Solvency II

Open Forum 4th March 2008

Michael Aitchison

Solvency II : Agenda What is Solvency II

Change Context

Aims

Key Features

Implementation

Impact & Benefits

Solvency II: What is it?Solvency II is:A European Commission Directive that will provide a far reaching new model for the supervision and regulation of insurance companies. The Directive will lead to the adoption or more sophisticated risk and capital management techniques across the EU built on a foundation of modern market-based valuation of assets and liabilities.

“At the same time, we see Solvency 2 as a contribution to the emergence of a world-wide standard.” Commissioner Charlie McCreevy

Recent implementation of revised shareholder reporting in IFRS Phase I. IFRS Phase 2 to follow.

Continued need for supplementary reporting on an embedded value basis, due to stakeholder preference

Development of European Embedded Value, and Market Consistent Embedded Value reporting in quest for consistency and shared standards

FSA has developed the ICA assessment – stepping stone to S2?

Insurance Industry Context: All Change Please!

Solvency II: Aims

Increase confidence in the insurance industry Deliver a more competitive single market Increase efficiency in the use of capital: higher

returns Facilitate more streamlined supervision of

insurance groups

Solvency II: Key Features 3 Pillar Structure (cf. Basel 2) Market Consistent Valuation of Assets & Liabilities SCR & MCR: risk responsive capital requirements Focus on improved risk & capital management, including

use of Internal Models

Solvency II – 3 Pillars

Pillar 1: Asset and liability valuation standards; Minimum Capital Requirement; Solvency Capital Requirement

Pillar 2: Supervisory Review Process More interactive relationship with regulator Enhanced focus on risk management

Pillar 3: enhanced public disclosure and confidential supervisory reporting

Harness market discipline to encourage good practice

Solvency II: proposed Pillar 1 “The overall objective of prudential regulation must be to ensure that an insurer

maintains, at all times, financial resources which are adequate, both as to amount and quality, to ensure there is no significant risk that its liabilities cannot be met as they fall due.” (CP20, 2.2)

Solvency II – Capital Requirements

The Solvency Capital Requirement (SCR) should deliver a level of capital that enables an insurance undertaking to absorb significant unforeseen losses and gives reasonable assurance to policyholders that payments will be made as they fall due.

Standard Formula Internal Model

The Minimum Capital Requirement (MCR) is the minimum regulatory capital requirement, the breach of which would trigger major regulatory intervention.

Relationship to SCR

Ladder of regulatory intervention Extension Ladder!

thanks to Towers Perrin for the diagram

SCR – QIS4 specificaton

Solvency II – Group Issues

How to evaluate diversification benefit at Group level

Ability/Obligation to pass resources around a Group

‘Sum of solo’ approach gives no credit Group Internal Model approval if credit taken? Non-EEA group companies

Solvency II – Implementation

Timetable QIS Internal Model Approval

Solvency II – Implementation Timetable

2005 2006 2007 2008 2009 2010 2011/2

Directive Development (Commission)

Directive Adoption (Council & Parliament)

Implementation(Member States)

CEIOPS work on Pillar I

CEIOPS work on Pillar II and III

QIS1 QIS2 QIS3 QIS4

Model calibration

Priorities - Impact assessment - Group issues

CEIOPS works on implementing measures

Further QIS?

Solvency II – Quantitative Impact Studies

Part of extensive and open consultation process

QIS4 running now Participants quantify the capital requirements

based on QIS specification rules Consultation was run on the specification IAS 19 basis for employee benefits

Outcome will shape detail of ultimate implementation

Solvency II – Internal Model Approval

Supervisory objectives

better risk management, which also improves policyholder protection,

continual upgrading and encouragement of innovation in risk management methodology and

improved risk sensitivity of the SCR, especially for undertakings with non-standard risk profiles.

Solvency II – Internal Model Approval

Conceptual framework Base methodology / ‘actuarial model’:

Statistical quality test Are the data and methodology underlying both internal and regulatory applications sound

and sufficiently reliable to support both satisfactorily?

Internal risk management: Use test Is the actuarial model genuinely relevant for and used within risk management?

Regulatory capital requirement: Calibration test Is the SCR computed by the undertaking a fair, unbiased estimate of the risk as measured

by the common SCR target criterion?

The combination of the actuarial model and the risk management function built on top of it is called the 'internal model in a wider, risk management sense' (CfA 11.14).

Solvency II – Internal Model Framework Governance & Policies

Policy Governance

Risk Strategy Accountability

Risk Appetite

Internalising

Actuarial Models Reporting

Projection & Analysis Models

Annual: planning, forecasting, budgeting Risk Monitoring

Risk Maps Risk Analysis

Economic Capital BAU: pricing, capital management Risk Reporting

Sensitivity Measures & Analysis

External Factors

financial markets, competition, tax & regulation

Solvency II – Impact & Benefits Best practice risk and capital management

In particular: Risk management - processes and controls Capital management - eligible capital and quality of capital

Improved market perception: enhanced reputation for risk management

Reduced capital requirements + improved return on capital

Enhanced management information to support more optimal management decisions

Reduced costs: Operational efficiencies from better risk management

Solvency II

Open Forum 4th March 2008

Michael Aitchison