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A Critical Perspective
on the Solvency II
Implementation
Dr. Dieter Wemmer
ICIR | Goethe University
Frankfurt, 28 June 2016
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2016 2017 2018 2019 2020 2021
ICS
consultation
BCR and HLA refinement / reporting
ICS v1.0 Adoption of ICS v2.0 replacing BCR
Application of HLA
Solvency II went live this year but the evolution of
regulatory frameworks will continue
Solvency II
application
Solvency II
development
Recent
comments by
supervisors
Review of standard formula
Planned further development of international capital requirements (by EU and IAIS, respectively)
International
capital
developments
ICS v2.0
consultation
Solvency II
application
Review of LTG
measures
“Solvency II is too
complex and volatile”
“The future review of Solvency II
should take into account the progress
achieved at an international level”
“Solvency II to shape the ICS and let
Solvency II be shaped by the ICS”
IAIS = International Association of Insurance Supervisors LTG = Long Term Guarantee ICS = Insurance Capital Standard
BCR = Basic Capital Requirement HLA = Higher Loss Absorbency
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A Critical Perspective on the Solvency II Implementation
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INTERPRETATION RISK MANAGMENT
REPORTING AUDIT
Inconsistent interpretation of key
elements of Solvency II
Sovereign Risk
Volatility Adjustment
Solvency Capital Requirement
Interference of national accounting
with Solvency II and divergent
stress testing approaches
Challenging effective risk management
Cross-sectoral divergence in stress testing
Scope ranges from complete waiver
to comprehensive audit requirements
Considerable variation in
external audit requirements
Insurers are currently facing inconsistent Solvency II
implementation throughout Europe
National specific reporting templates
Narrative reporting requirements
Substantial additional local
reporting requirements
beyond Solvency II scope
A Critical Perspective on the Solvency II Implementation
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Inconsistent interpretation of key elements of
Solvency II results in an un-level playing field
Solvency
Capital
Requirement
Key topics Issue Implications
Sovereign
Risk
Volatility
Adjustment
For jurisdictions which only allow a
“static” Volatility Adjustment:
Limitation of volatility mitigation
Inconsistency between valuation and risk capital calculation
Different approaches for granting the
Volatility Adjustment within Internal Models.
Legislation requiring consistency in valuation and risk capital
calculation.
The role of the MCR as genuine
minimum capital requirement is not acknowledged.
Expectations for Solvency II SCR
ratios seem to be driven by Solvency I based experience.
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A Critical Perspective on the Solvency II Implementation
MCR = Minimum Capital Requirement SCR = Solvency Capital Requirement
For Internal Models no consistent
treatment of sovereign credit risk throughout Europe.
Different approaches within the
Allianz Group Internal Model required, depending on location of the subsidiary.
Un-level playing field between
Internal Model companies.
INTERPRETATION INTERPRETATION
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Market Value Balance Sheet (Solvency II) Local Accounting Balance Sheet (HGB)
Objective:
Policyholder protection
Dividend payment capacity
Trigger of supervisory action
Valuation approach: market value
Use of current market values and market parameters (interest rates) adjusted to
cater for the long-term nature of (life) insurance business
Best estimate of liabilities
Solvency assessment: capital requirements
based on worst case scenario changes in own funds (1-in-200 year loss)
Objective:
Measurement of annual profit
Dividend payment capacity
Trigger of insolvency actions (in some countries, including Germany)
Valuation approach: book value
Asset valuation based on cost value
Liability valuation based on present value
of liabilities discounted with fixed interest rate
Conservative estimation of liabilities and provisions for adverse deviations
Solvency assessment: positive net asset
value at valuation date
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A Critical Perspective on the Solvency II Implementation
HGB = Handelsgesetzbuch (German Commercial Code)
RISK
MANAGEMENT Interference of national accounting with Solvency II
challenges effective risk management
Inconsistent valuation framework and different solvency assessment approach lead to
diverging capital perspectives which challenge effective risk management
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1,000
50
1,000
50
Asset Liability
Asset Cash Liability NAV/OF
1,000
50
1,000
50
Asset Liability
Asset Cash Liability NAV/OF
In principle, different valuation approaches result in
different perspectives on capital
HGB
Balance Sheet Market Value
Balance Sheet
The liability is discounted at the
guaranteed rate of 0%.
The asset is valued at
acquisition cost.
Net Asset Value is held in cash.
Best estimate value of the
liability is determined using the
risk-free rate of 0%.
The asset is held at market
value.
Net Asset Value is held in cash.
Single premium product
due after 10 years providing a guaranteed interest rate of 0% p.a.
Premium received of 1,000 is invested in risk-free
10 year zero bond at a current market yield of 0% (full asset-liability
match).
Note: since the liability is
perfectly matched, there is no interest rate risk or credit risk, resulting in zero
Solvency II capital requirement in this
example.
Starting Point Base case in year 1
6 NAV = Net Asset Value OF = Ow n Funds
A Critical Perspective on the Solvency II Implementation
RISK
MANAGEMENT
As guaranteed rate and market rate are equal in the base case,
Solvency II and HGB are identical as well.
EXAMPLE
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< 0 % < -0.4 %
DE 70.8% 48.5%
FR 58.5% 26.8%
IT 25.6% 1.9%
ES 25.1% 2.9%
NL 61.4% 37.9%
BE 48.7% 22.7%
AT 58.2% 21.6%
PT 3.7% 0.0%
FI 52.9% 24.4%
IE 38.7% 0.0%
SK 35.8% 0.0%
SL 15.3% 0.0%
GR 0.0% 0.0%
LI 11.5% 0.0%
LT 37.6% 0.0%
LU 81.2% 0.0%
CY 0.0% 0.0%
MT 0.0% 0.0%
Eurozone 45.2% 19.7%
Market volume of outstanding public debt* with negative yields and yields below the ECB’s deposit rate (EUR bn)
Over 70% of German
public debt with
negative interest rates
A Critical Perspective on the Solvency II Implementation
*) excluding agencies, excluding T-Bills, including inflation-linked bonds **) including EVB and EIB holdings of GGBs
Sources: Bloomberg, Allianz GI Global Capital Markets & Thematic Research. Data as of 20 May 2016
Risk management needs to consider that ultra low
interest rates may not continue forever
RISK
MANAGEMENT
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942
50
1,000
8
Asset Liability
Asset Cash Liability NAV/OF
942
50
942
50
Asset Liability
Asset Cash Liability NAV/OF
HGB
Balance Sheet Market Value
Balance Sheet
NAV = Net Asset Value OF = Ow n Funds
Assuming four years of rate
increases…
0,0%
0,2%
0,4%
0,6%
0,8%
1,0%
1,2%
1 2 3 4 5 6 7 8 9 10
Increased rates lead to write-
downs on assets (due to
“Niederstwertprinzip”) while
liabilities remain unchanged
resulting in accounting losses
and insolvency.
Increased rates lead to lower
asset values and equally lower
liability values.
…results in insolvency under
HGB (negative NAV) while the entity is still well capitalized under Solvency II (as
economically reasonable) and all policyholder promises can be
fulfilled.
Development and implications Solvency situation in year 4
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A Critical Perspective on the Solvency II Implementation
Rising interest rates trigger default under local
accounting in contrast to Solvency II
RISK
MANAGEMENT
EXAMPLE
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-20
-10
0
10
20
30
40
50
60
70
0 1 2 3 4 5 6 7 8 9 10
Net Asset Value (HGB, ZZR)
Net Asset Value (HGB w/o ZZR)
Own Funds (Solvency II)
At maturity of the
contract the policyholder is paid out, the
insurer is solvent and has the same
capital under HGB and Solvency II.
Although being
insolvent under HGB earlier, the
net asset value of the insurer recovers towards
maturity of the contract.
The additional
interest rate reserve further accelerates capital
depletion under HGB.
Those additional reserves (e.g., ZZR in Germany) are
designed to provide an additional safety
margin and reflect the gap between guaranteed rate and
historic average yield.
9
Year
CU
CU = Currency Unit ZZR = Zinszusatzreserve (additional interest reserve under German law )
A Critical Perspective on the Solvency II Implementation
Local accounting framework requires more capital than Solvency II in order to avoid interim default.
RISK
MANAGEMENT Additional interest rate reserves are a meaningful tool
but could accelerate the default
EXAMPLE
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Harmonization of local accounting regimes with Solvency II is a prerequisite for effective
risk and capital management.
Local
Accounting Solvency II Implications Country examples
Equalization
reserve
Required
capital (SCR)
Inconsistent approach to provide a buffer
for deviations from expected payouts.
Germany, Austria,
Portugal, Spain, Belgium, Italy
Specific
technical reserves (e.g., for adverse
deviations)
Best Estimate
cash flow projections
Local reserving requirements drive
Solvency II liabilities away from the best estimate approach and distort Solvency ratios.
Romania, Portugal,
Spain, Belgium, Italy
Further local
constraints
Economic
perspective on solvency
Further local reserve assessments
limiting dividend payments “Sicherungsvermögen” (restricted assets
under German law)
Germany, Belgium
A Critical Perspective on the Solvency II Implementation
RISK
MANAGEMENT Inconsistencies of local accounting rules with
Solvency II provide additional challenges
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Divergent stress test approaches between insurance
and banking
Insurance sector double-hit
scenario 2016 Banking sector adverse macro-financial scenario
Shocks to EURO-SWAP rates
Maturity 1 2 3 5 7 10 20 1 2 3 5 7 10 20 30
(bp) -60 -65 -77 -71 -61 -61 -61 2016 44 47 55 55 58 54 51 47
2017 45 40 53 49 55 48 48 41
2018 27 19 29 24 30 24 26 20
Implied shock to credit spreads (German 10-year sovereign bond)
2016 2016 2017 2018
(bp) 153 17 32 44
Shocks to stock prices
2016 2016 2017 2018
(%) -33.4 -25.4 -24.7 -16.4
Shocks to residential property prices in EU
2016 2016 2017 2018
(%) -6.7 -11.6 -7.4 -4.9
Source: “EIOPA Stress Test 2016 Technical specifications” and “Adverse macro-financial scenario for the EBA 2016 EU-wide bank stress testing exercise”
Moderate interest rate
up scenario
Insurance and banking stress tests appear economically inconsistent and placing a
higher onus on insurers. This may result in inadvertent loss of public confidence in insurers.
Extreme credit spread stress
Moderate credit
spread scenario
Extreme interest rate down shock
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A Critical Perspective on the Solvency II Implementation
RISK
MANAGEMENT
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Substantial additional local reporting requirements
beyond already generous Solvency II scope
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National specific reporting templates
France
37 local templates
Submission via XBRL
Starting in 2017
United Kingdom
13 local templates
Initially to be submitted in Excel
Starting in 2017
Ireland
13 local templates
Submission via XBRL
Starting in May 2016
Spain
11 local templates + additional information
in 2 QRTs
Submission via Access based Application
Starting in May 2016
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Narrative reporting requirements
Germany
Widening of qualitative reporting scope
Detailed information on valuation approach and
explanation of valuation differences compared
to Solvency I
Netherlands
Specific audit procedures
Additional templates in report
Ireland
Special analysis of Solvency I closing and
Solvency II opening balance sheet
Greece
External audit report on balance sheet
information within report requested
Spain
Special analysis of Solvency I closing and
Solvency II opening balance sheet
RSR = Regular Supervisory Report SFCR = Solvency and Financial Condition Report XBRL = eXtensible Business Reporting Language
QRTs = Quarterly Reporting Templates
Examples from selected jurisdictions
A Critical Perspective on the Solvency II Implementation
REPORTING
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SII Audit is still under discussion in: Czech Republic Finland
Ireland (BS/SCR/OF) Italy (BS/SCR/OF)
Malta Norway Portugal (SFCR and QRTs)
Romania (SFCR)
Currently no SII Audit planned in: Croatia Denmark
France Latvia
Slovakia Sweden
No feedback on SII Audit received from: Bulgaria
Estonia Lithuania
Luxemburg Slovenia
UK (under discussion) Public disclosures: Solvency Balance Sheet
SCR/MCR/OF TPs and Risk Margin
LTGs and Transitionals Sections of the SFCR
Greece Solvency Balance Sheet Own Funds
Information of supervisor if SCR/MCR-non-compliance
Belgium QRTs RSR/SFCR
Spain SFCR
Germany Solvency Balance Sheet Information of supervisor if
SCR/MCR-non-compliance
Poland SFCR
Austria Solvency Balance Sheet SCR/MCR/OF
Effectiveness ICS, RM-System and Internal Audit
Hungary Solvency Balance Sheet SCR/MCR/OF
Effectiveness ICS, RM-System and Internal Audit
Cyprus Solvency Balance Sheet SCR/MCR/OF
Netherlands (Day 1) Solvency Balance Sheet SCR/MCR/OF
Internal Controls/Data
BS = Solvency Balance Sheet RM = Risk Management TPs = Technical Provisions
Source: Pw C
Considerable variation in external audit requirements
National audit requirements under Solvency II
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A Critical Perspective on the Solvency II Implementation
AUDIT
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While the evolution of regulation continues, Solvency II cannot be considered
successfully implemented before fundamental issues are addressed:
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A Critical Perspective on the Solvency II Implementation
A common interpretation of key Solvency II elements is essential for a
true level playing field in Europe.
Obstacles to effective risk and capital management arising from local
accounting implications need to be removed.
National specific reporting requirements should be abandoned as
incompatible with a single insurance market in Europe.
Audit requirements should be harmonized across Europe to allow for efficient reporting processes.
Summary
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Disclaimer
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These assessments are, as always, subject to the disclaimer provided below.
Forward-looking statements
The statements contained herein may include prospects, statements of
future expectations and other forward-looking statements that are based
on management's current views and assumptions and involve known and
unknown risks and uncertainties. Actual results, performance or events
may differ materially from those expressed or implied in such forward-
looking statements.
Such deviations may arise due to, without limitation, (i) changes of the
general economic conditions and competitive situation, particularly in the
Allianz Group's core business and core markets, (ii) performance of financial
markets (particularly market volatility, liquidity and credit events) (iii) frequen-
cy and severity of insured loss events, including from natural catastrophes,
and the development of loss expenses, (iv) mortality and morbidity levels and
trends, (v) persistency levels, (vi) particularly in the banking business, the
extent of credit defaults, (vii) interest rate levels, (viii) currency exchange
rates including the Euro/U.S. Dollar exchange rate, (ix) changes in laws and
regulations, including tax regulations, (x) the impact of acquisitions, including
related integration issues, and reorganization measures, and (xi) general
competitive factors, in each case on a local, regional, national and/or global
basis . Many of these factors may be more likely to occur, or more
pronounced, as a result o f terrorist activi ties and thei r consequences.
No duty to update
The company assumes no obligation to update any information or forward-
looking statement contained herein, save for any information required
to be disclosed by law.
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