Solvency II in the EU - current developments and next steps

1. Solvency II in the EU - current developments and next steps Ministry of Finance Seminar, 5 April 2011, Tel Aviv Ulf LINDER Deputy Head of Unit, Insurance and Pensions, European Commission

2. Why Solvency II? • Current regime (Solvency I) 30 years old • Lack of risk sensitivity • No incentives for insurers to manage risks adequately or to improve & invest in risk management • Does not facilitate accurate & timely supervisory intervention • Supervision of groups sub-optimal • Lack of convergence within the EU • Lack of consistency with international developments (IAIS, IASB)

3. Solvency II – 4 Principal Objectives • Deepen the Single Market • Enhance policyholder protection • Improve (international) competitiveness of EU insurers and reinsurers • Better Regulation

4. A real change of culture … • Protection of consumers comes with a cost for the industry  establishes risk-sensitive capital requirements to encourage and reward good risk management • Places emphasis on the responsibility of the senior management to manage their business responsibly (not on the regulator!) • Align economic capital with regulatory capital • Principles-based and prospective • Proportionality

5. Solvency II – A great leap forward Huge benefits are expected from Solvency II: • More transparent / better risk allocation between insurers, policyholders and capital markets • Better pricing, product innovation • New asset management strategies • Decrease in the cost of capital • Better capital allocation (commensurate with risk profile)  improved financial stability

6. Legislative Process Level 1: Framework Directive Level 2: Implementing Measures (Commission) Level 2.5: Binding Technical Standards EIOPA Level 3: Guidance by EIOPA to ensure consistent implementation and cooperation between MS Level 4: Rigorous enforcement of Community legislation by the Commission

7. New Europeansupervisoryarchitecture European Systemic Risk Board (ESRB) Governors of NCBs + ECB President and Vice-President Chairs of EBA, EIOPA & ESMA European Commission Non-voting: One representative of the competent national supervisor(s) per Member State + EFC President + + + Information on micro-prudential developments Recommendations and/or early risk warnings European System of Financial Supervisors (ESFS) European Banking Authority (EBA) European Insurance and Occupational Pensions Authority (EIOPA) European Securities and Markets Authority (ESMA) National Banking Supervisiors National Insurance and Pension Supervisors National Securities Supervisors

8. Solvency II Timetable for 2007-2013 2012 2011 2007 2008 2009 2010 2006 Directive development (Commission) Directive adoption (Council & Parliament) Implementation (Member states) CEIOPS work on technical advice necessary for implementing measures + preparation of Binding Technical Standards and guidance Commission preparatory work implementing measures (IM) Adoption of IM July 2007 Solvency II Directive published January 2013 Solvency II enters into force QIS2 QIS3 QIS4 QIS5

9. Solvency II… • 3 ‘Pillars’ of equal importance: • Quantitative requirements • Qualitative requirements • Disclosure and reporting • Economic, risk based approach • Proportionality principle • Group supervision

10. Group supervision & cross-sectoral convergence Groups are recognised as an economic entity => supervision on a consolidated basis (diversification benefits, group risks) Pillar 1: quantitative requirements 1. Harmonised calculation of technical provisions 2. "Prudent person" approach to investments instead of current quantitative restrictions 3. Two capital requirements: the Solvency Capital Requirement (SCR) and the Minimum Capital Requirement (MCR) Pillar 2: qualitative requirements and supervision 1. Enhanced governance, internal control, risk management and own risk and solvency assessment (ORSA) 2. Strengthened supervisory review, harmonised supervisory standards and practices Pillar 3: prudential reporting and public disclosure 1. Common supervisory reporting 2. Public disclosure of the financial condition and solvency report (market discipline through transparency) Solvency II: 3 pillars and a roof

11. Pillar 1: Quantitative Requirements • Market consistent valuation of assets and liabilities, including technical provisions • Two capital requirements: MCR and SCR • SCR: calibration: VaR 99.5% 1-year • SCR can be calculated using either a standard formula or an internal (full/partial) model • MCR between 25% and 45% of the SCR • Less or no need for lists of eligible assets or limits on investments (Prudent Person Rule) • Credit for risk mitigation (securitisation, derivatives, reinsurance) • Credit for diversification

12. Pillar 2: Qualitative Requirements • New regime places much emphasis on good governance (functions) • Risk-management: key change from old regime  Own Risk & Solvency Assessment gives focus and structure • Supervisory Review Process • More developed than in Basel II/CRD • Response to weaknesses identified

13. Pillar 2: Supervisory Activities • Supervisory activities • general rules on supervision • supervisory powers • supervisory review process • principle of • proportionality • Qualitative requirements on undertakings • system of governance • principle of proportionality

14. Pillar 3: Supervisory Reporting and Public Disclosure • New approach in Pillars 1 & 2 means new approach needed for Pillar 3! • More freedom for firms to run themselves; but with new responsibilities new requirements for disclosure to harness market discipline in support of achieving the regulatory objectives • Power & discretion to supervisors; need to earn trust of stakeholders; need to foster supervisory convergence & achieve competitive equality  new requirements for transparency

15. Improved group supervision • Clear intention to improve the supervision of groups • Recognition of economic reality of groups • Group supervision will no longer be supplementary • Organised co-ordination and co-operation between all supervisors • Clear role and responsibilities for group supervisor • Group internal model • Group ORSA and Group Solvency and Financial Conditions Report

16. Impact financial crisis (1) • Revised calibrations for market risk • Special treatment structured products and derivates in spread risk sub-module • Revised correlations between market risks • Symmetric dampener in equity sub-module • Illiquidity premium in the discount rate of technical provisions

17. Impact financial crisis (2) • Revision of requirements on eligibility of own funds • Pillar 2 dampener • Provisions in relation to retention for repackaged loans • Remuneration • Financial stability concern in supervisory actions

18. Current developments • QIS5 results • Where are we on: • Level 1: Updating Solvency II Directive • Level 2: Elaborating implementing measures • Level 2.5: EIOPA prepares technical standards • Level 3: Guidance from EIOPA • Reporting templates

19. QIS5 results • Strong participation • Generally acceptable results • Need for simplification • Need for further work in certain areas • Non-life calibrations • Natural catastrophe risks • Need for transitory arrangements • No QIS6 • Reactions from industry

20. Level 1: Update the Solvency II Directive • Why « Omnibus II » changes are needed: • Binding mediation through EIOPA • Specific tasks assigned to EIOPA • Transitional measures on Solvency II • Binding Technical Standards and their prioritisation • Consistency with other financial sectors

21. Level 2: Elaborating Implementing Measures • Well advanced, 350 pages • Member States and industry involved in the elaboration • Translations major stumble block • Need to prepare impact assessment

22. Level 2: Implementing Measures – points under discussion • Contract boundaries and ”future profits” • Volatility - long term investments and liabilities (e.g. illiquidity premium) • Calibrations, in particular non-life and Nat Cat • Transitory measures

23. Level 2.5: Binding Technical Standards • Scope of BTS discussed at the moment in Council and Parliament • To be prepared by EIOPA • Around 20 areas • Need for prioritisation – which ones need to be ready at inception • Adoption through the Commission

24. Level 3: Guidance from EIOPA • Legally non-binding nature, but will be used by supervisors • Guidance in the same areas as BTS, but also in others • Adopted by EIOPA

25. Reporting Templates • EIOPA is developing extensive reporting spread sheets • Industry: too burdensome • Justification of each disclosure • Importance for consistent implementation, supervisory work and statistics • Early consultations already underway • Need to prepare IT systems

26. Some future milestones • Level 1: Omnibus II adopted Jan 2012 • Level 2: Presented 1st quarter 2012 (incl IA), adopted autumn 2012 • Level 2.5: Consultations 2nd quarter 2012, adoption late 2012 • Level 3: Consultations during 2012, adoption 2012 • Solvency II to be applied from 1 Jan 2013

27. Solvency IIInternational developments

28. IAIS and Solvency II • Solvency II is well aligned with the new solvency standards being developed by the IAIS • Promotion of international convergence is a specific objective of the Solvency II project • The development of international standards is the best way to promote the creation of open international insurance markets, whilst at the same time ensuring that policy holders are adequately protected

29. Solvency II and equivalence • Under Solvency II, the Commission can make binding decisions regarding the equivalence of third countries’ group and reinsurance supervision • Where a third country is deemed to have equivalent standards, EU supervisors will rely on the supervision applied in that country and (re)insurers from that third country will be treated in the same manner as EU (re)insurers

30. Way forward on equivalence • Commission has decided to assess in the first wave the equivalence of Switzerland and Bermuda and Japan only for reinsurance • Transitional regime is foreseen for other 3rd countries that are working on risk-based supervision systems that may become equivalence • CEIOPS to proceed with assessment of countries in first wave by end September 2011. Commission will take decisions in July 2012 • System to be in place by 1 January 2013

31. Ulf Linder Deputy Head of Unit H2 – Insurance and Pensions Directorate H – Financial Institutions Directorate General Internal Market and Services European Commission (Spastraat 2) B-1000 Brussels, Belgium  +32 2 299 22 76 E-mail ulf.linder@ec.europa.eu Website:http://ec.europa.eu/internal_market/insurance/index_de.htm