Solvency II Update. Nick Dexter. 24 November 2011

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1 Solvency II Update Nick Dexter 24 November 2011

2 Agenda Solvency II Overview Current Status of Solvency II Own Risk and Solvency Assessment Solvency II v Canadian regime 2

3 Solvency II Overview

4 Solvency II Overview What is Solvency II? Solvency II is a major overhaul of the European supervisory structure for insurers replacing the existing regulatory regimes across Europe. It aims to: increase policyholder protection across Europe; encourage transparency and market discipline; remove regulatory barriers to entry by setting a level playing field increasing competition. It is based on the principles of: market consistency; risk-based capital requirements; market discipline through enhanced transparency; group-wide application and supervision. 4

5 Solvency II Overview Solvency II overview: The Three pillars Three pillar approach (similar to Basel II approach) Pillar 1 Pillar 2 Pillar 3 Quantitative requirements SII accounting basis Minimum Capital Requirement (MCR) Solvency Capital Requirement (SCR) Investment rules Qualitative requirements Principles for internal control and risk management Individual risk and capital assessment Supervisory review process Market discipline Transparency Disclosure Support of risk-based supervision through market mechanisms Market-consistent valuation Capital calculation New focus for supervisors Maximum level of harmonisation Use test More pressure from capital markets More pressure from rating agencies Supervision on a group basis (colleges) 5

6 Solvency II Overview The UK market scorecard Insurance risk risk Risk strategy and appetite Governance Monitoring and management Reporting &/MI Market risk risk Liquidity risk risk Credit risk risk Organisation Quant Measures Models / Validation Capital Reqs (SCR/ MCR) Pillar I Use test Outsourcing Own Risk and Solvency Assessment (ORSA) Pillar II Disclosure Disclosure Pillar III Reinsurance Systems and data Operational risk risk Policies, standards and definitions Internal control 6

7 Solvency II Overview Pillar 1 Capital modelling alternatives Model concepts under Solvency II Fields of application ACCURACY standard approach factor formula or scenarios, partial internal model full internal model full company specific measurement of risk company specific enhancement of parts of a standard approach COMPLEXITY & EFFORT business planning and performance management capital management ERM structuring reinsurance portfolio management limit system supervisory purposes page 7 7

8 What is an Internal Model? No definition was given by the Solvency II Framework Directive but Industry bodies attempts to define it as: A risk management system developed by an insurer to analyse the overall risk position, to quantify risks and to determine the economic capital required to meet those risks IAIS 2007 The overall internal model process is much wider than a capital calculation engine and reflects the importance of the methods by which parameters are developed and how the output is used in the company s decision making and risk management framework. A successful internal model will involve the integration of expertise across many disciplines Institute & Faculty of Actuaries

9 Why use an Internal Model? From a firm s perspective: Lots of incentives to do so! Lower capital requirements standard formula approach are most likely be calibrated conservatively Good risk management better ratings from rating agencies lower cost of capital Competitive advantage in the market through additional insight provided by internal models Important part of a company s ERM framework From a regulator s perspective: To maintain a better market place The development of an internal model encourage firms to understand their risks better The industry as a whole would be better equipped to manage their risks and hence gain more confidence from the general public Achieve stability of the insurance markets (e.g. by avoiding systemic risk) 9

10 Current status of Solvency II

11 Current status of Solvency II Where are we in the process? Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Omnibus 2/ SII level 1 Level 2: Delegated acts Council on-going EP vote 17 January 2012 Commission working draft Public consultation/ finalisation Level 2: Implementing technical standards EIOPA pre-consultation EIOPA public consultation and draft advice to Commission (to end 2016) Level 3: Guidelines No clear timetable Industry milestones FSA IMAP window Live date? Implementation progress report Live date? 11

12 Current status of Solvency II Omnibus 2 Directive : Proposed timeline PHASING IN 2015 Jan Omnibus II Initial Draft Jul ECON Proposal Jun Implementing Technical Standards Jul Jan Jun Jul Transitional Provisions (ECON Proposal) Companies may be given up to 2 years to: Comply with SCR (if Balance sheet total is less than 500 bn) Supervisory authorities given power Information to be provided by firms (ECON proposal): Calculation of SCR, MCR, own funds Have in place all appropriate systems and structures for reporting requirements Have in place appropriate systems and structures to provide info for group supervision ECON Council Balance sheet and profit and loss account prepared in accordance with the Directive information referred to in Article 35, which may be waived for companies which do not comply fully with the requirements to have appropriate systems and structures in place in accordance with Article 35(5) FULL IMPLEMENTATION 12

13 Current status of Solvency II Omnibus II The main amendments that Omnibus II proposes to make to Solvency II fall into the following categories: Deferral of the implementation date of Solvency II; Introduction of transitional measures; Procedural changes reflecting the change from CEIOPS to EIOPA; and Incorporating EIOPA s enhanced role in the supervisory process Omnibus II is currently at proposal stage only where the first draft published in January 2011 deferred the Solvency II implementation date from 1 November 2012 to 1 January There have been a number of redrafts to the Omnibus II directive during the year. 13

14 Current status of Solvency II The FSA view Following the Council s updated draft of Omnibus II issued on 21 September 2011, the FSA has now confirmed that it has changed its implementation assumptions and is now planning on the following key dates: Supervisors and EIOPA responsibilities gained - 1 January 2013 Firm requirements switched on - 1 January Internal model application window will start on 30 March 2012 as previously announced, but will now run to mid-2013 (previously intended to close on 31 May 2012). For standard formula firms, FSA will be open for any required approvals from 1 January There is no comment in the FSA announcement regarding the possibility of replacing the Individual Capital Assessment (ICA) regime with a Solvency II overlay in 2013, 14

15 Own Risk and Solvency Assessment

16 Own Risk and Solvency Assessment Definition of the ORSA The ORSA can be defined as the entirety of the processes and procedures employed to identify, assess, monitor, manage and report the short and long term risks an undertaking faces or may face and to determine the own funds necessary to ensure that the undertaking s overall solvency needs are met at all times Return ORSA (CEIOPS Issues Paper on the ORSA) Insurance and reinsurance undertakings shall have in place an effective risk-management system comprising strategies, processes and reporting procedures necessary to identify, measure, monitor, manage and report, on a continuous basis the risks, at an individual and at an aggregated level, to which they are or could be exposed, and their interdependencies Risk Capital, performance and risk management Solvency Capital Risk Management System (Article 44) From the definitions above it can be seen that there is significant overlap between the ORSA process and the risk and capital management system 16

17 Own Risk and Solvency Assessment Requirements Background The Solvency 2 Directive Level 1 text requires all firms to perform an own risk and solvency assessment (ORSA) as part of its risk management system. Fundamentally, the ORSA is a process that firms will be required to design and have in place and then document to demonstrate compliance The requirements The ORSA is required to include the firm s view of at least: Its overall solvency taking into account its own risk profile Its compliance, on a continuous basis, with its MCR, SCR and technical provisions The significance with which the firm s risk profile deviates from the assumptions underlying their SCR The risks it faces in both the short and long term The ORSA is required to be an integral part of the firm s business strategy. The ORSA is required to be independently assessed 17

18 Own Risk and Solvency Assessment Why ORSA is important Requires a number of activities that supervisors consider a firm should be doing that don t fall elsewhere e.g.: Aligns the management of significant risks Pillar 2 with the undertaking s own funds and solvency requirement Pillar 1 Enhances decision-making through assessments of the impact on the undertaking s risk profile and solvency and its strategic and business development planning Facilitates discussions with regulators about management s ability to assess key present and future risks Get firms thinking beyond Pillar 1 (if on standard formula) Ensures that firms have a process in place to meet the Pillar 1 requirements Aims at multidisciplinary teams within a firm working closer together 18

19 Own Risk and Solvency Assessment Requirements principles Evaluating the past and present Technical provisions Regulatory capital Overall solvency needs SCR deviations Looking to the future Risk profile Solvency projections Strategy link Stress tests Process Design Standard formula / Internal model Integration multi-disciplinary requirement Frequency metrics OWN ASSESSMENT Application Proportionality Valuation Independent challenge Documentation / ORSA Report Decision-making 19

20 Own Risk and Solvency Assessment What should firms be asking themselves? Emphasis on their own assessment How much capital do we think we need? When and how often do we need to run this assessment? Have we met the regulatory requirements over the year and what process have we used to ensure continuous compliance? Do we think we have the right SCR? Can we meet the capital requirements in the future given our strategy? Is the strategy within risk appetite? Have we involved the right people internally to undertake this assessment? If not / no, why not / what do we do about it etc? 20

21 Own Risk and Solvency Assessment Supervisory expectations for ORSA Part of a firm s risk management framework/process Does not require an undertaking to develop an internal model Is not a regulatory capital requirement - different from SCR and MCR Supervisory review focused on the process (not the outcome) and will include our understanding of the risks in the firm Principles-based firm s own assessment (lack of regulatory prescription) needs thought and application! Understand the business Should not be too burdensome (i.e. proportionate to nature, scale and complexity of the business) 21

22 Own Risk and Solvency Assessment Challenges Coherent & Robust Process Multidisciplinary approach The focus of the ORSA is on the process and not the outcome. How does it work? Who owns it and starts it? How does the process include ensuring continuous compliance? How does the process build in the forward-looking perspective? How often is it run? Challenge of bringing the required expertise together in one coherent process The Past The ORSA requires a review of the firm s compliance with the technical provisions and the regulatory capital requirements. The Future The ORSA requires future projections of the balance sheet, capital requirements and own funds over the business planning horizon. How sophisticated should the forecasting be? Documentation Documentation needs to fulfil two purposes: 1) Allow easy completion of the Pillar 3 requirements (SFCR and RSR) and 2) Appropriately evidence that the outcomes have been met. Proportionality The ORSA should be tailored to fit the risk profile of the business. 22

23 How does Solvency II compare to the Canadian regulatory regime for insurers?

24 Solvency II compared to the Canadian regulatory regime How Canadian regulatory practices compare to Solvency II Pillar 1: Quantitative requirements Similarities & Differences* * differences are in italicized text Canadian capital requirements use the same measurement basis as the published financial statements unlike other jurisdictions that use a statutory/regulatory model Canadian rules based largely on standard model, limited use of ownuse models (eg. segregated funds) S II capital formula: is more complex includes margin for operational risk, and credit for diversification allows own-use models, with approval to be based on market-consistent valuations as to some extent is Canada now Canadian Outlook OSFI has expressed reluctance to have a capital model that is less demanding than the accounting model concerns expressed that IFRS stage 2 will create capital volatility in Canada but not in other countries may create pressure for Canada to disconnect regulatory capital from accounting New Canadian capital rules becoming more complex including specific measures of additional risks own-use/economic capital modeling will likely become more accepted, with a use test will complex capital models become a competitive differentiator? 24

25 Solvency II compared to the Canadian regulatory regime How Canadian regulatory practices compare to Solvency II, cont d Pillar 2: Qualitative requirements Pillar 3: Market discipline Convergence and equivalence Similarities & Differences* * differences are in italicized text Strong interest in risk management practices Governance, fit and proper tests, and sound practices standards are very similar Canadian analysts and rating agencies have for several years been deeply interested in disclosures of regulatory capital information S II public disclosures are much more detailed EU has declared Switzerland, Bermuda and Japan equivalent US not being assessed Canada is not in the queue yet either Canadian Outlook Increasing convergence Canadian regulators are active in IAIS and are citing IAIS standards and ICPs Introduction of ORSA Own-use capital models are less comparable between companies than standard models will markets find these less useful? Canadian regulators are active in IAIS, and both influence and align with international developments Less clear whether formal equivalence with S II will be sought in the near term Is equivalence an advantage for Canadian insurers? 25

26 Thank you Nick Dexter Partner KPMG Risk Consulting Tel: 44 (0) Fax: 44 (0) Mobile: 44 (0)

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