What is Solvency II?

What is Solvency II?

...is a project which was initiated by the European Commission in 2001 ...will come into effect at the end of 2012
Origin

...establishes capital requirements and risk management standards that will apply across the EU
Target

Timing

...aims to provide protection to policyholders by reducing the risk of insolvency to insurers

Aim

Solvency II...

Scope

...affects all areas of an insurers operations

Consequence Comparison

...encourages companies to manage risk in a way which is appropriate to the size and nature of their business

...aims to move away from the idea that one approach fits all

Some feedback from market players

What is changing?
Solvency II will bring changes across all of an insurers operations.
Current Solvency I Solvency II Replaces Solvency I across Europe: promises a (more) level playing field Encourages and rewards companies for managing risks Requires insurers to look at their risks more closely Requires a completely different set of financial information for reporting Future

Uneven playing field

Punishes prudent behaviour One size fits all rather than risk based approach to solvency capital requirements (e.g.4% technical provisions and 0,75% capital at risk) Limited reporting requirements Many different requirements for different countries

Requires increased integration of systems and processes, including IT systems

Requires detailed documentation Allows for application of internal risk models for capital calculations

Why are capital requirements important?

A solvency capital requirement has the following purposes:

To reduce the risk that an insurer would be unable to meet claims.

To reduce the losses suffered by policyholders in the event that a firm is unable to meet all claims fully. To provide supervisors early warning so that they can intervene promptly if capital falls below the required level. To promote confidence in the financial stability of the insurance sector.

Position European Commission The objective of the Solvency II regulation is to ensure that insurance companies are financially sound and able to cope with adverse events, to protect policyholders and the financial system in general.

Solvency II Structure

How is Solvency II structured?

Solvency II is based on 3 pillars
Solvency II is based on three guiding principles which cut across market, credit, liquidity, operational and insurance risk. The new system is intended to offer insurance organisations incentives to better measure and manage their risk situation - i.e. lower capital requirements, lower pricing etc. The new solvency system will include both quantitative and qualitative aspects of risk, each pillar focusing on a different regulatory component; minimum capital requirements, risk measurement and management and disclosure.
SOLVENCY II
Pillar 1 Quantitative Requirements Minimum capital Requirement Solvency Capital Requirement (SCR) Pillar 2 Qualitative Requirements & Rules on Supervision Pillar 3 Supervisory Reporting and Public Disclosure Transparency

Market Risk

Credit Risk

Liquidity Risk

Own Risk and Solvency Assessment (ORSA)

Capabilities and powers of regulators, areas of activity

Disclosure requirements

Technical Provisions Operational Risk Investment Rules Insurance Risk

Competition related Elements

Own funds

Quantification

Governance

Disclosure

Pillar I: Quantitative requirements

Pillar 1 concerns the Solvency II balance sheet. It requires regulated firms to calculate its capital requirement using either a standard formula or an internal model. Solvency II foresees two levels of capital requirements: Solvency Capital Requirements (SCR) Level of capital to enable firm to absorb significant unforeseen losses Gives reasonable assurance to policyholders and beneficiaries Calibrated at 99.5% confidence over 1 year Can use standard formula or own Internal Model Minimum Capital Requirements (MCR) Threshold that could trigger the ultimate supervisory action if breached Unacceptable risk to policyholder Consider expenses in run-off

Pillar 1

Quantitative Requirements
Minimum capital Requirement Solvency Capital Requirement (SCR)

Technical Provisions Investment Rules Own funds

Quantification

Pillar II: Qualitative Requirements & Rules on Supervision

1 The Supervisory Authorities and General Rules: supervisors shall be responsible for evaluating how insurance and reinsurance undertakings are assessing their capital adequacy needs relative to their risks (i.e. the Supervisory Review Process, or SRP). To perform this role, they are empowered to require remedial actions when capital does not seem to be adequate.
Pillar 2

Qualitative Requirements & Rules on Supervision

Own Risk and Solvency Assessment (ORSA) Capabilities and powers of regulators, areas of activity

2 The System of Governance: robust governance requirements being a pre-requisite for an efficient solvency system, (re)insurance company are requested to comply with the requirements on fit and proper, risk management, the ORSA, internal control, internal audit, the actuarial function and outsourcing. In particular, the underlying objective of the ORSA is to ensure they identify and assess all risks they are (or could be) exposed to; they maintain sufficient capital to face these risks; and they develop and better use risk management techniques in monitoring and managing these risks.

Governance

Pillar II: Qualitative Requirements & Rules on Supervision

Pillar II requires firms to have effective processes in place to measure and manage risk. The supervisory review ensures that these processes are adequate and that firms meet capital requirements. Supervisory Review Process Firm has considered all material risks Appropriate risk management systems and controls are in place Appropriate risk mitigation policies are in place and are effective Capital add-ons could be imposed Governance Written policies on risk management, internal control and internal audit Establishment of permanent and effective internal audit, internal control and actuarial functions Clear lines of responsibility and reporting of information reviewed annually Risk management system of strategies, processes and reporting procedures

Risk management Firms should have in place an effective, integrated risk management system The process needs to be owned by the Board Firms will need to produce their ORSA Companies will need to have their own view of the capital they need to meet their goals and hence they will need to define their risk appetite and put in place consistent risk policies

Pillar III: Supervisory Reporting and Public Disclosure

Pillar III deals with market transparency and discipline in the insurance industry, ensuring that firms publish key information that is relevant to the market.
Pillar 3

Market transparency and discipline will be increased in order to provide a better insight into the actual risk and return profile of an insurance company. Disclosure, market transparencies and market disciplines will include: Solvency & Financial Condition Report Extensive publishing duties Risk-Management Processes Scenario-Analysis Reinsurance Processes Push transparency towards corporate governance Dialogue with IASB Pillar 3 will aim to harmonise reporting to supervisors, including different types of information a supervisor needs to perform its functions and information normally not in public domain A more consistent and open regulatory framework should make it easier for companies to sell across different markets, promoting competition

Supervisory Reporting and Public Disclosure

Transparency Disclosure requirements

Competition related Elements ctivity

Disclosure

Pillar III: Public Disclosure and Supervisory Reporting

Public Disclosure
The Solvency and Financial Condition Report (SFCR) is an annual report in which firms disclose information relating to their solvency and financial condition. The SFCR covers: Business overview and performance - description of the business, objectives and strategies and performance. Governance structure. Solvency valuation basis . Risk and capital management processes - description of the strategy to identify, manage, mitigate and control each risk, level of available capital, capital requirements (possibly broken down by each component, i.e. MCR, SCR and capital add-ons) This is still being discussed. The amount and explanation of any breach in the MCR and SCR during the year. Qualitative description of the internal model.

Supervisory Reporting
The Report to Supervisor (RTS) is basically the outcome of the ORSA process. It includes all information necessary on a regular basis for the purposes of supervision. Compared to the SFCR, the information in the RTS will be more detailed. The RTS contains confidential information that is not disclosed in the SFCR. All insurers must disclose a complete qualitative RTS in 2013. In subsequent years, only substantive changes are reported. The supervisor may designate certain insurers, based on their risk profile, to supply a complete qualitative RTS annually. Core information" disclosed in Quantitative Reporting Templates (such as MCR and SCR) must be reported quarterly and other information annually.