Solvency II

1. Solvency II Open Forum 4th March 2008 Michael Aitchison

2. Solvency II : Agenda • What is Solvency II • Change Context • Aims • Key Features • Implementation • Impact & Benefits

3. 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

4. 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?

5. 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

6. 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

7. 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

8. 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)

9. 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!

10. SCR – QIS4 specificaton thanks to Towers Perrin for the diagram

11. 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

12. Solvency II – Implementation • Timetable • QIS • Internal Model Approval

13. 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

14. 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

15. 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.

16. 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).

17. Solvency II – Internal Model Framework

18. 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

19. Solvency II Open Forum 4th March 2008 Michael Aitchison