Solvency II

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Solvency II

• Open Forum 4th March 2008
• Michael Aitchison

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Solvency II Agenda

• What is Solvency II
• Change Context
• Aims
• Key Features
• Implementation
• Impact Benefits

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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

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Insurance Industry Context All Change Please!

• 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?

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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

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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

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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

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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)

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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!

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SCR QIS4 specificaton
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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

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Solvency II Implementation

• Timetable
• QIS
• Internal Model Approval

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Solvency II Implementation Timetable
2005
2006
2007
2008
2009
2010
2011/2
Directive Adoption (Council Parliament)
Directive Development (Commission)
Implementation(Member States)
CEIOPS work on Pillar I
CEIOPS works on implementing measures
CEIOPS work on Pillar II and III
QIS1
QIS2
QIS3
QIS4
Further QIS?
Model calibration
- Impact assessment - Group issues
Priorities
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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

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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.

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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).

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Solvency II Internal Model Framework
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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

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Solvency II

• Open Forum 4th March 2008
• Michael Aitchison