competition for capital within insurer Poor performance not tolerated?
Internal effects? (2)
Senior management involvement Responsible for understanding Systems and data changes Embedding models for reduced capital? Detailed disclosures
Risk management centre stage Procedures and documentation Different forms and/or levels of risk transfer?
Final thoughts
Regulatory Plans & Procedures not finalBig demands on insurers and regulators “Proportional” for smaller companies? Possible political compromises?
Good to be ready for this early!
