An introduction to Solvency II

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1 An introduction to Solvency II Impact on your organisation The Netherlands Singapore Germany Date: October 2013 Author: Sander Ver Loren van Themaat & Bert-Jan Nauta

2 Introduction Solvency II will establish harmonised requirements across the EU Solvency II is an EU Directive aimed at protecting interests of policy holders and stability of the financial system, by ensuring financial stability (solvency) of European (re)insurance companies. The rules stipulate the minimum amounts of financial resources that (re)insurers must have in order to cover the risks to which they are exposed. Solvency I Drivers behind Solvency II The Solvency margin is the amount of regulatory capital an insurance undertaking is obliged to hold against unforeseen events. Solvency margin requirements have been introduced in A limited reform was agreed by the European Parliament and the Council in 2002, which is known as Solvency I. Primarily focused on the prudential standards for insurers and did not include requirements for risk management and governance within firms. Lack of risk sensitivity Scattered EUinsurance market Sub-optimal supervision for groups Several key risks, including market, credit and operational risk, are not properly captured. Risk measurements are not forward-looking and contain very few qualitative requirements. Ensure accurate and timely intervention by supervisors. The present EU framework sets out minimum standards that can be supplemented by additional rules at national level. Differences on a national level result in increased costs for EU insurers and policy holders and hinder competition within the EU. Gap between the way groups are managed and supervised. The current approach to the supervision of groups focused on legal entities, while in reality groups have become increasingly centralised. Lack of convergence A lack of international and cross-sectoral convergence undermines the competitiveness of EU insurers. Lack of cross-sectoral consistency also increases the possibility of regulatory arbitrage. An introduction to Solvency II 2

3 The main elements of Solvency II Increased requirements on risk management and supervision Given the weaknesses of the Solvency I regulation, Solvency II has the objectives to: deepen the integration of the EU insurance market, enhance protection of policyholders and to improve the international competitiveness. These objectives are translated into a framework which is based on three pillars. An overview of the key issues of Solvency II is provided below. Solvency II Pillars Pillar 1 Pillar 2 Pillar 3 Quantitative requirements Focus on quantitative requirements for insurers. 1. Valuation principles. The prudential balance is based on market values (of Assets & Liabilities) and gives a realistic estimate of the financial position of the insurer. 2. Capital requirements. Insurers must comply with two capital requirements: Solvency Capital Requirements (SCR) Minimum Capital Requirements (MCR) SCR are additional requirement on MCR to cover 99.5% to secure bridging one year. If capital is below SCR the supervisor may interfere. Supervisory review Focus on qualitative risk management and system of governance. 1. Risk management. Includes strategies, processes, and procedures necessary to identify, manage and report on the risks at individual and aggregated level. 2. Own Risk and Solvency Assessment (ORSA). As part of the risk management function an insurer assesses recurrently risk and solvency. 3. Capital Add-on. The Supervisor can adjust capital requirements of insurers by a so called capital add-on. Market discipline Focus on disclosure, this should enhance transparency and market discipline. Two reporting streams defined: Reports for the public (Solvency and Financial Condition Report - SFCR). Reports for the supervisor. These disclosures will encompass to various degrees: Business overview and performance Governance Valuation basis used for solvency purposes Risk and capital management Group supervision An additional layer of supervision on consolidated level in addition to individual supervision on insurers, to mitigate systematic risk. An introduction to Solvency II 3

4 Timeline & Stakeholders An on going process that affects numerous stakeholders The proposed implementation date for Solvency II was set at January 2014 and will not be met. This is primarily due to adoption to the Lisbon treaty, covered in a legislative proposal known as Omnibus II. As of today, the final draft of Omnibus II is still waiting for parliament s vote. In October 2013 it was announced that the application date is postponed to January Timeline Introduction of Solvency I, a verification and harmonization of existing EU-wide solvency requirements. Solvency II level one directive approved by the European Parliament and adopted by the European Council. Target application date November Deadline seems unrealistic given the slow progress on Omnibus II. First Quick Fix. The Commission proposes that transposition of Solvency II will be in June 2013 and application from January Application deadline 1 January, During the introduction. the demand for a second more comprehensive reform process evolved. Solvency II level one text has to be adopted to the Lisbon Treaty, A legislative proposal known as "Omnibus II will be developed. Start negotiations on Omnibus II directive (The Commission, the Council and the European Parliament) CEIOPS replaced by EIOPA. Second Quick Fix. Application date is postponed to January 2016 and Transposition date to January Who benefits with decreased chances of failing insurers? Policyholders Uniform/enhanced level of protection across EU and strengthen confidence in insurers products. Increased competition (price drops and increase in innovation). Insurers Alignment of supervisory requirements with market practices. True level playing field. International competiveness. Supervisors Better supervisory tools, enabling more timely and effective action. Sharing of tasks between solo and group supervisors. Economy as a whole Increase international competiveness of insurers. Efficient allocation of risk and capital. Decrease in cost of raising money by insurers. An introduction to Solvency II 4

5 Legend Your organisation: Key impact areas of Solvency II Solvency II has a high impact on risk related areas Compliance Develop and implement policies and procedures for ORSA test. Enhance existing control environment for increased requirements. Risk / ALM Develop capital models for capital management on SCR and MCR. Develop integrated model capability to set risk appetite tolerance. Business model Procedure to assess diversification benefit across products and business units. Data Management Enhance effective data. management system for reporting and risk. Underwriting Changes in risk appetite may affect product offering. Reporting Design reports for key stakeholders (supervisors, analyst, policyholders). Technology Infrastructure and running costs increase due to more stringent requirements. Operating model Adjust operating model across risk, actuarial, finance, compliance and audit. Develop processes and systems for additional reporting requirements. High impact Medium impact Low impact An introduction to Solvency II 5

6 How we can help you to manage the impact Functional expertise with broad project management experience We support our clients (banks, insurance companies and pension funds) in successfully translating business strategy into organisational design, optimised business processes and technology solutions. Our wide functional expertise areas result in effective and commercially relevant solutions. High impact areas Our expertise areas Risk / ALM Develop capital models for capital management on SCR and MCR. Develop integrated model capability to set risk appetite tolerance. Business model Procedure to assess diversification benefit across products and business units. Regulation Risk Management Operating model Adjust operating model across risk, actuarial, finance, compliance and audit. Develop processes and systems for additional reporting requirements. Modelling Project management Operating Models Data management Reporting Design reports for key stakeholders (supervisors, analyst, policyholders). Compliance Develop and implement policies and procedures for ORSA test. Enhance existing control environment for increased requirements. Unique mix of content driven expertise areas with experience in project management within financial institutions. Thorough insight in regulatory and risk management developments through continued training and thought leadership. An introduction to Solvency II 6

7 Focus on pillar one: quantitative requirements Solvency II has a focus on risk measures Solvency is also referred to as Basel for insurers. From a risk perspective there are strong similarities in the risk measures used within banks to those within solvency II, especially within market risk measures. Quantitative requirements on assets Solvency Capital Requirements Technical provisions Consist of best estimate value of liabilities + risk margin. Solvency Capital Requirements (SCR) Measure for quantifiable risk of insurer. Corresponds to VaR net assets at 99,5% CL on a 1 year horizon. Minimum Capital Requirements (MCR) Lower level of capital sufficiency than SCR. Threshold for immediate supervisory intervention. Market Risk quantifies the impact from various shocks: Adjustment Solvency Capital Requirements (SCR) BSCR Operational risk In scope of our risk experts Market Health Default Life Nonlife Intang Assets covering technical provisions, the MCR and the SCR Assets MCR RM BE Solvency Capital Requirements (SCR) Minimum Capital Requirements Technical Provisions Interest Rate: Equity: Property: Spread: Currency: Concentration Illiquidity: Interest-rate term structure shock Equity value shocks Real estate value shocks Credit spread shocks FX rate shocks Charge for excess counterparty concentrations 65% fall of illiquidity premium Each shock is calibrated such that it corresponds to the required Value-at- Risk at 99.5% C.L. on a 1-year horizon. Shock scenarios are provided by QIS5 technical specifications (here we refer to version 5 July 2010). An introduction to Solvency II 7

8 Our track record A sample of our experience, covering the entire risk value chain Double Effect is uniquely qualified to solve the challenges insurers face. We know the business, we are content driven, and we are always ready to go the extra mile to exceed our clients expectations. Our experience covers the entire value chain of risk and regulatory driven projects within financial institutions. Track record Our offering Data management Implementation of a golden source system for FX, interest rate and security related instruments for a large Dutch bank. Strategy translation Strategic analysis and operating model definition. Ability to work across the entire value chain. Pricing / modelling Risk Development of a multi-curve pricing tool for interest rate and FX derivatives. Assessment of new regulation on existing risk organisation, reporting, processes, policies. Tailor made solutions Drive best practice from our industry experience. Deliver tailor made solutions to maximise client value. Economic Capital Enhanced an EC model from using regulatory exposures to modelled exposures. Mixed teams We build mixed teams with the client, mobilising the combined experience to get the best solutions. Reporting In the lead of a project for a regulatory capital calculator and reporting tool, which resulted in significantly lower RWA capital. Business results Business case driven and fact based decision making. Project management to deliver business results. An introduction to Solvency II 8

9 Who we are Our core values determine the way we work A financial services specialist with an entrepreneurial spirit. Over 75 consultants based in Amsterdam, Singapore and Frankfurt who all share the same core values. We want to fully understand our client s business in order to add value with our commitment and advice. Client and result driven Quality resulting from intrinsic motivation Understand customer needs. Act in the client s best interest. Be reliable. Be responsible and proactive. Intrinsic drive to excel. Never stop asking. 4 eye principle. Assertive & proactive. Our Core Values Growth through teamwork We instead of I. Coaching on the job. Challenge each other. Open for feedback. Integrity, clarity & authenticity Be transparent and open. Clear and direct communication. Share successes and failures. Embrace diversity. Work hard, play hard together Celebrate successes. Join and initiate events. Accessible and positive. Take care of each other. An introduction to Solvency II 9

10 Want to know more? Please contact one of our Solvency II experts Mark Tuente Practice Lead Insurance Sander ver Loren van Themaat Consultant Risk Mark Barten Consultant Double Effect Hullenbergweg CP Amsterdam The Netherlands Phone Double Effect Singapore Phone Double Effect Germany Phone An introduction to Solvency II 10

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