Solvency II

A Work in Progress

CAE Meeting, Zurich

Alessa Quane

November 29, 2007

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Agenda

I. Introduction & Timing Update

II. Implications for Firms & Actuaries

III. Directive Issues under Debate

IV. QIS 3 Results

V. Conclusions

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Soundbites

“This is an ambitious proposal that will completely overhaul the way we ensure the financial soundness of our insurers.” – Charlie McCreevy, European Commissioner for Internal Market and Services

“We are setting a world-leading standard that requires insurers to focus on managing all the risks they face and enables them to operate much more efficiently. It’s good news for consumers, for the insurance industry and the EU economy as a whole” - Charlie McCreevy, European Commissioner for Internal Market and Services

“Solvency II is not just about capital. It is a change of behavior.” – Thomas Steffan, Chairman of CEIOPS

“The purpose of Solvency II is not necessarily to strengthen the industry’s capital base, but more to ensure that sufficient regulatory and internal risk management controls are in place to enable management and regulators to more fully understand and control the dynamics of the industry’s risk profile.” – Simon Harris, Moody’s Team Managing Director for European Insurance.

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Three Pillars of Solvency II

Assets

Firm Analysis

Liabilities

Risk Margin

SCRMCR

SurplusSurplus

Liabilities

Risk Margin

SCRMCR

Assets

Add-Ons

Supervisory Analysis

DisclosureRequirements

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Solvency II Timetable

Directive Adoption

Framework Directive Published

2005 2012201120102009200820072006

Directive Development Full Implementation

QIS 1 QIS 4QIS 3QIS 2 Further QIS

SCR/MCROwn Funds

GroupsSimplifications

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Implications for Firms

I. Require more formal approach to governance demonstrating that insurers are aware of the risks affecting their business and that they have embedded this awareness in the daily running of the business.

II. Cost of compliance is likely to be significant and will be a large change for many jurisdictions.

III. Likely to be “winners” and “losers” due to the solvency standards changing.

IV. Move toward risk sensitive pricing as data begins to improve at a more granular level to support internal modeling. This will lead to great segmentation and value driven products.

V. Further fuel the rating agencies shift in focus onto companies’ risk management frameworks and desire for disclosure.

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Implications for Actuaries

I. Require more complex analysis and systematic approaches to risk management. This will increase the demand for actuaries and risk management personnel.

II. Need to more closely coordinate with finance, risk management and other business functions.

III. Better explanation of assumptions, sensitivities, limitations and methods underlying the computations and results to senior management who will be relying on this information throughout the risk embedding process.

IV. Increase in the development of advanced analytical tools and systems capable of providing a more informed basis for control and decision-making.

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Highlighted Concerns with Directive

I. Non-EU supervisors and group proposalsI. Equivalence of regimes

II. Level playing field for EU vs non-EU groups

III. Application of a consistent economic assessment of available and required capital to all businesses, both EEA and non-EEA

II. Structure and calibration of the MCRI. Ladder of intervention

II. Consistent framework

III. Geographic diversificationI. Credit should be considered

II. Legal entity vs risk exposure

III. Group support

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Goals of QIS 3

I. Obtain further information about the practicality and suitability of the calculations involved and alternatives tested.

II. Obtain quantitative information about the possible impact on balance sheets and the amount of capital required if the approach and calibration as set out in QIS3 were to be adopted as the standard.

III. Collect information about the suitability of the suggested calibration for the calculation of the SCR and MCR.

IV. Initial test on the effect of applying the specification to insurance groups.

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Participation in QIS 3

28 out of 30 member states participated

1027 solo entities – increase of 100% over QIS2

51 groups participated

Type of Firm Small Medium Large Total

Life 116 135 79 330

Non-Life 254 194 63 511

Reinsurer 12 10 6 28

Composite 40 79 39 158

Total 422 418 187 1027

Mutuals thereof 118 99 34 251

Health thereof 16 30 10 56

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Participation in QIS 3Country Life Non-Life Reinsurance Composite TotalAustria 6 10 0 11 27Belgium 1 6 0 8 15Bulgaria 2 4 0 0 6Cyprus 3 2 0 0 5Czech Republic 1 3 0 8 12Denmark 31 38 0 0 69Estonia 4 3 0 0 7Finland 8 11 0 0 19France 41 52 2 59 154Germany 60 110 9 0 179Greece 1 0 0 0 1Hungary 4 3 0 6 13Iceland 2 5 0 0 7Ireland 16 16 7 0 39Italy 29 26 0 18 73Latvia 1 1 0 0 2Lithuania 3 8 0 0 11Luxembourg 6 7 3 0 16Malta 2 2 0 1 5Netherlands 14 44 0 0 58Norway 3 16 0 0 19Poland 9 15 0 0 24Portugal 14 14 0 5 33Slovakia 3 0 0 2 5Slovenia 2 2 2 5 11Spain 15 57 2 34 108Sweden 14 13 0 0 27United Kingdom 35 43 3 1 82Total 330 511 28 158 1027

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Participation in QIS 3

Average market share coverage was 69% for life, 63% for non-life and 79% for health

Internal Model submissions included:

Number of Models Life Non-Life Composite

Full 54 56 15

Full and Partial 55 65 15

Represents 13% of firms, by submission numbers

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Financial Impact Based on QIS 3

I. No significant overall change in terms of the composition or size of the balance sheet compared with Solvency I at a European level

II. Technical provisions tend to decrease due to the implicit prudence in the current regime thereby increasing available capital

III. 98% of firms would not find it necessary to raise additional capital to meet the MCR

IV. QIS3 solvency ratio is lower than the current solvency ratio for most participating firms

V. The proposed regime does not require extra capital in the European insurance market as a whole.

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Assessment of the SCR

I. CEIOPS believes that there is general satisfaction with the proposed correlation matrix. General consensus for a geographic diversification benefit to be included.

II. Diversification effects through the correlation matrix were 20% on average.

III. Many firms want the expected profit/loss element returned to the calculation.

IV. Subjectivity of the cat risk scenarios is inappropriate and needs to be reviewed

V. Non-life underwriting risk results were excessive compared to internal model results.

VI. Operational Risk

I. Opposition to the 100% correlation with the other risk factors

II. No incentive to develop adequate risk management systems

III. Suggestion that administrative costs could be a more appropriate measure than premiums

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Composition of Non-Life SCR

Source: CEIOPS’ Report on its Third Quantitative Impact Study for Solvency II

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SCR Comparison with Internal Models

I. Internal models generally produce a higher charge for credit risk than the SCR module

II. For non-life insurance, internal models produce significantly lower total SCRs than the standard formula, with an average reduction of 25%

III. No clear pattern as to whether internal models produce a lower or higher operational risk charge than the standard formula

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Assessment of the MCR

Calibration target is 80-90% value at risk over a one-year time horizon

Non-life firms’ results under both alternatives were broadly consistent with the calibration target. For alternative 1, the MCR nowhere exceeded 70% of the SCR

Source: CEIOPS’ Report on its Third Quantitative Impact Study for Solvency II

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Assessment of the MCR

Problematic interaction with the SCR for life and composite firms due to the loss absorbing capacity of future discretionary benefits methodology

Source: CEIOPS’ Report on its Third Quantitative Impact Study for Solvency II

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Own Funds

95% of capital was designated as Tier 1 with the average proportion over the industry being 94%

For those firms with Tier 2 capital, the average proportion was less than 25% in almost all countries

For those firms with Tier 3 capital, the average proportion was less than 20% for life firms and less than 33% for non-life firms in almost every country

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Areas for Further Work

I. Technical Provisions

I. More guidance on calculation of the risk margin

II. Possible simplifications or proxies to make up for a lack of data

II. SCR

I. Segmentation

II. Calibration of non-life underwriting risk

III. Granularity of equity risk shocks

IV. Treatment of unrated entities

V. Possible simplification of the concentration risk component and impact on firms in smaller countries with fewer market options

VI. Clarification of replacement cost in the counterparty default risk module and treatment of intragroup reinsurance

VII. Inclusion of expected profits

VIII. Exclusion of free assets in the market risk module

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Areas for Further Work

III. MCR

Testing of additional approaches to enable a choice between the MCR being a stand alone capital requirement and having it as a percentage of the SCR

IV. Value of Assets

Clarification on valuation of participations (look-through vs market value)

V. Own Funds

Guidance on classification of eligible elements

VI. Groups

Non-comparable data has been supplied and clarification is therefore needed in order to draw conclusions on these issues

I. Scope of consolidation

II. Group coverage

III. Internal model results

IV. Consideration of the rules to which cross sector and non-EEA entities are subject as well as the extent to which surplus assets are transferable

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Conclusions

Industry needs to provide detailed input on key issues to assist the Council of Ministers and the European Parliament better understand how the Solvency II regime will work in practice.

Industry needs to support CEIOPS work on the development of QIS4 and further quantitative surveys to assist in developing the implementing measures of Solvency II.

Actuaries need to stay abreast of the topics and add their expertise to the debate. In addition, we need to acquire the necessary skills to assist our management in meeting the demands that Solvency II will thrust upon on our firms.