Solvency II

Alok Tiwari
CEO
Aptivaa Consulting
22nd February 2008
Contents

1. Overview of Solvency II

2. Comparsion of Solvency Regime

3. Solvency Regime in India

4. Pillar 1 - Solvency Capital

5. Pillar 2 - Overview

6. Impact of Solvency II

7. Q&A
Overview of Solvency II
Solvency II – Introduction

Solvency II is the proposed new EU legislation which will govern

The capital requirements of insurance companies.
„ European Commission drafts the European legislation, with advice
provided by CEIOPS who compile detailed analysis according to a
framework of calls for advice prepared by the European
Commission.
„ European Commission will then publish a Solvency II Framework
Directive to be approved by the European Parliament and
European Council. This will set out the broad principles and
outcomes to be achieved under Solvency II.
„ Solvency II is a radical move from the current Solvency I
regulatory approach, a simple factor-based insurance solvency
regime that has been in-force since the early 1970’s.
Solvency II – Key Features

An economic approach to determining solvency capital

for European Insurers

„ A principles-based approach

„ Creates harmonisation across the EU

„ Balance between protection of policyholders and encouraging

efficient operations of companies

„ Drives use of integrated internal models

„ Retains proportionality for small & medium sized companies

„ Treats groups as economic entities

Solvency II – Some of the Key Stakeholders

Government, regulation Insurance industry

Insurance
Companies
European Council
Parliament of Ministers National
Insurance
Associations

European Commission
CEA
(DG internal market)

AISAM / ACME
ICISA
EIOPC
CFO Forum
CRO Forum
CEIOPS
Groupe
Consultatif

Other stakeholders
Source: CEA
 Solvency II – The Three Pillars

Pillar 1 Pillar 2 Pillar 3

Quantitative requirements Qualitative requirements Prudential reporting and
and supervision public disclosure

f Calculation of technical f Enhanced internal f Disclosure to supervisors

provisions governance, controls, risk f Public disclosure of the
f "Prudent person" management and financial condition and
approach to investments solvency self-assessment solvency report
f Solvency capital f Strengthened external
calculation: supervisory review,
- SCR and MCR harmonised supervisory
standards and practices
- internal model vs.
standard approach

Group Supervision
Groups are recognised as economic entities
 The Solvency II Timeline

2007 2008 2009 2010 2011 2012

Government, regulation

Directive development Directive adoption Implementation

(Commission) (Council, EU Parliament) (member states)

10 July 2007 2009 / 2010 2010 2H 2011 31 Oct 2012

SII Directive Adoption Implementing UK FSA Solvency II
proposal is expected1 Measures2, and rules operational
published National final
Supervisor
Standards3
finalised
Insurance Industry activity

QIS 1 QIS 2 QIS 3 QIS 4 Implementation

Nov 2007 March to

Results Nov 2008
published 1,2,3: Stages of the Lamfalussy process
Based on CEIOPS guidelines, 27 Sept 2007
Comparison of Solvency Regimes
Comparison of Solvency Regimes: Solvency II vs Basel II

Solvency II Basel II
Objective Protect policyholders against Reduce systemic risk in the
bankruptcy banking system
Method Mostly principle-based Mixture of principle-based
and rule-based
Scope Applies economic principles Concentrates primarily on
to both assets and liabilities assets
Main risks Underwriting, counterparty Credit, market (as per BI),
covered default, market & ALM, operational
operational

Approach Standard formula or Standard or internal

internal model (full / partial) approach (full / partial)

Risk models Integrated approach Separate models for credit,

market and operational risks

Diversification Explicitly allowed Mainly included in general

calibration
Solvency Guidelines - India
Solvency Guidelines - India

„ Simple Factor Based Approach

f Life Insurance
 Linked business – 2% of Reserve + 0.2% of Sum at Risk
 Non Linked business – 4% of Reserve + 0.3% of Sum at Risk
 Health Insurance – 2% of Reserve
f General Insurance
 Max (% of Premiums , % of Claims)
f Limited benefits of Reinsurance
* Indian insurers have to maintain a Solvency Margin of 150%.
Pillar 1 - Solvency Capital
Framework for Pillar 1

free assets excess capital

Assets
available
for SCR
Solvency Capital Requirement
(SCR)
MCR

market
value
margin

market
Assets covering consist-
all assets at best Technical provision
technical provision ent
market value estimate
valuation

Hedgeable Non-
hedgeable

Assets Liabilities & Capital

Calculating the SCR - The Standard Formula

SCR

BSCR SCROp risk

SCDefault SCMarket SCHealth SCNon Life SCLife

„ The SCR is composed of:

f Basic SCR (Market, Default and Underwriting)
f Solvency Capital charge for Operational Risk
„ Solvency capital is assessed separately for each risk
„ Explicit allowance is made for diversification benefits
f To promotes better risk management
f To facilitate the transition to Partial Internal Models

: adjustment for risk mitigating effects of future profit sharing

Pillar 2 - Overview
Pillar 2 – Qualitative Requirements and Supervision

„ Objective
f Entrench good governance to ensure policyholder protection

„ Key components
f System of internal governance

 Establish a robust system to demonstrate:

– Sound and prudent management

– Risk and capital mgt is part of strategic decision-making

 Complete an Own Risk and Solvency Assessment (ORSA)

 Inform the regulators about the results

f Supervisory review process

 To ensure compliance with the Directive

 Capital add-ons for material deficiencies

Pillar 2 – Development of Own Risk and Solvency Assessment

Disclosure 10 Public disclosure of risk

exposure & quality of risk
management

Role of Supervisors Regular evaluation of

9 strategies, policies,
procedures & practices
Ensure companies have
8 effective systems in place

Risk Management Process: Implement cost effective

7
Identification, Measurement, solutions to mitigate risks
Monitoring and Control 6 Monitor exposure and loss events

5 Develop policies and measure risk

Identify & assess risks in activities,

4 processes, systems, people
Developing an Appropriate Risk
Management Environment 3 Information flows provide effective monitoring

2 Senior management responsible to oversee implementation, setting

1 policies, procedures
Board sets strategy and framework plus oversight
Impact of Solvency II
Impact of Solvency II – Current Readiness

Current Approach to Risk Management

Responses

UK 28

France 38
Italy 14
Germany 116
Eastern 48
Rest 198

0% 20% 40% 60% 80% 100%

„ comments
Do not manage / Solvency I Internally discussing improved approach
Implementing or improving framework Already implemented a risk based framework
Other

‘…the new framework will turn the spotlight on the accurate

identification, measurement and management of risk. The new
rules will spur insurers to raise their game in this area.’
C McCreevy, European Commissioner

Source: CEA Impact Assessment survey, March 2007

Impact of Solvency II – Expected Approach

Expected Method for Calculating SCR

Large

Med - large

Medium

Small - med

Small

0% 20% 40% 60% 80% 100%

Standard approach Partial model Internal model

Definition of company size

Net premium in force % of respondents

Small: < € 50 million 24

Large: > € 2,500 million (life) 15
> € 1,500 million (non-life)

Source: CEA Impact Assessment survey, March 2007

Solvency II – Expected Impact on Insurers (1)

„ Improvement in risk management practices

f Need to integrate these practices into the management process

f Possible change in organisational structure

„ Greater volatility in balance sheet

f Possible move to less volatile asset classes

f Greater diversification of assets and use of risk mitigants

„ Increased capital requirements for higher risks

f More innovative risk management

f Industry consolidation

f Changes to product design

f Revision of product diversification

Solvency II – Expected Impact on Insurers (2)

„ Increased focus on internal governance including Identification, measurement ,

monitoring and control.

„ Introduction of Operational Risk in the framework for Solvency99.99%

II
Confidence level

Risk Causes

Event Frequency
RISK
• Process
• People
EXPECTED UNEXPECTED CATASTROPHIC
• Systems
LOSS
• External LOSS LOSS
Effect Severity

Risk Governance Operational Risk Definition/ Governance/ Policies

1. Self Assessments Strategic Diagnostic Study

(SA) Risk & Control Self Assessment (RCSA )
Risk Management

2. Key Risk Indicator Key Risk Indicator (KRI)

3. Loss Data Loss Data Capture

Management (LDM) Loss Data Analysis

Integrated Reporting ( SA, KRI & LDM),

4. Risk Mitigation New Product & Activity ( including Outsourcing)

Programmes Internal Control Supervision
BCP/DRP
Gross Income Allocation to calculate
Loss capital under SA
Risk Measurement Provisioning AMA Capital calculation using LDA,
SBA & HMA
Solvency II – Expected Impact on Insurers (3)

„ Temporary resourcing and cost issues

f Shortage of resources and increased implementation costs

f Should be mitigated by principle of proportionality

„ Alignment of supervisory requirements with market practice

f Improved international competitiveness

f Integration of the EU insurance market

“Solvency II is not just about capital,

it is a change of behaviour”
Thomas Steffen, Chairman of CEIOPS
Questions