Solvency II Implications of the New Regulations for US

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Solvency IIImplications of the New Regulations
for US EU BusinessOffices of Dewey LeBoeuf
December 5, 2011

• Joseph L. Petrelli, ACAS, MAAA, FCA
• President, Demotech, Inc.

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Mission Statement

• Demotech, Inc. will continue to be the leading
  provider of innovative solutions to financial
  analysis issues by focusing our resources on
  niches presenting opportunity for corporate
  growth.

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Joseph L. Petrelli, ACAS, MAAA, FCAPresident

• Mr. Petrelli began his insurance career in 1969.
  Since that date, he has acquired progressively
  responsible Property and Casualty (PC) actuarial
  and financial analysis experience. He has
  extensive experience with loss and loss
  adjustment expense reserve evaluation, product
  development, and pricing for virtually all PC
  and Title insurance products as well as expertise
  with loss cost filings, Financial Stability
  Ratings (FSRs) and merger and acquisition
  valuations.
• He has been actively engaged in the Title
  insurance industry since 1992. Prior to founding
  Demotech, Inc. he was employed by a large
  national PC insurer, a regional property and
  casualty insurer and Insurance Services Office.
• He is a Member in good standing of the Casualty
  Actuarial Society, American Academy of Actuaries
  and the Conference of Consulting Actuaries. Mr.
  Petrelli has a Bachelors of Actuarial Science
  from The College of Insurance at St. Johns
  University and an MBA from The Ohio State
  University.

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Serious About Solvency - Our Perspective

• Demotechs business model is to support
  financially stable insurers that are unrated or
  underrated by other services. We will not review
  or follow insurers once we have concluded they
  have mediocre financial stability.
• Other rating agencies seem to focus on solvency
  yet they seem to weigh the ability to accrue and
  enhance quarterly earnings heavily.
• Demotech encourages carriers to focus on
  long-term solvency. Our perspective encourages
  carriers to increase loss and loss adjustment
  expense reserves to adequate as opposed to
  reasonable levels.
• Earnings should be stabilized by booking adequate
  loss and LAE reserves, not manipulated by
  accruing loss and LAE reserves at an optimistic
  level.

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What Is Solvency II?

• European Union regulation for insurers
• Similar to Basel II for banking
• Three Pillars
• Capital Requirements for Solvency
• Governance and Risk Management of Insurers,
  Regulatory Supervision
• Disclosure and Transparency Requirements

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Timeline

• April 2009 European Parliament approves
  framework
• 2009-2011 EIOPA (European Insurance and
  Occupational Pensions Authority), the European
  regulators, perform quantitative impact and
  country equivalence studies
• November 2011 EIOPA published a consultation
  document on reporting requirements under Solvency
  II. The opportunity to provide feedback or
  commentary regarding the clarity of Solvency IIs
  reporting requirements is open until January 20,
  2012.

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Timeline (cont.)

• October 31, 2012 Original Effective date of
  implementation
• February 2012 European Parliament will consider
  Omnibus II amendments
• Changes effective dates to January 1, 2013 for
  supervisors and January 1, 2014 for insurers
• Adds transitional provisions to allow longer term
  implementation

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Own Risk Solvency Assessment (ORSA) Use Test

• Under Solvency II
• All insurers and reinsurers will have to conduct
  regular ORSAs a view of the companys own risk
  profile and solvency assessment, or capital,
  needs.
• Article 45 of the Solvency II directive requires
  that all companies perform a regular ORSA and
  that they provide the companys regulator with
  documentation on the process.
• Use test requires insurers to demonstrate that
  any internal model of capital requirements is
  widely used in and plays an important role in
  governance, risk management, decision making and
  ORSA

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Impediments

• Technical standards
• These are under development therefore companies
  are not sure how to implement
• Some draft standards are not due until December
  2017 would these require changes to a prior
  implementation?
• High costs involved in trying to comply with a
  moving target
• Equivalency
• Only Bermuda, Switzerland and Japan have
  regulatory systems deemed equivalent to Solvency
  II
• United States system is not yet considered
  equivalent since it has many state regulators
  instead of one federal regulator

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Impact on Domestic Insurance Companies

• Direct
• Only 196, or 7, of the 2,765 companies reporting
  in 2010 had direct premium written outside the
  United States or Canada
• Not all of these countries are in the European
  Union, so this number overstates the number of
  companies directly impacted by Solvency II
• Indirect
• Many U.S. companies use international reinsurers
• Some U.S. companies reinsure offshore captives
• Solvency II will impact reinsurance pricing and
  collateral requirements

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Financial Services Authority

• The Financial Services Authority is exploring
  ways to reduce costs for U.K. insurers, who will
  effectively have to comply with both the current
  and new rules during 2013, due to the U.K.
  Insurance regulation deciding to delay full
  implementation of Solvency II until 2014
• Larger U.K. insurers will have to demonstrate
  some form of Solvency II reporting as well as
  comply with the FSAs current individual capital
  assessment rules

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NAIC Solvency Modernization Initiative

• Process began in 2008
• Represents an alternative framework for insurance
  solvency regulation
• Includes consideration of Solvency II as well as
  international financial reporting standards and
  regulation of internationally active insurance
  groups
• For example, ORSA draft proposal effective
  January 1, 2014 for insurers with annual premium
  greater than 500 million or groups with annual
  premium greater than 1 billion
• All major policy decisions expected to be made by
  December 2012

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Other Thoughts

• Former FDIC Chairperson Sheila Bair gave the
  keynote address at a recent NAIC meeting.
  Speaking about the financial crisis, she said
  that the non-adoption of Basel II, the banking
  counterpart to Solvency II, was the only thing
  that saved our baconWe kept our leverage ratios
  and fought Basel II and I am so glad we fought it
  off.
• NAIC President-Elect Kevin McCarty said, You
  cant prevent an AIG by focusing on capital.
• Basel II did not work for banking, why would
  Solvency II be expected to work for insurance?

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