Introduction to Solvency II. 2015, XL Catlin companies. All rights reserved. I MAKE YOUR WORLD GO 1

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1 Introduction to Solvency II 2015, XL Catlin companies. All rights reserved. I MAKE YOUR WORLD GO 1

2 What is Solvency II? Solvency II is a fundamental review of the capital adequacy regime for the European insurance industry. It aims to establish a revised set of EU-wide capital requirements and risk management standards that will replace the current solvency requirements, known as Solvency I. Primarily this concerns the amount of capital that EU insurance companies must hold to reduce the risk of insolvency. 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 early warning to supervisors so that they can intervene promptly if capital falls below the required level; and To promote confidence in the financial stability of the insurance sector. 2015, XL Catlin companies. All rights reserved. I MAKE YOUR WORLD GO 2

3 Historical Context Dating back to the 1970s, Solvency I was the first pan- European capital regulatory framework for the insurance industry, following on the heels of Basel I, aimed at the banking industry. Fortunately (or not), the Solvency I regime was relatively simple, with a formula related to written premium. Although premium represents one measure of risk for an insurance company, the business is usually much more complex. Solvency II is the new regulatory framework that adopts a more dynamic, risk-based approach 2015, XL Catlin companies. All rights reserved. I MAKE YOUR WORLD GO 3

4 Three Pillars of Solvency II Solvency II is based on three guiding principles (pillars); Quantitative Requirements, Supervisor Review and Market Discipline; which cut across Market, Credit, Liquidity, Operational and Insurance Risks Three pillar structure from Basel II has been adopted for the insurance industry The new system offers insurance companies incentives to measure and better manage their risk situation The new solvency system includes both quantitative and qualitative aspects of risk, each pillar focusing on a different regulatory component. 2015, XL Catlin companies. All rights reserved. I MAKE YOUR WORLD GO 4

5 Three Pillars of Solvency II Source: 2015, XL Catlin companies. All rights reserved. I MAKE YOUR WORLD GO 5

6 Three Pillars of Solvency II Pillar 1: Quantitative Requirements / Implementation Solvency Capital requirements (SCR) Quantification of risks (Internal Models, Parameterization, Data etc.) Pillar 2: Supervisor Review / Control Risk management What risks surround the business Documentation, Processes and Governance. Pillar 3: Market Discipline / Disclosure Transparency Implementing ERM and reporting on it to stakeholders 2015, XL Catlin companies. All rights reserved. I MAKE YOUR WORLD GO 6

7 Pillar 1 Solvency Capital Requirement / Model Choices Standard formula or Internal model? Organizations can apply either the standard formula, internal model or a combination of the two to calculate their solvency capital requirements. Standard formula The standard formula approach calculates the capital requirements of an insurer by determining the capital charges for various risks using prescribed formula, categorization and stress parameters and then aggregates them using prescribed correlation matrices. Internal model The internal model is a risk management system developed by an insurer to analyze the overall risk position, to quantify risks and determine the economic capital required to meet those risks (CEA definition). Using an internal model gives the firm the opportunity to alter the categorization and parameters to their specific risks. Partial model / parameters A combination of the above where firm specific stress parameters or categorizations are used for some of the risks that are not dealt with appropriately under the standard formula. 2015, XL Catlin companies. All rights reserved. I MAKE YOUR WORLD GO 7

8 Pillar 2 Risk Management, Governance and review Pillar 2 deals with the qualitative elements, defining both the principles of risk management systems and governance as well as the supervisory review Encourages insurers to develop and implement internal risk management processes Where risk management is defined in a broad sense, including actuarial reserving principles, accumulation control and asset liability management It includes specific requirement for formal risk management, actuarial and internal audit functions Insurers are required to embed a robust risk framework and carry out an Own Risk and Solvency Assessment (ORSA) against SCR calculations to determine their own capital requirement against which they manage the business. 2015, XL Catlin companies. All rights reserved. I MAKE YOUR WORLD GO 8

9 Pillar 2 - ORSA The ORSA is a process that provides additional insights beyond the standard capital requirements under Pillar I to enable a clear understanding of an insurer s risk profile. It can be defined as the entirety of the processes and procedures employed to identify, assess, monitor, manage, and report the risks a firm faces and to determine the own funds necessary to ensure that overall solvency needs are met. ORSA is not solely a quantitative representation of the risks but also requires a systematic identification, assessment and management of the risks. Clear documentation of all the activities of risk identification, risk measurement and assessment, risk mitigation actions, etc. within the ORSA context is extremely important. ORSA plays a key role in the communication between an insurance company and regulator. It is important that possible problems with an insurance company s capital adequacy are identified and reported where necessary. 2015, XL Catlin companies. All rights reserved. I MAKE YOUR WORLD GO 9

10 Pillar 3 Reporting and Disclosure Pillar 3 deals with the reporting and disclosure requirements, which aim to provide greater transparency to the stakeholders and information necessary for the purpose of supervision. Discloser of an annual report on the insurer s solvency and financial condition Requirements to submit necessary, non-public information to the supervisory authorities. Information may be required both for group, as well as individual company/legal entity, and may utilize other public disclosures in order to avoid duplication Information and reporting should be relevant, accessible, meaningful, reliable, and readily understandable Reflect the nature, scale, and complexity of the business (proportionality principle) Utilize assumptions and figures based on economic principles; be comparable and consistent over time 2015, XL Catlin companies. All rights reserved. I MAKE YOUR WORLD GO 10

11 Solvency II Group Considerations Solvency II s Group requirements include: A group solvency calculation, including eligible capital requirements A group ORSA Group disclosure and supervisory reporting Reporting of group risk concentrations and intra group transactions Requirements relating to group governance and risk management. Group solvency Method 1 - Accounting consolidation method (default method) Method 2 - Aggregation and Deduction method Combination of Methods 1 and 2 Capital fungibility considerations Local Restrictions Determination of Own Funds 2015, XL Catlin companies. All rights reserved. I MAKE YOUR WORLD GO 11

12 College of Supervisors What is College of Supervisors? College of Supervisors is a platform for cooperation and coordination dedicated to enhance the exchange of information among supervisory authorities involved within Group supervision. Key objectives: Be a platform for cooperation and coordination Enhance the exchange of information Facilitate group-wide supervision Enhance solo supervision Facilitate convergence of supervisory practices 2015, XL Catlin companies. All rights reserved. I MAKE YOUR WORLD GO 12

13 What s Next? Equivalence and Other Regulatory Regimes Switzerland (full) Australia Bermuda Brazil Canada Mexico US Other countries? International Association of Insurance Supervisors (IAIS) Applicable to global groups IAIGs (Internationally active insurance groups) Basel III for Banks Increasingly complex and coordinated Global Regulation!! 2015, XL Catlin companies. All rights reserved. I MAKE YOUR WORLD GO 13

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