Impacts of the Solvency II Standard Formula on health insurance business in Germany

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1 Impacts of the Solvency II Standard Formula on health insurance business in Germany Sascha Raithel Association of German private healthcare insurers

2 Agenda 1. Private health insurance business in Germany 2. Current regulatory framework (Solvency I) 3. Quantitative Impacts of Solvency II 4. Conclusion 2

3 1. Private health insurance business in Germany The private healthcare insurance association (Verband der privaten Krankenversicherung e.v. (PKV-Verband, PKV)) had 46 ordinary member companies on 31 December The precondition for membership in PKV is that an insurance company has to conduct its business in Germany and be approved by the German Federal Institute for Financial Services Supervision (Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin)). The companies that offer private health insurance are bound to regulations about calculation, capital investment, group structure and the form of contract in order to guarantee a lifelong contract term. 3

4 1. Private health insurance business in Germany Germany has a special health insurance system in comparison with other countries. Types of PKV healthcare insurance products: Comprehensive healthcare insurance (instead of a mandatory healthcare insurance (GKV)) Long-term care insurance Additional insurances (outpatient tariffs, tariffs for elective hospital services, dental care tariffs) Special form of PKV healthcare insurance: - foreign travel healthcare insurance - special-purpose insurance policies - state health care reinsurance - insurance against residual debt and ongoing payment of wages/salaries 4

5 1. Private health insurance business in Germany Customer base of PKV healthcare insurance on 31 December ,000,000 11,769,700 10,000,000 8,639,300 9,352,400 8,000,000 6,627,800 6,000,000 5,382,700 4,000,000 3,404,000 2,000,000 0 Comprehensive healthcare insurance Long-term care insurance Additional insurances, outpatient tariffs Additional insurances, tariffs for elective hospital services Additional insurances, dental care tariffs Additional insurances, per diem sick pay 5

6 1. Private health insurance business in Germany Revenue from contributions of PKV healthcare insurance in 2008 in Mio. Special forms of insurance % 19.45% 2.21% Additional insurances 5, % Long-term care insurance 1, Comprehensive healthcare insurance 21, ,000 10,000 15,000 20,000 25,000 6

7 1. Private health insurance business in Germany Insurance benefits and revenue from contributions and superannuation accruals of PKV ( mill.) in 2008 & 2007 Superannuation accruals 123, , Superannuation accruals 8.68% Total revenue from contributions (healthcare and long-term care) Total insurance benefits (healthcare and long-term care) 29, , , , Total revenue from contributions (healthcare and long-term care) Total insurance benefits (healthcare and long-term care) 2.95% Change 2008/2007 in percent 6.73% Private health insurance business is predominant calculated on a similar technical basis to that of life insurance with the possibility of increasing premiums or reducing payments even for current contracts. 7

8 1. Private health insurance business in Germany Capital assets of PKV healthcare insurance in 2008 Total capital assets: ,8 Mio. capital asset mix (approximated) 7% 6% 5% 82% Fixed income Equity Property Duration of fixed income assets: 5-9 years Predominant rating of fixed income assets: A - AAA Other capital assets (cash, private equity, hedge funds, commodities) 8

9 Agenda 1. Private health insurance business in Germany 2. Current regulatory framework (Solvency I) 3. Quantitative Impacts of Solvency II 4. Conclusion 9

10 2. Current regulatory framework (Solvency I) Current regulatory framework Solvency I based on Directive 2002/13/EC of the European Parliament & the Counil of the EU of 5 March Art. 16a, clause 1 in combination with clauses 3 and 4: The required solvency margin shall be determined on the basis either of 16-18% annual amount of premiums ( ) or of 23-26% the average burden of claims for the past three years. Art. 16a, clause 2: The amount of the required solvency margin shall be equal to the higher of the two (above) results. Art. 16a, clause 6: The fractions applicable to the (above) portions shall be reduced to a third in case of health insurance practised on a similar technical basis to that of life assurance, if 10

11 2. Current regulatory framework (Solvency I) a) the premiums paid are calculated on the basis of sickness tables according to the mathematical method applied in insurance; b) a provision is set up for increasing age; c) an additional premium is collected in order to set up a (special) safety margin of an appropriate amount; d) the insurance undertaking may cancel the contract before the end of the third year of insurance at the latest; e) the contract provides for the possibility of increasing premiums or reducing payments even for current contracts. Most of the health insurance products in Germany comply with these conditions, so the current required solvency margin (Solvency I) is between 5-6% of the annual amount of premiums. 11

12 2. Current regulatory framework (Solvency I) Example (simplified): Two health insurers No. 1 and No. 2 have each annual amounts of premiums of 100 Mio. - Health insurer No. 1 is rather risk neutral, e.g. in terms of assets, and - Health insurer No. 2 is more risk-averse Altough the economic risk profile of health insurer No. 1 is higher than the economic risk profile of health insurer No. 2, both health insurers would have the same required Solvency-I-margin (risk capital), e.g. 100 Mio. * 6% = 6 Mio.! 12

13 2. Current regulatory framework (Solvency I) Disadvantages of Solvency I? - Solvency I is a quite rough approach - the specific risk profiles are not taken into account - diversification effects are not considered - Asset-Liability-Management-(ALM-)aspects and the risk attitude of the management body are not regarded. => the economic risk profile is not (or hardly) measured appropriate. In fact there might be even incorrect economic risk management incentives, e.g. the lower the annual amount of premiums is (the higher are c.p. the economic risks), but the lower! is the required solvency margin of Solvency I! Further problems: - different interpretations of responsibilities & power of 27 EU supervisory bodies - EU-insurance market is hardly harmonised & there might be arbitrage - misallocation of capital and net over-capitalisation across the market - distortions of competition within the EU (no level playing field) 13

14 Agenda 1. Private health insurance business in Germany 2. Current regulatory framework (Solvency I) 3. Quantitative Impacts of Solvency II 4. Conclusion 14

15 2. Future regulatory framework (Solvency II) Calculation of the technical provisions (2009/138/EC, Art. 77) 1. The value of technical provisions (TP) shall be equal to the sum of best estimate (BE) and a risk margin ( ). 2. The BE shall correspond to the probability-weighted average of future cash-flows, taking account of the time value of money ( ), using the relevant risk-free interest rate term structure ( ). 3. The risk margin shall be such as to ensure that the value of TP is equivalent to the amount that insurance ( ) undertakings would be expected to require in order to take over and meet the insurance ( ) obligations. 15

16 3. Quantitative Impacts of Solvency II Using the relevant risk-free interest rate term structure for calculation BE The actuarial interest rate must not exceed 3,5% ( 4 Kalkulationsverordnung (KalV)) and could be change in the medium-term, even for current contracts 16

17 3. Quantitative Impacts of Solvency II Quantitative Impact Studies of the European Commission (since 2005) 24 German health insurers with a market share of 80% participated in the Fourth Quantitative Impact Studie (QIS4) of CEIOPS on behalf of the European Commission in About 67% of PKV QIS4-participators are stock corporations and 33% are mutuals. 17

18 3. Quantitative Impacts of Solvency II Local GAAP balance sheet (HGB) in comparison to SII (in 2008, average) Local GAAP (HGB) Solvency II Reinsurance 0,9 Equity 2,7 Reinsurance 0,9 Equity 7,2 Equities 10,0 Equities 9,7 Riskmargin 1,6 Bonds 41,7 Bonds 46,8 Property 1,9 Property 2,9 Loans 40,5 TP 94,5 Loans 34,3 TP 85,8 others 5,0 others 2,8 others 5,4 others 5,5 18

19 3. Quantitative Impacts of Solvency II Ratio (technical provisions of Solvency-II (QIS4) in comparison to technical provisions of local GAAP balance sheet (HGB)) Insurer 1 Insurer 2 Insurer 3 Insurer 4 Insurer 5 Insurer 6 The ratio depends on the economic risk profile of each insurer, e.g. capital asset mix, duration & rating of fixed income assets and the amount of the additional safety margin (at least 5%), 7 KalV. 19

20 3. Quantitative Impacts of Solvency II Technical provisions impacts of Solvency II For health insurance business in Germany the technical provisions will generally reduce slightly under Solvency II (average value). The extent of the change depends upon the level of risk free yields relative to the prescribed valuation rate at the time Solvency II comes into force (expected 1 November 2012 (2009/138/EC, Art. 310)). 20

21 3. Quantitative Impacts of Solvency II Structure of risk drivers to SCR The key risk drivers to SCR are market risk and underwriting risk. The main elements of market risk are spread risk, property risk, equity risk and interest rate risk, since the assets and liabilities are typically not matched perfectly by term and due to the fact that investments are made mainly (about 82%) in fixed income assets. The main elements of underwriting risk are claims/morbidity risk and lapse risk. Due to the premium adaption clause the interest rate risk and the underwriting risk are mitigated in Germany. 21

22 3. Quantitative Impacts of Solvency II Structure of SCR underwriting risk (average values) 22

23 3. Quantitative Impacts of Solvency II Structure of SCR underwriting risk (fictive examples) 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 10% 10% 15% 20% 45% 15% 14% 11% 7% 18% 25% 35% 14% 14% 29% 35% 40% 45% 29% 13% 16% 7% 8% 11% 11% 18% 14% 25% 24% 22% Insurer 1 Insurer 2 Insurer 3 Insurer 4 Insurer 5 Insurer 6 Structure of SCR underwriting risk depends on the economic risk profile of each insurer. CAT risk expense risk longevity/mortality lapse risk claims/morbidity 23

24 3. Quantitative Impacts of Solvency II Structure of SCR market risk (average values in 2009) 24

25 3. Quantitative Impacts of Solvency II Structure of SCR market risk in % of the total SCR market risk (fictive examples) currency risk concentration risk property risk equity risk spread risk interest rate risk 10 0 Insurer 1 Insurer 2 Insurer 3 Insurer 4 Insurer 5 Insurer 6 Structure of SCR market risk depends on the economic risk profile of each insurer, particulary on the capital asset mix, duration & rating of fixed income assets. 25

26 3. Quantitative Impacts of Solvency II Structure of QIS4-Basis-SCR (average values in 2008) market risk underwriting risk diversification effects* -10 * := the correlation between SCR (u/w-risk) and SCR (market risk) = + 0,25, cp. 2009/138/EC, Annex IV, 1. 26

27 3. Quantitative Impacts of Solvency II Capital Requirements and AFR impacts of Solvency II Solvency II will lead to an increase in capital required based on the SCR, because the requirements under Solvency I does not capture the risks embedded in the different products or the risks associated with how the management run the business. The size of the increase depends particulary on market risks, claims inflation, limitation of premium increase and the amount (/capability) of profit sharing to policyholders. Solvency II will move the assessment of the value of assets from book to market value. So market conditions will determine the impacts that changes in the value of capital assets could have on the level of AFR. In the Quantitative Impact Studies (QIS1-QIS4) the AFR of health insurance business in Germany increased significantly. 27

28 3. Quantitative Impacts of Solvency II Solvency II Ratio in comparison to Solvency I Ratio (AFR/SCR in % average values) meanvalue ( ) standard deviation ( ) Solvency I Solvency II* * According to the technical specifications of QIS3 (2007), QIS4 (2008), QIS4modified (2009), cp => Solvency II Ratio (AFR/SCR) will be more volatile & risk sensitive 28

29 3. Quantitative Impacts of Solvency II Solvency II Ratio in comparison to Solvency I Ratio of health insurance undertakings (examples) SI 2008 SI 2009 SI 2007 SII 2008 SII 2009 SII risk averse insurer risk neutral insurer => Solvency II Ratio (AFR/SCR) has to take the true risk profile of health insurers better into account. The calibration of each risk factor and each correlation between SCR components have to be appropriate. 29

30 Agenda 1. Private health insurance business in Germany 2. Current regulatory framework (Solvency I) 3. Quantitative Impacts of Solvency II 4. Conclusion 30

31 4. Conclusion Solvency II will have quantitative and qualitative impacts on health insurance business in Germany Solvency II will be based on economic principles for the measurement of assets and liabilities SCR and AFR will increase. The level of the Solvency II Ratio will be near the Solvency I Ratio, but will be (much) more risk-focused and volatile Solvency II will be good for all stakeholders and shareholders and could become a shining example for a global regulatory framework for insurers 31

32 Contact Details Sascha Raithel Association of German private healthcare insurers (Verband der privaten Krankenversicherung e.v.) Bayenthalguertel Cologne Germany Phone: /

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