Solvency II in practice. Speaker: Tim O Hanrahan Deputy Head, Insurance, Central Bank of Ireland 16 March 2016

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2 Solvency II in practice Speaker: Tim O Hanrahan Deputy Head, Insurance, Central Bank of Ireland 16 March

3 Recap on Solvency II Regulatory Framework under Solvency II Pillar I - Capital Pillar II - ORSA Pillar III Reporting 2 3

4 Recap on Solvency II The Solvency I regime has been in place since the 1970s and consists of 14 separate Directives. There have only been very minor modifications to the regime over that period. Break There was growing concern that the Solvency I requirements did not reflect the increasingly complicated risks facing the modern insurance industry. Solvency II is a more sophisticated regime where capital requirements will match the risk profile of the firm. Risk assessment and management of risk will be key tools in running the firm. The new Directive aims to introduce a safer and sounder insurance industry this will ultimately benefit consumers. Solvency II requires a new approach to supervision one that requires increased supervisory judgement! 3 4

5 Recap on Solvency II Regulatory Framework under Solvency II Pillar I - Capital Pillar II - ORSA Pillar III - Reporting 4 5

6 Regulatory Framework under Solvency II Insurance Directorate The revised structure, as illustrated below, is fully in place from 1 st of January Insurance Director Head of Supervision Head of Advisory, Analytics & Actuarial Services Onsite Inspections Domestic Life Domestic Non-Life Reinsurance Cross-Border Actuarial Services Manager Prudential Analytics Manager Supervisory Strategy, Authorisations & Projects Key Highlights Supervision: Sectoral-based supervision model having regard to IMF and EIOPA reviews; Building of a specific on-site inspection capability to support execution of supervisory mandate; To be supported by new PRISM engagement model for Solvency II. Analytics: Dedicated teams to actuarial & internal model support, prudential analytics and supervisory strategy across the directorate; Key focus on developing a big data and research capability within insurance directorate to identify trends and developments at an early stage to guide and steer supervisory agenda; New team dedicated to development of a house-view on supervisory matters as we move from policy development to implementation for Solvency II. 5 6

7 Regulatory Framework under Solvency II PRISM Framework PRISM Review - Progress Impact is being complemented with a Risk Score this will drive engagement level intensity. The four proposed categories of engagement level intensity are: Intensive, Enhanced, Standard and Basic. An intensity level is applied to each risk category for each company. Separate model for Low Impact firms. PRISM - Summary Supervisory engagement will focus on risk areas requiring most attention. Bespoke Risk Assessment Framework developed for Insurance. Changes delivered in February

8 Regulatory Framework under Solvency II Risk categories PRISM - Updated for Solvency II The goal of this work was to align the operating model within the Insurance directorate with the new supervisory regime Progress Full review of the Risk Assessment Framework and Supervisory Engagement model; The PRISM Risk Framework for insurance undertakings aligned with Solvency II requirements the realigned risk categories are below. 7 8

9 Regulatory Framework under Solvency II 2016 Core Focus Underwriting, Pricing, Reserving, Claims, Investments and Capital Adequacy Stress Testing; Brexit; Cyber Risk ; Day to Day Supervision Bespoke Supervisory Engagement Plan with Your supervisory team - Dependant on Sector and PRISM engagement intensity Level Focus on work includes Embedding Solvency II; ORSA; Capital; Technical Provisions; Day 1 and Q1 Reporting in May 2016; and Group Supervision. Other Issues Audit of Solvency II returns Consultation paper to issue; and Governance to create a consumer-centric culture. Non-Life Underwriting; Non-Life Claims; Operational Risk ; and On-site focus How is Risk Management embedded. Enhanced Supervision; Thematic Reviews Non-Life pricing and governance; Low Impact Model On-site and Off-site complemented by Thematic Inspection; and Group Supervision transactions with captives in Nonequivalent jurisdictions. 8 9

10 Recap on Solvency II Regulatory Framework under Solvency II Pillar I - Capital Pillar II - ORSA Pillar III - Reporting 9 10

11 Pillar I Capital Capital Requirements and Own Funds have changed significantly with the introduction of Solvency II. As at 31/12/2014 Non-Life firms Solvency ratio on a Solvency I Basis was 317% - The Solvency II ratio of Own funds to required capital was 127%*. To date, Quantitative Impact Studies, Preparatory phase reporting, Applications for approval of ancillary own funds, detailed discussions in relation to subordinated debt, detailed engagement with companies in relation to their capital. Next phase of information is Day 1 Reporting due in May. Capital Strategy; Own Funds; Required Capital; and Deferred Tax/Pension Surplus/Receivables/Reinsurance. *Unaudited figures, preparatory phase data for High and Medium High firms. 10

12 Pillar I Capital Capital Management Policy includes; Meet technical requirements of Solvency II; Consistency with Medium Term Capital Plan; Dividend/Distribution Policy; and Transitional Measures. Medium Term Capital Management Plan includes; Planned capital issuance; Terms of Own Fund items; Application of Distribution Policy; and How capital management plan incorporates the output from the risk management system and the forward looking assessment of own risks (based on the ORSA principles). What might supervisors ask? Copies of board approved policies? Discuss how the policies have operated in practice? How Capital Strategy is aligned with Overall strategy, business planning, Risk Management and ORSA? Overall Capital Target? 11

13 Pillar I Capital - Own Funds Key changes Tiers of Capital; Greater use of Subordinated Debt and Ancillary Own Funds; Subordinated Debt Detailed criteria (Directive/SI485 of 2015, Delegated Acts, EIOPA Guidance) Time consuming; Certain areas very clear, others require consideration (E.g. Encumbrances); Also consider Eligibility limits in stress scenario s e.g. Tier 3 If currently using Tier 3 capital to limit - no capacity for deferred tax assets? Ancillary Own Funds As subordinated Debt and also Regulatory approval required; What is the total exposure to the group? How is this monitored? Approval can be with conditions and subject to on-going review. What might supervisors ask? What is the mix of Tier 1, 2 and 3 capital? Is the firm close to any limits? Were all necessary approvals sought (Ancillary Own funds, Items not on the List)? And were any concerns raised in the approval process? Any review of Ancillary own funds necessary? Did we discuss Sub-ordinated Debt? What happens to Own Funds in a stressed scenario? 12

14 Pillar I Capital - Own Funds Eligibility Limits Eligibility limits SCR Surplus Tier 1 unrest. + rest. MCR Surplus Tier 1 unrest. + rest. Total T1 items 50% of SCR Tier 1 unrestricted basic own funds Total T1 items 80% of MCR Tier 1 unrestricted basic own funds Restricted T1 items < 20% of Total T1 Tier 1 restricted basic own funds Restricted T1 items < 20% of Total T1 Tier 1 restricted basic own funds Tier 2 basic own funds Thus T2 items 20% of MCR Tier 2 basic own funds Thus T2+T3 items 50% of SCR T3 items < 15% of SCR Tier 2 ancillary own funds Tier 3 basic own funds Tier 3 ancillary own funds 13

15 Pillar I Required Capital 207 Solvency II companies Currently 8 Internal Models and 199 companies using Standard Formula; In relation to Non-Life, 98 firms - 3 using Internal Models, 95 using Standard Formula. However, Internal Model firms are the larger firms so cover a higher proportion of the market. Standard Formula companies Multiple components and subcomponents of capital charge. 11 components of the required capital on regulatory return S Part 2 and further subcomponents. What might supervisors ask Is the capital charge computed correctly? What are the key drivers of a companies capital charge? Do the drivers of the capital charge make sense in the context of our understanding of the Company? Any data challenges in preparing? Levels of diversification? Treatment of Reinsurance? 14 15

16 Pillar I Capital Standard Formula 1 Market Risk 2 Counterparty default Risk 3 Life underwriting Risk Solvency Capital Requirement (SCR) 4 Health underwriting Risk 5 Non-life underwriting Risk 6 Diversification 7 Intangible asset risk 8 Operational risk Loss-absorbing capacity of technical provisions Loss-absorbing capacity of deferred taxes Diversification between ring fenced funds and between ring fenced funds and remaining part 15

17 Pillar I Capital Deferred Tax Impacts in a number of ways Recognition on Balance Sheet impacting on Available Capital Loss-absorbing capacity of deferred taxes on Required Capital Overall size of Deferred Tax requires careful consideration of Deferred Tax Assets and Liabilities and Loss-absorbing capacity of deferred taxes. Materiality considerations Size of Deferred Tax but also Capital Strategy of company. From 35 preparatory phase reports as at 31/12/2014, the levels of Deferred Tax assets, Deferred Tax Liability and Loss absorbing capacity of Deferred Taxes varies significantly across companies. The Loss absorbing capacity of deferred taxes has reduced the SCR on aggregate by 7%. This is based on preparatory phase data and the figures are expected to move on significantly. We will be publishing aggregate data from August

18 Key Considerations for Assessment Teams Pillar I Capital Deferred Tax What might supervisors be asking in relation to Deferred Tax? Materiality What is the overall level of deferred tax Deferred Tax Asset, Deferred Tax Liability and Loss-absorbing capacity of deferred taxes Capital Strategy Supervisors will consider responses in context of overall capital strategy Avoid double counting Taxable profits supporting any DTA arising after the 1 in 200 cannot be the same profits used to support any existing DTAs on the SII Balance sheet. Impact of any existing DTA on the recoverability period Profits used to justify the additional DTA arising from a 1 in 200 event are further away and more uncertain

19 Key Considerations for Assessment Teams Pillar I Capital Deferred Tax What might supervisors be asking in relation to Deferred Tax? How probable are future profits Projection Period? Credibility of Planning? History of recent losses? How credible is a post stress business plan After a stressed event will the company continue as is or could there be a significant curtailment in operations Is the modelling at a sufficiently granular level? Is the modelling at a sufficient level of granularity to address the relevant detail of all applicable tax regimes? e.g. different tax regimes in different countries Is the tax regime that actually determines taxes being modelled? 18 19

20 Key Considerations for Assessment Teams Pillar I Capital Defined Benefit Pension Schemes/Receivables Pension Benefit Surplus (if any!) Ring Fenced Fund - deduct from reconciliation reserve; Expect significant regulatory challenge if this is not the case. Debtors/Classification of Receivables Capital charge depends on volume of receivables and their quality. Our view for receivable balances is that the due date is by reference to the policy term and not by reference to any intermediary credit arrangements in place. Reinsurance Are the capital benefits appropriate in the context of the risk transferred

21 Recap on Solvency II Regulatory Framework under Solvency II Pillar I - Capital Pillar II - ORSA Pillar III - Reporting 20 21

22 ORSA Process - Review of 2015 FLAOR Reports First FLAORs Not ORSA, but ORSA principles Second FLAORs 24 reports from ultra-high, high & medium-high firms Dear CEO Letter Issued Individual supervisory reviews now progressing 21 22

23 ORSA Process Dear CEO Letter Board involvement evidenced Some firms have considered a wide range of risks Some good mitigation plans for non-quantifiable risks Firms have begun to assert continuing SCR compliance Risk profile deviation explanation is improved Using a more appropriate time horizon 22 23

24 ORSA Process - Findings from 2015 FLAOR Review Overall Solvency Needs Generally assessed as a capital buffer above the SCR Underlying capital for all quantifiable risks should be determined Next year: show capital linked to strategy and decisions Content Firms have taken the opportunity to put strategy, risk management system, business plans in one place (the FLAOR report). Next year: don t expect this to be repeated, but expect to see evidence of these structures etc. working. Reports range from 31 to 228 pages, average 88 pages Boards must find content useful Next year: to see impact of dynamic risk management system 23 24

25 ORSA Process - Findings from 2015 FLAOR Review Board use of the ORSA and the report Board and supervisor reports identical Next year: conclusions should be relevant (may follow naturally with a better link to strategy and decision making). Timing How long does it take to produce an ORSA report? Is it realistic to expect that a new ORSA can be done when the risk profile changes? This is the requirement A 24 25

26 Recap on Solvency II Regulatory Framework under Solvency II Pillar I - Capital Pillar II - ORSA Pillar III Reporting 25 26

27 Reporting Reporting Significant change under Solvency II - Over time, the existing Solvency I returns became less relevant to both insurance companies and their regulators Solvency II Reporting requirements include Day one (once-off) reporting of quantitative regulatory returns and narrative reporting; Regular report to supervisors including quarterly quantitative regulatory returns and annual quantitative regulatory returns and narrative reporting; Annual public reporting of the Solvency and Financial Condition Report, which includes both quantitative and narrative reports; and Own risk and solvency assessment (ORSA)

28 Reporting Challenges Include Volume of forms; Valuation Basis; Data challenges; Data Submission formats; Internal Governance. Experience to date - Preparatory Phase reporting, Test Environment, 2 Industry workshops, Solvency II matters, Accountancy Ireland Article (Oct 2015) Auditing of Returns Consultation paper will commence shortly

29 Reporting Next Milestone Day 1 Reporting Due 20/5/2016 1st Set of Quarterly returns (as at 31/3/2016) Due 26/5/2016 Quantitative reporting comprises: SII Reporting Requirements Insurance NSTs ECB Statistical NSTs Step change in data granularity and volume Test Environment remains open EIOPA will stop supporting the T4U tool in July

30 Reporting Technical Queries Online Reporting How-to Guides & Tutorials Test Online Reporting Access Queries XBRL Validation Errors Queries during testing Other technical Issues during testing Business Queries To your normal supervisory contact 29 30

31 Recap on Solvency II Regulatory Framework under Solvency II Pillar I - Capital Pillar II - ORSA Pillar III Reporting 30 31

32 Questions and Answers 31 32

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