Solvency II – a new area in insurance regulation

1. Solvency II – a new area in insurance regulation 2nd International Istanbul Insurance Conference30 September 2010 - Susanne Kaske-Taft

2. Content Solvency II – Introduction & timeframe Solvency II – Comparison with Solvency I Solvency II – Key features Solvency II – Impacts on the European industry

3. What is Solvency II all about ? Key message Swiss Re: “Rather than a rigid, rule-based approach, Solvency II uses a risk-based assessment of the assets and liabilities, based on economic principles. This complements our approach of integrated risk management as well as effective asset/liability matching. Solvency II will create state-of-the art risk management and bringing greater transparency.”

4. QIS 6 ? QIS 1-3 (2005 - 2007) QIS 4 QIS 4B QIS 5 Solvency II - Timeframe 2000 ... 2007 2008 2009 2009 2010 2010 2011 2011 2012 2013 2014 2000 ... 2007 2008 2012 … Level 1 Directive adopted (approved 25 Nov 2009) Level 2 Draft implementing measures (expected by end 2010) Level 2 implementing measures (expected by end 2011) Solvency II system in force Level 1Draft framework Directive (published 10 July 2007) Level 3 Level 4 starts in 2014 • Level 1:Framework Directive: Setting out basic enduring principles or political choices underpinning the solvency system. • Level 2: Implementing Measures: Definition of detailed technical rules. • Level 3: Supervisory Standards: Setting out guidelines for national supervisors to ensure a consistent interpretation and application. • Level 4: Evaluation: Enables the European Commission to monitor compliance and enforcement.

5. Objectives of Solvency II in comparison with Solvency I Solvency I Solvency II Regulatory arbitrage possible due to different local regimes One consistent economic framework within the EEA* Consistency of regulatory framework Policyholder protection based on mechanistic, unspecific formula Policyholder protection based on economic principles and integrated risk approach Policyholder protection Rules do not reflect economically risk modelling Rules require risk modelling on economic principals Alignment of capital requirements with economic risk modelling Limited recognition of traditional reinsurance Material economic risk transfer will qualify for capital relief Consideration of risk mitigation tools Statutory approach with prudence reserves and investment regulations Economic approach, plus additional market value margin for technical provision Introduction of mark-to-marketvaluation of balance sheet * European Economic Area

6. Quantitative requirements Qualitative requirements Market discipline Implementation of Solvency II The requirements of the three pillars of Solvency II have to be embedded in an overall Risk Management Framework including all steps of the value chain of an insurance company. Enterprise Risk Management Quantitative requirements Qualitative requirements Quantitative requirements Market discipline Market discipline Risk Governance & Culture Product Develop. UW Sales Admin Assets RM Claims Value chain

7. Economic balance sheet Market value of assets Economic value of liabilities probability Economic net worth VaR ES Loss Profit 1 in 200 years loss Expected result (mean) Solvency II – Key elements Consideration of all risk categories Probabilistic risk measurement Economic balance sheet Solvency I Insurance risk Market risk SCR Solvency Capital requirements Risk aggregation Credit risk Operational risk The Solvency I regime only considers the insurance risk and in some extent the market risk. Other risk categories are covered in different regulatory frameworks (eg upper limits for investments in certain asset categories) Solvency II risk measure will be based on a Value at Risk (VaR) level of 99.5% which is equivalent to a 0.5% target default probability, and specifies a time horizon of one year • Introduction of market-consistent valuation of balance sheet items • Increased volatility of balance sheet items expected

8. available capital solvency ratio = required capital • Steering of the solvency ratio: • Increase the available capital • Reduce the required capital The economic balance sheetBuilding blocks Economic balance sheet Market valueof assets Excess Capital Equity andretained earnings Available assetsto cover SCR/MCR Own funds = available capital Solvency CapitalRequirement (SCR)including MCR = required capital Hybrid capital risk margin¹ • Cash • Fixed income instrument • Property • Equity • Reinsurance assets market-consistent valuation of hedgable risks Discounted Best Estimate ¹ for non-hedgeable risks

9. Balance sheets recovering • Less capital intensive parameterisation of the Standard Formula Solvency II – Impact on solvency level Solvency ratio – industry wide (EU) 250% 210% 210% 200% 150% 140% 150% QIS 5 ? 100% 75% 60% 50% 0% QIS 4 FY08 (CRO)/FY09e (JPM) (estimated) QIS 4 FY07 (official) QIS 5 FY09 QIS 5 (CP¹based) FY08 (CRO)/FY09e (JPM) (estimated) • Stable parameters (QIS 4) • Impact of the financial crisis on 2008 balance sheet figures • Very conservative parameterisation based on the Consultation Papers CRO Forum J.P.Morgan ¹ Consultation papers

10. Solvency II –Impact on the EU economy • European equity markets would lose trading volume and investments by insurance companies • Unusual growth in low-risk asset classes • If the amount and quality of capital is excessive, insurers would be required to issue a huge amount of ordinary equity • At the same time the largest institutional investors (banks and insurers) would be discouraged from investing in equity • Investment returns to be lower Source: CEA report / “Why excessive capital requirements harm consumers, insurers and the economy” March 2010

11. Solvency II- Impact on the EU insurance sector • Profitability and prospects for growth would decline • Small to medium-sized players with limited access to new sources will • focus mainly on the distribution of policies • retaining less insurance risk (so-called fronting) • transferring the risks to larger players (reinsurers) • Mutuals would find it more difficult to raise capital • Life insurance products would be far less attractive to customers • EU-domiciled companies would be at a competitive disadvantage to other players Source: CEA report / “Why excessive capital requirements harm consumers, insurers and the economy” March 2010

12. Solvency II – Impact on policyholders and beneficiaries • Life • Reduced supply of traditional life policies with minimum guaranteed returns • Product redesign, eg adjustment of guarantees and options embedded in the products • Price increases of up to 20–30% • Consumers may increasingly rely on other pension providers • Non-life • Lower supply of capital-intense products, eg, motor liability, professional liability or natural catastrophe policies. • Product redesign, • Price increases in the range of 5–20%for more capital-intense products Source: CEA report / “Why excessive capital requirements harm consumers, insurers and the economy” March 2010

13. Solvency II will change the European insurance landscape Likely developments • A new wave of consolidation is likely • Solvency II seems biased towards larger groups Market developments • Outlook • The system is currently geared against insurance companies investing in risky assets • Regulatory pressure increasing (Basel III) particularly affecting bancassurers • Rating agencies negative outlooks from S&P and Moody‘s • Solvency II QIS 5 in 2010 with significantly increased capital requirements • Branch structures may become more popular • Larger companies may consider Head Office relocation depending on the portfolio and operational structure • ERM will become embedded in decision-making Structure of insurance companies • Companies will need to further consider size, geographical mix, lines of business, asset/liability correlations • In the absence of capital raising capacity smaller insurers and mutuals may have no option but to allocate more assets towards government bonds, or to reduce capital intense lines of business Business mix & asset allocation • Products with guarantees will require higher levels of backing capital • Products incorporating long term volatility will also affected • Product development will incorporate capital considerations • Capital bias towards short term lines • Company may wish to offload long tail risks • Low frequency / high severity lines also hit Product development

14. Thank you Susanne Kaske-TaftHead Market Dynamics & Opportunities+41 43 285 3964susanne_kaske@swissre.com

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