The World Bank Group 1st Contractual Savings Conference

1. The World Bank Group 1st Contractual Savings Conference The EU Solvency Margin for Life Insurance Michael Thom Washington, 2 May 2002

2. Presentation Outline • The Europe Union & Insurance • The European Commission and the basic EU Prudential Framework • The EU Solvency Margin Regime • Solvency I • Solvency II • Conclusions

3. The Europe Union & Insurance

6. i n m i l l i o n s ( 2000 ) 3 78 293 1 2 6 E U R 1 5 U S A J A P A N

11. The European Commission and the basic EU Prudential Framework

13. European Commission Key objective : • Creation of a single market Classic reasons: • Economic efficiency • Increased choice and quality, • lower prices

14. Basic Prudential Framework Three Generation of Life & Non-Life Directives: • the single licence • exclusive home country control for prudential matters • freedom of establishment & provision of services • minimum harmonisation and mutual recognition of supervisory / prudential standards

15. Basic Prudential Framework • no economic needs test • no prior approval of premia or premia changes • no prior approval of policy conditions CONCLUDE: most open liberal system in world

16. Basic Prudential Framework • Prudential supervision: sole responsibility of the home Member State, who shall require • sound administrative and accounting procedures and • adequate internal control mechanisms of the company, and

17. Basic Prudential Framework Respect of common EU financial rules covering: fit & proper managers (premiums) technical provisions investment rules solvency margin

18. The EU Solvency Margin Regime

19. Rule of Law / Fit & proper managers Liabilities Assets Solvency Margin Investment Rules Technical Provisions Adequate premiums

20. Fit & Proper Managers • Fitness : formal qualifications, experience • Propriety: financial position, absence of criminal record, questionable business practices • Very important • Managers can react long before supervisors

21. Technical Provisions • Meet all liabilities at all times (as far as can be reasonably foreseen) • prudent • more developed for life

22. Technical Provisions- Life • Must establish sufficient technical provisions • prospective actuarial basis • prudent valuation (claims and expenses) • all options - (guaranteed surrender values) • reference rate of interest - (60% state bond; portfolio rate)

23. Investment Rules (ALM) • Assets covering technical provisions take account of : • type of business • need to secure safety, yield, marketability • requirement to be diversified and adequately spread

24. Investment Rules (ALM) Assets covering technical provisions: • list of admissible assets (marketable securities, land, buildings, tax recoveries, salvage, rent, etc.) • prudently valued • derivatives: • only to reduce risk / manage portfolio • in relation to underlying assets

25. Investment Rules (ALM) Assets covering technical provisions: • max 10% in one piece of land or building • max 5% in single bond, share, debt, etc. • max 5% in unsecured loans, • 1% single unsecured loan • max 3% in cash • max 10% in unregulated market securities

26. Investment Rules (ALM) Assets covering technical provisions: • no obligation to invest in particular assets (but Member States may limit) • EU localisation (EU risks matched by EU assets) • Currency matching max 20% non-currency congruence (Euro always congruent)

27. The EU Solvency Margin

28. Solvency Margin: Basic definition: “ assets of the undertaking free of any foreseeable liabilities less any intangible items”

29. Solvency Margin: Eligible Items • Paid-up share capital (contributions) • 50% of unpaid capital ( after 25% paid) • Free reserves • Profits carried forward • Cum. pref. Shares / subordinated debt (max 50%) • less • Intangibles

30. Solvency Margin: Eligible Items • Hidden reserves (unrealised gains) plus Life: • max 50% future profits, max 10 years

31. Solvency Margin Requirement- LIFE Technical Provisions (TP) Investment risk (4% of 2000) 80 No inv. risk (1% of 2000) 20 & >5 yr. expense guar. -------- 100 reinsurance reduction x85% Total 85

32. Solvency Margin Requirement- LIFE Capital at risk Sum assured 10 000 Technical provisions4 000 capital at risk 6 000 (x0.003) 18 reinsurance reduction x50 % solvency margin requirement 9

33. Solvency Margin Requirement- LIFE • Technical provisions 85 • Capital at risk 9 • Total 94

34. The guarantee fund Equals a third of solvency margin required but subject to a minimum guarantee fund: class mEURO mEuro 9 and 17 0.2 2.0 1-8, 16, 18 0.3 2.0 10-13, 15 0.4 3.0 14 1.4 3.0 Life 0.8 3.0

35. What happens when things go wrong ? • Staged approach • If actual solvency margin < required solvency margin • then company must submit for approval a plan for the restoration of a sound financial position

36. What happens when things go wrong ? • If actual solvency margin < guarantee fund, • then short-term finance scheme for approval • supervisor may restrict or prohibit free disposal of assets • supervisor may take all measures necessary to protect insured (idem if technical provisions not covered) • must inform other Member States • who may take the same measures

37. What happens when things go wrong ? • if technical provisions not covered • supervisor may also take all measures necessary to protect insured

38. SOLVENCY I

39. EU solvency margin system is • Simple • Robust • Easy to understand and use • Inexpensive to administer • Has worked well in practice

40. 97 Commission Report • Present scheme has proved satisfactory • Certain weaknesses in specific cases • Main alternatives not demonstrably superior • Avoid unnecessary cost to industry

41. SOLVENCY I : Main themes • Level of harmonisation • Minimum guarantee fund • Special supervisory powers • Reinsurance • “Class enhancement approach” • Miscellaneous

42. 1. Level of harmonisation • Minimum or full ? • Not clear • Now clearly minimum harmonisation • in practice • mirrors banks, investment firms • subsidiarity principle

43. 2. Minimum guarantee fund • Unchanged since 1973 (non-life) 1979 (life) • Impact of inflation on claims and expenses class mEURO mEuro 9 and 17 0.2 .0 1-8, 16, 18 0.3 2.0 10-13, 15 0.4 3. 2 0 14 1.4 3.0 Life 0.8 3.0 2.0 3.0

44. 3. Special supervisory powers • When policyholders rights are threatened, supervisors may take early intervention • Supervisors can: • require financial recovery plan • require higher solvency margin • revalue downwards all solvency margin items

45. 4. Reinsurance • Max. reduction of 50% retained • Calculated over last 3 years • Decrease reinsurance reduction if: • nature or quality of reinsurance programme changed • no significant risk transfer

46. 5. Class enhancement approach • Problem for long term, long tail risks • Third index not a solution • indiscriminate, perverse • Keep simplicity of current method • but increase current solvency margin for “risky” classes of business.

47. 6. Miscellaneous Future profits : • Currently max. 50% for max. 10 years • Propose “ 50% “ “ 6 “ but • actuarial report • no double counting with hidden reserves • But…….only up to 2009

48. 6. Miscellaneous Unit-linked business- Life • where no investment risk • where expenses not fixed for more than 5 years • Required solvency margin = 25% of relevant overheads

49. Strengthens solvency margin requirement • Important- more competition in future • (tariff liberalisation, new distribution channels, euro, further consolidation and integration, “shareholder value”) • (reduced investment profits)

50. Implementation Timetable • 14 Feb 2001 Adoption by Council & EP • 20 March 2002 Publication in OJ • 20 Sept 2003 In force • 2002-2007 Transitional period