Insurance Roadshow London, October Solvency 2 Update

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1 Insurance Roadshow London, October 2008 Solvency 2 Update

2 Agenda Progress to date Overview of key component of Solvency 2 Further issues for discussion Impact on ratings

3 Solvency 2 - What s new? Progress in 2008 > Quantative Impact Study 4 conducted, results pending > Draft Framework Directive debated in European Parliament, approved (by year end?) > Further draft advice published by CEIOPS (Committee of European Insurance and Occupational Pensions Supervisors) on: Groups Principles of proportionality Proxies Progress in 2007 > Quantative Impact Study 3 conducted, results published > Draft Framework Directive published in July by European Commission

4 Quantative Impact Studies 3 and 4 (QIS3 and QIS4) Preliminary Results for QIS4 compared with QIS3 > Overall reduction in solvency ratios compared with Solvency 1 (QIS3: the same) > UK: 95% of companies meet the Minimum Capital Requirement (MCR) (QIS3: 98% EU-wide) 89% of non-life, 73% of life companies meet the Solvency Capital requirement (SCR) (QIS3: 84% EU-wide) > Wide range (5% - 60%) of ratios of MCR to SCR > SCR Internal models results: Lower (60-70%) than standard formula for non-life business Higher (130%) than standard formula for life business

5 Future Developments Directive Adoption (EC & EP) Implementation (Member States) CEIOPS works on Implementing Measures Solvency 2 in force QIS 4 Next QIS? Industry preparation

6 Agenda Progress to date Overview of key component of Solvency 2 Further issues for discussion Impact on ratings

7 Overview of key component of Solvency 2 PILLAR 1 > Measurement of Assets, Liabilities and Capital MCR SCR > No clarity yet on preferred method of calculation: choice of Compact, or Linear approach > Standard formula or Internal Model > Insurance, Market, Default and Operational risks > Diversification between risk types Own Funds > 3 Tier classification Technical Provisions > Best estimate, discounted using risk free yield > Risk margin calculated using a constant 6% Cost of Capital

8 Overview of key component of Solvency 2 PILLAR 1 > Measurement of Assets, Liabilities and Capital MCR SCR > No clarity yet on preferred method of calculation: choice of Compact, or Linear approach > Standard formula or Internal Model > Insurance, Market, Default and Operational risks > Diversification between risk types Own Funds > 3 Tier classification Technical Provisions > Best estimate, discounted using risk free yield > Risk margin calculated using a constant 6% Cost of Capital

9 Solvency 2 Structure: Pillar 1 SCR SCR Basic SCR Operational Risk SCR Non-life Risk Market Risk Default Risk Life Risk Health Risk Reserving Underwriting Cat Equity Spread Interest rate Lapses Expenses Morb./Long. Long term Short term Work. Comp. Property Cat Currency Disability

10 Overview of key component of Solvency 2 PILLAR 1 > Measurement of Assets, Liabilities and Capital MCR SCR > No clarity yet on preferred method of calculation: choice of Compact, or Linear approach > Insurance, Market, Default and Operational risks > Diversification between risk types Own Funds > 3 Tier classification Technical Provisions > Best estimate, discounted using risk free yield > Risk margin calculated using a constant 6% Cost of Capital

11 Solvency 2 Structure: Pillar 1 Own Funds Own Funds - Limits for SCR Own Funds - Tiers Tier 3 Max 1/3 Tier 1 Min 1/3 Tier 1 Share capital and reserves Tier 2 Subordinated loans, Letters of Credit Tier 3 Other contingent capital Own Funds Criteria Tier 2 No limit 1. Subordination 2. Loss-absorbency 3. Perpetuality 4. Redemption requirement 5. Absence of mandatory fixed charges 6. Absence of encumbrances TIER 1

12 Overview of key component of Solvency 2 PILLAR 1 > Measurement of Assets, Liabilities and Capital MCR SCR > No clarity yet on preferred method of calculation: choice of Compact, or Linear approach > Insurance, Market, Default and Operational risks > Diversification between risk types Own Funds > 3 Tier classification Technical Provisions > Best estimate, discounted using risk free yield > Risk margin calculated using a constant 6% Cost of Capital

13 Overview of key component of Solvency 2 (cont.) PILLAR 2 > ORSA (Own Risk & Solvency Assessment) > Potential capital add-ons For risks not covered by SCR, or If weaknesses exist in company s governance and controls > On site visits > Supervisory peer reviews

14 Overview of key component of Solvency 2 (cont.) PILLAR 3 > Annual report on solvency and financial condition containing info on: MCR, SCR, quality of own funds SCR add-ons Non-compliance with MCR and SCR Valuation basis for assets and liabilities Risk profile, risk management and governance systems

15 Agenda Progress to date Overview of key component of Solvency 2 Further issues for discussion Impact on ratings

16 Issues - Nitty-gritty details > Own funds classification > MCR > SCR Hybrids need for consistency of methodology with Banks Linear approach not risk-based Calibration of compact approach Equity risk charge calibration, dampener to shock proposal Life risks parameterisation issues > Operational Risk Simplistic formula > Cost of capital Justification for constant 6% assumption

17 Issues - Keeping things simple > Simplifications to standard formula Proportionality principle Limits to application > Proxies Use of benchmarks and market data to calculate provisions Temporary or permanent use?

18 Issues - Big picture > Groups Group support regime purpose and application Allowance for Diversification Fungibility of capital > Equivalency measures for Non-EU subsidiaries > Internal models Standard for approval how high? Who reviews and approves role of independent/external opinion

19 Agenda Progress to date Overview of key component of Solvency 2 Further issues for discussion Impact on ratings

20 Impact on Ratings > No widespread upgrades / downgrades expected Impact on Insurance sector > M&A activity > Rebalancing of investment portfolios > Rebalancing of capital allocated to lines of business

21 Solvency II Overall Impact > Higher Regulatory Solvency requirement for some insurers > Greater focus on embedding internal models into day-to-day operations > Some M&A activity, re-allocations within investment portfolios and between product lines

22 Fitch Ratings New York One State Street Plaza New York, NY FITCH London 101 Finsbury Pavement London EC2A 1RS Singapore 7 Temasek Blvd. Singapore The Fitch Group Fitch Ratings Algorithmics Fitch Training

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