Presented by: Edward MaguireDate: 23rd May 2012

Solvency II

Pillar 1 Latest Developments

Agenda

• European Parliament report for the Omnibus II Directive

• Summary of Implications from a Pillar 1 perspective

Followed by Focus on– Risk Free Rates

– Adapted Risk Free Rates (Illiquidity Premium)

– Spread Risk Submodule

– Matching Adjustment

– Health Underwriting Risk Submodule

– Equivalence

– Post Implementation Review

– Other developments

European Parliament report for Omnibus II

• Published by Economic and Monetary Affairs Committee (ECON)

• Report Rapporteur: Burkhard Balz MEP

• Tabled and Passed by Parliament 28th March 2012

• Implications for Pillar 1

especially in relation to discounting

Implications for Pillar 1

• EIOPA to be granted responsibility for drafting regulatory technical standards covering all aspects of Pillar 1

• Zero risk treatment for Government bonds no longer reflects economic reality

– New recital to require report from Commission on allowance for such exposures within capital requirements, bearing in mind any potential destabilising effects this may have during stressed markets

• Changes to MCR Floor, introducing consistency between reinsurers and insurers

• Counterparty default risk: OTC derivatives not cleared centrally subject to higher capital requirements than those cleared through central counterparty

Implications for Pillar 1

Continued• Various proposals on discount rates including

– Approach for Risk Free Rates including extrapolation

– Illiquidity premium - adapted risk free rates

– Spread Risk Submodule: Symmetric Adjustment Mechanism extended to fixed interest securities

– Matching Adjustment (Matching Premium)

• SCR for Health should reflect national equalisation systems and changes in national health legislation

• Equivalence requirements for third countries and transitional measures

Risk Free Rates

•EIOPA to publish risk free rates by currency on at least a monthly basis

•Extrapolation of risk free ratesNew Recital and Article to propose– Extrapolation of risk free rates beyond time by which relevant markets

are no longer considered to be deep, liquid and transparent

– Extrapolation under current markets for Euro curve to start after 20 years

– Converging to ultimate forward rate for maturities 10 years beyond point where markets no longer considered deep liquid and transparent

– Extrapolated rates at this point to be within 3 bps of ultimate forward rates

Illiquidity premium

• Illiquidity premium – adapted risk free rates• EIOPA, in co-operation with ESRB, to publish adapted risk free

rates with illiquidity premia by currency – On demonstration of temporary and exceptional stressed financial

markets for a given currency

– The adaptation shall be calculated with reference to a portion of the spread between the interest rate that could be earned from assets included in a representative portfolio of assets and the rates of the basic risk-free interest rate term structure

– Applies to certain illiquid liabilities matching criteria

– Subject to requirement that the use and impact of any illiquidity premium spreads to be disclosed by undertakings

Spread Risk Submodule

•Symmetric Adjustment Mechanism• Proposed inclusion of symmetric adjustment mechanism within

standard formula spread risk sub-module– To cover the risk arising from changes in the level of bond prices and

prices of other fixed income securities with similar cash-flow characteristics.

– Mirroring the mechanism under the equity risk sub-module

– Based on current level of appropriate fixed income index relative to weighted average level of that index

– Impact limited to maximum of 25% change in unadjusted spread risk capital

– Insurance and reinsurance undertakings applying the illiquidity premium shall not apply the symmetric adjustment in the event the result of the adjustment is a spread capital requirement lower than the standard spread capital requirement

Matching Adjustment

•Matching Adjustment (Matching Premium)New article proposed for certain life insurance obligations– Member states can approve for individual companies within their

jurisdiction

– Adjustment based on spread of matching assets less fundamental spread in respect of expected default and downgrade risk retained by the company

– Subject to a floor of 75% of the long term average spread

Matching Adjustment

•Matching Adjustment (Matching Premium)New article proposed for certain life insurance obligations– Companies cannot apply Matching Adjustment in tandem with Adapted

Risk Free Rate and Spread Adjustment Mechanism

– Companies cannot actively switch between applying and not applying Matching Adjustment

– Restrictions for non-compliance with conditions

– There will be reporting requirements for companies applying the adjustment

Matching Adjustment

•Eligibility Criteria– Replicating Portfolio of appropriate assigned assets

– Maintained over the lifetime of the life insurance obligation

– Ring-fenced and managed separately from the rest of the business

– No future premiums arising from the liabilities

– The liabilities should only be exposed to longevity, expense and revision risk

Matching Adjustment

•Eligibility Criteria– No policyholder options, or only a surrender option where the

surrender value does not exceed the value of the underlying assets

– The asset cashflows should be fixed, except for any dependency on inflation, and should not be changeable by the issuers of the assets or any third party

– The activities of the undertaking to which a matching adjustment can apply are restricted to those carried out in the country where the company is authorised.

Health Underwriting Risk Submodule

• EIOPA to publish standard deviations in relation to Member States which use Health Risk Equalisation Systems subject to the following requirements(a)  the mechanism for the sharing of claims is transparent and fully specified in advance of the annual period to which it applies;

(b)  the mechanism for the sharing of claims, the number of insurance undertakings that participate in the health risk equalisation system (HRES) and the risk characteristics of the business subject to the HRES ensure that for each undertaking participating in the HRES the volatility of annual losses of the business subject to the HRES is significantly reduced by means of the HRES, both in relation to premium and to reserve risk;

(c)  health insurance subject to the HRES is compulsory and serves as a partial or complete alternative to health cover provided by the statutory social security system;

(d)  in the event of default of insurance undertakings participating in the HRES, one or more Member States' governments guarantee to meet the policyholder claims of the insurance

business that is subject to the HRES in full.

Equivalence

• Temporary equivalence allowed for up to 5 years (with possible extension of 1 year) for third countries that do not fulfil equivalence criteria but satisfy certain conditions

• Proposed conditions for third country solvency regime include– There must be written commitments from third country that equivalent regime will be

adopted before end of period

– Third country must have a convergence programme and demonstrate that it has sufficient resources to carry out the programme

– Current third country solvency regime must be risk based, using an economic balance sheet approach

– Other requirements cover independence of supervision, professional secrecy for persons acting on behalf of third country’s supervisory authorities , exchange of supervisory information

• Reinsurance contracts written in 3rd country with full or temporary equivalence treated as if written under Solvency II regime

Post Implementation Review By EIOPA

• Subject to review 5 years after full Solvency II implementation:– Adapted risk free rate– Extrapolation of risk free rates– Symmetrical adjustment mechanism

• Matching adjustment subject to review 3 years after full Solvency II implementation – If found not to be appropriate then a transitional measure will be

applied

Other Developments

• Late 2011 Joint Working Group recommended amendments to standard formula calibration for– Health NSLT– Non-life business

• Main changes proposed include– Credit and Suretyship (premium risk factor down from 21.5% to 11.7%)– Assistance (premium risk factor up from 5.0% to 9.3%)– Marine, Transport Aviation (factors reduced by 2.1% for premium risk and

by 3.0% for reserve risk)– Large fall in reserve risk factor for Medical Expenses (from 10.0% to 5.3%)– Legal Expense reserve risk factor increased from 9.0% to 12.3%– Miscellaneous Financial Loss reserve risk factor up from 15.0% to 20.0%